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Bad FinTech News: European Regulators Crack Down On BaaS Providers!

Regulators crack down on BaaS providers
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Amy O’Brien published an interesting article on BaaS on Sifted, elaborating on the regulatory hurdles for BaaS providers. The European fintech sector, with 61 unicorns, would now face a regulatory storm. Most notably, the prevalent Banking-as-a-Service (BaaS) model, which fueled the rapid growth of companies like Revolut and Wagestream, is under regulatory scrutiny. Investors shy away from the €100 billion market!

BaaS: A Double-Edged Sword for Fintechs

BaaS platforms have been the bedrock for 82% of European fintechs, enabling them to launch swiftly by avoiding the labyrinth of securing a banking license and building their own infrastructure. However, the very foundations of these fintechs are now shaking as their BaaS providers face regulatory clampdowns, with some founders expressing fears of potential shutdowns.

Banking-as-a-service (BaaS) providers offer a range of services, including account management, payments, and lending, among others. BaaS is a rapidly growing industry, with a market size of €100 billion in Europe alone, according to a McKinsey report.

The Crux of BaaS Providers

Holding necessary banking and payment licenses, BaaS providers offer a lifeline to fintechs by selling regulated financial services through their infrastructure. This model allowed fintechs like Revolut to operate with an e-money license in the UK while partnering with BaaS providers for licensed activities such as account creation.

Regulatory Restrictions Tighten

But now, the BaaS providers that underpin Europe’s fintech ecosystem are battling regulatory pressures. High-profile cases include Railsr‘s license revocation by the Bank of Lithuania and restrictions on new customer onboarding by the UK’s FCA. Similarly, Germany’s Solaris faces a “permission proviso,” requiring regulatory approval before taking on new clients.

Read the Railsr reports here.

As regulatory challenges mount, investor confidence has waned, with funding for BaaS startups plummeting by 94% from 2021 to mid-2023. The once-buoyant BaaS sector is now grappling with the consequences of rapid growth without proportional compliance capabilities.

The BaaS Business Model at a Crossroads

The asymmetry in the BaaS business model is becoming apparent. Fintechs have benefited from the speed and ease of scaling provided by BaaS platforms, but the regulatory onus falls heavily on the BaaS providers. Y

With the sector’s past leniencies no longer viable, fintech founders and BaaS providers alike are reevaluating their operational models. Weavr, for instance, is opting to internalize processes typically handled by fintechs to mitigate compliance risks. Yet, this approach might not be universally applicable, suggesting that the next generation of BaaS may prioritize compliance from the outset.

As the BaaS model undergoes its sternest test, the industry ponders whether it can withstand the tide of regulatory scrutiny. The consensus is clear: without a substantial realignment that equitably distributes risk and emphasizes compliance, the BaaS model, as it stands, might not survive.

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