Regulatory whiplash in Banking-as-a-Service (BaaS) threatens a business strategy relatively popular among community banks. Most at risk is the deposit-focused model common to the neobank era. Regulators have attempted to address risks common to BaaS amid over a dozen public regulatory enforcement actions on sponsor banks related to their BaaS programs — we’ve seen recent third-party risk guidance for community banks, and as we just covered, a statement on deposit products offered through third parties.

We appear to be on the road to regulatory normalization. But a new status quo could freeze out prospective BaaS banks, push others to unwind their programs, and change the nature of BaaS itself. By classifying nearly any deposits that came from a fintech or other third party as brokered — more expensive than core deposits — the FDIC’s proposed rule on brokered deposits, if finalized in its current form, could cause many sponsor banks to pivot to payment services and lending and make BaaS deposits the domain of super-regional and megabanks.

“The proposed rule would simplify the definition of ‘deposit broker,’ eliminate the ‘exclusive deposit placement arrangement’ exception, and revise the interpretation of the primary purpose exception (PPE) to consider the third party’s intent in placing customer funds at a particular [insured depository institution].” — FDIC

The FDIC’s current rule covering brokered deposits has enabled a crucial aspect of sponsor banks’ relationships with BaaS platforms, which often play a role in the distribution of deposits. As a result, it has also lowered the barrier to entry for sponsor banks. Under today’s regulation, contracts can be written to avoid the “brokered” classification, keeping the costs to a sponsor bank low for holding partners’ deposits. Under a final FDIC rule, exceptions that make those arrangements viable would disappear.

Sponsor banks and technology providers face uncertainty. One key question is: Would the proposal stay intact in revisions? It in effect seems a blunt instrument against BaaS, whose issues haven’t stemmed from brokered deposits per se. Top lapses in BaaS have been related to board governance, third-party risk management, and BSA/AML — and the proposed rule points to “forms of disruption such as the potential or actual insolvency of the third party” and gives Synapse as an example. A second key question is: What judgement calls would the FDIC make about brokered deposits within the narrow bounds of the new rule (what, for example, would happen to prepaid programs)?

Whether or not the FDIC rule goes into effect as written, the trend is clear: Dabbling in BaaS is over. The median size of sponsor banks will likely grow and small sponsor banks will specialize, consolidate, or scale as the costs becomes prohibitive for some. We wrote recently that, at its most basic, BaaS may help a bank gather deposits with a low cost of customer acquisition and earn platform fees, transaction fees, and interest. Much of that may suddenly no longer be the case. Bankers at sponsor banks should ask themselves what exactly the long-term BaaS strategy should look like for their institution, if they choose to continue at all.