Welcome to the new age of embedded finance and banking as a service

Embedded finance is the integration of finance into a nonfinancial experience, typically on a website, mobile app or other digital journey. It seeks to deliver financial services exactly where and when they are needed by empowering nonfinancial brands to offer financial products and services.

This is not an original concept. For several decades, retailers, airlines and other brands have offered private-label credit cards to increase brand awareness, boost customer convenience and build loyalty. So, what’s new about embedded finance in the 2020s?

Financial regulations around the world dictate that banking and finance become more open and competitive. As a result, the banking industry is shifting from a closed, monolithic architecture toward an open, more collaborative ecosystem.

In parallel, technology is becoming more open and redefining what’s possible, thanks largely to application program interfaces (APIs). Although APIs are not new, they have recently come of age as the enabling technology of open banking around the world.

Technically, APIs allow data to be exchanged in real time so nonfinancial systems and apps can easily embed financial capabilities, such as payments, trading, lending and wealth management. By making financial services frictionless, this technology helps increase customer engagement and, in turn, build loyalty.

Commercially, however, embedded finance is enabled by banking as a service (BaaS), which allows e-commerce platforms to extend their offerings to include financial services and become a hub for not only goods, but also everyday banking needs.

Customers welcome this because it makes life simpler and increases convenience and efficiency. Nonfinancial brands benefit by augmenting their customer experience with finance without the hassle and expense of becoming a regulated financial institution.

But what does the new age of embedded finance and BaaS mean for financial institutions?

Embedded finance – Threat or opportunity?

Creative digitalization is disrupting many business models across all sectors, and financial services is no exception. As new digital banks continue to redefine banking, established institutions have responded by launching their own digital banking services.

Enabled by BaaS, embedded finance is effectively a new digital channel and an exciting opportunity for incumbent banks. At a time of universal branch closures, an increasing compliance burden and compressed margins, it empowers financial institutions to tackle the cost of customer acquisition. This is estimated at $100-$200 under a traditional model but drops to around $35 when finance is embedded.¹

¹ FIS customer research

However, embedded finance is not principally about cost reduction. It empowers a financial institution to extend its reach into new markets and geographies that were previously inaccessible or uneconomical, thereby increasing deposit accounts. Partnerships with major brands can be a magnet for new customers, especially when the brand has a lot of repeat visitors or subscription-based services.

Embedded finance also allows a financial institution to offer bespoke products or services to specific market segments based on customer data. Every customer interaction is an opportunity for a financial institution to learn, refine and improve its proposition by harnessing the power of that data.

In this sense, embedded finance removes the guesswork from making business decisions. It also paves the way for financial institutions to become more profoundly driven by data and introduce an iterative improvement cycle for the customer experience.

What can you embed?

Although any financial product can be embedded, perhaps the most obvious is payment, the end point of every transaction.

However, as trusted providers with an ongoing customer relationship, brands with frequent or regular customer interactions are well placed to offer a wide range of additional, bespoke financial products – loans or credit facilities, deposit and saving accounts, prepaid or debit cards, wealth management, insurance, and trading products and services.

The sky’s the limit, and the embedded finance product portfolio will inevitably keep expanding as business digitalization increases. Although most of the publicity around embedded finance has been directed at retail customers, the proposition is equally valid for small and midsized businesses. Here, embedded finance can offer day-to-day support with loans and cashflow management tools when they are needed.

Many of the world’s top financial institutions are considering how to position themselves for success in the small-to-midsize business market, which Accenture forecasts to be worth up to $124 billion by 2025. Accenture also suggests that transactional banking products – such as payments, cards and accounts – are most at risk from embedded finance.²

² https://www.accenture.com/us-en/insights/banking/embedded-finance-smes

In the scramble to win digital, corporate and retail accounts, small and midsize businesses are often overlooked. Embedded finance is the ideal way for financial institutions to serve these customers better and to build lasting meaningful relationships.

As small and midsized businesses become familiar with embedded finance, they will become more willing to pay for value-added banking services that become essential as a business grows. From a financial institutions’ perspective, embedded finance can also be a cost-effective business development that builds loyalty.

Bringing embedded finance to life with BaaS

Through BaaS, licensed financial institutions can provide access to their infrastructure with APIs and rapidly launch new, customer-centric services with minimal capital outlay. That means a neobank can offer a full range of bank and payment services in markets where the licensed banks may not operate.

BaaS is a perfect example of how white-label banking can extend a financial institution’s reach into new markets and geographies. But as with all modern banking, success requires the right technology and a collaborative culture.

In many respects, financial institutions have become technology businesses operating within the constraints of a banking license. To make embedded finance possible, BaaS operates as an orchestration layer where nonbanks can embed financial products into their own platforms, typically using APIs.

A financial institution that has digitalized will already have an API strategy, which is central to providing seamless plug-and-play integration with third-party applications with little or no development work. Those without an API strategy should ask their technology providers for help.

Banking, but not as we know it

Digitalization has changed how people invest, borrow and pay for almost everything, and embedded finance is part of this wave of disruption. In the new order, established financial institutions have everything to play for. But they need to act now, or risk being left behind.

It takes only a little imagination to see how financial institutions might transcend traditional roles and manifest instead within and through powerful brands, giving financial institutions new life and extending their influence while also offsetting the investment and effort of being a customer-facing business. For customers, this evolution marries their trust in regulated financial institutions with the special affection they have for a desirable logo. Modern financial institutions and brands are moving briskly in this direction; incumbent banks limited to traditional roles should consider this development a call to arms.

Embedded finance is here to stay and is both an opportunity and a threat. For financial institutions with the right approach, technology and partners, participating in embedded finance is relatively straightforward and can become part of business as usual. But it’s crucial to get the thinking right at the outset.

The customer experience is crucial to success in embedded finance, but it is markedly different from the in-branch experience it seeks to augment or replace. While reaching new customers is highly appealing, a financial institution may have to surrender the customer experience to a website or mobile app branded by a different company.

Embedded finance is less about the experience with the financial institution than about the customer journey in the application. The customer may not even realize there’s a financial institution involved. With its own brand and reputation top of mind, a financial institution must choose embedded finance or BaaS partners that align with its own culture, business objectives and technology strategy.

Embedded finance and BaaS are all about partnership. You must identify partners with compatible technologies and capabilities that are critical to success. But it’s equally important that partners have the right business and cultural mix. A successful partnership must mitigate risk across a range of issues, including regulatory compliance, cybersecurity, data privacy and end-user knowledge.

As more financial institutions move embedded finance to the top of their growth agenda, we’re entering an era of unlimited innovation for both financial institutions and their partners. Participants must choose their partners carefully to seize this opportunity quickly, safely and profitably.