It has been a long way coming but over the past years the EU’s financial sector has gotten a regulatory upgrade which initiated its technological progression in a notable way. You have probably come across the terms Open Banking, BaaS (Banking as a service), and Embedded Finance. And though they all mean different things, the finance and tech world tends to use them interchangeably. Whether you are looking for a financial product to integrate, are aiming to build your own solution, or are simply curious about the fintech world, the following article will help demystify these three terms.
Open Banking cannot be discussed nor defined without mentioning PSD2, the EU’s revised Payment Services Directive that came into effect in January 2018. In fact, PSD2 is often used synonymously with Open Banking as they both refer to the authorization of 3rd parties (i.e. AISPs and PISPs) to access financial data for the sake of
(1) empowering consumers to obtain control over their own data and
(2) promote innovation and competition in the financial sector.
Thus, Open Banking has established itself as a mandatory standard for banks to securely share and exchange financial data. Since its introduction, end users were able to benefit from the heightened level of self-governance that OpenBanking has established as it relates to users' money management, payments and borrowing. Meanwhile, fintechs could capture entirely new market opportunities for financial products. Thanks to improved portability of consumer data, financial service providers were able to offer an elevated product/ service experience which earned them new customers altogether and improved engagement with existing ones.
While Open Banking has been the(much-needed) step toward a more open financial market, it remains a regulatory framework only. Its innovation was—in most part—limited to account aggregation as well as data sharing/ categorization. More profitable products/ services such as lending or foreign exchange were not yet addressed. Necessity and demand were calling for more technological advancements: so BaaS emerged.
In short, BaaS is SaaS but against the backdrop of finance. That means that a customary bank or financial institution (FI) supplies a 3rd party with its banking infrastructure. This infrastructure can encompass a spectrum of financial products/ services, such as bank accounts, KYC, credit cards, bonds, foreign exchange, or crypto. Turning to a BaaS solution rather than building a product in-house, allows 3rd parties such as fintechs to bypass the hassle of obtaining a banking license. This minimized regulatory burden is one of BaaS’s fundamental benefits and has earned it its nickname CaaS (Compliance as a Service). Other positive byproducts include savings in cost, time, and human resources. Next to fintechs being frequent users of BaaS, banks do not have to look far to find customers. They can deploy their proprietary BaaS solution to create their own neo-bank from scratch or supply another bank with their product/ service.
None of these 3rd party exchanges and BaaS use cases would have been viable without the introduction of PSD2 and Open Banking. It goes to show the technological progression and evolvement of banking over the past five years—a progression that does not end with BaaS. Though it massively simplified the regulatory burden of licensing, BaaS solutions are largely focused on back-end processes. 3rd parties are left with a considerable front-end developer effort as it pertains to (e.g.) individual API integrations or creating appealing interfaces.
The existing demand in the market for a more cost-effective, ready-to-use financial product/ service, brought about the concept of Embedded Finance: An offering that allows non-banks (i.e. platforms) to integrate one or more financial product(s).
Frankly, the divide between BaaS and Embedded Finance can be blurry. It appears both terms are used interchangeably to describe the process of plugging financial products into a 3rd party offering. There is, however, a substantial difference between the two concepts. Whilst BaaS delivers a mostly back-end focused product, Embedded Finance does that too—but takes it a step further. Its financial solution is not “merely” a quick back-end plug but also a front-end integration. That way, 3rd parties (such as platforms) do not have to invest time and effort into creating multiple API integrations or a design-savvy interface. Embedded Finance solutions can be plugged into a platform without being visible (i.e. as a white-label solution), creating an exceedingly seamless customer experience. Compared to a BaaS product, Embedded Finance solutions are typically more cost-effective, streamlined, scale more easily, and allow platforms to become a one-stop-shop for their users.
Fintechs like Banxware will set the pace in shaping new banking frontiers. Fortunately, there are many ways to collaborate: Whether you are a marketplace, payment or shop system provider, or a bank yourself, if your platform lacks a financing solution for customers, your future lies with an embedded product. Banxware’s lending product can close this gap in your platform ecosystem. With a simple API integration, we make it as easy as technically possible for you to launch a financing solution. Once our white-label product is embedded, your customers enjoy seamless lending for their businesses, turning your platform into a one-stop shop.
Zooming out, Open Banking set the regulatory cornerstone for inventive banking concepts to come to existence. It caused a new openness—even a necessity—for cooperation between traditional banks or FIs and 3rd parties. Both, BaaS and Embedded Finance emerged from PSD2 and Open Banking. Though they complement each other, Embedded Finance can be viewed as a progression to what BaaS kicked off. A progression greatly accelerated by innovative, daring fintechs like Banxware that aim for a more accessible financial service market and strive to provide the best customer experience possible.