04 December 2023 |

The BaaS Flight-to-Quality

By Alex Johnson

E.A. Séguy’s vintage butterflies (1925) insect illustration.

3 FINTECH NEWS STORIES

#1: Two different Bets on the Future of BaaS Compliance  

What happened?

New products in the exciting world of BaaS compliance!

From Socure:

Drawing on deep, hands-on knowledge from partnering with more than 80% of all sponsor banks and more than 400 fintechs, Socure launched Control Center to help sponsor banks responsibly seize this surging opportunity. The solution enables sponsor banks to easily manage data across a vast array of rapidly growing and increasingly complex fintech providers, de-risking support and making it easy to stay compliant and be prepared for changing regulations.

Socure’s Control Center gives sponsor banks an all-in-one dashboard providing real-time visibility into all programs’ compliance KPIs, including fraud rates, CIP approvals, lagging watchlist screening case closures and more.

And from Cable:

Cable … today announced the launch of its industry-first solution, Transaction Assurance, pioneering a new wave of financial crime compliance and transaction testing.

Cable’s advanced assurance engine transcends traditional, manual sampling methods — which are costly, error-prone, and highly inefficient, typically covering only 1% of an organization’s transaction volume — offering a more reliable, automated solution. Cable’s Transaction Assurance fills that gap, providing 100% coverage at scale, capable of handling millions of transactions.

So what?

As I am fond of saying around here, banks that want to win BaaS tomorrow are investing in compliance today. So it’s not terribly surprising to see new compliance products that are well-suited for the challenges of BaaS popping up with increasing frequency. It’s a seller’s market!

The question is, which model of BaaS compliance do you build for?

There are two viable models to choose from:

  1. Compliance-as-a-Service – In this model, the bank requires that all of its fintech partners use its existing risk, governance, and compliance infrastructure. The fintech company doesn’t take on any of the frontline work of setting up and operating controls nor any of the back-office compliance monitoring and case management. The bank does it all. This model is expensive for banks and doesn’t give the fintech companies as much control as they’d like, but it’s extremely low-risk.
  2. Bank-as-Regulator – In this model, the bank directly manages all of its fintech programs. However, the bank will allow the fintech companies to, over time, take on a lot of the frontline risk management and compliance work, including the design and operation of the controls. Instead of doing all that day-to-day work, the bank focuses its energy on closely monitoring its fintech programs and testing their processes and controls. It essentially plays the same role for its fintech partners that government regulators play for it. This model is slightly higher risk but much more scalable for banks and flexible for fintech companies. 

Reading between the lines, it appears that Socure’s Control Center is built to enable the Compliance-as-a-Service model. It’s an end-to-end solution covering IDV, fraud prevention, watchlist screening, customer decisioning, and bank partner management. It does everything, but it requires the bank to do most of the heavy lifting, and it requires that all of the bank’s fintech partners use the same Socure-powered compliance tech stack.

Cable, by contrast, is able to support the Bank-as-Regulator model. Transaction Assurance is, essentially, a way for banks to comprehensively monitor the effectiveness of their fintech partners’ frontline compliance controls without having to provide those controls directly. It’s designed with scalability in mind and doesn’t require existing compliance tech to be ripped out and replaced.

BaaS is evolving quickly as regulators apply additional scrutiny to the space. It’ll be interesting to see which of these two models proves to be more popular in the long run.  

#2: The BaaS Flight-to-Quality

What happened?

Blue Ridge Bank is dropping a significant number of its fintech partners:

Blue Ridge Bank, once a major player in the banking-as-a-service space, is shrinking its portfolio of fintech partners as it looks to regain favor with regulators after a 2022 consent order identified issues with its fintech partnership program.

The Charlottesville, Virginia-based firm said in an investor presentation last Thursday that it is in the process of offboarding about a dozen of its roughly 50 BaaS partners. 

