When I walked into a popular retailer to do some last-minute Christmas shopping, the first thing I saw was a stand to pay for all your items. But this wasn’t the checkout area – the stand offered a branded retailer credit card with a sign-on bonus and points for purchases. This stand was the hallmark of an increasingly popular trend – banking as a service (BaaS). Banking as a service is a strategy where non-bank businesses offer financial services to their customers using a financial institution or fintech partner. This growing trend is commonly being used by businesses to reduce customer friction, including sticker shock, and to make each relationship more valuable by increasing the number of services provided and deepening the customer relationship. But who are the winners and losers of this growing trend?
said they would use point of sale (POS) financing over the next six to 12 months
* Source: McKinsey & Company
Like most other questions, it depends. Banking as a service isn’t new or uncharted territory. In fact, many customers are willing participants in the practice, buying items through their Macy’s card or ordering their everyday coffee through their Dunkin’ mobile app. It provides convenience and creates a way for your customers to engage with your company more frequently than if they were to pay with cash or a banking product. In addition, per McKinsey & Company, 60% of consumers said they would use point of sale (POS) financing over the next six to 12 months, which includes the hard-to-ignore popularity of buy now, pay later options. Fintech companies in this space have been gaining market share, including new public companies like Affirm.
Banking as a service presents major opportunities for financial technology companies looking to either provide financial services to consumers and businesses or develop software that allows other businesses to begin offering these additional services to their customers. With the introduction of this technology, fintech companies can streamline the loan origination process and make the unprofitable, profitable. POS and other loans provided by non-bank lenders are often smaller, and the time spent originating didn’t make this activity an enticing or profitable business decision for companies to pursue. The introduction of financial technology has enabled businesses to introduce this additional service to improve the customer experience and increase revenue.
Fintech companies thrive at developing technology that can enhance or streamline financial services products. What they don’t want to do is also run a financial institution, including addressing all the regulatory requirements that come with it. This is where choosing a BaaS partner is key, as fintechs offering financial products are nowhere without their banking partners. From leveraging the financial institution’s charter to be able to accept deposits, to gaining access to a core processer to track customer activity, and even taking loans and deposits off the fintech’s balance sheet, banking partners are essential to the operations of early stage fintech companies.
Fintech companies must make efforts to understand the advanced scrutiny they’ll face when working with a financial institution, lest they encounter pitfalls. Financial institutions will continue to be held to strict compliance, information technology, credit, operational, and other requirements, which will extend to the fintech partner. Not addressing regulatory requirements may result in lost customers or increased regulatory burden.
For financial institutions that ignore the space entirely, this will likely result in a lost opportunity against mounting competition. Customers that may have historically gone to their hometown bank for a credit card, line of credit, or personal loan, have begun obtaining this new type of direct financing through retailers, consequently reducing demand for these higher-yielding bank products. In addition to lost revenue, banks are also missing out on an opportunity to attract young new customers.
The right banking partner can also provide valuable capital or other financial incentives to attract new customers to the financial institution. Many growing fintech companies are open to taking capital to expand operations, and the right BaaS partner could be interested in the opportunity to have ownership in a promising fintech company. Being that back-end banking partner also offers a great way to monitor the performance of the company.
Fintech companies will open themselves to regulatory scrutiny as they begin to offer financial services to consumers and businesses. Financial institutions are well-versed in compliance and overall security concerns to help fintech companies address the complicated regulatory landscape.
If your fintech is looking for assistance with regulatory, tax, cyber, or financial matters, Wolf & Company can help. Visit our website to learn more.