The middleware banking-as-a-service, or BaaS, space is all straight forward.

The definition of “direct” is still confusing. Some players in this space – in general, providers that connect banks to fintechs and provide matchmaking services and technologies – let’s say that tripartite agreements between a bank, a non-bank provider and a middleware provider are still straightforward when the bank has oversight of its BaaS customer. Other vendors say this means selling software to banks that will boost their BaaS capabilities, but leaves fintech involvements entirely in the bank’s hands.

Regardless, the role of financial institutions in this space is widely recognized require more supervision of their partners.

“Direct or indirect is not the issue,” said Jonah Crane, partner at Klaros Group, who notes that most middleware companies have largely facilitated direct relationships between banks and fintechs over the past couple of years. “The real question is: who is doing what?”

Regulators are worried about how little banks understand theirs fintech partners and the confusing arrangements are over which party is responsible for which aspects of risk and compliance.

“The easiest way to manage risk is to get closer to it,” Crane said.

Suppliers including Synctera, Treasury Prime and Unit have adapted in recent months and have increasingly shied away from such tripartite contracts. But the question of how middleware vendors can survive in a space where banks are more reluctant to offload some degree of oversight looms larger after one of the early players in this space, Synapse, filed for bankruptcy. Instant payments company TabaPay then pulled out of the deal to acquire Synapse’s assets. (Synapse founder Sankaet Pathak did not immediately respond to a request for comment.)

However, industry observers find it Synapses era uniquely problematic.

The BaaS middleware model is not broken, said Kirsten Muetzel, who advises banks on financial risk management and compliance as founder and director of KLM Advisory and was previously chief risk officer at Synctera, where she still holds stock option.

“The problem is that regulators have found that some banks have completely abdicated responsibility for overseeing these middleware vendors and partners,” he said. For community banks, which tend to lack large, sophisticated risk management staffs, the BaaS provider “[is] augmenting, not replacing.”

The economics of business are also changing. If they maintain their efforts in this area, banks may face increased compliance costs.

“Middleware vendors will need to focus on the core value they provide, which is the transfer of data and information,” said Jason Henrichs, founder and CEO of community banking consortium Alloy Labs Alliance. “It is not possible to charge costs for services that the bank will have to duplicate anyway.”

What does it mean to go direct

Itai Damti, co-founder and CEO of Unit, founded four years ago, sees three elements in Unit’s role in the bank-fintech relationship.

One is technology services, where non-bank customers will use Unit’s application programming interfaces to download customer statements or apply for a debit card. Another is managed services, such as producing and filing 1099-INT tax forms on behalf of the fintech client. The third is the exchange of communications between banks and fintechs in a standardized way. For example, if the fintech wants to increase ACH limits for a specific customer, Unit will explain the reasoning to the bank, obtain approval, and pass this approval to the fintech using its template.

The third piece is changing so that banks and fintechs can communicate without as much participation from Unit. Banks can apply any template for launching or modifying the program instead of using the Unit template. Unit is also introducing more features in its supervisory dashboard that allow banks and customers to communicate without contacting Unit so that, for example, a fintech can possibly request a limit change for its customer in the Unit dashboard and receive the approved by the bank, with a verifiable check. extra paper trail.

“We are increasingly breaking out of the communication loop and asking parties to speak without relying on us,” Damti said. As he has seen regulators increase their expectations of partner banks, “We don’t want to run the risk that Unit might forget to say something or ask a question. This direct exchange allows the bank to have full control and visibility over the line of reasoning customer,” he said.

Blue Ridge Bank, Choice Bank and Piermont Bank they are all former clients of the Unit.

Treasury Prime, founded six years ago, sees itself as a software provider that allows banks to put rules in place to manage relationships with fintech partners. Fintechs use its APIs to open bank accounts, issue cards, send ACH, wires, and more.

“When Jim [Brusstar] and founded Treasury Prime, we had the idea that we would focus on managing the operational, legal and contractual risks associated with the broader banking industry and would not explicitly handle any compliance ourselves,” said co-founder and CEO Chris Dean “Our first customers were the banks. Banks had their own fintech relationships.”

About four years ago, banks started asking Treasury Prime to also act as a sales arm, so the company struck some deals through tripartite agreements between the bank, the fintech and Treasury Prime. Towards the end of 2023, that business sector began to fade away as banks preferred to wind down their operations for compliance reasons. Treasury Prime eliminated this arm entirely in February, which led to the layoffs reported that month.

