There’s no doubt that Banking-as-a-Service (BaaS) is contracting amid the model’s regulatory scrutiny and outright failures. Sponsor banks are skittish about adding program partners, the market for new entrants has frozen, and some sponsor banks have shrunk or started to unwind their BaaS programs completely. We estimate that at the market’s peak, there were about 100 BaaS sponsor banks in the US, dominated by community banks — about 70% of sponsor banks had less than $10 billion in assets and 60% with less than $5 billion. That mix and high number won’t last.

Regulators better understand BaaS, but parts of their response to things gone wrong is causing whiplash in the industry. They’re catching up to the BaaS of three years ago and reacting to today’s most egregious failures, not always in productive ways. This turn of events shows how quickly things can go south for an innovative business model. A proposed FDIC rule, if finalized as drafted, would effectively reverse regulatory support for BaaS that has been in place since 2020.

BaaS has swung from its high point to its low. With the community bank-driven stage of the model nearing its end, it’s a good time for bankers to reflect on the excesses that led to BaaS’ fall from grace and look to measured practices for innovation (as we’ve discussed). Bankers must be ready to evaluate and adapt appropriately to what comes next in today’s fintech-enabled, partnership-driven world of banking.

Recent statements from regulators suggest how bankers should be wary about partnership-driven innovation strategies, particularly when they depend on third-party channels. It’s not a short list. A recent interagency document looked at BaaS with a focus on safe and sound practices and financial-crime prevention. In addition to third-party risk, it cited potential problems with operations, compliance, growth, and governance. All those factors get more complex as the number of partners grows, even more so when intermediary vendors are involved (an approach on its way out amid compliance, and in some cases, competence concerns).

There’s an industry-level responsibility to manage risk appropriately, but under today’s regulations and expectations, the buck stops at the bank for controls. It’s wise to be on the same page as partners about responsible growth; have the operational capacity to keep up with them; where applicable, acknowledge concentration risk from certain partners and partners’ financial products; keep partners close; and follow through on due diligence.

As we’ve noted, the key to a successful innovation strategy is focus — being good at identifying where a bank’s capabilities align with its opportunities, taking advantage of that alignment, and conscientiously managing risk. Banks need to double down on their strengths and to build their expertise in areas they want to innovate. Dabbling isn’t how it should be done.