Thursday 20 Jun 2024
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This article first appeared in Digital Edge, The Edge Malaysia Weekly on October 10, 2022 - October 16, 2022

Here’s a beautiful banker story. After a long day at work, bankers Ben and Bud decide to go to a busy bar on the shady side of town for a booze session. Later that night, armed robbers burst in and line everyone up against the wall. The robbers frisk everyone and take their cash and valuables.

The two bankers are standing towards the end of the line. “I just remembered something important,” Ben whispers to Bud, digging into his pocket and then thrusting a US$100 bill into his friend’s hand. “What’s this?” Bud asks in surprise. “Thank you very much, bro. It’s the US$100 I owe you,” Ben replies.

If that short story bugged you, here’s something that should bother you. More non-bank firms are now offering financial services such as e-wallets, payments and lending services. Companies of all types and levels of maturity — retailers, telcos, big tech players, software companies, car manufacturers, insurance providers and logistics firms — are preparing to launch embedded financial services to serve business and consumer segments.

The new demand for embedded finance has a new name — BaaS, or banking-as-a-service — referring to bundled offerings, often white-labelled or co-branded, that non-banks use to serve their customers.

BaaS is usually distributed to clients via application programming interfaces (APIs), usually in partnership with a finance player. BaaS is the provision of banking products and services via third-party distributors that integrate non-banking businesses with regulated financial infrastructure. Some banks welcome these tie-ups, but many don’t.

Partner banks

Many banks worry that distributing their products through partners threatens their client relationships. “But if end-users begin adopting embedded finance in significant numbers, banks may have little choice but to launch BaaS business lines,” notes global management consulting firm McKinsey & Co.

“The good news is that enabling partners to distribute banking products can be a low-margin, high-volume business for banks. Banks often struggle with their cost structures, which are based on legacy technology and enabled through manual processes and operations.”

Meanwhile, fintech firms offering intermediate BaaS relationships have emerged. Examples include Treasury Prime, Synctera, Unit and Bond.

“Banks will also need new business models, such as pay-for-use monetisation, B2B2C and B2B2B distribution capabilities and a careful consideration of branding,” says McKinsey. “To offer BaaS, banks must undergo digital transformation; many already have. More than 66% have undergone the modernisation and digital transformation necessary to be competitive in BaaS.”

How short is the runway? BaaS will hit mainstream adoption within two years, estimates Gartner Inc. The technological research and consulting firm predicts that 30% of banks with more than US$1 billion in assets will launch BaaS for new revenue streams by end-2024. However, about 50% will not meet targeted revenue expectations.

BaaS is one of four technologies with potential for high levels of transformation in the banking sector. The other three are chatbots, public cloud for banking and social messaging payment apps.

“Bank CIOs (chief information officers) should consider how key innovations are shaping their industry and prioritise tech investment strategies accordingly,” advises Jeff Casey, senior director analyst at Gartner. “BaaS sits at the peak of the Gartner Hype Cycle and is gaining traction from both banks and non-banks aspiring to set up or enhance direct and intermediate revenue streams.”

What about Asia-Pacific? Banks are set to hit as much as 18% of revenues through BaaS partners in Asia-Pacific ex-Japan, estimates IDC Corp.

“Seemingly making up for the distraction of the past two years, many banks are poised to go beyond open banking and are priming for BaaS. There appears to be a spectrum of maturity being created of how ‘open’ banks are, with some playing in the fringes of open banking while others succeed with BaaS,” says Michael Araneta, associate vice-president at IDC Financial Insights.

What’s the difference between “open” banking and BaaS? Open banking is the sharing of basic financial data of customers with third parties. This sharing is useful to come up with an aggregated view of a customer’s financial standing and is beneficial to many parties, such as aggregators, credit bureaus, other banks and financial service providers that seek to get a share of customers’ wallets.

