In the rapidly evolving financial landscape, two terms have been garnering significant attention: Banking as a Service (BaaS) and Embedded Finance. These concepts represent a fundamental shift in the way financial services are delivered, integrated, and consumed across various sectors. As the industry progresses, the convergence of technology, evolving customer expectations and regulatory advancements will continue to propel BaaS into the mainstream.

Evolution of BaaS

The evolution of BaaS can be delineated into distinct phases, each characterised by technological advancements and changing market dynamics. Initially, BaaS emerged as a means for banks to extend their reach and offerings through partnerships with non-financial entities. This phase, often referred to as BaaS 1.0, primarily involved the provision of co-branded products such as credit cards.

As technology matured, BaaS transitioned to a more sophisticated model, denoted as BaaS 2.0, where non-bank entities, particularly technology firms, began acting as regulated financial intermediaries. This phase witnessed the proliferation of digital platforms and application programming interfaces (APIs), enabling seamless integration of financial services into diverse ecosystems.

In its current iteration, BaaS 3.0 represents the culmination of these advancements, characterised by the convergence of banking and non-banking services within consumer experiences. This shift empowers businesses to embed financial products directly into their offerings, eliminating the need for traditional banking infrastructure and enhancing customer engagement.

Overcoming growing pains

Following the boom in 2021, BaaS has undergone a shift, with investors adopting a more cautious approach amidst the uncertain economic backdrop. Many early-stage companies secured significant funding in 2021 to develop their technology and establish initial traction. However, the BaaS space has become increasingly crowded, leading to challenges for both late-stage platforms, which must demonstrate continued advancement, and new entrants striving to carve out their niche amidst stiff competition.

Despite a decline in financing figures in 2023, with core banking and BaaS businesses raising $0.4 billion compared to $2.4 billion in 2022, the sector remains optimistic. This decline is in line with trends across various fintech verticals, and BaaS is poised for a strong resurgence in the coming year.

How well do you really know your competitors?

Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.

Company Profile – free sample

Thank you!

Your download email will arrive shortly

Not ready to buy yet? Download a free sample

We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form

By GlobalData
Visit our Privacy Policy for more information about our services, how we may use, process and share your personal data, including information of your rights in respect of your personal data and how you can unsubscribe from future marketing communications. Our services are intended for corporate subscribers and you warrant that the email address submitted is your corporate email address.

Regulation, particularly driven by initiatives like open banking, continues to shape the growth trajectory of the sector. Open banking has catalysed the development of numerous embedded finance applications, sparking increased demand for BaaS infrastructure. With greater levels of transparency and data sharing, this regulatory framework has empowered fintechs and merchants to innovate and offer fresh banking solutions, creating new and interesting customer paths across e-commerce and lending in particular.

Challenges and opportunities

While the potential of BaaS is undeniable, navigating the associated challenges requires a nuanced understanding of regulatory frameworks, data privacy concerns, and interoperability standards. Regulatory compliance, in particular, remains a paramount consideration, with businesses needing to adapt to evolving regulation regarding AML/KYC, client money handling and credit/product suitability.

The BaaS sector is undergoing a learning curve inherent to innovation in a regulated industry. Yet a growing regulatory focus also represents an opportunity to develop best practices, and demonstrate strategic differentiation and market leadership. Many businesses have already worked through the regulatory and operational grey areas that often defined them, establishing operating models that will satisfy regulators.

The BaaS landscape is composed of both licensed providers or middleware providers, relying on sponsoring banks or affiliated PSPs. With such increasing regulatory scrutiny, the sponsoring banks will continue to be more ‘hands on’ regarding the risk management of these complex BaaS client programs. At same time, BaaS partners now acknowledge that this is no longer ‘the banks’ problem’, and have proactively changed their existing setup by enriching their own risk management capacity and setting up APIs with all the regtech solutions that their bank partner may use.

Outside of regulatory developments, macroeconomic conditions are also driving the need for client monetisation, presenting more opportunities for BaaS. Lending has become increasingly appealing to various non-bank players seeking higher interest yields and new revenue streams, leading them to explore BaaS and Lending as a Service (LaaS) solutions. This trend not only expands product offerings from BaaS to LaaS but also underscores the importance of embracing emerging technologies such as blockchain and artificial intelligence to streamline operations, mitigate risks, and bolster customer trust.

Industries and applications

The impact of BaaS and Embedded Finance transcends traditional boundaries, permeating various industries and revolutionising established business models. In the travel sector, for instance, one prominent and growing use case is the integration of banking functionalities into airline loyalty programmes. Passengers can now earn, manage and redeem rewards seamlessly, thereby augmenting customer retention and generating ancillary revenue streams.

Moreover, the advent of ride-hailing services has heralded a new era of financial integration, wherein payment processing and financial services are seamlessly embedded into the user experience. Prepaid cards for drivers, fuel payment options, and insurance packages tailored to specific needs are just a few of the growing use-cases. This convergence not only enhances convenience for consumers through simplified payment methods, but also creates a more stable and efficient ecosystem for drivers.

As BaaS continues to permeate various industries, the potential use cases seem boundless, promising a future where financial services seamlessly integrate with everyday activities.

Embracing change

As BaaS continues to redefine the contours of the financial ecosystem, organisations must embrace agility and innovation to thrive in an increasingly interconnected world. By recognising the evolution of these concepts, exploring their diverse applications across industries, and proactively addressing the associated challenges and opportunities, businesses can position themselves as pioneers in the digital age of finance.

Aman Behzad is Managing Partner, Royal Park Partners