Disadvantages of Banking as a Service

Banking as a service is set to transform the commercial banking industry. It is the latest buzzword in the commercial banking industry and almost every well-known commercial bank is allocating billions of dollars from its budget to get this model implemented at the earliest. This is because there are several advantages to implementing banking as a service. However, it would be naive to assume that the concept of banking as a service has only advantages and no disadvantages. A careful evaluation can only be done after considering the various disadvantages which are associated with banking as a service.

In this article, we will list down important disadvantages of banking as a service as well as how they impact the commercial banking sector.

1. Reduced Personalization: As we have discussed in the previous articles of the module, commercial banking is dependent upon providing personalized services to large corporations.

   The scale of the business provided by the corporations to the commercial bank makes them feel entitled to receive special personalized service. However, with banking as a service, this is not possible.

   Commercial banks provide white label services and the task of personalization is carried out by third-party fintech providers. Hence, over time, corporate customers become completely indifferent to which commercial bank is being used to provide the service. Commercial banks are reduced to back-end service providers which causes them to lose customers over the long term.

2. Reduced Customer Loyalty: Since the personalization of banking services is reduced, there is no reason for corporate customers to favor one commercial bank over the other.

   In the banking as a service model, commercial banks do not have many competitive advantages over one another. The only reason that they are in existence is that banking licenses are tough to obtain and hence the technologically superior fintech firms have to collaborate with such banks. The end result is that the banks witness a drastic fall in their customer loyalty. This also begins to have an impact on their other revenue streams.

3. Increased Competition: Commercial banks which follow the banking as a service model face increased competition from both other commercial banks and even fintech companies. Since commercial banks have very little competitive advantage which can help them attract customers, they have to collaborate with other fintech companies based on their price offerings.

   The end result is a price war that exerts a lot of pressure on the already thin margins of the commercial banking industry. Hence, the commercial banks are forced to compete with one another in order to obtain a small revenue stream. Also, the importance of commercial banks is likely to get reduced in the long run since they only exist because of licensing norms across the world. If these norms change and banking licenses are given out more liberally, commercial banks will end up facing an existential crisis.

4. Reduced Focus on Technology: It is important to note that almost all experts agree that technology is the future of commercial banking. Hence, it is important for any commercial bank to be abreast with the latest technology if they want to be ahead in the game. However, in the banking as a service model, commercial banks end up outsourcing most of the technical work to fintech companies.

   Hence, the commercial banks tend to become more complacent and start focusing their efforts on providing more mundane banking services. It seems to be a comfortable arrangement in the short run. However, the problem is that over a period of time, the technological gap between fintech companies and commercial banks will keep on widening. The end result would be that fintech companies will become market leaders since they will be better poised to drive technological innovation across the marketplace.

5. Reduced Data Security: Data security is also seen as an important issue by regulators when they think of banking as a service business model. Banking as a service can only operate when data is shared freely across different entities. However, different entities have different players in the value chain.

   For instance, it is possible that one of the partners in the value chain has outsourced its business to an offshore location. Hence, the data will end up being shared in a country where the regulator does not have jurisdiction. Also, the chain of data custodians can be long and complex, and sometimes it can become difficult to ascertain who is really responsible for data security. Until regulators come up with a comprehensive framework that clearly outlines the data security policy, banking as a service will continue to be a threat.

6. Brand Dilution: Last but not least is the fact that commercial banks face a lot of brand dilution as a result of the banking as a service model. Commercial banks are not directly engaged with the customers.

   Hence, the brand image of the bank is not reinforced each time the corporation interacts with the bank. This can cause material losses to commercial banks. The brand value of many such banks is worth millions of dollars and they will witness the erosion of this intangible asset if the banking as a service business model is applied on a large scale.

The bottom line is that the banking as a service business model also has significant drawbacks. It is important for commercial banks to carefully think through their banking as a service strategy before they make an attempt to implement it on a large scale.