Banking as a Service

BaaS & Neobanks: 2023 Roadmap & Regulation

Banking as a Service (BaaS) refers to a business model that enables non-bank companies to offer banking products and services to their customers through partnerships with traditional banks or neobanks. Under this model, banks provide the underlying banking infrastructure, including regulatory compliance, risk management, and banking technology, while the non-bank companies use their own branding and customer-facing channels to offer banking services to their customers. BaaS enables companies to offer a range of financial products and services to their customers without having to obtain their own banking license or build out their own banking infrastructure. This can include products like deposit accounts, payment processing, lending products, and other financial services.

A neobank is a type of financial institution that operates exclusively online, without any physical branches – while utilizing BaaS as its banking platform. Unlike traditional banks, neobanks typically offer mobile apps and web-based platforms that allow customers to manage their finances, make transactions, and access various financial products and services entirely online. Neobanks often leverage modern technologies, such as artificial intelligence, machine learning, and data analytics, to offer innovative and personalized financial solutions. They also tend to have lower operating costs than traditional banks, which they may pass on to their customers in the form of lower fees and better interest rates.

A BaaS provider will typically offer its non-bank partners a range of services, including:

  1. Account opening and management: the BaaS partners provides tools to allow its partners to open and manage deposit accounts for their customers, including checking and savings accounts.
  2. Payment processing: the BaaS provider enables its partners to process transactions, including ACH transfers, wire transfers, and bill payments, through its banking infrastructure.
  3. Compliance and regulatory support: the BaaS partner provides compliance and regulatory support to its partners, including AML and KYC compliance, transaction monitoring, and regulatory reporting.
  4. Loan origination and servicing: the BaaS provider can offer lending products, such as personal loans or business loans, to their customers, with Synapse handling the loan origination and servicing processes.
  5. Card issuance: the BaaS provider can issue debit and credit cards on behalf of its partners, with customized branding and features.

The cost to start a neobank can vary widely depending on a range of factors, such as the scope of the services offered, the target market, and the level of customization required. Standard costs for starting a neobank include:

  1. Technology development costs: Building and launching a mobile app or web platform that offers a seamless user experience and integrates with banking infrastructure can be a significant cost, potentially ranging from hundreds of thousands to millions of dollars.
  2. Regulatory compliance costs: Neobanks are subject to strict regulatory requirements, and complying with these requirements can require significant investments in compliance technology, legal and consulting fees, and regulatory reporting.
  3. Banking infrastructure costs: Neobanks may need to partner with an existing bank or financial institution or obtain their own banking license, which can involve substantial costs such as capital requirements, regulatory fees, and infrastructure development.
  4. Marketing and customer acquisition costs: Building brand awareness and acquiring customers can be a significant expense for neobanks, particularly in a crowded and competitive market. This may involve spending on marketing campaigns, social media advertising, and referral programs.
  5. Operating costs: Neobanks will incur ongoing operating costs, such as payroll expenses, rent, and utilities.

Overall, the cost to start a neobank can range from a few hundred thousand dollars to tens of millions of dollars, depending on the specific business model and the level of investment required. Moreover, The minimum capital requirements for BaaS partners can vary depending on a number of factors, including the type of services provided and the specific terms of the partnership agreement. Popular BaaS platforms include:

  1. Green Dot Bank
  2. Cross River Bank
  3. The Bancorp Bank
  4. CBW Bank
  5. Central Bank of Kansas City
  6. Synapse
  7. Sutton Bank
  8. Marqeta
  9. Stripe Treasury
  10. Galileo

From a regulatory standpoint, the obvious advantage of utilizing a BaaS platform and operating as a neobank is that a banking license is generally not required. However, other regulatory considerations must be taken into account.

First, the question as to whether a neobank must be registered as a money service business (MSB) depends on the specific activities and services that the non-bank intends to offer to its customers. If the non-bank intends to offer financial services that fall under the definition of an MSB, such as money transmission or check cashing, then it may be required to register with the Financial Crimes Enforcement Network (FinCEN) as an MSB under the Bank Secrecy Act (BSA). In this case, the non-bank would need to comply with all applicable AML and KYC regulations, as well as reporting requirements and other obligations. However, if the non-bank only intends to offer deposit accounts and other traditional banking services, then it may not be required to register as an MSB. In this case, the non-bank would still need to comply with applicable banking regulations and obtain any necessary licenses or approvals, but may not be subject to the specific requirements of the BSA or other MSB regulations.

Second, the same rationale holds true as to whether a neobank must obtain state-level money transmission licenses. That is, if the non-bank intends to engage in activities that fall under the definition of money transmission, such as receiving and transmitting money on behalf of others, then it may be required to obtain a money transmitter license in the states where it operates. Currently, there are no specific state laws that specifically regulate neobanks.

Third, the Consumer Financial Protection Bureau (CFPB) is responsible for regulating a wide range of financial products and services, including those offered by neobanks. The CFPB regulates neobanks in the following ways:

  1. Examination and supervision: The CFPB has the authority to examine and supervise neobanks for compliance with federal consumer financial laws, such as the Truth in Lending Act (TILA) and the Equal Credit Opportunity Act (ECOA).
  2. Enforcement actions: The CFPB can take enforcement actions against neobanks that violate federal consumer financial laws, such as issuing civil monetary penalties or pursuing legal action.
  3. Rulemaking: The CFPB can issue rules and regulations that apply to neobanks and other financial institutions, such as rules promulgated under the Fair Credit Reporting Act.

Overall, neobanks offer a range of advantages that can provide customers with greater convenience, cost savings, and personalized banking services.

About Adam Tracy

Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.

Tracy has been involved in the blockchain, payments and cryptocurrency space since 2013, and he has worked with a wide range of clients, including startups, established businesses, and investors. He has advised clients on legal and regulatory issues related to initial coin offerings (ICOs), cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.

In addition to his consulting work, Tracy has founded several companies in the blockchain and cryptocurrency space, including a digital asset hedge fund and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.

Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, CoinDesk, and Bitcoin Magazine.

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