Banking-as-a-service is among the most talked-about innovations in banking, and also perhaps among the least understood.
Jeannette Kescenovitz, who leads development of banking-as-a-service capabilities at Finastra, shares her views on how BaaS might grow its presence at U.S. banks and credit unions in 2023.
A few takeaways from the conversation:
- U.S. financial institutions are still in the early stages of adopting banking-as-a-service, with a key obstacles being uncertainties from the regulatory side.
- Higher rates and a possible recession could help banks by presenting a financial headwind for nonbanks now leading the way in implementing BaaS.
- The growth of nonbank competitors may spur more partnership activity between banking institutions and fintechs offering banking-as-a-service solutions.
INTERVIEW TRANSCRIPT
So Jeannette Kescenovitz, senior director solution management for banking-as-a-service at Finastra, welcome to the BAI Banking Strategies podcast.
Thank you, Terry. I’m very excited to be here.
So Jeannette, I’ve seen more than one definition of banking-as-a-service. It seems like it’s one of those things that mean different things to different people. So right here at the start, before we get too deep into this, could you tell us Finastra’s definition of banking-as-a-service?
Terry, I think I spent the first year I was in this job trying to figure out that definition. Finastra’s definition is really, banking-as-a-service provides retail and wholesale banking products in context as a service for licensed financial institutions, usually regulated infrastructure, API-driven platform. We really like to use the term “orchestration.” As a BaaS provider, what we do is orchestrate the banking services, connecting banks to fintechs and, through them, to the end consumer in context.
Now that we know what we’re talking about here, we have that definition to work with, where would you gauge the U.S. as being in terms of adoption of banking-as-a-service? Are we early to the game? Are we perhaps late to the game? How would you compare that level of adoption to where things are in Europe or in Asia?
It’s so difficult to tell with this constantly changing macroeconomics, and I believe that that uncertainty means that we’re still in the early stages of this game in the U.S. One thing is for sure: The threat of regulation to non-traditional lending practices, the lack of clear definition and standards has caused a lot of banks and credit unions to delay their strategy. Whereas in comparison, the European market, really led by the U.K., got out in front of us. They are seeing their own challenges with open banking standards and regulation around data. From an Asia perspective, I think the emerging markets are going through those early stages, again, with open banking regulation, data sharing, but it’s really growing very quickly.
What would you say is driving interest in banking-as-a-service in the U.S.? And flip side to that, if we are in the early stages, what are some of the key obstacles at this point to even wider acceptance and wider adoption?
I think demand from consumers in the U.S. for in-context banking services is certainly driving some of that interest, along with revenue in this economy. Banks and credit unions can gain access to new customers through indirect lending channels, so their acquisition cost of every new customer … Many of them are requiring deposit accounts be opened in the lending situation, so they’re able to increase their deposits at the same time. With the current levels of volatility in the market, having a fully digital strategy is essential to success, and having a platform provider that can allow access to a lot of different services that can be integrated quickly with open APIs is definitely going to help them succeed.
You mentioned economic uncertainties, and of course we’re facing a number of those as we start out this new year: aggressive central bank action trying to tame inflation, elevated risk of recession perhaps being at the top of the list. How are you looking at these macro factors, and particularly interest rates, as possibly having an impact on banking-as-a-service adoption in 2023?
Interest rates, funny enough, I read an article this past week around how rising interest rates are impacting the auto market. So borrowers even with an 800-plus credit score, are seeing interest rates of 6%, 7%, 8% range already. The theory is that credit-based risk decisioning may not be as relevant in this new market. And what that means is that alternative data such as banking transaction history overlapping with open banking would be imperative in the decisioning process. So we are monitoring obviously the rates, we’re monitoring the impact to trends in the lending space, and we’re working very closely with our customers to understand everything from risk profiles to approval rates and that alternative decisioning capability.
Jeannette, in preparing for this conversation, I spent some time reading Finastra’s 2022 State of Financial Services survey. And in that survey, you look at a number of emerging trends in the industry globally. Among the findings, Finastra distinguishes between banking-as-a-service and embedded finance, and this caught my eye because I tend to think of embedded finance as a subset of banking-as-a-service, rather than its own separate thing. What am I missing in terms of the distinction between them?
I 100% agree with you that embedded finance is a subset of banking-as-a-service. I really think this goes back to your first question. You asked me to define banking-as-a-service before we even started the conversation, and I think it can be confusing to read about. It’s subtle at times, but I can add to my original definition: BaaS enables any business to develop new capability with financial services that are embedded into the customer experience. So that’s the end goal of banking-as-a-service, is to take this capability to the end consumer where they are in context.
There’s an interesting chart in the survey report showing deployment of banking-as-a-service and embedded finance in different countries. For the U.S., nearly half of financial institution respondents reported either starting or improving their banking-as-a-service in the past year, while only a third or so did the same with embedded finance. So what do you think might account for the different implementation rates, and how do you expect those numbers to perhaps change in 2023?
