For nearly every industry imaginable, regulations are an unavoidable part of business. Whether it be privacy, health, or data-related, companies must conform to rules and laws, often in conjunction with a local regulator.
Financial services are no exception. In this vital industry, regulators dictate the rules and define the sector’s boundaries to a degree not seen in other sectors. As a result, the entry barriers are steep, costly, and time-consuming, keeping innovation limited to those already in the ‘club.’
However, the world is becoming increasingly horizontal. Innovators worldwide are seeing an opportunity to incorporate financial services into a vast range of products that traditionally had nothing to do with finance.
How can companies that have a promising business idea surmount the higher regulatory barriers to entry? As we will show in this article, Regulation-as-a-Service might provide a way out.
The long road to regulation
In the financial services industry, becoming a regulated entity is a tough journey. Before a firm can even request authorization, it must spend months preparing their application with the support of a team of lawyers and risk professionals.
Once all the appropriate due diligence work is done and the application has been prepared, it is submitted to the appropriate governing institution (such as the Bank of Spain in our case) which will review it and usually make a series of requirements for clarification and additional information on any points that stand out. Depending on the license being requested and the complexity and strictness of the regulatory requirements, this process can go on for weeks or even months.
Once the regulator is satisfied that the applicant has fulfilled the necessary information requirements their application can be approved and the license is granted. However, the process doesn’t end here.
Regulated entities must continue to ensure their compliance with a comprehensive set of rules and laws, which include reporting certain parameters to the regulator on a regular basis. Things such as volume of operations and amounts of these, treasury position, and fraud rates, among others. These firms will often deploy “Regtech” software to make the monitoring and reporting process more manageable. However, these tools merely ease rather than replace the regulatory burden that licensed firms carry, nor do they eliminate the need to keep a team of legal and compliance experts on the payroll.
These time-consuming and costly barriers act as a deterrent, not an accelerator to innovation.
Regulation-as-a-Service: simple shortcut to providing regulated services
To help companies offer financial products without getting a banking license, a small handful of Fintech companies are now offering Regulation-as-a-Service (RaaS). Like other “as-a-Service” models, RaaS allows companies to build on top of a regulated company’s software. However, this connection goes beyond tech, with the provider acting as a sort of regulatory shield to the client by handling onboarding and being responsible for all compliance requirements.
Put differently, RaaS enables a company to use another company’s regulatory license and software to offer services that would usually require they become regulated themselves.
In this sense, the relationship RaaS users have with their providers extends far beyond the technical aspects seen in other “as-a-Service” models. Here, the business only needs to plug into the RaaS provider’s stack, start building, and that’s it – the compliance is “out of the box.” with no need to deal with costly and time-consuming regulatory burdens.
RaaS in action
RaaS allows innovators in non-financial companies to build great financial products. Let’s take a look at an example.
A real estate agency specializing in matching renters with available apartments see opportunity in a highly fragmented and inefficient market. The company’s product manager believes that managing contracts and security deposits are a significant pain point, leading to distrust and costly disputes.
To solve this problem, she proposes that the agency builds an app that electronically stores documents and creates escrow accounts between tenants and landlords.
Eager to get started, She researches how a real estate company can open and manage bank accounts. Her quest yielded two different solutions.
- Get a license from her national financial regulator, find a correspondent bank to hold the deposits, and then build the escrow feature on top.
- Work with a RaaS provider who already has the appropriate license and the tech stack ready to go.
To ensure she can make the right decision, she contacts her colleague in the legal department to get his opinion. As she soon learns, option one would mean that the company would hire lawyers specialized in financial law and a small team of compliance officers. The application process will take many months and requires the agency to create a new legal entity that must meet strict regulatory mandates.
Option two, however, requires none of the above steps. Instead, the real estate agency would only need to have their IT department work with the RaaS provider to connect their systems. Regulatory compliance is already built-in. Here, the real estate agency can focus on growing its market share by offering instant escrow accounts complete with unique IBANs, rather than deal with continuous regulatory red tape.
She goes with option two, and within a few short months, the company brings its new app to market. Landlords and renters love it. The word gets out, and the agency sees a significant rise in business
RaaS in practice
Of course, in practice, this process isn’t as instantaneous as with non-regulated SaaS. RaaS companies still need to perform due diligence on their clients. Both parties need to install and audit their tech connections before launching any services.
However, once meeting these conditions, the user can “set it and forget it.” From there, the company can offer financial services without worrying about dealing with market authorities or maintaining regulated infrastructure.
Compared to the costly alternative of preparing for and then requesting a regulatory license (not to mention ongoing compliance burdens), RaaS is a quick walk in the park.
RaaS will transform the ways companies interact with consumers
Regulation-as-a-Service is nascent now but will become a crucial driver of our economy from now on. Venture Capital heavyweights Andreesen Horowitz wrote late last year that every company will be a Fintech company in the future. If this prophecy is to come true, firms will need to reconcile the desire to provide financial services with the regulatory reality that traditionally comes with doing so. To that end, RaaS offers companies from practically every industry a rapid shortcut to financial innovation.