Do banks understand their place in the embedded finance ecosystem?

Accessing financial services has been made available via multiple routes over the years. In the recent past, applying for loans and enabling payments was usually achieved by interacting directly with a bank — the customer walked through the doors of their branch to do this in-person. However, anyone who has purchased a car in the past 30 years will be familiar with applying for financing on the shop floor of a dealership, rather than with a bank manager. Department stores have long offered in-store credit and holiday lay-away deals, effectively offering consumers an easy way to buy now and pay later (BNPL). 

Today’s world of smartphones, e-commerce and open-banking initiatives have opened up new ways to access financial services. Much like the car dealership, many more merchants now offer point-of-sale (POS) financing for higher priced items, insurance add-ons are commonplace and payment for things like food delivery or taxi rides are seamless. All are embedded in the process and usually made available by non-financial players.  

Continuing with the wave of disintermediation that flavoured much of the fintech revolution over the past decade, embedded finance has grown both as a market and as a new buzz phrase on event stages and blog posts. But what is embedded finance in 2022? 

Embedded finance

Quite simply, embedded finance is a financial product, such as a loan, insurance or a payment, made available via a non-financial services company. Often many of the services and financial procedures, such as credit checks, are performed by a new fintech entrant rather than a traditional bank. These services are embedded into non-financial offerings via open application programming interfaces (APIs) and delivered as part of banking-as-a-service (BaaS) platforms. 

The embedded finance market is estimated to be worth around $3.5tn today and expected to grow to $7tn by 2030, according to 2021 research by core banking provider Mambu and Amazon Web Services. This report found that retail lending represented almost a third (29%) of the embedded finance offerings, with the digitalisation of retail services set to drive increased adoption of digital wallets and flexible finance options, such as POS lending and BNPL services. 

Embedded finance may not be the final push that completes the long promised, but not yet delivered, total disruption of traditional banking. However, despite the opportunities represented, many traditional banks struggle to see their place in this new configuration of the customer journey.

Ron Shevlin, chief research officer at Cornerstone Advisors, identified three reasons why so many banks dismiss the BaaS opportunity in his recent research report, ‘Banking-as-a-service: banks’ $25bn revenue opportunity in fintech banking’: fear of losing the customer relationship, lack of technology capability and confusion around the term. 

Wendy Cai-Lee, CEO and president of Piermont Bank in the US, agrees that technology capability is a major barrier for some banks. “Banking institutions, whether it’s banking, insurance or wealth management, sit on so many different layers of technology platforms, [for them] to want to start using a new app or a new reporting system after all these years of overlaying, building and customising, it just takes that much longer for internal adoption,” she says.

Mr Shevlin argues that it is the regulatory environment, requiring banking licences to supply loans and payments, in addition to a myriad of banking-related services, such as underwriting and compliance, that fall under regulatory supervision, is barring traditional banks from the BaaS environment and being part of the embedded finance landscape.

Many fintech companies have emerged to provide the technology infrastructure to enable brands and fintech companies to connect to banks, he says. This leads to what Mr Shevlin says is a misguided fear that traditional banks will be regulated to ‘dumb pipes’ and lose the connection to the customer. 

“First, banks have already been disintermediated ... Second, so what if a bank is a ‘dumb pipe’? If a bank can generate more revenue and profits by being a ‘dumb pipe’ than as a ‘smart provider’, then why is the former an inferior strategy?” he asks. 

Mark Jenkinson, director of strategy at Chetwood Financial, agrees. “That front-end disintermediation of banks has been going on for a long time, it’s not just embedded finance that's doing that. You can make a good point for price comparison sites, for embedded finance at the point of traditional sales of a car or mortgages — all are all stepping away from the traditional routing to a bank, which is through the front door of the branch.”

With BaaS, traditional banks are given the opportunity to operate within a different economic structure, dealing with unit costs that allow banks to charge for each component of the transaction from account access to compliance, argues Mr Shevlin. 

“It might actually be better unit economics to provide your banking services to an intermediary like a brand or a fintech, then trying to capture all that revenue directly from the consumer,” he says. “Banks are charging very low per unit costs, but with a million customers here and there, it starts to add up to real money.”

Open banking

Many banks are exploring their place in the customer journey driven by advancements in open banking. 

In the UK, Bank of America (BofA) recently launched Pay by Bank, in collaboration with payments platform Banked, allowing customers of e-commerce companies to pay directly from their bank account using UK Faster Payments Service, requiring no credit or debit card details. The bank claims that the benefits of this include: reduction of customer data storage, streamlined reconciliation, straightforward connectivity to a company’s existing treasury system using APIs, and increased security and cost effectiveness by avoiding card-processing fees.

“As e-commerce continues to grow, we’re seeing in Europe roughly one-fifth of sales is done via an online channel,” says Natalie Willems-Rosman, managing director and merchant specialist executive at BofA. “Business models are evolving rapidly; in the business-to-business (B2B) space, there are increased sales via marketplaces or directly to consumers. These changes are calling for further integration of e-commerce and treasury, whether it’s for foreign exchange, cash forecasting, reconciliation or offering more ways to pay.”