Banking-as-a-service covers many different financial service types. And when I read the report, this indicates that nearly half of the respondents are doing some form of banking-as-a-service. For instance, it could be leveraging a platform to access more fintech capability to enhance their own solution, such as vendor integrations. But only 35% are actually embedding this capability in context for consumers.
More businesses offering banking-type services, by definition, means more competition for traditional banking institutions. So specifically in terms of banking-as-a-service as an offering by banks, what are the opportunities here, and is this something we might expect to see more of in 2023?
As we read the news every day and hear more and more layoffs across the tech industry, I think it’s clear that the non-traditional banks are going to struggle a bit. As interest rates rise, it means that banks and credit unions have a real opportunity, and I think many of them felt like maybe they didn’t have a right to play in this space, so to speak, but a healthy balance sheet is going to go a long way in this economy. And deposit accounts can make that happen.
In recent years, the relationship between banks and credit unions on one side, and fintechs on the other, has been less about disruption and more about finding ways to partner. Banking-as-a-service and embedded finance really get into core functions performed by traditional banking institutions, so it kind of has a disruptive feel. Is there room for partnership here? And if so, what might these partnerships look like?
So I might broaden this one just a little bit, and I want to talk about it from a software perspective. So from a financial institution’s software that they’re using, having spent 20 years in this industry in engineering, the biggest change I’ve seen is exactly what you’re asking here. Third parties, fintechs, previous competitors, current competitors – it’s literally all fair game. Every day I’m having conversations on how we can partner. From a bank and credit union perspective, it’s a little bit more complex, but I am seeing more of our customers looking for services that can automate processes such as decisioning, underwriting, and I’m seeing more banks and credit unions willing to participate in marketplace concepts, perhaps providing second-look opportunities. So I’d say that partnerships are going to continue to be imperative on both sides – on the provider side and on the enabler or the distributor side.
Another tech driven area of banking that’s emerging is open banking, where customers own and are free to share their financial data as they see fit. What’s the nexus between banking-as-a-service and open banking now, and how do you see that changing, perhaps, in the next year?
As banks are looking to compete in this tight, volatile market, I think it’s going to be crucial to leverage open banking. I gave a good example earlier with the alternative decisioning. More and more financial service providers are turning to alternative data when deciding new account opening, credit limit increases, loan approvals. The more data consumers are willing to share, the better the algorithms are going to get. Credit score is only simply one factor, and we’re going to see more service providers emerge that are going to offer alternatives to financial institutions.
Open banking is considerably further along in Europe and in Asia than it is in North America, thanks in large part to the EU regulators getting involved with mandates and regulatory structure. What are you seeing in the growth of open banking in other parts of the world that might be applicable or we might be seeing more of in the U.S. in 2023?
Regulation is really the name of the game. U.S. regulators need to watch and learn from both the European rollout and the efforts in Asia. I read that in many cases, when banks are asked to build and maintain APIs simply for regulatory reasons, instead of revenue generation, the quality of what’s provided really starts to suffer. In addition, even though the U.K. has the API requirements for open banking and they’re well-defined in great detail, it’s not the case throughout all of Europe. Many of the countries have their own rules that they’ve put in place. What we’ve seen in the U.S. with mass regulatory changes, and what that can do to the industry – take Dodd-Frank, for instance – millions of dollars were spent by financial institutions and service providers to meet all those new requirements. This points back to my earlier statement around why U.S. banks may be cautious entering into banking-as-a-service.
Jeannette, I’d like to finish up our conversation by going back to Finastra’s 2022 Financial Services Survey. In those findings, there’s a strong belief that open banking is just a way station on the road to open finance, but it doesn’t really talk about how we get from one to the next. So let me ask you, and because we are liking definitions and defining things in this conversation, what is open finance in Finastra’s view, and what’s needed for that transition to take place? And on top of that, are you seeing any signs that we could see progress in that direction in the coming year?
Just like all these terms, I’m sure there’s a lot of opinions on the subject. From my perspective, open finance is really the evolution of open banking, where consumers can provide access to that same financial data to third parties, really for the purpose of getting better, personalized financial services. It goes beyond the financial industry and really starts to include everything from healthcare, government … I’m seeing a lot of fintech players that I’m talking to that are looking to bring this capability to customers in context, and I think it’s going to be driven by consumer demand, and obviously for fintechs from a revenue perspective.
That means, basically, it’s not a build it and they will come. It’s more like we’re going to be pulled along by demand within the industry.
I believe so.
Okay. All right. So Jeannette Kescenovitz, senior director solution management for banking-as-a-service at Finastra, many thanks again for joining us on the BAI Banking Strategies podcast.
Absolutely, Terry, thank you for having me.
