Banking as a Service

Technological innovations are having a huge impact on the commercial banking industry. Many parts of the commercial banking business are being completely transformed. For instance, earlier commercial banks used to own the entire banking value chain. However, of late, this has changed. Commercial banks now coordinate with a wide variety of financial and non-financial entities in order to provide banking services to their customers. The introduction of the open banking information technology architecture has played an important part in this process.

In this article, we will see how commercial banks have adopted a new model wherein they provide banking as a service to their corporate customers.

What is Banking as a Service?

Banking as a service can be best understood with the help of an example. Let us imagine an online retailer like Amazon. Now, Amazon wants to provide certain cashback or discounts to their loyal customers. They also want their customers to be able to borrow money to complete their purchases. Ideally, Amazon would like to enable borrowing using a single click. This would help them to increase their sales.

In such cases, Amazon can deploy banking as a service model. They can launch their own credit card which provides certain customized features which help customers shop on their website. Since Amazon does not have a banking license, it cannot actually provide banking services. Hence, the system is devised in such a way that at the front end, Amazon would be providing credit cards whereas, at the back end, Amazon’s system will connect to the bank’s system using APIs.

Hence, in simple words, banking as a service allows a modular structure to be implemented in the banking value chain. This means that the front-end service can be provided by some other entity whereas, at the same time, back-end services can be integrated with a bank. This approach allows the creation of many new products, channels, partnerships, and opportunities that did not exist earlier.

How Does Banking as a Service Work

Banking as a service is a technological system which works allows banks to work in close coordination with other banks, non-banking financial entities, or any other commercial entities.

In order to enable banking as a service, the first step is to ensure that the bank opens up its system and allows the other entity to communicate with these systems using APIs. Entities like Amazon can then use their systems to build innovative financial products which can then be offered to their end consumer. It is common for banks to charge a fee to enable the development of such APIs.

Once, the financial product has been developed, the commercial banks then allow the other entity to communicate with their systems at any given point in time. Hence, the banking system virtually becomes an extension of the commercial entity’s own system. However, each time, the bank’s system is used a fee has to be paid to the bank.

The end result is that banks are able to monetize their banking license as well as the robust back-end systems that they have in place.

Roles in Banking as a Service Value Chain

The banking as a service system has created a new banking value chain wherein the roles provided by banks have changed. Earlier, commercial banks would work on all the roles in the value chain. However, now their action is restricted to certain parts of the value chain. The details of these roles have been mentioned below:

1. Commercial banks have assumed the role of the service provider. This means that they are involved in the execution of the service in the back end. Hence, banks have to coordinate with other entities in order to enable the service. Their name may or may not appear in the branding of the financial product which is being marketed.

2. The second role which is played in banking as a service value chain is that of a distributor. A distributor is a financial entity that has a close connection with the end consumer. As a result, the distributor is able to maintain the relationship with the customer and also collect data or provide after-sales services.

3. Some commercial banks play the role of provider aggregator. This is a composite role that is an extension of the provider role. This means that the commercial bank will not only provide the services in the back end but will also collaborate with other vendors in the ecosystem and provide a complete solution to the distributors.

4. Another possibility is the role of the distributor aggregator. This role is also a composite role. As a part of this role, the same distributor can collaborate with multiple service providers. In the end, they provide an aggregated bouquet of products to their clients. For example, Amazon can provide their customers with a credit card provided by one bank while their one-click loan may be powered by another commercial bank in the back end.

The bottom line is that banking as a service has now become a marketplace reality. Different entities now specialize in providing different services across the banking value chain. Commercial banks will have to strategize to inculcate this new reality into their operational strategy. Failure to do so will lead to the commercial bank being left behind in the new paradigm.