What we’ve been thinking: Despite the painful regulatory reckoning the banking-as-a-service market is undergoing, banking and fintech analysts are talking about the potential behind the concept of headless banking—another form of sponsored banking—per the Financial Brand.
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Headless banking has been described as “banks without apps or a user interface”—that is, financial institutions (FIs) that offer banking services decoupled from front-end user interfaces.
Why it matters: Over the past year, lower profit margins caused by higher interest rates, tightening regulation around smaller banks, and the plummeting value of commercial real estate has created a challenging environment for more modestly scaled FIs.
- US Treasury Secretary Janet Yellen has warned that, as a result, some smaller FIs would fold or merge, and business publications have run somber editorials with titles like “Too Small to Survive?” and “Will America’s Smaller Banks Die—And Should They?”
- As a survival strategy, smaller banks will need to “get big, get embedded, or get creative,” per Bain Capital Ventures. That second option includes exploring the different flavors of banking as a service (BaaS)—which now includes headless banking.
Yes, but: The BaaS business model to which headless banking is related has been the subject of not-good headlines weekly as regulators ding banks for their sloppy third-party know-your-customer (KYC) and compliance processes.
Nevertheless, BaaS remains a great equalizer for smaller FIs, helping them benefit from collaboration, better align their financial products with customers’ needs—and emerge as leaders alongside big banks.
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The US BaaS market is still expected to top $25 billion in annual revenues by 2026, per Cornerstone Advisors.
What is headless banking? We’ve already used the term three times, so let’s explain it.
- Headless banking enables banks to stop caring about providing the perfect customer experience by letting another business handle customer interactions.
- Instead, headless banks focus solely on delivering banking services like checking, bank accounts, or an automatic clearinghouse infrastructure through an open application programming interface (API).
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Banks that do headless banking have been compared to Shopify, an e-commerce platform that helps small businesses build an online store and sell through one simple, user-friendly dashboard.
How does headless banking differ from BaaS and neobanks? Headless banking dispenses entirely with the conventional banking infrastructure.
- That’s not the same as Chime or MoneyLion, for example, which serve as an alternative to traditional banks.
- They concentrate on offering a user-facing experience and rely on partnerships with licensed banks like Bancorp or Pathward to hold deposits and issue cards.
Break that down for me further, please: Banks are made up of three different elements: systems of engagement, systems of record, and their banking charter. The last is pretty self-explanatory, so let’s look at the first two, according to Geoffrey Moore’s definitions.
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Systems of record focus on optimizing business processes and transactions. That’s what core banking systems enable—”the infrastructure underpinning the experiences customers touch every time they log in,” according to Ben Goldin, founder and CEO of the fintech Plumery.
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Systems of engagement are optimized for interactions with customers. They provide the functions that support and power the digital experience in mobile and web banking.
Headless banking combines the technology and infrastructure underlying systems of record with a banking license—and lets partners focus on systems of engagement to offer financial products and interact with customers.
Who’s actually doing headless banking?
- Firms with banking licenses that focus on these services are Column in the US, founded in 2022 by Plaid’s co-founder, William Hockey; Solaris Bank in Europe; Griffin Bank in the UK, which recently ran a Series A funding round; and Pave Bank in Singapore.
- Some banks that do work with consumers also offer this service. In the UK, examples include Starling and @NatWestGroup Boxed.
What’s the advantage of headless banking? For some banks, it ends the digital and artificial intelligence-powered customer experience arms race. The model better allocates roles and responsibilities of groups and lets them focus solely on what they do best.
- Empathetic experience designers can deliver what customers want and need—while banks provide compliant, stable and reliable financial transaction platforms.
Memorable quote: As Simon Taylor, head of strategy and content at Sardine.ai, wrote on LinkedIn, “If you’re a smaller bank and don’t have the funds to invest in customer experience, maybe the answer is not to compete on digital user experience.”
Our take: The buzz around headless banking feels a little like the rising hype over BaaS before the end of 2023 and a steady stream of consent orders. Yes, it could be attractive to community banks and provide a new way of generating revenue.
- But regulators haven’t caught up with this idea of the bank not facing customers. At the moment, banks are far from being able to wash their hands of their responsibilities for knowing their customers and AML compliance.
- And headless banking requires a hefty tech investment in robust APIs, which let partners access back-end data structures and business logic. Unlike most banks, Column’s entire tech stack is built around having APIs, and required three years’ work to create a customized core focused on supporting fintech developers.