Banking as a service (BaaS) is a business model that allows fintech companies to offer banking products and services to their customers without having to obtain a banking license. Instead, they partner with banks that provide the regulatory compliance, infrastructure, and access to the payment system. BaaS has been seen as a win-win situation for both fintechs and banks, as it enables innovation, customer acquisition, and revenue diversification.
However, the future of BaaS may be in jeopardy, as new federal guidance for managing third-party relationships took effect on June 6, 2023. The guidance, issued by the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, applies to all third parties, not just BaaS partners. It aims to ensure that banks have effective risk management and oversight over their third-party relationships, and that consumers are protected from potential harm.
The guidance, however, has been criticized by some experts as being vague, burdensome, and restrictive for BaaS partnerships. Jelena McWilliams, former FDIC chair and now a partner at Cravath, Swaine & Moore, said she has concerns that the new guidance will have a chilling effect on BaaS and stifle innovation. She said the guidance does not give banks enough clarity and information regarding the parameters and expectations for third-party partnerships, and that it sends a message that the current regulators do not want BaaS to flourish.
Konrad Alt, partner at Klaros Group and a former senior federal regulator, also expressed his skepticism about the new guidance, saying that it reflects a general movement towards greater caution and scrutiny of financial innovation by regulators. He said that Washington is down on big tech firms’ financial activities right now, and that fintech firms are taking some of that heat by association. He added that the time of the fintech side of BaaS deals being somewhat outside the federal umbrella is coming to a close.
The new guidance may pose significant challenges and costs for banks and fintechs that want to continue or enter into BaaS partnerships. They will have to comply with more rigorous due diligence, monitoring, reporting, and auditing requirements, and ensure that their BaaS products and services are fair, transparent, and compliant with consumer protection laws and regulations. They will also have to deal with the uncertainty and inconsistency of how the guidance will be interpreted and enforced by different regulators and examiners.
BaaS is not dead, but it may face some headwinds in the near future. Banks and fintechs that want to pursue BaaS opportunities will have to be prepared to navigate the complex and evolving regulatory landscape, and demonstrate that their BaaS offerings are beneficial and safe for consumers and the financial system.
