Views on… embedded finance: “Should a good brand put its customers in debt?”

In this inaugural edition, we are gathering Views on… embedded finance, which is widely regarded as having enormous potential for financial services and wider industry sectors. 

In our first instalment, John Salter, chief customer officer at ClearBank, shares his views on embedded finance and the new social responsibility it brings.

Tune in next week when we speak with Alex Mifsud, co-founder and CEO of Weavr.

Q: What are the key differences between banking-as-a-service (BaaS) and embedded finance?

A: You’ve asked one question and it’s going to take me an hour, so forgive me. From a ClearBank point of view and a John Salter point of view, the two things are intertwined. We think that BaaS as a buzzword is not a thing; it’s a point-in-time acronym – white-labelled language morphed into clumpy things like SaaS [software-as-a-service], and then BaaS, which is the latest thing. Now the latest incarnation of that is embedded finance.

Now finance is kind of bifurcating into: “What do we mean by embedded finance and what do we mean by embedded banking.” So as a buzzword, [BaaS is] just the ‘word of the week’, in our view.

Clearly, from a technical point of view, at the most simplistic level, it’s the core of the technology or the platform that lets non-financial businesses distribute financial products under its own name. That’s the theoretical piece around it. 

But in practicality, what is the market doing? I like this concept of the attention economy, and how we’re increasingly being driven by powerful brands (I think I actually stole it from IBM 10 years ago). If you’re not a powerful brand, relative to an Amazon, how do you keep people on your brand experience and how do you finance that brand experience and make it interesting? Embedded finance really is paying for that brand experience.

Initially, there were two ways embedded banking came in – either a buy now, pay later model or a bank card to pre-fund experiences and services. The problem you have there is debt. 

There’s a raging debate now:“Should a really good brand put its customers in debt?” We are now in a situation with high interest rates, unemployment, recession and everything else. Do you really want your brand, that you protect, associated with a service where a customer could find someone knocking on their door saying: “You defaulted on XYZ”? That negative spiral all the way down has the potential to damage the brand much more than the benefit on the way up. 

Up until now, most of the banking service stuff has ended on a path towards debt and I don’t think that is socially responsible. I think most people will recognise that the ‘buy now, pay later’ industry could well be the next payment protection insurance in the UK in terms of litigation. That has longer-term ramifications if you’re a brand that’s been using those services for some time.

Q: Where’s the potential for banks in this universe?

A: The most successful banking businesses in the UK start with a bank account. [For example, if you use an app to access] your foreign exchange because you’re going on holiday, everything is in and out of a bank account and it’s frictionless and all online. You know where your money is at all times. If something goes wrong, [for example] I’m paying my [holiday rental] deposit and it doesn’t get there, I know I just go back to my bank account and my bank. 

Whereas if you've got these Frankenstein’s monster apps, I can do my foreign exchange within the payments, but it’s through a third party. How do you know where your money is? It just creates this friction. 

We think the bank account is where it should start. You have an app, start with a bank account, then deploy the bank account to decide how you want to develop your brand experience. The only people who can provide a bank account, by definition, are banks, because it’s the law. That’s where banks sit.

Q: Which non-financial sectors have the most potential for embedded finance?

A: The regulators across Europe and the UK wrote what we call ‘Dear CEO’ letters to all fintechs both in UK and in Europe [asking]: “Do your people, your clients understand where their money is at any point in time?” That will only come under greater scrutiny as non-regulated companies try to play in this space, because the regulator is going to read up the Ford Motor Company and ask: “You’re offering these bank accounts, does everybody know where the money is, is it safe?”

The way embedded banking works, on a technical point, if it’s our bank account, [is that they are] technically our customers from a regulatory perspective. So there’s a lot of burden on the bank to manage those accounts the right way [when] we outsource it to the underlying corporate. 

Obviously, you can pick any use case in the corporate world, if you take the concept behind it as being a big brand and keeping loyalty. So what about [approaching] the Premier League and saying:“Would you like to offer a Premier League bank account for football fans?” If the answer is yes, you can see how it works. 

Q: It seems like the rise of embedded finance coincided with the pandemic. Now that we’re on the tail end of that, are we going to see a slowdown in growth? 

A: It’s interesting that the regulators have now started pushing consumer duty really hard and showing value for money around the same time [buy now, pay later is experiencing a pushback] and the recession kicks in. The regulators always try to get out in front of things a little bit, right? They may not be that successful all the time, but they’re always anticipating. 

[The regulator will increase] the regulatory burden on anything to do with consumers, small business lending or credit. That usually translates into more costs to the provider to serve and to fund. No natural revenue growth will mean people will start to shrink their market share or pull out of the market. Double that up with a recession that we’re going through now, it’s exactly what you would expect. You see the share price collapse. What’s happened to Klarna, the poster child – something like a 60%, 70% collapse in its share price. Why is that? Because I think what I’m describing is probably the direction of travel. 

You’ll see a tightening in the market, making it much more difficult to get those sorts of credit, even in the short term. You saw it with the old payday lenders, the Wongas and everything else, went up like a rocket and came down just as fast once the regulator decided it was a bit too risky and the risks were not fully understood.

Q: What have been some of the barriers to the sector’s growth?

A: I think there’s a bit of everything in it. I think one is tech. The technology is not easy. It’s why ClearBank is here in its own right; the technology needs to be top-end if you’re going to meet the ambition of everything real-time, 24/7. 

If you look at most of the big banks they’re still batch processing, they’re not 24/7. I saw a stat the other day that said 54% of Faster Payments in 2022 were processed outside banking hours. 

We don’t have a culture of part-time here or nine to five, we are 24/7, 365 [days a year]. It’s interesting that more than half of our transactions happen when normal banks are shut. 

Quite simply, if you’ve got an app and you can’t get payments in and out, it doesn’t quite work. The tech is a big blocker, [as is] the legacy tech and IT stakes in the big banks. It’s really hard for them to move into this space. We don’t really see the big banks in this space at all.

Q: Where do you see the growth potential?

A: I think as we come out of Covid and we’ve all changed a little bit, [there’s] this sudden increase in emphasis on sustainability, doing the right thing, moral brands, the highest high-principle brands. 

I think you can see signs of that in the US, which generally tends to lead. We’re starting to see more and more conversations around the need for brand loyalty. One of the things that people start to use as a differentiator is the whole ESG agenda. A bank account to fund the experience just naturally plays into that rather than: “Here’s a buy now, pay later that’s going to get you in debt.” It doesn’t quite fit. We’re seeing that pivot now. 

We just think any brand can do that – it’s not a unique type of brand to do that – you just need to be a brand that’s committed to that. 

And interest rates have finally become relevant, right? So people are much more comfortable saving for things than they were before, because they got to return. Companies are much happier creating loyalty by rewarding loyalty, where before you just couldn’t do it. 

The interest rate cycle has made the use of cash a little bit more important in people’s minds – people naturally want to get a return on their money where before they didn’t. Then that starts to split between them on paying for a debt product charging 10% or earning 3% on the credit. That’s a 30% delta on your purchase. Suddenly, the economic story feels very different. I don’t think there’s a specific use case because there’s a use case if it’s built around a theme that is socially responsible.

Read other Views on... embedded finance:

• “Moving fast and breaking things simply does not work in financial services”