Financial news

Banking-as-a-service (BaaS) has been a transformative force, simultaneously heralded as a driver of innovation and critiqued for potential overreach. As some BaaS entities navigate the fine line between progress and opportunism, looming regulatory challenges add layers of complexity.

With a keen entrepreneurial eye and a history in the fintech sector, Michael Galvin, CCO and co-founder at SaaS global financial platform Toqio, unpacks these nuances. 

Regulation changes leading to the rise of banking-as-a-service providers rapidly changed the financial landscape throughout the last decade. We saw a surge of challenger banks, neobanks, and embedded finance providers seeking to bring about positive change to the financial service market. Recently, however, the tides have turned. Though BaaS started off as a great driver of innovation it’s also responsible for fintech’s biggest black eyes.

Many of the companies built on the back of BaaS providers that we once hailed as early stage innovators ushering in a new era of financial democratisation, have, in hindsight, begun to resemble a group of opportunists jumping on a bandwagon.

The innovations they supported (such as crypto) and the regulations that allowed them to thrive may now be the source of their downfall. To say BaaS is at an inflection point is an understatement. I don’t think the BaaS infrastructure paradigm is going to disappear but it is going to change. Drastically.

Funding for new fintech ventures has dried up. Regulators are cracking down and they are making it clear that they don’t want unqualified companies operating in their sector. They are obviously intent on slowing down the market. The big unknown is where the BaaS market will go from here. Will it be business as usual with fewer players? Will incumbents seize the opportunity to squeeze out challengers? Is fintech innovation set to be outshined by all the new AI hype?

Revolutionary shift

According to a recent report The State of Banking-as-a-Service in the UK & Europe report by WhiteSight, commissioned by Toqio, the potential opportunities for BaaS in Europe could lead to a revolutionary shift in the financial service industry. Changes have already begun and are gaining momentum, indicating a rapid evolution of BaaS and BaaS-powered business models.

The report states BaaS unlocks two significant market opportunities in the financial industry: embedded finance and fintechs. The first pertains to the growing integration of embedding financial services into the customer journeys of non-financial companies with large customer bases, such as those in the retail and e-commerce industries. The second centres on niche-focussed fintechs emerging that offer targeted financial products for specific customer segments through technology and business model innovations.

A substantial rise of BaaS across Europe is already clear. While a few major players currently dominate the European BaaS market in terms of market share, mid-sized to large incumbent banks are gradually expanding their market presence by forging alliances with technology providers to offer new propositions.

The BaaS landscape in Europe and the UK is also evolving rapidly. The presence of a mix of players, regulations, and a thriving financial ecosystem have acted as key drivers. The market has been racing forward for the last three years, with a few of the early-stage fintechs growing their presence outside of Europe and the UK, followed by regional players popping up and going after local markets. Now, we’re seeing a re-trenching of this expansion with funding getting tighter and banks entering the market with their own BaaS or open banking solutions.

Growth drivers

One of the main use cases for BaaS has always been to enable early stage innovation. Yet, it seems that with fewer early stage businesses set to participate in the market over the next couple of years, new use cases are needed to drive growth.

As mature businesses, specifically those outside of financial services, look to take advantage of BaaS, we anticipate this will drive a shift in player make-up. Hence, we expect to see the market consolidate around maturity. We’re probably going to see smaller, regional players get acquired or fail outright. It’s also clear that incumbent banks will have a major role to play if they can shift their mentalities.

With new regulatory challenges, larger banks will be able to leverage their balance sheets and compliance infrastructure to provide a safe haven for bigger market participants.

BaaS isn’t going anywhere. Rather than be used merely as a neobank pipeline, however, the true power of BaaS is going to emerge as it inevitably evolves into embedded finance. We’re going to see a myriad of new use cases and innovative implementations of financial services by everyone over the next few years, from manufacturers to FMCG retailers to distribution firms.