The lender said it expects to reduce fintech exposure to a limited number of core BaaS partners with a commercial focus or strong consumer traction. 

So what?

This isn’t a surprise.

Blue Ridge’s new CEO, Billy Beale, has been saying (pretty much since the beginning of his tenure back in July) that his priority is to get the bank out from under the OCC consent order by, among other things, dramatically scaling back on the bank’s BaaS ambitions.

The challenge for the industry is that every other BaaS bank is doing basically the same thing right now. 

It’s a flight-to-quality.

If you’re a well-funded fintech company, backed by brand-name VCs and founded by veteran financial services entrepreneurs, BaaS banks will still want to work with you (particularly if you already have significant traction with customers).

However, if you’re an inexperienced first-time founder with little-to-no VC backing and no meaningful customer traction, your chances of landing a reputable BaaS bank partner – one that’s not about to get slapped down by regulators – are becoming vanishingly small.

That’s a problem.

I understand that prudential regulators are trying to get their arms around BaaS right now. And I understand that the quickest and easiest way to do that is to significantly ramp up the level of scrutiny in supervisory exams for any bank that is engaged in BaaS.

However, I don’t think regulators quite understand the chilling effect that this regulatory crackdown is having (and will continue to have) on the establishment and growth of fintech startups, particularly those started by founders from underrepresented or non-traditional backgrounds.

That chilling effect, combined with our prohibitively expensive and onerous process for granting de novo charters, may lead to a significantly less competitive financial industry over time if we’re not careful.    

#3: Fintech for Film & Television

What happened?

An interesting new B2B fintech company just raised a pre-seed round:

Conduiit, Inc. … announced the closing of $1 million in pre-seed capital.

Conduiit provides a comprehensive suite of tools designed to enhance profitability and streamline financial processes for film and TV productions. The platform builds a bridge between production finance and corporate finance, integrating payroll, payments, and tax incentives. In one year alone, Conduiit has served 200 customers, run 30 projects, and overseen $70 million in transactions. They’ve saved users thousands of hours and helped secure millions in tax incentives.

So what?

This is exactly why we want to continue to make it easy for financial industry outsiders to start fintech companies.

Conduit was founded by Shawn Hamilton and Jason Thurman, both of whom have long histories working in various production, product, and technology roles in the entertainment industry. They don’t have any background in fintech, which is just fine because the core competency that’s needed in this case is a detailed understanding of the software workflows that need to be built in order to streamline production finance for film and television studios.

It reminds me a lot of the solutions that fintech startups are building in the world of construction finance – connecting the team that is on the ground, building the project with the back-office finance team that is trying to keep track of everything and making sure that the project doesn’t run over budget. Part project management software. Part accounting system. Part corporate expense management tool.

Pretty cool!


2 FINTECH CONTENT RECOMMENDATIONS

#1: Breaking Down the Open Banking Rules (by Reggie Young and Matt Janiga, Fintech Layer Cake) 🎧

Reunion show!

This is like Alan Jackson and Jimmy Buffett getting back together to record more songs after making “It’s Five O’Clock Somewhere”. Just tremendously exciting for niche fintech podcast fans like me.

And a great topic, which Matt and Reggie (unsurprisingly) bring a lot of insight to. 

#2: B2B payments aren’t payments, they’re workflows (by Matt Brown) 📚

Matt continues to publish some of the best (and least discussed) writing on fintech trends and strategy.

This piece does a great job outlining the real opportunity in B2B payments – the software-driven workflows – and why it’s likely that the winners in B2B payments will be vertical rather than horizontal. 


1 QUESTION TO PONDER

What’s the next great fintech/embedded finance vertical?

I feel like accounting, healthcare, construction, and shipping/logistics are all highly saturated at this point. Creators, which isn’t really a vertical anyway, was a ZIRP phenomenon. Climate and franchises are on their way up.

What’s next? What industry will we be talking about in 2024 that isn’t really on the radar yet?