Introduction
When the Fintech industry emerged, regulated banks needed to support simpler product constructs through Fintechs, narrowly focused on deposits, merchant acquiring or ACH (Automated Clearing House) processing:
* Orange denotes legacy technology
Anything that fell outside of those use cases and required a more comprehensive service had to be entirely customized at the bank and the fintech level:
*Orange denotes legacy technology
As the Fintech industry evolves, the need for comprehensive services has only grown. This evolution has led to the rise of Banking-as-a-Service (BaaS), where Fintechs can embed these use cases relatively quickly via APIs. Even though the APIs are easy to use, the sad reality is that (under the hood) most of these services are built on an amalgamation of legacy vendors that were never meant to serve the embedded finance use cases.
*Orange denotes legacy technology
On top of that, as products are becoming more comprehensive, the dimensions of regulatory risk & compliance obligations inherited by the sponsor banks has only grown.
The increase in product requirements has also added additional barriers to entry for banks to participate in the Fintech revolution. It takes time to build the right infrastructure to manage and mitigate the risks arising out of multiple services across multiple products, versus just one or two. The dimensionality of risk and operational complexity only seems to be growing.
Further, Fintechs are wholly dependent on single banks. If any hiccup occurs on the technical, and more importantly on the regulatory front, it leads to a pause in onboarding new customers, or worse, even outright suspensions.
In short, to enable the Fintech market to scale further, the following challenges need to be solved:
Two Solutions
To be able to solve the challenges highlighted above, we propose two different ways of approaching the solution:
While both options are good ways to serve the evolution of fintech needs, both pose their own set of challenges.
For instance in the case of Multi-Banking, while it does reduce the single point of failure risk, it does not address any of the other challenges.
On the other hand, Modular Banking addresses all challenges listed above, but poses a unique challenge where the Fintech or BaaS provider has to be in the flow of funds to be able to effectively build a network like this. For that to be possible, the BaaS provider or the Fintech must be rightly regulated.
A good analogy to describe Modular Banking is that this approach makes BaaS a froyo machine. The different yogurt flavors from sponsor banks come together to make one treat (or solution in this case). Said differently, banks supply the ingredients they feel most comfortable with (e.g. Fed sponsorship, BIN sponsorship, etc.), while the BaaS provider builds the technology that eliminates legacy vendor reliance, and acquires appropriate licenses to diligently manage regulatory responsibilities.
Our Choice
Because of all the benefits highlighted above, we believe that we are at an inflection point in Fintech and BaaS, and that Modular Banking represents the next chapter.
For that reason, we have been working diligently to get rightly regulated for the last two years and we are happy to report that we have two regulated entities that are fully operational.
Synapse Brokerage LLC is a registered broker-dealer and member of FINRA and SIPC and Synapse Credit LLC, a licensed U.S. state-by-state lender. Our broker dealer license allows Synapse, as opposed to an underlying bank holder, to be the account administrator of record. Our lending entity enables us to underwrite and originate loans for individuals and businesses across the US without needing a sponsor bank. This means that banks don’t have to onboard accounts directly. Now, they can move from the ‘all-or-nothing’ approach to a specialized, back-end service approach. This approach enables us to build a much more modern stack for our customers:
*All technology managed by BaaS and Fintech. Bank partners just manage sponsorship
Modular Banking is also empowering our customers to bring their own sponsor banks for certain modules of their choice (like BIN sponsorship) with little-to-no effort. This is because incremental integrations with partner banks are much easier in this model for both the sponsor bank and Synapse.
For banks, there is wisdom in not only a regulated entity working with them, but also working with one to multiple banks providing incremental capabilities for a larger solution. In Synapse’s case, we were doing that through an API versus directly to a customer. But we are not the first ones to scale a model like this. PayPal, for example, is built similarly (except consumer facing). It’s a regulated Fintech with banks specializing in one or two commercial products at the wholesale level. We have drawn inspiration from the success of this model and have brought it to the BaaS ecosystem.
Regulatory Analysis
Modular Banking represents a fundamental shift for BaaS. It creates the quickest route to launch financial products via a BaaS platform optimized for Fintechs and enables banks to participate in this ecosystem at a faster pace by reducing their scope and overall risk.
Most importantly, Modular Banking reduces regulatory risk for both Fintechs and banks. For Fintechs, underlying services are distributed across specialist bank partners. There is no single point of potential disruption. For partner banks, through their ability to specialize, their services are streamlined and optimized for Fintech ecosystem support. Making the whole model far more stable and resilient.
With Modular Banking, the regulatory and compliance burdens include the regulated and licensed BaaS platform provider as well. In this model, the roles and responsibilities of all parties are the clearest they have ever been in the history of Banking-as-a-Service.
In comparison, in the older model (even with Multi-Bank), the liability more heavily sits with the bank partners. Given its an all-or-nothing setup, the risk profile only increases in scope and magnitude:
Modular Banking makes the entire ecosystem more reliable and less risky through a regulated BaaS, bank partner specialization, and the diversification of bank services provided by multiple banks on a modular platform.
It doesn’t need to be all-or-nothing anymore.
What’s next for our customers
We are thrilled about the future prospects of what Modular Banking can bring to the industry. Our goal is to extend this benefit to all of our customers over time.
If you are a customer currently implementing with us, you are already leveraging our modular banking technology. If you are already live, we will soon be reaching out to you to enable modular banking by disclosure updates (no API updates needed).
If you would like to enable modular banking sooner rather than later, you can also reach out to your customer growth manager to expedite this update.
