Fintechs navigate a choice: BaaS middleware or go direct?

Fintechs spooked by the Synapse bankruptcy may conclude that integrating directly with banks to achieve their financial services ambitions is the way to go.

But the choice between using a banking-as-a-service middleware provider or "going direct" is not that simple. Especially for an early-stage startup, a middleware provider can offer a speedier path to market and employ engineering talent that may not exist at the startup, or even at a number of the community banks in the broader BaaS space. A provider such as Unit or Synctera has connections to multiple sponsor banks, which could make it easier for a fintech client to double up, or switch over if its original sponsor bank leaves the business.

Jesse Silverman, counsel at law firm Troutman Pepper, has firsthand experience with the growing pains of nonbanks seeking bank partnerships. He has served as general counsel for fintechs including LendUp, Highline and Steady.

"When I first started, BaaS middleware wasn't a thing," he said. "You went direct or you didn't go at all."

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The mini industry of BaaS middleware has evolved over the past year. Many of these players have redefined themselves as technology layers that help banks and fintechs partner more efficiently and communicate directly, rather than as intermediaries that claim to offload some compliance and risk.

For most startups making this decision, it comes down to their stage of life and what kinds of risk matter most.

Bryan Mulcahey, managing partner at financial services consultancy FS Vector, finds the middleware setup can be practical for early-stage software businesses that want to focus on other parts of their operations and are not gunning hard to be unique.

But fledgling fintechs with big ambitions may find that sticking with a middleware provider for the long haul can inhibit their growth.

"Fintechs in these arrangements lack control over product development and often fail to build a strong appreciation for compliance and risk management," said Mulcahey.

When middleware makes sense

For early-stage companies, speed is of the essence. Startups must get to market to understand if their product works, said Silverman.

"I can integrate much quicker through a middleware provider because they have dedicated engineering staff who know exactly what they're doing," said Silverman. "Any chance you get to minimize engineering time is a huge win."

This was a factor for Retirable, a retirement guidance platform that launched in 2019. In 2022, it introduced a checking account and debit card that houses each user's "safe to spend" amount per month.

"We wanted to get to market quickly with the best technology out there and work with a bank with great fraud, risk and compliance controls," said Ian Yamey, chief technology officer of Retirable.

Retirable landed on Unit as its vehicle.

"You get the benefit with Unit that a lot of [the know-your-customer, compliance, integration] processes are efficient and built directly into an API," said Yamey. "Their technology stack allowed us with one engineer to build and launch this in a couple of months."

Retirable is currently transitioning accounts from Blue Ridge Bank in Charlottesville, Virginia, to Thread Bank in Rogersville, Tennessee. (Blue Ridge was deemed to be in "troubled condition" by the Office of the Comptroller of the Currency in January. Thread Bank entered into a consent order with the Federal Deposit Insurance Corp. in June and is one of many BaaS banks to feel the heat from regulators.) Yamey said that the experience of moving to Thread has been positive.

"We've found we have strong and direct connections to their team so we are not seeing the limitations of going through middleware," said Yamey.

Silverman is still a fan of the middleware concept.

"It introduces risks but it solves others," he said.

One example is redundancy. A middleware provider with a network of bank relationships could make it easier for fintech clients to double up.

"For many of the fintechs partnering with banks, if you only have one bank partner, that is a binary existential risk to your existence," said Silverman. "If that bank partner decides they don't want to be in business or there is some regulatory violation, they can end that program in the blink of an eye." 

Middleware fintech clients may also have a smoother experience migrating to a new banking relationship, as Retirable is doing now.

Mulcahey finds that banks are unlikely to wind down programs with their direct partners even after they receive an enforcement action. But he has seen the opposite happen in the middleware space, where providers are quick to cut banks that run into trouble.  

That means for fintechs, partnering directly with a bank means a lower risk of getting dropped. But it is typically harder to migrate to a new bank if that does happen.

"I often tell my clients, it's a wash," said Mulcahey. "It's really hard to compare those two risks."

The tipping point

Eventually, a fintech may feel it has outgrown the middleware model.

"It's hard to scale and innovate [when a company] is so reliant on middleware," said Mulcahey. "You don't own that customer relationship and you're not building expertise around customer service or compliance."

This was a tipping point for Comun, a Spanish-first challenger bank aimed at Latino immigrants to the U.S.

Comun launched its first product with Unit and one of Unit's partner banks in October 2022. The ability to quickly go to market and test Comun's viability "was great," said Andres Santos, CEO and co-founder of Comun. But he doubted Comun's ability to scale if it continued down the same path.

"My sense is this is a model that works well with embedded finance players where the economics don't matter as much. If the economics matter and you are trying to build a sustainable business, you are sharing a big part of the economics with middleware," said Santos. "You don't have that direct relationship with the bank where you can build the best program for your users."

Comun partnered directly with the Woodhaven, New York-based Community Federal Savings Bank in November 2023. Comun also built integrations to all of its vendors, including those that handled know-your-customer verification, transaction monitoring and fraud monitoring; the fact that its staff included former engineers from expense management company Brex and Brazilian neobank Nubank made this possible. Santos finds that Comun can now develop new functionality faster than before, such as enabling low-cost money transfers between Comun users and their friends and family in Latin America.

"We appreciate the complexities of building financial products and wanted to own that," said Santos. "It's a hard process, but the right type of hard."

Atmos Financial, a nonbank company that invests customer deposits in solar and climate projects, has a similar story.

Atmos onboarded with Synapse in 2020 so one of its partner banks could hold its consumer deposits. But even before its contract with Synapse came up for renewal in early 2023, Atmos started exploring direct integrations. Synapse's lending capabilities couldn't support the large solar loans Atmos wanted to make, said Ravi Mikkelsen, co-founder and CEO of Atmos Financial. Atmos had integrated directly with Five Star Bank in Warsaw, New York, in 2022 for lending. It moved its deposits program over as well in August 2023, so everything would live under one roof.

Having Synapse as a layer between Atmos and its partner bank meant "delays and other inefficiencies," said Mikkelsen. "If you have anything in between you and the source of truth it causes complications." For instance, if Atmos had a question for its partner, it could take one to two days for Synapse to relay the question and another one to two days to return an answer, he said.

"Now we can ping people at Five Star directly and get an answer in 30 seconds," said Mikkelsen.

The direct lines of communication has also helped the two companies sync up on timelines and expectations.

"Now we've got a relationship with the entity that holds and deploys capital," said Mikkelsen. "It allows us to do more together."

Atmos' departure from Synapse predated the company's bankruptcy. But to address a handful of customer concerns, Atmos published a blog post in June outlining the difference between direct and indirect models. It issued a press release as well explaining its transition, and tries to make clear on its website that it is a technology company. Mikkelsen even chimed into a Reddit conversation on Atmos' customer-created subreddit three months ago to clarify that Atmos no longer partners with Synapse and Evolve.

"We try to reaffirm that we have this direct relationship so it is not the same risk as with middleware," said Mikkelsen. "But I couldn't tell you how long that knowledge sits with someone versus degrading over time."