‘Why would anyone want to become a bank’: Will more challenger banks evolve as banking as a service providers?

Starling Bank recently raised £75 million to fund a European expansion. As part of that announcement, the UK-based challenger said it had signed on three new clients to its banking as a service.

According to Starling, it has 20 institutional clients on its BaaS platform, which it launched in August 2018. Payment volume through the service is doubling month over month.

Challenger bank turns into a platform

With its banking as a service, Starling enables other companies to offer banking services without the headache of running a bank. Banking as a service exposes all the technology Starling built for its own retail offering and makes it available to other companies to embed in their apps and software.

Starling created a standard set of APIs so partners can get up and running quickly. Startups, in particular, can use banking as a service to expand into financial services for their users.

"How you consume the APIs is very important," said Julian Sawyer, Starling Bank's chief operating officer. "If you are a big company or startup, you'll get the same service from us. We hope, through our services, that startups become the next big unicorns."

Starling's first client was Raisin. The savings marketplace required a current account to hold client money before it was invested. But the firm didn't want to become a bank. In this model, Raisin captures all customer information while Starling performs AML and KYC requirements. Through an API, the banking as a service delivers an interest-bearing account and access to payment functionality to Raisin customers.

Outsourcing the bank, insourcing the functionality

With BaaS, partners don't have to obtain the appropriate licenses or struggle with the burden of running a regulatory organization -- a huge hurdle to get over in order to enable financial services. Instead, they rely on Starling for technology and oversight.

"Why would anyone want to become an emoney institution?" said Sawyer.

"120 years ago, a factory owner needed a generator and had to pay people to feed coal to produce electricity. Power generation was part of a core value exchange. With modern electricity, I wouldn’t think about running a furnace. With banking as a service, you just plug into payments infrastructure. Starling is better at running payments and banking infrastructure than you are."

It's unclear whether other challengers will follow Starling's path and offer BaaS solutions. Revolut, Chime, and Monzo didn't respond to Tearsheet's request for comments to this story.

Some challengers, like N26, have built platforms to ingest other firms' technology to offer to their own customers. In this way, they become like marketplaces for top fintech firms to reach retail banking customers. For example, N26 integrates Transferwise to its banking app, so customers can use the popular money transfer service to convert foreign currencies.

"We always want to give our customers the best product offerings and services available, and we do this either by building a solution in-house or partnering with other fintechs," said Nicolas Kopp, US CEO of N26. "Our partnership with Transferwise for international money transfers is one example of a successful integration."

Challenger banks like Starling see themselves more as technology companies than banks. Their technology was deliberately built with scale in mind which enables partners to grow with them. This is a far cry from the days when financial services companies developed technology solutions in their IT departments.

"Google, Amazon, Facebook and Apple already control data which can predict how a consumer will spend their money without the financial data required in the past," said Eric Solis, CEO and founder of MovoCash.

"With this power, coupled with open banking where banks are slowly being forced to make available their APIs to these giant tech companies, banks' long standing moat is quickly eroding."

The slowly evolving ecosystem

As more firms enter the banking as a service market, the ecosystem of vendors and buyers is also shifting. Instead of relying upon a handful of big providers, there are more options now. Banking software vendors like Fiserv, FIS, and Jack Henry typically had a symbiotic relationship with their clients, supporting each other's growth.

But over time, this created massive technology platforms that are complex and difficult to change. "While vendors may sell a product as nimble and agile, in reality there’s a huge foundation supporting that technology," said Paul Thomas, managing director at Provenir.

"You can almost compare it to an iceberg: what you’re sold is the visible tip of the product, and what you end up getting is a huge behemoth of a solution that takes an incredible amount of effort to maneuver."

Challenger banks still face an uphill and expensive marketing challenge acquiring and servicing new clients. Also, regulations, like capital requirements, are onerous for small banks. This may be pushing banks like Starling to explore different business models.

"For some challengers, the temptation may be to capitalize on their distinct advantages by partnering with or selling services to traditional players," said Ruth Foxe-Blader, managing director at Anthemis. "Essentially, the business model shifts from direct to consumer to business to business."

The move to distributed financial services enabled by banking as a service is growing. For some basic banking tasks, like moving and managing money, people are changing their consumption habits. Walmart customers have their paychecks deposited, spend money and earn rewards off their Walmart MoneyCard, using it like they would a bank. Walmart didn't create a bank to offer this service. MoneyCard is powered by Green Dot's banking as a service.

"Banking services will increasingly be integrated with business operations processes and personal financial management tools to provide decision support and execute banking functions in a real-time or near real-time fashion," said Frank Sanchez, co-founder and CEO of Finxact.

"The inherent friction, delay and risk associated with exchange of value and settling transactions will be dramatically reduced and minimized. Commerce is becoming more efficient."