“We started to see the cost of the relationship increase dramatically as the regulatory environment tightened,” Dean said. “Regulators didn’t like this three-way deal at all.”

Synctera describes itself as a marketplace where banks and fintechs create relationships and a system of record when those relationships are formed. It provides APIs for accounts, payments and loans, and tools to manage operations, compliance and data needs. Coastal Community Bank in Everett, Washington, was his first customer.

Historically the company has signed tripartite agreements with the bank, the fintech partner and itself. More recently, it has offered other contract models, including the ability for a bank to contract directly with a fintech and for fintechs to use the Synctera platform by seeking relationships outside of their banking network. In all versions, the bank retains direct oversight rights and compliance responsibility for fintech partners, Synctera says.

“Direct bank supervision, in its most abstract terms, means: Does the bank know what is happening to end consumers, and do they understand KYC and all their transaction obligations?” said Peter Hazlehurst, co-founder and CEO of Synctera. “Technology has positioned itself in the middle to make this possible.”

Some new entrants into the overall BaaS technology space structure “lead” differently.

Braid, launched in November 2022, licenses software to banks that want their fintech payment processing operations in-house rather than using a third-party processor or BaaS middleware platform. Portage Bank in Bellevue, Washington, has partnered with Braid, while another bank and a credit union have signed contracts.

Randy San Nicolas, co-founder and CEO of Braid, describes it as a parallel core, where the retail business remains in the existing core system. “This is an on-premise installation. The banks will install it in a cloud environment that they control,” he said. “The most important thing is that they can kick us out. We are a seller of the bank and not of a third party.”

For him this is the key to “going direct”.

“Everyone says ‘we will give control to the banks,’” San Nicolas said. “We define control as giving the bank full ownership of the software and all the technology surrounding it.”

Infinant provides embedded financial technology to banks in a cloud-native software-as-a-service model that overlays their core systems, including capabilities to open accounts, issue cards and move money. Banks can use existing fraud monitoring, customer insights and anti-money laundering software or Infinant’s vendors. It has been on the market for more than a year and has five banks as clients.

“Fintechs have a direct relationship with the bank and we do not take part in that relationship,” said Riaz Syed, founder and CEO of Infinant. “There is no tripartite agreement.”

Their entry into the market suggests there is unmet demand, Crane notes.

“They position themselves by telling banks we’re not trying to disintermediate you, we’re a technology layer for you,” he said.

The next direction middleware will head

In recent years the Unit has moved toward larger deals, such as public or more mature companies with “significant distribution,” Damti said.

“Banks don’t want to serve smaller companies these days,” he said.

Hazlehurst says Synctera has added banking partners in just the last year and a half and regularly signs two to three new fintech clients every month.

“The market is fundamentally supply-constrained,” he said. “There are not enough banks ready to take on fintech programs and launch them.”

Like Unit, Synctera is raising the bar for which fintech clients it will accept as banks tighten their risk appetite. Most of the non-bank companies it signs tend to be at Series C or higher, or are public companies. In the past, Synctera has most commonly signed startups in the seed or pre-seed stage.

Even as compliance costs for BaaS banks increase, “these partnerships are imperative for them to be integrated into the system. VCs funding fintechs will need to factor this into their estimates,” Crane said. “Some form of technology layer is going to be critical because community banks are not going to build that layer on their own.”

Some suppliers have cut staff to move forward in this new reality.

Treasury Prime has laid off employees after closing the part of its business that sought fintech partners for banks. Synctera laid off employees in March to streamline the business and give it more financial autonomy. Meanwhile, the company has strengthened its payment operations and compliance teams.

The unit did not carry out any layoffs. In the future, it plans to add loans beyond banking to the services it facilitates; perhaps monetize forms, such as 1099-INT filing, which charges no additional fees for today; and sell Unit as a lateral core system so banks can launch their own white-label digital experiences.

The layoffs at Treasury Prime and Synctera may be more of a temporary bump in the companies’ trajectories than a serious sign of trouble.

“It’s the recognition of the change between what you can charge and what your core business is,” Henrichs said. “It’s an acknowledgment that the model has changed.”

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