Three Layers of Banking as a Service

The concept of banking as a service is revolutionary. This is because banking as a service is a mechanism using which commercial banks can now collaborate with other non-banking entities in order to expand the coverage of their services. Hence, this model has led to a decomposition of the commercial banking value chain.

Earlier, all banking-related activities had to be performed by the commercial bank itself. However, this has changed with the introduction of banking as a service. In this model, the tasks which were earlier done by commercial banks are now spread across various business entities. In this article, we will explain the three-layered system as well as the three players which play a pivotal role in providing banking services to the end clients.

The Three-Layered System

Banking as a service cannot be provided by commercial banks alone. This service is provided only after the collaboration of three different entities viz. the commercial bank, the banking platform, and the corporation.

Let us understand the role performed by each of these players in banking as a service value chain.

1. Commercial Banks

   Commercial banks are the bottom layer of the pyramid. This is because they are the only players in the value chain who have the license to actually perform banking-related services. Hence, ultimately the banking-related tasks need to be executed by them. However, commercial banks are also required to communicate with the next layer of the system.

   Hence, commercial banks are required to have servers and communication hardware in place. They offer these servers and communication hardware to the other players in the form of infrastructure as a service and charge a fee each time their systems are used. Hence, it can be said that just like Amazon AWS provides servers on demand, commercial banks are required to provide infrastructure as a service on demand in this new business model. The banking as a service business model is being adopted by traditional banks as well as new-age banks.

2. Banking As a Service Platform

   The banking as a service platform is a specialized layer of middleware. This layer consists of technology players who are specialists in the field of banking as a service. Over the years, they have understood the intricacies of this field and now provide software that enables safe communication of data between commercial banks and the end consumers of banking as a service. There are some platforms that are also licensed as a bank. However, they choose to focus on enabling the transactions instead of actually executing the transactions.

   The purpose of banking as a service platform is to enable secure communication. These platforms have been built to ensure that all commercial banks do not have to build their own data security mechanisms. Instead, a few centralized platforms can be kept in charge of ensuring that all transactions are securely routed.

   Banking as a service platform has APIs which communicate with the corporate customers as well as read the data which is exposed by the commercial banks. Developing and maintaining a platform is a technologically challenging as well as expensive task. Hence, there are limited service providers which operate in different parts of the world.

3. Businesses

   The last and customer-facing end of the value chain is the business that needs to integrate financial products and services into its own products and services. These businesses could be fintech companies or they could also be non-fintech companies such as Amazon which want to provide credit cards to their clients or want to enable their clients to obtain loans just by clicking a few buttons.

   The job of these business entities is to handle the distribution end of the value chain. This means that they will create embedded financial products which the end customers find appealing.

   The creation of these products is based on a deep understanding of consumer behavior as well as their needs and wants. Also, these business entities have to bear the expense of marketing these financial products. All the costs related to marketing are borne by them alone. They merely use the services of the other two members of the value chain on a pay-as-you-go basis.

The end result of the process is that a wide variety of financial as well as non-financial companies are able to provide their customers with very specialized financial products. However, it also means that the entire value chain has been decomposed into several parts.

There are many critics who believe that this modular design of the banking value chain allows different entities to focus on different aspects of the business and hence enhances the overall customer experience. However, there are other critics as well which believe that the introduction of banking as a service is a negative development for the overall commercial banking system. We will try to understand both these points of view as we look at the advantages and disadvantages of this model in the forthcoming articles.