The revenue potential of banking-as-a-service, in 4 charts
- Many banks are undergoing digital transformation, but struggle to monetize their new infrastructure.
- One of the ways banks could leverage their new digital payments infrastructure is through adopting a banking-as-a-service strategy, which can unlock new revenue streams.
As banks and credit unions face revenue recession challenges generated by decreasing non-interest income, new digital transformation initiatives could unlock other revenue streams such as those in Banking-as-a-Service solutions.
Banking-as-a-Service (BaaS) represents a partnership between a financial institution and another company, enabling the latter to offer banking services to its customers by leveraging the BaaS provider’s financial services capabilities such as account management, fraud, compliance, as well as payments and lending.
“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,” according to Oliver Wyman.
Given the fast entry and growing market share of fintechs in financial services, banks are experiencing displacement in payments volume and interchange revenue from mobile payments, merchant mobile apps, BNPL and cryptocurrencies, according to a report by Cornerstone Advisors.
To meet these challenges, mid-size financial institutions have launched digital transformation initiatives, but results have been mixed, and few have produced gains in payments-related revenue. Only 9% of financial institutions reported an increase of more than 5% in payments-related revenue, non-interest income, or products per customer resulting from their digital transformation efforts, the study showed.
Nevertheless, a modernized payments infrastructure could unlock a new revenue stream, as it represents a core building block of a BaaS solution offering.
Fintechs in particular are looking for partner banks that can support bank transfer payments, especially account-to-account payments which are gaining momentum. There is also interest in subscription payments, Ecommerce payments, bill and loan payments, and more.
“A core system replacement may not be in the cards for every institution – at least, not right now. But it is definitely time to make a strategic decision and move forward with a payments modernization plan,” the research said.
Many banks are showing interest in BaaS - according to Cornerstone, 38% of banks either have a BaaS strategy in place or are considering pursuing one.
This strong interest in BaaS is generated by attractive growth and return prospects, in addition to new revenue sources.
As shown in the chart below, the returns on assets and equity for banks pursuing a BaaS strategy exceed the industry averages for all banks. According to VC firm Andreessen Horowitz, banks that were early entrants in this space are reporting ROEs that are 2x or 3x above the market.
In order to visualize the income potential from BaaS, Cornerstone created a revenue breakdown model in consumer lines.
A partnership between a company with one million consumer accounts, growing at 2% per month, and a BaaS platform provider would result in roughly $17.2 million in annual noninterest income from providing consumer-related BaaS.
According to the model, interchange fees represent nearly 40% of the total revenue potential. Besides interchange and card processing fees, which together make up around half of revenues, there are also attractive margins at ledger and ACH fees.
Doing a similar exercise in commercial lines shows a different breakdown. With a starting point of 300,000 commercial accounts supported, growing at 2% a month, a BaaS provider could generate nearly $24 million in annual revenue. This is due to higher revenue per unit for interchange and ACH transactions, and a higher average transaction value of purchases, explained Cornerstone.
This breakdown showed that BaaS-related revenues come from many different sources, besides interchange and card processing fees that many banks currently focus on.
And this market is only set to grow in the future. Cornerstone estimated that the BaaS market could surpass $25 billion in annual revenue in 2026 – potentially offsetting the revenue loss from overdraft fees that the industry will be facing.
“A change in mindset could transform the way banks make money. Instead of competing on digitisation and UX, banks could play the role of enabling new market entrants. To not just survive but thrive, they must find their place in the future of financial services,” said 11:FS.