Origins of Non-Bank, Consumer-Facing Fintechs
When the fintech industry emerged in the late 1990s, non-bank technology platforms initially offered person-to-person payments. Next came the expansion of person-to-merchant payments, supported by regulated banks that focused on deposits, merchant acquiring or ACH (Automated Clearing House) processing. Before merging to become Paypal in 2000, Confinity and X.com are examples of non-bank tech companies that launched person-to-person payments near the end of 1999.
The Rise of Banking as a Service (BaaS)
As the fintech industry evolved, the need arose for more complex services supported by sponsor banks. Demand grew for more robust fintech solution-stacks, leading to the rise of BaaS platforms on which fintechs could embed these services relatively quickly via APIs. While these APIs were easy to use, most of the services were built on an amalgamation of legacy vendors that weren’t designed to support embedded finance.
As more fintechs emerged, and more feature-rich, comprehensive products were offered, the dimensions of regulatory risk and compliance obligations inherited by the sponsor banks grew exponentially.
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The infrastructure that was necessary to manage and mitigate these risks arising from multiple services across multiple products created additional barriers to entry for the industry.
In addition, fintechs in the early stages of BaaS were wholly dependent on single bank sponsors. If any hiccup occurred on the technical or regulatory front, it led to a stoppage in onboarding new customers.
The Elegant and Scale-Enabling Solution Going Forward
Imagine a fintech or BaaS provider leveraging multiple banks – yet with each bank, integrating a specialized set of services that are fintech-optimized to meet each bank’s scale, risk and compliance profile. For example, one bank may provide money movement services, another providing BIN sponsorship, a third providing international transfers, while a fourth bank with a larger balance sheet provides deposit services. In this approach, each bank can be considered a module of a larger, integrated, end-to-end solution.
This is Modular Banking, which features a regulated BaaS provider, bank partner specialization, and the diversification of bank services provided by multiple banks on a modular platform, making the entire ecosystem more reliable while lowering risk.
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However, this model poses a challenge in which the fintech or BaaS provider has to be in the flow of funds and regulated to build the necessary network. For this reason, Synapse created two regulated entities: Synapse Brokerage LLC, 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 to be the account administrator of record rather than an underlying bank holder. Our lending entity enables us to underwrite and originate loans for individuals and businesses in designated States without needing a sponsor bank. This lightens the load for banks, which don’t have to onboard accounts directly and can move from an ‘all-or-nothing’ approach to a specialized, back-end service approach.
Modular Banking also empowers 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 the BaaS platform.
For banks, there is wisdom in not only a regulated entity working with them, but also working with multiple banks to provide incremental capabilities for a larger solution. Fintechs like PayPal are similarly built, regulated and have proven that this model can work at scale. Thanks to forward-thinking innovators like these, BaaS platforms are paving the way to ensuring everyone has access to financial services regardless of their net worth.
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