BaaS, on the other hand, goes beyond just sharing of data and allows the bank to offer financial products and services from within the distribution channels of non-bank third parties. With BaaS, the bank can externalise products (for example, non-bank third parties can launch their own loyalty cards by white-labelling the bank’s debit cards), financial services (banks can fund buy now, pay later transactions on e-commerce sites) or services (carry out identity authentication for e-commerce transactions).

“BaaS brings banks to a larger playing field than open banking. It requires banks to have more mature approaches to tech, innovation, creation of business partnerships and design of business models,” says Araneta.

Why the sudden interest in BaaS? Deloitte says BaaS offerings are rapidly gaining ground because 30% of customers are considering switching banks, 42% of customers have used a “buy now, pay later” service, and banks that offer BaaS might double their return on average assets (ROAA).

Deloitte says successful BaaS players align to one of four configurations:

Provider only: They offer banking licences and products, operations and/or tech for use by other banks and NFCs (non-financial companies). Product lines include deposits, loans and payments. The Uber debit card, for instance, is offered to new drivers and delivery partners at enrolment. With accounts held by Green Dot, cardholders can cash out their trip earnings instantly or receive cashback rewards at merchants like Exxon.

Provider-aggregator: They offer the above as well as aggregate capabilities with other vendors to provide an out-of-the-box solution for distributors. For example, Shopify Balance uses Stripe to integrate small business bank accounts (held at Evolve) into the e-commerce platform. Merchants using a Balance account also get faster access to revenue processed by Stripe.

Distributor only: They offer unique financial services, largely out-of-the-box solutions by third parties. Their solutions can be tailored to serve new (neobank) or existing (retail) customers.

Distributor-aggregator: They create options for customers and/or enable novel features by adding new products or technology from multiple providers.

Digital banks

What about Malaysia? BaaS could get a good boost, especially with the rise of digital banks. At end-April, Bank Negara Malaysia approved five digital banking licences out of 29 applicants: RHB Bank with Boost Holdings; GXS Bank with Kuok Brothers; YTL Digital Capital with Sea Ltd; KAF Investment Bank; and a consortium comprising AEON Financial Service, AEON Credit Service and MoneyLion.

“Digital banks can help individuals and businesses gain better access to more personalised solutions backed by data analytics,” Bank Negara governor Tan Sri Nor Shamsiah Mohd Yunus stated in a press release. “As businesses move online, digital banking will also provide a safer and a more convenient way to transact.”

Across the Causeway, Singapore has granted a full digital bank licence to Grab-Singtel and Sea Ltd, as well as a wholesale digital licence to Ant Financial and Greenland Financial Holdings. “The Grab-Singtel venture was one of two groups besides Sea to get a full digital bank licence in 2020, allowing it to take deposits and serve both retail and corporate customers,” Bloomberg reported on Aug 31.

“The licence requires S$1.5 billion in capital and local control. That compares with a wholesale digital banking licence for companies like Ant, which requires a capital commitment of S$100 million and can only serve SMEs and other non-retail segments.”

The bottom line? “BaaS may well be a land grab,” says McKinsey. “If so, banks will need to develop a BaaS strategy today, with a realistic understanding of their cost structure and the path to transformation. They should also clearly see the impact that a significant increase in customer demand for integrated banking experiences will have on their businesses.”

Since we started with a banker story, let’s end with another. A couple of decades ago, I was bitten by the entrepreneur bug. I invited my banker buddy for a couple of drinks. “I need some advice, bro,” I said. “How do I start a small business?” My friend took a couple of swigs of beer. “Start a large one and wait six months,” he smiled. That response upset me, more so because I was paying for the drinks. “That’s very flippant advice coming from a banker, bro,” I frowned. “Don’t you worry about judgement day when you die?” He took another swig of beer. “Bankers never die, bro. We just lose interest,” he laughed.


Raju Chellam is vice-president of new technologies at Fusionex International, Asia’s leading big data analytics company

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