Towards a new digital era
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While trying to adapt to our needs and expectations as modern customers, financial services take firm and fast steps forward into a new digital era. To keep pace with FinTechs and the innovations that come along with them, traditional banking institutions also search for new ways to technologise their product offers. At this specific point, BaaS and Open Banking arrive on the scene.
With BaaS and Open Banking which make banking transactions easier than ever, customary ways of managing finances and doing ‘business’ are becoming a history. Although BaaS and Open Banking might seem like similar banking models to those who have a small grasp of the topic, they have significant differences. Thus, it is vital to understand how each model differentiates and what kind of benefits they offer to customers.
Let’s take a closer look at what BaaS and Open Banking are.
What is this BaaS?
Essentially, BaaS could be defined as a business model where chartered banks place their online banking services into the products of their nonbank partners. In other words, it is a model in which banking services and products are provided via third party distributors. BaaS, which integrates nonbank businesses with a regulated infrastructure enables special offers and their fast release.
This is achieved through a process where banks authorise third parties to connect to their systems via application programming interfaces (API). Once the connection is established, nonbank institutions can offer banking services to customers without having to get a licence. These banking services may include various offers, from loaning and payment to bank cards and digital wallets.
If we were to give an example to further explain: Suppose that you are the director of an airline company. In a highly competitive atmosphere, in order to strengthen customer loyalty, you can provide the customer with a privileged bank card and give them loyalty reward points when they pay with that card. Customers using this card means that they interact with your brand which makes it possible for you to analyse their spending habits, understand them better and offer them more specialised services.
Or suppose that you can directly grant online loans to your customers for plane tickets on your website. This way, while your customers can finance their flights without interruption, you can increase the number of plane tickets you sell and directly impact the customers’ sum of spending.
There are dozens of ways of improving customer experience and increasing their revenues for nonbank institutions by offering their own services. However, if you want to offer banking services, every government in the world requires you to get a banking licence. On the other hand, getting such a licence is not only very difficult due to important capital requirements, but also due to the commitment to strict regulations on money laundering, banking confidentiality, and deposit protection. BaaS steps in at this point.
Defined as a business model where chartered banks place their online banking services into the products of their nonbank businesses, BaaS enables nonbank institutions such as airline companies to provide customers with digital banking services such as mobile bank accounts, bank cards, loans, and payment services without having to get a banking licence.
What about Open Banking?
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Just like BaaS, Open Banking too, includes the connection of banks to nonbank institutions via APIs, which is the main reason why the two models are confused with each other. But, these two models serve completely different purposes. While nonbank institutions integrate banking services into their own products in BaaS, nonbank institutions known as third party providers (TPP) only make use of the data provided by banks for their products in Open Banking.
For example; making use of Open Banking, financial management applications are outstanding TPPs. These applications gather the data in all of your different bank accounts under a single application which might help with achieving your goal for savings or improving your spending habits by giving you a better control of your financial condition. However, this means that such an application will collect your data and import the transaction data from all of your bank accounts. This happens with an API integration into the banks’ systems.
On the other hand, since TPPs do not have a proper banking licence, they cannot execute certain banking services such as giving loans or depositing as opposed to BaaS providers. In this case, we can conclude that the essential difference between Open Banking and BaaS is ‘what is shared’. According to that, while Open Banking safely shares the data of existing banking customers with third parties, BaaS grants third parties access to banking transactions, using the existing infrastructures of banks.
What are the pros and cons of BaaS and Open Banking?
Advantages and disadvantages of BaaS
BaaS, the combination of technology and finance, which provides beginners, and service providers with the opportunity of offering modern financial products/services which were previously subjected to strict regulations and offered by traditional financial institutions, extensively complements a financial service that is provided upon online requests and managed within a fixed time. Although it sounds like this model facilitates everything, it has certain problems within itself.
So, what are they?
Banks can expand their realms: As banks continue to meet our needs, they can partner up with institutions that help expand the reaches of banks at the same time.
- The interest in banks can be sustained: Banks can make use of BaaS to adapt to the continuously transforming digital environment.
- Companies can offer banking services: Nonbank businesses can benefit from all the advantages of having access to banking processes to offer you a wide range of services instead of creating their own processes.
- More options for customers: As a customer, you get more options about how and where to make transactions with BaaS. In addition, more competition in the sector theoretically means more savings for you.
- Competition can decrease the customer bases of banks: For banks, BaaS signifies the risk of losing a portion of their market share to nonbank companies that provide better service.
- Generally, they do not have one-on-one relations: If you prefer digital banking, but also face-to-face interaction with your financial institution at the same time, we can say that BaaS accounts aren’t your thing.
- Your data is less safe: Since you use two companies for your banking transactions (the company that offers the account and the bank), your data is exposed twice, instead of once.
And now, the advantages and disadvantages of Open Banking
Of course, Open Banking, which is based on credit cards, account statements, data on account types, and everything else related to the finances of customers, has advantages and disadvantages. Let’s take a quick look at them:
Helping customers with their operations: Open Banking makes it much easier to provide suitable responses and services for each individual’s needs . The reason is that many existing APIs and newly emerging APIs simplify everything. All you need to achieve that is access to technology. If the access is gained, both the time you spend on financial operations decreases and your operations become automated.
- Centralisation of services: With Open Banking, banks get full control of various services customers need such as advice, loans, transfer and finances. This way everything is done with more visibility and under a single administration.
- Increase in the financial market: More customers coming to Open Banking and diversification of APIs and services increase in direct proportion. This way countless offers adapted in accordance with everyone’s needs emerge.
- Reputation: We can claim that there is a lack of interest and trust towards Open Banking. This results partly from customers’ concerns of sharing their data and partly from the lack of information on how Open Banking works
- ‘FinTech’: The FinTech market is rapidly growing, and the growth of such companies poses a great disadvantage to big banks since they replace many services traditionally controlled by banks. FinTechs that offer various services and increase in number, can be more appealing to the customers by being simple, fast, and low-cost.
- It eliminates the interpersonal relationship with customers: As we mentioned while talking about the cons of BaaS, addressing everything digitally in the Open Banking model means that the talks between customers and the bank will be digitised too, which can lead to degeneration in the psychological relationship and brand loyalty between customers and providers.