Banking-as-a-service (BaaS) — which covers licensed banks and fintech startups that provide banking infrastructure, products or services to other businesses — has seen a slump in investor interest in the past two years. From the heady highs of $1.9bn invested into the sector in Europe in 2021, to just $136m raised in 2023 — a fall of 92%.
But that doesn’t mean the sector is dead, say founders, CEOs and experts in the space. McKinsey forecasts that Europe’s total addressable market for BaaS is set to reach a value between €90bn and €105bn by the year 2030.
They believe the first couple waves of the sector have simply run their course — and a new and improved third iteration is ready to give the space a renewed boost.
Need-driven BaaS
So what will the third wave look like? Neil Chandler, CEO of digital bank and BaaS provider Aion Bank believes it will be defined by the needs of end users — like retail customers.
“Customers don't want a loan, they don't want a credit card and they don't want a mortgage. They want a holiday or a pair of jeans, or a house,” says Chandler.
Until recently, Chandler says, banking’s biggest challenge has been misunderstanding that core need, especially with early BaaS. “It was more product-led than need-led… What is driving adoption [now] is BaaS providers who understand the needs of their client's end customer,” he explains.
Products need to create customer value and this can take time to figure out.
Lars Markull, founder at Embedded Finance Review, agrees that there has been a shift: “The majority of new fintech products being developed are not about standalone solutions but embedding new fintech functionality into existing apps or solutions.”
No customer will use a company’s fintech products just because they are ‘embedded', Markull adds. “Products need to create customer value and this can take time to figure out.”
The next wave, Markull believes, will see BaaS moving away from standard financial products and heading toward niche solutions where the financial features are so seamlessly built-in, that you might not even notice they’re there.
The BaaS providers who’ll really succeed, Chandler adds, will be the ones working closely with retailers and marketplaces to embed financial services earlier in the customer’s journey.
For example, a third-wave BaaS could help retailers filter a customer’s options based on what they can actually afford. A responsible lender knowing a customer is carrying debt won’t (or shouldn’t) push them toward the £200 jeans. Instead, maybe they would point them to something more affordable, like a £50 purchase on credit or BNPL.
And when it comes to winning over regulators, Chandler says transparency and cooperation are key. “I think that lack of absolute certainty of who the good providers are is causing a slower rate of adoption than there has been before.”
In the ‘responsible era’
Winning over regulators “might be the biggest and most important challenge for the industry,” says Markull. “We see different regulators taking a closer look at different as-a-service providers, and these providers are required to restrict their new business until compliance activities have been improved.”
It is forcing BaaS into what has been dubbed ‘the responsible era’. “You have to understand compliance; you have to understand banking,” says Chandler.
The consumer neobank boom has largely happened, but the B2B space has much more room for embedding.
The ‘responsible era’ is also influenced by PSD3 — upcoming EU rules for non-bank payment providers. While they’re not aimed directly at Banking-as-a-Service (BaaS), it’s possible the future is likely to be banks offering only APIs, which will fuel a wave of new business services, explains Simon Taylor, founder of Fintech Brainfood.
“The consumer neobank boom has largely happened, but the B2B space has much more room for embedding. Embedded lending in your accounting software, embedded insurance in your B2B marketplace and so on.”
“I think the regulators have got it largely right [now],” says Chandler.
Still, they have to be open to learning from startups to build regulation for the next wave of BaaS solutions. There are already positive signs of this. For example, Aion Bank is working very closely with the National Bank of Belgium, helping them to better understand the nuances of the BaaS model, says Chandler.
Combining forces
European commercial bank UniCredit recently announced its agreement to acquire Aion Bank and BaaS technology platform Vodeno — a move that Chandler says marks the start of a wave to get ahead of what consumers will want.
If you want to describe BaaS 3.0, I think it’s a merging of all of these models where some consumers will want to go to one provider for everything.
“I think you'll see a merging and an [...] integration between the traditional world and the Fintech world. [UniCredit are] the first massive bank to recognise the value of that BaaS model and see it as complementary, not separate or challenging, to its current model.”
“Consumers have lots of quite complex financial needs,” he adds. “Some of those needs will be met by traditional banks; some will be met by neobanks, some will be met by BaaS providers. If you want to describe BaaS 3.0, I think it’s a merging of all of these models where some consumers will want to go to one provider for everything.”
