It’s been a long hard road for Banking-as-a-Service (BaaS). The darling of management level conversations at Money2020 2022 and 2023 – everyone seemed convinced that BaaS was going to be a key cog in the future of banking and financial services machinery – BaaS was positioning to be the new technology bridging the gap between traditional financial institutions and fintechs, with a slew of APIs designed to launch digital banking, embedded finance, and better user experiences (UXs). Importantly, BaaS would allow for this without having to modify, switch, or build a new banking core. In its simplest form, BaaS companies were banking technology infrastructure companies that connected, managed, and enabled new fintechs – fintechs with products and services that required a bank account and payment rails. Through a BaaS provider’s APIs, these fintechs could “speak” to banks, move money, and transfer the critical data necessary to facilitate commercial activity, whether on behalf of their consumer or business end-users. The excitement around the vertical was ubiquitous….until it wasn’t.
BaaS falls out of favor
Holes in the BaaS business model slowly appeared in 2023 when consent orders started piling up with participating sponsor banks, brought by both the OCC and FDIC. This roiled the BaaS ecosystem. Fear crept into all four primary participants: banks, fintechs, BaaS infrastructure companies, and the early-stage venture investors that funded the same. At the heart of the consent orders was risk monitoring – in onboarding, KYC, and AML protocols. The deficiencies weren’t just technical, but more importantly, which entity in the BaaS system – fintech, bank, infrastructure platform – was responsible for what, and who, at the end of the day, held the liability for lapses and breakdowns in compliance? According to regulators, there wasn’t much of a question at all – it was the banks. But to the banks, the picture wasn’t as clear. Fingers were pointed at BaaS companies and fintechs, and ultimately, the traditionally conservative FIs, in many cases, shuttered existing programs and/or exited the newfangled BaaS banking model altogether.
A step backward for BaaS sure, but the real “train wreck” came with the Mercury, Synapse, and Evolve Bank debacle.
BaaS infrastructure company Synapse collapsed in the spring of 2024, after a failed attempt to move all of its accounts away from Evolve. This came after (allegedly) Mercury and Evolve cut a deal to disintermediate Synapse altogether (Mercury was Synapse’s largest customer). The implosion and fallout from the failure reverberated across the industry, causing all BaaS participants to run for cover, slamming the brakes on the BaaS business model. It looked like BaaS was dead, and for good reason. The high profile exposure of the Synapse collapse pulled the curtain back on what was arguably the worst deficiency of the BaaS system – the inability to properly ledger, in real-time, end-users balances in pooled, For the Benefit of Owner (FBO) accounts. A cardinal sin in banking – not knowing depositors balances and preventing them from accessing their funds – laid waste to the entire system, and turned BaaS into a four letter word.
Historical perspective
As with all new technologies, especially nascent financial services schemes, it’s a bumpy road traveled for those who dare – the innovators, entrepreneurs, and the forward-looking legacy players that are willing to take risks. Somebody has to go first, and those same participants are exposed to the greatest risk for doing so. Alternatively, they are also the trailblazers, cutting a wide enough swath through the unknown so that the next round, the “2nd wave“, can innovate, fix, and lock-in to an effective, efficient, workable model.
The present, the reality, the next chapter
Demand for digital banking, embedded financial products, and seamless user experiences (i.e. mobile) is extraordinarily high. And, on the supply-side, banks, fintechs, and BaaS infrastructure players recognize that these same products are powerful growth vectors. That is why we’re beginning to see green shoots of investor dollars trickling back into the BaaS ecosystem. Of note, in February, Y Combinator backed Shiboleth, a generative AI-based compliance monitoring startup, secured $1.5M in seed to help banks better track and identify their fintech partners’risk management capabilities. Shiboleth also monitors the banks’ compliance , KYC, AML, and fairness in lending vulnerabilities. The funding is an affirmation that banks understand they will need to lean on additional technology solutions to make the BaaS business model viable.
Further, in March, pure-play BaaS infrastructure firm Synctera raised another $15M (bringing its total to $94M), heralded in with extremely bullish sentiment from existing investor Fin Capital. Per the announcement, “Fin Capital has supported the Synctera team since its very early days. Their laser focus on doing things the right way, putting banks and end customers first, is why they’ve been able to build a world-class banking platform,” said Fin Capital Managing Partner & Founder, and Synctera board member Logan Allin.
This isn’t to say that there won’t still be setbacks from the first wave of BaaS. There is still a “shaking out” process underway. At this writing, another pandemic era BaaS infrastructure company just filed for bankruptcy protection. Palo Alto-based Solid worked with fintech and vertical SaaS companies offering banking, payments, cards and cryptocurrency products via easy-to-integrate APIs.
But, if we follow the investment dollars (and we do), we continue to see that the 2nd wave of BaaS firms are once again gaining purchase, garnering investment dollars and expanding the ecosystem. Just yesterday, UK-based BaaS firm BKN301 announced it raised another $24.5M in Series B funding led by existing investors and new participants CDP Venture Capital SGR, Azimut Libera Impresa SGR, and SIMEST. BKN301 specializes in embedded finance and digital banking, connecting fintechs and other third-party providers to sponsor banks.
Better technology too
There’s also been the emergence of new technology players that solve BaaS’ greatest deficiency – the ledgering problem. There exists today payments and banking solution providers using “Digital Twin” technology to address the critical technical lapse in the Evolve/Synapse catastrophe. This Digital Twin technology acts as a shadow or “sub” ledger that both the bank and fintech can rely on for real-time account balances and payment transactional data in FBO accounts. At any time, any customer, BaaS player, bank, or (and perhaps most importantly, regulator/auditor) can access up-to-date balance information for any user’s funds.
Follow the demand
For the skeptical, I’ve already put my money where my mouth is on BaaS (so to speak). No wagers, but I had occasion to speak about the re-emergence of BaaS’ 2nd wave on a NYPAY panel in late March. The organization asked each panelist to identify one trend that’s going to be surprisingly relevant for 2025. I chose BaaS. Not because I thought it would be controversial…but because I believe it to be true. When there’s economic demand for an objectively better technology, financial or otherwise, that technology will be iterated, innovated, and enter a phase of accelerated diffusion.
