Banking-as-a-service (BaaS) has risen ever stronger over the course of 2022 and 2023. Global market value is predicted to rise at a rate of 16.2% between 2022-2030, driven by digital transformation and increased interest in embedded finance options.
But within this boom of BaaS, cracks are starting to show.
On October 8, 2023, Jason Mikula wrote an explosive report on the trouble between the BaaS platform, Synapse, and Evolve Bank. The pair had entered into a partnership in 2017, and the going hadn’t been easy. Mikula’s report told of a history of discrepancies in transfers, many of which had apparently remained unresolved.
According to Mikula, the reconciliation problems were “astonishing,” differing, at times, by millions. He quoted a 2022 email from Evolve’s open banking controller, Chris Vendetti, which stated, “The balances tend to differ a couple hundred million on the daily. I am comparing the Synapse data to the FBO for consumer and business users. Are there other Evolve core accounts that we should take into consideration for the totals?”
Reconciliation issues became a significant area of friction for the two entities, reaching a head in September 2023, when Evolve terminated the relationship with Synapse. A deficit of €13 million between the parties now hangs in the air, with both parties holding the other responsible.
How could such an “astonishing” deficit have occurred between two established, regulated entities?
The answer could lie in their use of middleware, a common approach for BaaS systems.
The Middleware Approach to BaaS
“Most of the banking as a service platforms that exist build a thing called middleware,” said Ahon Sarkar, general manager, Helix by Q2. He explained that the majority of US banks use traditional core systems for back office operations of their products. The bank’s core is what the customers of BaaS companies want to access.
“It’s old, it runs in batch, but it does things like open accounts and onboard customers effectively,” Sarkar continued. “So a lot of BaaS platforms opted to build an API layer on top of this core that would allow their customers to do things like launch cards quickly…They didn’t rebuild the core.”
Helix, by Q2, since its inception, has focused on building cloud-based core systems for their BaaS solutions. Today, Q2 has extended this approach with its Q2 Fabric solution, providing banks with new cores to build their own personalized digital products.
“The problem with not rebuilding the core is, it’s kind of like taking a Fiat 500 and taking out the body and then putting a Ferrari body on top. It’s still a Fiat 500 underneath. The approach allowed people to launch products quickly, but the moment you needed to actually access the real core, you couldn’t do that. Ultimately, it’s a wrapper around the traditional business.”
He explained that this approach can cause a delay in reconciliation between the two systems. The information collected by BaaS systems is often copied to the bank’s core at the end of each day, which can create points of failure and errors in reconciliation and money movement that are difficult to identify.
“It’s not a real-time source of truth,” he continued. “It’s different sources of truth that like communicate with each other at the end of the day and update themselves.”
The division between the two systems can also affect visibility within the bank.
“In many cases, consumer accounts from the BaaS provider are set up in the bank in what’s called an FBO account, as opposed to like real bank accounts for real people,” he said. “They create one big bank account for the client. And they just subledger all the individual customers underneath. So from the bank’s perspective, they’re seeing one big $50 million account, not 500,000 customers with different balances.”
While BaaS services are, for the most part, compliant with regulatory standards, they have attracted increased scrutiny as the popularity of the sector has increased. The delay between the systems and the separation of the BaaS and bank cores have attracted concern over banks’ oversight.
While news of discrepancies to the extent seen between Synapse and Evolve is uncommon, the makeup of middleware, with a lack of “real-time truth,” indicates how it could come about.
