Before the global penetration of the internet in the financial world, banks were largely focused on credit facilitation and being a safe keeper of private deposits. With the internet bringing the world closer, digitalization became the new buzzword in the banking sector in the first decade of the 21st century. It was an obvious and swift realization for the sector that without digitalization, the cost of globalisation would be too high with conventional brick-and-mortar and paper filing systems.
In the quest to expand the markets and embrace newer technologies for efficient operations, banks started incorporating IT companies. The IT companies, while assisting in the incorporation of the core banking operations faced several regulatory restrictions, which hindered the overall onboarding process. As soon as the IT companies procured the licenses to carry out the financial transactions, it led to the birth of several fintech companies. Thus, Banking as a Service (BaaS) came into practice. In BaaS, a licensed institution like a bank provides access to its financial system to a non-banking entity like an IT company for banking and financing-related activities. In other words, it is an end-to-end approach for third-party companies to collaborate with banks through APIs (Application Programming Interface) and deliver financial services.
Plugging IT in Core Banking
The idea of BaaS arose from the need for breaking down the banking process and automating them or offloading or outsourcing them to reliable third-party ventures. Today BaaS service providers are mainly plug-and-play software. This way, several startups that provide services in insurance, retail, securities and international transactions could come together to form a bank. Taking a glimpse into the future, Japan already has a fully operational bank that has no branches, is completely digital and has roughly around 100-150 employees.
One of the prime reasons for non-commitment to digital technologies in the banking system has been the lack of a strong redundant security system for the data. However, due to rampant innovations by several fintech companies, BaaS has become the most trending platform for banks and financial institutions. It also opened a whole new opportunity for non-financial institutions to play a role in the global financial industry.
The need for a robust and dependable IT infrastructure led to the advent of several IT major brands becoming the preferred partners for some of the biggest banks in the world. BaaS became the preferred choice for online payments especially on non-banking platforms. Today, BaaS is seen as the go-to option for personal loans, payment processes, wealth management, credit and debit card onboarding processes, updation and monitoring of regulatory compliances about taxation and more.
Banking on the Next Fintech Disruption
As per reports, the BaaS solutions will provide around USD 5 trillion opportunities to e-commerce companies and other retailers. This comes to 70 per cent of growth in the next 3 years for the adoption of BaaS solutions. There are other reports that estimate that the BaaS market could reach USD 5.32 billion in 2024. With a CAGR of 26.60 percent, it is expected to reach USD 14.72 billion.
The benefits of BaaS for the non-banking finance corporation are quite evident from above. However, banks are currently investing heavily in BaaS platforms, mainly as a customer retention strategy. Through BaaS, a bank’s customer could explore several payment options making it a smooth online experience for shopping or bill payments. The biggest benefit, however, has been the third-party applications where a third-party company incorporates the Application Programming Interface (API) services for the traditional banks and BaaS providers for their financial products and services. The third-party benefactors incorporate BaaS as a software layer in their operations. NBFC, Fintech startups and other financial companies customize the BaaS layer platforms for a smooth user interface. Furthermore, tech companies with banking licenses are turning their BaaS layer platforms into BaaP (Banking as a Platform). This way the IT company with a strong IT infrastructure and a valid banking license are providing a plug and play style services for the banking needs of any commercial entity. For a retailer in, let’s say, the FMCG sector, this reduces the payment complexities and leverages credit, savings management, investments, user data storage and management and more without the involvement of the banks.
We spoke to Jeremy Mah, the CEO and Founder of NeuXP, a Malaysia-based financial app that provides a complete and highly integrated financial and lifestyle services ecosystem that complements the lifestyle needs of its users beyond borders. According to him, “Most of the businesses, especially the traditional ones, still have their IT infrastructure deployed on-premise while the newer ones especially startups are having their infrastructure over the cloud.”
As per a market study, the market for BaaS providers is set to grow by over 50 percent per year in the upcoming five years. SME and corporate banking activities are going to be the major sectors for BaaS. Currently, governments across the globe are transforming their regulations on banking from macro-level to micro-level processing. The biggest challenge to digital transformation in almost all sectors has been accountability and modern financial entities are seeking accountability at a nano level. This has made the entire compliance protocol even more complex. Even though blockchain seems to showcase a significant promise it is still at a nascent stage. The whole idea of decentralisation does not seem to be finding much admiration among the bureaucracy.
The main challenge to the harmonious relationship between a bank and an IT company is the difference of interest. While banks are concerned about adhering to compliances and registering profits in the books, the fintechs concentrate widely on delivering the best customer experience. This explains why more and more banks are investing heavily in their IT infrastructure. Subsequently, many IT ventures are also seeking banking licenses of their own. The moral – banks are developing their own BaaS and BaaS providers are establishing their banking operations.
Blog by Ujal Nair
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