Banking as a Service (BaaS) is big‍—‌and it’s getting bigger. Last year, SoFi acquired Galileo for $1.2bn, and 11:FS predicts the BaaS market could be worth $3.6 trillion by 2030.

The recent surge of major financing and acquisitions in the BaaS space is, in part, being driven by demand for embedded finance. Financial and non-financial companies alike are looking for ways to integrate financial products seamlessly into their apps and ecosystems, at the point of greatest customer need. The use cases are virtually endless: from a car manufacturer that wants to offer branded, one-click insurance at the point of sale, to a prepaid card company that wants to branch into savings accounts, or an expense management platform that wants to offer bill payments and expense cards directly. Demand is particularly strong among ecommerce companies; buy now, pay later (BNPL) is now the fastest-growing payment method in the UK, worth £9.6 billion annually to retailers. Across almost every sector, embedded finance allows companies to capture a greater share of wallet, further monetising every individual relationship and growing customer loyalty.

But embedded finance can’t exist without banking to power it. To deliver almost any of those financial products, companies need to leverage the complex underlying infrastructure of a bank. That’s where BaaS comes in.

From banking to BaaS

Until recently, companies would have to go direct to traditional banks to leverage their infrastructure. That’s because, at minimum, they need bank accounts to hold customer funds, along with all the associated back-end infrastructure for clearing, payments and settlement.

But traditional banks were not built with the demands of embedded finance in mind. Leveraging their infrastructure involves building bespoke partnerships and retrofitting legacy tech. It’s time-consuming, expensive, cumbersome and often requires the company to have substantial scale or resources before they will even be entertained by prospective partner banks. Those are resources that many new players in the market simply do not have.

Enter BaaS. BaaS providers build the component parts of typical banking infrastructure, and package them up for companies. Companies can then easily deploy them to offer embedded banking and other financial services to their customers.

As these components are delivered through elegant and consumable APIs, companies are able to pick and choose the infrastructure they need, and customise it to provide a more tailored experience. Companies are able to assemble a best-in-class financial tech stack by choosing the optimal provider for things like payments, KYC, treasury management and so on, without having to invest in their own complex infrastructure, or navigate arduous partnerships with traditional banks.

The role of banks in BaaS

Whichever way you slice it, banks still have to be involved. Even if companies choose to work with BaaS providers instead of banks, those BaaS providers themselves depend on banking partnerships. Most BaaS providers in the UK are regulated as Electronic Money Institutions (EMIs), not banks. EMIs offer some banking functionality, like payments, foreign exchange, and SWIFT codes, but they still have to partner with banks to hold customers’ money. Under current financial regulations, most fintechs and BaaS providers can’t hold customers’ funds themselves; it has to be separated from their own money and safeguarded at a licensed bank.

That’s why so many companies still prefer to partner directly with banks. A traditional bank may not offer the same agility as a BaaS provider, but there can be real economic value in cutting out the middleman. Investing in a direct relationship can support a more stable, congruent and long-term partnership.

Banking is ripe for BaaS innovation

Banks are indispensable, but working with them today is far from optimal. It’s no secret that traditional banks are slower and less flexible than their product-led fintech counterparts; that’s why such a wide ecosystem has evolved in the first place.

Integrating with the APIs offered by banks can be a torturous process. Traditional bank APIs are typically built for their own internal use, or occasionally for use by other banks. Because they’re not designed for widespread external use, they lack flexibility, and can be difficult for non-banks to navigate. Even getting access typically involves a lengthy onboarding process that can easily take up to six months for companies to clear.

Most banks have limited appetite for risk, with some fintechs reporting that banks can reject up to 80% of fintech applicants. This is a huge problem, particularly for fintechs attempting to break into new markets with innovative new products. If a bank doesn’t fully understand a company’s business model, or lacks visibility and insight on their customers, they may also decide the partnership is too risky and pull the plug at a later stage. This can happen with as little as three months’ notice, leaving companies scrambling to find a new banking partner and potentially unable to operate while they do so. The threat of being “de-risked” is a real and present danger. The result is that companies are often forced to choose between prioritising growth and building customer relationships or protecting their banking partnerships so they can continue operating.

Even once a customer has been successfully onboarded, there are difficulties. New technology usually needs to be layered on top of the bank’s systems in order to run the business. For instance, most banks don't enable safeguarded funds to be segregated into individual customer accounts: instead, they hold all of a company's customer funds in one big, pooled account. This means companies have to invest a lot of time and resources into building or buying ledger technology to manage the separation of customer funds themselves, and have to grapple with the ongoing operational burden of keeping their systems in sync with the bank's. The lag between the systems‍—‌anywhere from 15 minutes to a full day‍—‌creates pockets of time where they might not know what money is where, creating massive exposure and potential liability.

The opportunity for full-stack BaaS

Today, companies face a trade-off when it comes to building embedded finance products and services: put up with the slow and arduous process of working with a traditional bank for the trust and security that comes with a direct partnership; or have a fast and relatively seamless experience with a BaaS partner who isn't actually holding the funds, and might have a difficult banking partnership of its own.

That means there’s a massive opportunity for a new approach. That’s why the BaaS landscape is thriving‍—‌and will be instrumental to the growth of embedded finance. BaaS providers are working to iron out the kinks and seamlessly enable embedded financial products and services. But there’s still a large blank space to build a full-stack solution offering both the functionality of BaaS and risk management of a bank. In short, there’s a gap where a full-stack BaaS provider should be.