Beyond Features: What makes or breaks your BaaS partnership
- Technology, the bank partnership, and economics are all critical to a successful BaaS partnership but are often overlooked in favor of product and marketing.
- Prioritize scale by thinking long term. The least expensive or simplest option may haunt you later.
By Ahon Sarkar, VP Product & Strategy, Q2
Certain flashy elements of banking as a service (BaaS) get all the attention, but product and marketing can only take you so far — the nuts and bolts of BaaS are what help you become a successful program. We’ve identified three key areas that often get overlooked but are critical to setting up banking services that allow you to scale.
Area #1: The Technology
If you’re a fintech shopping for a platform to help you launch banking products, the first question you’ll want to ask is what the platform’s core setup is. If they mention “middleware,” run the other way. Middleware is an additional layer of technology that operates by communicating with the legacy core running at most banks. All information flowing into and out of the core must pass through this middleware, which creates two major problems:
- Points of failure – Every time you add an additional layer of technology, you create more opportunity for malfunction. The middleware layer and the core are operating separately, and when one layer — such as the legacy core — updates, the middleware must accommodate the changes. If it doesn’t, incompatibilities can result — incompatibilities that can lead to service outages or incorrect financial data for your users.
- Lack of instant updates – The other problem with legacy cores is they can only handle batched updates, and only a few batches per day. But transactions don’t take place in batches. They’re happening constantly, one at a time. That means the middleware has to make interim decisions that only become final after the next batch request to the legacy core, which makes the final decision. And these interim decisions can be wrong. For example, an incorrect KYC approval could be made that will later need to be rolled back. Another problem with batch updates is they limit a fintech’s ability to display accurate, real-time information about a user’s funds.
What’s better than middleware? Some companies have done away with middleware and legacy cores and replaced them with a proprietary, flexible, cloud-based core. These new cores avoid the problems listed above, providing instant core updates and fewer points of failure compared to middleware systems.
Area #2: The Bank Partner
The heart of any BaaS system is the partnership between the fintech and the bank. The fintech handles the UI/UX and customer service, and the bank provides regulatory guidance, assists with compliance and fraud prevention, and provides FDIC insurance. Unfortunately, problems can arise as the fintech scales. For instance, the deposit needs of the fintech can outpace the bank’s capacity. Or the bank can be slower to implement new features that the fintech would like to add.
Fortunately, it’s possible to avoid most problems between fintech and bank by getting the partnership right from the start. That’s where your platform provider comes in. First of all, they should have multiple banks that they work with to set up BaaS partnerships, where each specializes in a different type of BaaS arrangement, so the chance of finding a good fit is very high. Second, there should be a stringent selection process, considering factors such as:
- Strategic mission of the fintech
- Desired product features
- Economic needs of the product
- Levels of risk
- Specialties of the bank
This match-making process and a successful partnership will allow the fintech and the bank to both do what they’re good at: fintechs create great products, and banks handle backend financial complexities. But what if the partnership still doesn’t work out? Although this is a rare situation and one that isn’t easy to manage, having multiple banks available makes it possible to switch bank partners.
What if I want to bring my own bank along?
If you want to bring your own bank into the BaaS arrangement, you’ll face a number of disadvantages.
First, you’ll have to spend months integrating a new tech provider at that bank before you can start to build products. You’ll also have to find a tech partner who’s willing to work with both you and your bank. The bank will need to figure out if it can offer the products you want to offer, and when you want to grow, you’ll have to spend time convincing the tech partner and bank to support your growth. And that’s all after the bank undergoes a massive transition to be able to support fintech partnerships in the first place, which requires new staffing considerations, regulatory and compliance set up, and a lot more.
Learning the ropes comes with hard lessons for the bank that can dramatically impact your customer experience, operations, and product growth. Rather than hitch the success of your product to a first-time bank, it’s far better to sign on with a bank who “gets it” and is able to accommodate your growth and product requirements from the start.
Area #3: The Economics
A sticky yet important subject, the economics of your deal are vital to ensuring you remain a viable company through every stage of growth. There are two core tenets to follow when you’re considering an economic arrangement with a BaaS platform:
1. Seek out flexible deals
Being able to tweak various aspects of your agreement will give you the right economic arrangement for your business. For example, if savings accounts are your priority, you might prioritize getting the highest rate over other variables, whereas large scale customers might be more focused on transactional revenue or per-unit economics. If the platform you’re considering has rigid terms or a one-size-fits-all structure, we advise you to seek out a platform who offers more flexibility. It might seem more complex, but you want an agreement that adds value as you grow.
2. Hang on to your revenue
You’ll often see deals that involve appealingly low monthly fees, or that offer you a prepackaged product deal, but the downside of these arrangements is they tend to involve significant revenue loss. Some companies will keep up to 80% of your interchange revenue just to put a card product together for you. While this might sound appealing when you’re a young company who doesn’t have a lot of revenue, or a larger company trying to get to market quickly, it will come back to haunt you as you grow. Our advice is to bet on yourself and keep a greater share of your revenue so you don’t have to switch platforms later.
3. Think about different sources of revenue
You can make money through a variety of sources, not all of which are directly connected to the numbers in your contract. Think about revenue that’s catalyzed through your banking product, and before you cut a deal with a partner, make sure they’re interoperable with the other revenue-generating parts of your business, such as rewards or investing.
The bottom line is, while the BaaS industry has matured significantly in the last few years, there are still a lot of moving parts that companies must consider when choosing a platform. Given the criticality of every product and partnership decision for most fintech companies, you can cut through the noise and help ensure your success by focusing on these three pillars of a scalable BaaS arrangement.
If you’re ready for a deeper dive into the mechanics of BaaS and how you can build innovative banking products, check out Q2’s eBook, The Age of Abundant Banking: How to stay innovative when every company offers a debit card.