Embedded Finance Is Fueling A $25 Billion ‘Banking As A Service’ (BaaS) Opportunity

A billboard advertisement for Apple credit card. Photographer: David Paul Morris/Bloomberg

OBSERVATIONS FROM THE FINTECH SNARK TANK

Ask five people in banking what “banking as a service” (BaaS) is, and you’re likely to get five different answers—which is not as bad as if they all replied “huh?”

A new report from Cornerstone Advisors, commissioned by Synctera, defines banking as a service and forecasts the future revenue opportunity for banks to realize from this growing trend.

What is Banking as as Service?

Cornerstone defines banking as a service is:

“A strategy where a financial institution partners with a fintech or other non-financial institution brand to provide financial services to the partner’s customer base, leveraging the institution’s charter and capabilities like account management, compliance, fraud management, payment, and/or lending services.”

For all the discussion and confusion surrounding the concept, BaaS really comes down to being a distribution channel play. According to consultancy Oliver Wyman:

“For a financial institution, BaaS is an opportunity to reach a greater number of customers at a lower cost. For the distributor, offering financial products opens up new revenue lines at attractive margins and can deepen its relationships with customers, and can then capitalize on cross-selling opportunities.”

Embedded Finance is Driving Banking as a Service

The rise of interest in banking as a service is the result of the growing embedded finance trend. There are different views of what embedded finance is. My definition:

“The integration of financial services into non-financial websites, mobile apps, and business processes.”

A good example of this is the debit card Lyft offers its drivers. Product features like a strong rewards program and instant payments are coupled with customer experience improvements like seamless account opening and integration into Lyft’s driver app provides a compelling offer for Lyft drivers.

Banking as a Service at Lyft

Source: Lyft

Behind Lyft’s debit card offering is a bank that: 1) provides the debit card, 2) manages the movement of money in and out of the accounts, and 3) handles the regulatory compliance requirements for providing the product.

Across a range of financial services—including payments, lending, and insurance—embedded finance will generate $230 billion in revenue by 2025, a 10x increase from $22.5 billion in 2020.

Embedded finance forecast

Source: Lightyear Capital

Banking as a Service: A $25 Billion Opportunity for Banks

Cornerstone’s survey of financial institutions found that 11% of banks already have a BaaS strategy, 8% are in the process of developing one, and 20% are considering it.

Banking as a Service adoption

Source: Cornerstone Advisors

Why the interest? Growth opportunities. On average, banks that currently offer BaaS have six partners and support nearly 1.3 million accountholders.

Overall, a sponsor bank supporting one million consumer accounts and 300,000 commercial accounts could generate more than $40 million in revenue annually—roughly $15 per consumer account and $71 per commercial account.

Industry-wide, Cornerstone estimates that the BaaS market could grow to more than $25 billion in annual revenue in 2026. This would go a long way to replacing the inevitable loss of overdraft fees the banking industry will face over the next five years.

Banking as a Service revenue forecast, 2021-2026

Source: Cornerstone Advisors

The Rise of BaaS Platform Providers

A bank could develop a BaaS platform itself from scratch, and most of the early entrants in the space did just that because alternatives didn’t exist at the time.

For most banks entering the BaaS space today or in the near future, however, this won’t be a viable option because of the time and cost requirements. In fact, even the early entrants are finding that the technical and operational challenges are daunting.

This is giving rise to banking as a service platform providers that productize services like payments, lending fraud management, compliance, and account management that are typically buried in banks’ core systems.

The time and cost advantages of going the platform provider route are significant for fintechs, as well.

According to BaaS platform provider Unit, working directly with a bank typically requires 15 to 18 months and roughly $2 million to launch, with ongoing annual costs of about $2.5 million. Working with BaaS platform providers can help fintechs reduce implementation time to less than two months and initial costs to $50,000, with ongoing annual expenses around $50,000, as well.

What Makes Embedded Finance and BaaS So Important?

Vertical integration isn’t a new concept. But, historically, companies integrated elements of the supply chain from within their industry.

What’s important about embedded finance is that the digitization of banking has enabled banking to be integrated into other industries.

That’s what embedded finance is. It’s the “embedding” of banking software into a non-banking company’s operations. And that is new. And what makes this even more interesting is that it benefits both the non-financial institution and financial institutions.

To download a copy of the report Banking as a Service: Banks’ $25 Billion Opportunity in Fintech Banking, click here.

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