The Big Idea: All About That BaaS
Throughout the year, we’ll be offering a deeper look at some of the biggest trends we see shaping fintech now and in the coming decade. This week, we’re taking a look at the rise of “Banking-as-a-Service” (or “BaaS”), one of the fastest-growing parts of the fintech landscape. As always, if you have any ideas for us, or if there’s anything you’d like to know more about, drop us a note at email@example.com.
First, let’s talk BaaSics.
Judging by the targets for funding and R&D efforts, there’s no hotter trend in fintech these days than Banking-as-a-Service (“BaaS”). Search for BaaS or “embedded fintech” on Google or Twitter, and you’ll get more hits than you know what to do with – most of them offering takes on why it’s “the future of fintech.”
But what exactly is BaaS?
If you’re familiar with the Software-as-a-Service (“SaaS”) business model, we can use that as a starting point. The two are analogous because they give users access to services that would otherwise require significant resources to build or buy. In SaaS, a vendor keeps its software in the cloud and licenses it to clients, who then access it remotely; customers get access to software without having to build it themselves or even download it to their hard drives. In BaaS, a program manager connects multiple customers to an underlying bank partner, allowing those companies to access and offer financial services without having to build a bank or even partner directly with one.
If you’re still unsure about the model, consider an example:
Let’s say you’re a successful ride-sharing startup, Noober. Your drivers love driving for you, but you find that they have a hard time separating personal fuel purchases from business fuel purchases, since they make them all on their personal credit card. You decide Noober should offer business debit cards to your drivers to help them better track their business-related gas purchases. To offer those cards, you’d need to either become a bank or partner with one. Becoming a bank (😱) is a non-starter; but partnering with one is still expensive, time-consuming, and comes with significant compliance burdens. Instead, you choose a BaaS platform, which already has the underlying bank relationship set up and allows you to plug into that relationship with little more than a few lines of code. By signing with the platform, you essentially license banking services for the duration of your contract, without having to go through the hassle of building banking or compliance infrastructure yourself.
Working with a BaaS provider allows customers to embed financial services into their products through APIs rather than brute force, dramatically lowering the time to market, financial costs, and potential regulatory risks of building new infrastructure or partnering directly with a bank. Tech companies can now offer financial products in as little as four weeks for the cost of an annual fee. (Cue the stampede of new challenger banks.)
Cool, now let’s get down to...BaaSness... (🤦♂️)
About a year ago, Andreesen Horowitz’s Angela Strange predicted that “in the not-too-distant future . . . nearly every company will derive a significant portion of its revenue from financial services.” A year later, and it seems that nearly every tech company and venture capital firm is hard at work bringing her insight to fruition. BaaS has become one of the frothiest spaces in fintech, attracting new entrants, encouraging incumbents to develop new services or form new partnerships, and driving all kinds of new funding to the sector.
Here’s a smattering of the examples we’ve seen in only the last six months:
Bond raised $32 million in Series A funding in July.
Weavr raised $4 million in seed funding last month.
Unit publicly launched two weeks ago, concurrently announcing $15 million in Series A funding.
Modern Treasury launched a self-service portal to launch banking products immediately.
Stripe expanded into the BaaS market this month, launching Stripe Treasury atop Evolve and Goldman Sachs.
Goldman itself launched Goldman Sachs Developer, a suite of APIs allowing clients to embed financial services into their products.
Add all of the above to the continued presence of and innovations by market leaders Synapse and Galileo, and you've got a competitive market where a variety of different companies are battling for market share.
So, are you all about that BaaS?
The frequency and size of recent news stories in the BaaS space suggest that the market is rapidly maturing and primed for increasing importance in the coming years. (If nothing else, the entry of a company as large and highly regarded as Stripe into the market is a highly significant data point, suggesting the market is legit.) We see this affecting market players in three ways:
Tech firms: As it becomes easier to access banking services through API platforms, we think there will be an explosion in tech firms focusing on specific, niche audiences rather than offering a specific product or service to a broad audience. Until now, fintech has been all about disrupting traditional services, like Lending Club did with loans or PayPal did with payments. Going forward, we think the focus increasingly will be on offering bespoke financial services to a target market. One example is a company like Barn2Door, a fintech aimed at helping farmers make direct-to-consumer sales, which is now capitalizing on its customer base to expand its product mix to include banking products designed especially for farmers. As BaaS becomes more prevalent, product specialization will become more attractive and attainable.
Bank partners: Right now, dozens of small and medium-sized banks around the country are working directly with tech firms to offer financial services. These “partner banks,” some of which serve dozens of tech customers, have become well known for their work in the fintech market. But regardless of their stature, they are limited – whether by their risk appetites, the size of their balance sheet, the size of their compliance team, or some combination of these factors. BaaS platforms allow banks to supercharge themselves by leveraging their existing infrastructure to oversee and support more customers for a fraction of the effort. We expect some banks to move more quickly and successfully than others; and over time, these banks will become recognized as the most trusted fintech partners in the industry. Rather than 100 bank partners serving four tech firms each, BaaS will create a market in which 10 serve 40 each.
Program managers: Similarly, the competition among program managers will continue to heat up, followed by a wave of consolidation. As we’ve said, the market is frothy at the moment, with about a dozen existing (e.g., Synapse, Galileo, Modern Treasury) and new (e.g., Unit, Bond, Moov) players vying for market share and VC dollars. Over time, we’ll be looking for a handful of these firms to rise above the fray to become the industry standards, others to fold, and some to be acquired – either by banks seeking their own, dedicated platform or by non-bank financial institutions seeking to expand their product mix to include banking products.
Zooming out, we’re fully on board with the growing industry consensus (whether commentators, founders, or the VCs investing in them) about BaaS being a key to the future of fintech. For the past five(!) years at TFU, we’ve been writing about fintech across a set of different verticals – payments, lending, credit, etc. – that are nonetheless in the same box. But in the next five years, we think the borders of the box will dissolve as financial services become more deeply integrated into every company’s product stack. To put it another way, we see fintech becoming a key building block in all business models rather than a model in itself. And in a growing market with lots of cash at stake, competition is going to get fierce. We’ll be watching closely.