Ad van der Poel, managing director and co-head product management for Europe, the Middle East and Africa, global transaction services at BofA, adds: “In the online world, whether it’s a web shop or an app of some sort, [merchants] are focused on what they call conversion ratio: converting a visitor to their shop into a transaction. There are many steps in that conversion. But one of the key areas where they often lose customers is in the payment process. So integrating or embedding the payment process will be beneficial from a merchant perspective and is something they’re looking for.”

In addition to working with merchants to ease transactions with their consumers, BofA is looking at the use of QR codes to enable payments. While QR codes are often used in consumer product labelling and advertising, Mr van der Poel says that the bank is examining embedding QR codes into invoices that come through email or in PDF form.

“Right now in the B2B process, the invoice processing is separate from the payment process, so the treasury function is not connected to the supply chain processes,” he says. “Then you move onto the next step in the process, which is making the payment. Then it becomes part of the treasury function, but it’s actually very separate from the earlier process in the supply chain.”

Card players

While BofA is circumventing the card networks, the networks themselves are not shying away from showcasing their place in the embedded finance structure. Recently, Mastercard announced 16 technology partners, including PayPal and Stripe (who have joined the Mastercard Send partner programme), for banks, financial technology providers and system integrators to deliver real-time digital payments to their customers. 

“I think that the very basic idea of being able to use something that people are familiar with — it’s convenient, it’s fast, it’s safe, it’s secure, and it’s something that is actually just a better experience for a lot of people than trying to give out their bank account details,” says Liz Oakes, executive vice-president of Mastercard Send.

According to Ms Oakes, there are different categories of partners within the initial group of 16 partners signed up to Send. The relationship with Oracle, for example, allows the tech company to embed Mastercard Send’s payment capabilities into civic programmes such as the Angeleno Card programme in Los Angeles, which has disbursed $36m in emergency funds to its citizens. 

“[Oracle’s] Civic Assist was created to better disburse social and economic assistance so those in need of help can get it fast. Through our partnership with Mastercard, we created an automated solution to help manage the complexities of eligibility, verification and transfer of funds that can be replicated across communities,” says Rob Tarkoff, executive vice-president and general manager, advertising and customer experience at Oracle.

Integration difficulties

Technology-led Raisin Bank has established itself as a leader in the BaaS space. Founded in Berlin in 2013 as a fintech bank, Raisin now operates as a modern credit and investment institution with a full banking licence in several countries. “We’re only at the beginning with embedded finance — let’s not fool ourselves, it’s not taking away any big business from traditional banks at the moment,” says Andreas Wolf, Raisin’s chief commercial officer.

He goes on to say that the platforms that do provide embedded finance still have to learn a lot about risk management. “Everybody is on a learning curve on how to do that from the customer perspective, from the product perspective, so we only see really small beginnings,” he adds. 

However, from a technical perspective, many traditional incumbents face barriers to fully integrating within the embedded finance market, because they are not that easy to integrate, technically, with new API-based cloud based platforms, says Mr Wolf. 

Another barrier is the revenue structure and business model inherent in many embedded finance offerings. “When we integrate with a partner, the money we earn — at least in the first one to three years — is probably not even enough to fund a project office at one of the incumbent banks. There are no clear market leaders in many areas where you will ultimately generate tens of millions of euros from day one,” he adds. 

The key is to invest in a portfolio of partners and grow with them, says Mr Wolf, and “that’s also traditionally not a strong suit of an incumbent bank”.

A third barrier, he adds, is that banks lack the expertise of working with distributed value chains. “Incumbent banks are used to everything in house,” he adds. “Now they have to work across organisations, where different parts of the value chain are owned and best governed by multiple players. That’s traditionally not a strong suit of incumbent banks, both because of compliance and governance reasons, and also lack of experience on how to make that work.”

According to Keith Grose, head of UK at Plaid, an open banking network and payments platform, banks that recognise open APIs as the most important access point for them going forward are going to benefit from embedded finance. 

“It’s not like it’s banks versus the world,” he adds. “It’s more like ‘how are you positioning your services to be able to support a future where everyone’s going to interact with financial services in a digital world, on an app-based ecosystem and make sure that your bank and the infrastructure you’re providing is suited for that type of future?’”

Many of the newer players in the embedded finance market predict a massive growth of the sector. Rob Straathof, CEO of Liberis, which offers an embedded finance platform that allows businesses to offer a suite of banking services to their customers, comments that embedded finance will “dominate every single bit of financial services” within 10 years.

Embedded finance is at the beginning of what is poised to become a mature market, says Mike Peplow, CEO of Paynetics, which provides a modular, digital payments platform for developing financial products. 

“The world is globalising in a way that we’ve never seen in history before, and nothing globalises more quickly than financial services,” he says. “I think we’re going to see this huge mixing of ideas and cultures, which is going to create new products, new propositions, and it’s going to give the big banks another run for their money — which actually is good for them because it’ll keep them competitive,” he adds. 

Mr Grose agrees, predicting a future when banking services are further embedded into everyday services and applications. “I know for a fact, that my younger brother would sign up for a bank account from Snapchat — why doesn’t that happen? Some people view that as a dystopian world, but I think it’s just reality,” he says.