An increasing number of banks are forming partnerships with non-financial brands through banking as a service (BaaS), embedded banking, embedded payments or corporate application programming interface (API) banking. The reason? To grow low-cost deposits and noninterest fee income.
A 2023 S&P Global study found that community banks with BaaS offerings outpaced their peers in deposit growth. In the second quarter of 2023, BaaS banks achieved a 2.2% median sequential growth rate, while other banks of similar size experienced a 0.8% decline.
Along the way, a unique paradigm has emerged where banks are engaging in bigger embedded finance deals alongside other banks through a responsible BaaS model. In this type of structure, akin to a syndication process, multiple banks can participate in a portion of an embedded finance deal without taking on sections of a program they are not equipped to manage.
Ryan Dumond, senior vice president at Bangor Savings Bank, is actively engaged in supporting BaaS partnerships and is a firm believer in this new collaborative model. “There’s a lot of value in banks working together,” he said.
Responsible Evolution in BaaS Models
In 2023, BaaS companies underwent rigorous vetting, with federal regulators issuing multiple consent orders and comprehensive guidance on third-party relationships. This regulatory scrutiny has fueled a notable shift towards a more responsible BaaS model – one that has demonstrated its effectiveness. Adoption is growing, with this bank vendor partnership model being leveraged by Emprise Bank, Grasshopper Bank, Piermont Bank, Bangor Bank, Third Coast Bank and other institutions.
In this model, multiple banks work directly with tech firms through an API layer while maintaining rigorous compliance and governance oversight over their partners. The embedded banking software platform creates the API, facilitating swift integration between partners.
“While technology in the bank-fintech partnership is important, it’s about so much more. It’s also about providing compliance and risk management oversight and having a relationship-based partnership where we can provide collaborative support to help them deliver the best banking product to the market,” said Emily Reisig, senior vice president at Emprise Bank.
Navigating Embedded Finance Bank Networks
When structured through a responsible BaaS model, collaborations between bank network participants and technology companies offer numerous advantages, allowing banks to engage in more deals than they typically would outside the network. Here are some of the key benefits:
1. Managing Pipeline Volume and Concentration Risk
Being part of a BaaS bank network can be invaluable for managing pipeline volume and concentration risk. Selective deal participation allows banks to pace themselves and accept only aligned deals while avoiding the concentration risks and rapid deposit growth that can come with being the sole sponsor.
For example, a $2 billion community bank looking at a $1 billion embedded finance program can share the deposit burden with other banks. The network acts as a pressure valve to maintain control over the portfolio’s size and composition.
2. Product Specialization
Banks have the flexibility to select only the components that align with their unique business models and strategic objectives. Operating within their expertise and comfort zone enables banks to navigate potential learning curves effectively.
Starting with a product that a bank already specializes in is advisable. For instance, a consumer-oriented bank in the network can support the retail checking account product, while a commercial bank can power a company’s business checking account and other commercial products. Neither bank needs to commit to the entire deal; both can stay within their areas of expertise.
One of the concerns for banks working within this network model is whether it could be easier for businesses to move funds freely across the different partner banks. Ethan Singleton, Principal Advisor at consulting firm FS Vector, said this risk is significantly reduced by the fact that each bank has a direct contract with the business they are sponsoring.
In the direct contractual agreement between the bank and fintech, every detail is explicitly outlined in advance. The program management agreement can be strategically structured to designate the bank as the exclusive deposit partner, securing a specified amount of deposits.
BaaS networks and other embedded finance models offer banks the potential to grow the business by focusing on their areas of expertise while limiting concentration risk.