The Future of BaaS: Some notes for Q2 of 2024

In recent years, there has been an unprecedented rise in the adoption of banking as a service (BaaS), allowing non-banking companies to include banking services in their goods and services efficiently. However, the expanding industry is currently coming under significant regulatory investigation. Regulators appear to be concerned about ensuring that the swift expansion of BaaS does not compromise financial stability and consumer safety. This article examines how these recent regulatory developments are shaping the future of BaaS.

Increased Regulatory Involvement

The Federal Deposit Insurance Corporation (FDIC) and other regulatory agencies have assumed a pivotal role in closely monitoring the BaaS market. Their increased enforcement actions, particularly targeting banks that provide BaaS services to fintech startups, have been notable. Given that a smaller number of banks are involved in BaaS compared to the broader US banking industry, these institutions accounted for a significant 13.5% of the enforcement actions taken by federal bank regulators in 2023.

Recent Regulatory Actions

The main goal of regulatory proceedings is to ensure that banks that conduct BaaS operations follow stringent compliance and consumer protection standards. This involves implementing risk-based compliance procedures to handle the unique risks connected to fintech relationships with third parties. The need for rigorous oversight before and during these relationships is highlighted by the requirement that banks improve their rules and procedures for performing due diligence on fintech partners before finalizing contracts.

Expectations for Continued Guidance and Compliance

The FDIC and other regulatory authorities have updated their "Interagency Guidance on Third-Party Relationships: Risk Management," which clarifies what is expected of banks in third-party relationships, particularly those involving BaaS. According to Adams and Reese LLP, this advice highlights the significance of a whole-life-cycle approach to managing third-party risks, from due diligence to ongoing monitoring. 

Implications for Fintechs and Banks

Due to regulatory pressure, banks might have to drastically change their operating procedures to adapt their business models to comply with stricter requirements. These trends suggest to fintechs that they must impose more operational and compliance rigor to ensure their bank agreements can withstand regulatory scrutiny.

Conclusion

The rapid development of BaaS will likely slow down due to the increasing regulatory scrutiny, but everyone engaged could benefit from a more secure and stable environment. Under these new restrictions, the industry continues to evolve, and traditional banks and fintech companies must carefully manage these latest developments. Therefore, the ability of these institutions to adjust to a more stringent regulatory framework—ensuring that innovation persists while complying with more extensive financial rules and consumer protection laws—will likely determine the future of BaaS.