Banking as a Service- Implications for Community Banks

Part Two- Technology is the Key

 

 

In the first blog in this series, we discussed the overall concept of Banking as a Service (“BaaS”).  A recent Cornerstone Advisors survey of bank executives found that one in 10 banks is in the process of developing a BaaS strategy and another 20% are considering pursuing a BaaS strategy.  This is only likely the beginning!  There are a couple of major factors that are driving the need for BaaS. 

 

First, as we noted in the first blog- cellphones are ubiquitous and as a result mobile banking applications are growing.   In addition to that, the number of unbanked and underbanked households presents an opportunity. There is a huge pool of potential customers for financial institutions.  This pool represents a large source of potential income that is untapped.   The pool we are referring to is the large number of unbanked and underbanked households in the United States. 

 

Who are the Unbanked and Underbanked?

 

The unbanked have no ties to an insured economic institution. Essentially, they have no checking or savings account and no debit or ATM card.   Meanwhile, the underbanked do use some of these services – often a checking account – but they also used alternative financial options within the past year.   This population has been estimated to be as many as 30 million people. Around 20 percent of Americans are underbanked, according to the FDIC, which means they have either a checking or savings account, though rarely both. Households are also usually given the underbanked distinction if they've used alternative financing options during the previous year, such as money orders or rent-to-own services. Around 67 million Americans are underbanked, or the equivalent of 24.5 million households, based on 2019 figures from the most up to date FDIC survey.[1]

 

Just as important as the number of people who are unbanked and underbanked are the reasons that they have limited contact with banks.   The most recent FDIC study on the unbanked and underbanked was published in 2019.  In the study, the main reasons for not having bank accounts included:

 

·         Do not have enough money to keep in an account”.    

·         Don’t trust banks”

·         Bank account fees are too high

·         Bank account fees are unpredictable”

·         Higher proportions of unbanked households that were not at all likely or not very likely to open a bank account in the next 12 months cited “Don’t trust banks” (36.2 and 31.5 percent, respectively) in 2019, compared with unbanked households that were somewhat likely or very likely to open a bank account in the next 12 months (24.7 and 21.0 percent, respectively).[2]

 

When we put this all together there is a huge market opportunity for banking as a service.   This is where the FinTechs and banking comes together.  And the way they do so is through technology; including API’s and BaaS infrastructure that allows for widespread adaptation of the products and services that are being designed and offered.  

 

 

API’s

 

These are software programs called application programming interfaces.  This is a fancy word for patches that allow different forms of data to recognize each other.  In the real world an API is like the adapter that you put on a three-pronged plug to make it fit into two pronged outlets.  

Financial API’s are specifically designed to allow financial data to be shared between entities that naturally would want to share data- for example, your bank account and Turbo Tax. 

 

There are three types of API’s

·          Internal – these generally don’t touch activity that is consumer facing.  They are designed to help the flow of internal information with an organization

·         Partner – these are API’s that connect to distinct businesses-organizations.  These are the API’s that are most often used by banks that want to offer specific products and services

·         Open- These are the applications that allow financial data to third party service providers.  These are the applications that allow a person to be offered direct pay for bills and subscriptions

 

The development of API’s has made it possible for banks to apply technology that was unavailable in the past.  

 

Infrastructure

 

These software platforms allow banks to take full advantage of API’s and to offer new and innovative products and services.  Reasons why infrastructure is necessary include

·         Costs of development

·         Resources and organizations that are not designed for software development

·         Technology that isn’t compatible

 

BaaS infrastructure providers have begun to ramp up their services – these will be needed partners as the industry develops.    We will discuss the aspects of vendor management in a later blog.  

 

 

 

 

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[1] FDIC National Survey of Unbanked and underbanked Households

 

[2] Unbanked versus underbanked: Who they are and how they differ.  Dec, 23, 2017 Waly Wojciechowski