How to run a BaaS relationship, a guide for fintechs and banks
- The biggest problem in the current intermediary-reliant BaaS set up is that it makes it very hard to isolate who is responsible for what, and in so doing, complicates risk mitigation strategies.
- These relationships have now come home to roost and are forcing sponsor banks as well as fintechs to build partnerships that are clearer and more stable from the outset.
2024 has been a really tough year for BaaS players, and it’s reorganizing how the industry has structured itself over the years. Thanks to an increased amount of regulatory activity, as well as some very public instances of BaaS relationships failing and putting customers’ funds at risk, the bank-fintech partnership landscape has gotten a lot more complicated than it was just a handful of years ago.
The biggest problem in the current intermediary-reliant BaaS set up is that it makes it very hard to isolate who is responsible for what, and in so doing, complicates risk mitigation strategies.
“When you look at partner banks, the risk relationship kind of breaks down,” said Konrad Alt, co-founder of Klaros Group, which advises banks and fintechs on compliance and risk.
These relationships have now come home to roost and are forcing sponsor banks as well as fintechs to build partnerships that are clearer and more stable from the outset. 61% of banks are now contracting fintechs directly, according to new data.
“The banking industry wasn’t ready to have that direct relationship yet,” says Sara Seguin, Fraud and Identity Advisor at Alloy on why this shift away from BaaS intermediaries is happening right now.
Seguin, who also has experience working at KeyBank as its Head of Enterprise Fraud Strategy & Business Intelligence, has a unique insight into the troubles and obstacles banks face when partnering for BaaS.
The trials of partnership
The biggest challenge, according to Seguin, is establishing who is going to own what piece in the partnership and then managing the oversight of this process. “From a bank perspective, not all of those programs have been fully built out, or maybe they don’t have the technology in place to not only have that oversight, but then also have control,” she says.
This can significantly complicate matters for the fintech, which is often looking to the partner bank to handle the compliance angle, says Seguin.
How to run and enter a BaaS partnership
To ensure a partnership is successful both fintechs and banks need to make sure that going in, they are taking a measured approach and asking the right questions.
The fintech PoV
For 24% of fintechs, scalability of sponsor bank’s services to accommodate fintech growth is a top priority when looking for a bank to partner with. This sheds light on the fact that fintechs and banks are inherently different. While fintechs want to grow fast, banks typically move more slowly and check all the risk and compliance angles first.
This mismatch in priorities is why some bank-fintech partnerships go sour. Seguin adds that recently, mitigating risk and delivering services has been decoupled but the secret to a successful partnership may lie in how the partners marry those two areas together.
In this vein, fintechs should investigate how the partner bank and potential relationship with that firm will balance these two areas together:
“I think a really good question is, how can you have the growth and deliver those experiences while ensuring that, from a risk standpoint, it does not become a barrier. How can that sponsor bank meet the unique need of the product that the fintech will deliver and ensure that there is risk mitigation in place?” she said.
To judge a sponsor bank’s ability to support its fintech partners, Seguin suggests the fintech can ask a few questions:
- How robust is the bank’s partnership program?
- Does the bank have oversight and if yes what does that oversight entail?
- Does the oversight come with any guidance and controls?
- Is the partnership just relying on the fintech to perform and who wrote the oversight policies?
The bank PoV
For the bank, compliance reigns supreme but despite this, 75% of sponsor banks have lost $100,000 or more in compliance violations, according to Alloy’s data. Banks feel that a lack of control over their fintech partners’ compliance policies and a lack of auditability are the biggest hurdles to ensuring they aren’t bleeding money in compliance violations.
Moreover, this business of managing fintech partners gets further complicated when the bank is running multiple partnerships. Currently, most partner banks report being involved in 6 to 10 embedded finance partnerships at a time.
For this, banks need to follow a clear strategy which involves being proactive and vigilant about the evolving state of regulation and also emphasizing transparency and clarity within the partnership contract:
Define ownership: It sounds like stating the obvious but recent debacles like Synapse in the BaaS space show that when products and services get complicated, it becomes harder to identify who owns what piece of the service/product delivery pipeline. Defining responsibilities and roles is of utmost importance in a successful partnership, according to Seguin.
Oversight is not enough: Given that compliance is costing banks money, and they dont feel in control of their fintech partners’ policies, banks have now been making a shift towards a more involved partnership strategy. 96% of banks now want at least a moderate level of control over the compliance program of their fintech partners.
Watch the regulators: Sponsor banks and even traditional banks that are moving into the embedded finance space need to keep a close eye on the signals that regulators are giving around BaaS, according to Seguin. This means that banks need to be actively involved in conversations around the changes in compliance requirements and reevaluate their programs according to the changing shape of BaaS regulations.
“What we typically see is that the regulators start to point to the path they may go down through examinations. Banks should also focus on communication and talking across the industry to one another, to understand what others are experiencing,” she said.
Get the tech right: An important part of ensuring the success of a BaaS program is crafting a bespoke experience for each fintech you have partnered with. This is difficult and it involves the bank having to revisit its compliance and risk mitigation strategies to ensure they fit the fintech’s product.
“Maybe the fintech wants to use document verification as part of their onboarding flow. But another fintech, may not use document verification and it may not be appropriate for them, and so the sponsor bank has the responsibility to support, provide the guidance, as well as provide the ability to help the fintech scale in different ways,” she said.
This process can be made easier by technology solutions that focus on helping sponsor banks manage multiple partnerships and compliance risk. This is also an area that is going to see significant investment in the future as regulations around BaaS solidify and so does the importance of embedded finance, according to Seguin.
Sidebar: How to partner effectively
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