For the last decade, customer-facing financial technology (fintech) companies have been successful unbundling the products and services of banks and credit unions — offering a la carte, hyper-focused products that dramatically improve the experience around specific value propositions for customers. “Breaking banks” was a common phrase among startups, and this mindset broadly modernized financial products for customers around the world. 
‍

For fintechs to transmit money, banks were (and are) still required to support payment infrastructure and other critical services. The earliest institutions provided these “Banking as a Service” (BAAS) tools in exchange for fee revenue and cost-effective deposits. In the earliest days of BAAS, the barrier to entry for fintechs was still high due to the nature of working directly with banks. 

‍

To reduce the barrier to entry, middleware “Banking as a Service” (BAAS) platforms emerged. They asserted their “you don’t need a bank” model and reinforced rapid growth for fintechs. The middleware BAAS platforms took on larger roles in “managing” bank partnerships (creating a wedge between bank and fintech), reduced the overhead for banks to support BAAS systems, and brought greater fee potential to banks through scale. On the other side, middleware systems eased the point of entry for an increasing number of fintechs to enter the market. This has become known as the “indirect” model. 
‍

Removing Friction for Fintech Developers:  the “Indirect” model

This multi-layer “indirect” model was developed because it wasn’t feasible for every fintech company to develop connections into a bank’s core system, nor were banks willing to take a leap of faith for newly capitalized fintech companies. The development of middleware companies that took on the one-to-many chore enabled thousands of startups to quickly develop and launch new products. These platforms also allowed many small banks to grow their deposits cheaply by leveraging venture-backed marketing budgets. It seemed to be a win-win.
‍

‍

Nearly 140 banks in the US currently offer BAAS programs via these middleware layers, and it is still the most prominent model today.

Evolution to a Maturing Industry 

Over the last several years, a few things have occurred to force the industry to begin to evolve. 

‍

First, the Covid-19 pandemic forced many banks to accelerate their own plans to develop and deploy new technological solutions. For a growing number of banks and their core system providers, this modernization has again unlocked the business opportunity to power fintechs directly. 

‍

Second, visions of grandeur and increased competition negatively impacted the most successful middleware companies. A few of the most well known platforms were preparing for IPO exits and seeking to prove greater efficiencies through ever-increasing scale and product diversification. Amidst competitive pressure to show profitability and push into new markets, middleware companies seemingly favored growth over governance. 

‍

Third, the undeniable success of the industry became too big to ignore. With nearly half of new accounts in the US being created by fintechs in 2023, the “neobank” industry became much more than the fad some had anticipated. As a result, regulators began to more carefully investigate the indirect model and the various players supporting it to gain a better grasp of the underlying risks. For several of the players, those risks were unchecked and introduced threats to the monetary system.

‍

The culmination of these forces have resulted in a series of consent orders to both banks and fintechs in 2024. The most prominent blow to the industry was the April 2024 bankruptcy and collapse of Synapse Financial Technologies (Synapse) and the freezing of over $100M of end-customer funds at its partner banks. Synapse worked across multiple banks, offering access to both brokerage and standard bank accounts. To standardize the process for their customers, they developed their own ledgering (accounting) system. Small differences across the ledgers of theirs and partner banks systems widened over time, culminating in $85M in missing customer funds as of May 2024. This issue is currently unresolved with all parties pointing fingers at each other and none stepping up to pay for and reconcile the variances. 

‍

The future of fintech neobanking will survive (the opportunities are too big and the prospect for fast and cost-effective growth is too great), but the industry is necessarily adapting to the shocks and changing landscape.
‍

Innovation without Reckless Behavior

Forward looking banks and fintechs have started to explore the “direct” model (again) as a means to pursue prudent growth. The tech solutions are more accessible for more banks. So far, less than 20 BAAS banks offer direct programs, but this number is likely to grow in the coming years.

‍

In a direct relationship, banks absorb the role of the middleware platform and develop their own suite of API endpoints wrapped into their far more robust compliance framework. For banks that offer a “direct” option, banks rebundle certain services, such as Know Your Customer (KYC) and Know Your Business (KYB), and generate fee income by offering those services to their fintech clients while maintaining greater compliance oversight across customers and platforms. For fintechs, greater compliance provides resilience and a solid foundation on which to grow and develop. 

‍

This not only improves the safety of the entire platform, but it also reduces costs for these needed services for fintechs. Improving margins for the bank and reducing costs for the fintech partner create a more sustainable platform overall.

‍

‍

The required overhead will emerge as a problem for many “direct” BAAS banks and middleware companies are adapting their own models to serve those heightened needs.

What does the new model look like for customers? From the end-customer’s perspective, not much changes. Customers still interact with their primary fintech, which now has a shorter path to bank representatives to solve problems, address concerns/risk, meet regulatory requirements, and more. 

The Future of Fintech Banking is Direct

In the coming years, there is no doubt that new models will emerge. One thing is certain though — each of those models will favor greater control and transparency between fintechs and partnering banks. The rallying cry of “Breaking banks” will turn into something akin to “Supporting banks”.   

With a direct relationship, both banks and fintechs have aligned long-term incentives to grow the entire program in a safe and effective manner. Middleware providers still enable a majority of the industry today, but are likely to evolve into overhead solutions to enable direct relationships. As BAAS banks take on a growing roster of clients, more responsibility and accountability, regulators will become increasingly comfortable with the new breed of fintech companies.

Fintechs and BAAS partners that prioritize safety, sound business practices and risk management will continue to thrive.