How banks are staking a claim in the embedded finance ecosystem

Banking-as-a-service (BaaS) providers use modern API platforms to offer nonfinancial services brands modular banking solutions, using a licensed bank’s regulated infrastructure. Open API platforms and bespoke front-end customer journey technologies are making it faster and easier for FinTechs to partner with brands. The advance of cloud computing, digital architecture, and the proliferation of mobile devices, all enable rapid scale, real-time data exchange and greater connectivity between brands and customers.

As a result, several embedded value propositions are on the rise. For example, retailers that store customers’ credit or debit card information on their apps enable instant, one-click payments. And e-commerce platforms that allow merchants to open a financial account within the platform eliminate the need for a separate, traditional (business) bank account. Our survey indicated that over 70% of respondents believe that more than half of financial services will be offered via nonfinancial services platforms in the near future.

For a nonfinancial services company, the benefit of owning a significant amount of customer transactional data means it can further enrich its insight into each customer profile and tailor the offering to the customer’s desires.
“Financial services and nonfinancial services companies should pay attention to embedded finance because it's the biggest opportunity for growth,” says Remy Carole, Chief Operating Officer at Treasury Prime. “Embedded financial services in products are starting to become commonplace. There's a future where embedded finance is as ubiquitous as web technology is today.”

It’s clear that online marketplaces, retailers, automotive OEMs and software companies will play a growing role in influencing the future of financial services. However, embedded finance creates significant opportunity for financial services and nonfinancial services organizations, both separately and in concert.

The following questions provide a basis for banks to critically assess what route to take.

• Is there a high level of conviction in the growth potential offered by an embedded proposition that warrants increased capital investment and embracing new ways of thinking?
• Has the bank considered what its real value is to customers and businesses? If its value is solely its balance sheet, maybe it should not play a customer-facing role.
• Does the bank have the brand affinity and customer loyalty that will allow it to retain the customer, in an embedded experience?
• Can the bank benefit from harnessing the brand loyalty and affinity of a well-known nonfinancial brand to extend its customer reach?
• Are there specific value chains or experiences that the bank has the greatest involvement in, the power to lead, or the greatest value to add through the products and services it is best at?
• Is the bank open to not being the marquee brand at the point of distribution, but leveraging new modes of distribution to increase deal flow, customer awareness, data access, and gain increased services fees?
• Does the bank have the baseline digital maturity needed to be involved in profitable ways, or is partnering with an enabling technology or software a must? And if not, is it brave enough to place significant strategic bets in domains it is less knowledgeable about?
• Is the bank open to rethinking long-standing business models focused on narrow bands of revenue, e.g., transaction and interchange fees, to models that expand the revenue possibilities, e.g., subscription, data monetization, pay-per-use, but require dramatically different thinking?
  

Once banks have a clear overview of their capabilities, the next step is to establish what type of embedded finance strategy could successfully unlock new revenue streams. There are several ways to do this, but four distinct archetypes stand out.

1. Customer- or product-centered approach:

This is a customer-oriented model, aligned to a traditional product-focused approach. Here, banks extend products to others but maintain a focus on innovating products and services already at the core. It requires banks to re-evaluate what they know about their customers to gain a better understanding of who their customers are. It also demands that banks focus on innovative products to maintain their customer base as embedded propositions grow.

2. Enabler approach:

This approach enables a bank to extend its products and services through a platform business model. It requires setting up a digitized set of core banking products and services and developing a compelling go-to-market proposition to embed services into third-party platforms. In choosing this route, the bank needs to understand what products and services are best suited to being embedded into a third-party platform, e.g., payments, consumer loans. It also requires insight into what partnership models are best suited to the bank, based on its existing capabilities.

3. Builder approach:

Here, the bank owns the platform and orchestrates a mix of in-house and third-party products (open ecosystem). This requires heavy technology investment, with strong partnership capabilities integrated directly into customer offerings. It relies on an agile organization and operating model that’s able to continuously improve, adapt and coordinate with third-party platforms to evolve functionalities. The bank must consider what technology capabilities and products need to be built in-house and who it should collaborate with to provide best-in-class products and experiences.

4. Owner orchestrator approach:

In this case, the bank owns the platform, orchestrates products, and owns the customer distribution channels (vertical integration). In addition to the capabilities required of the “builder,” an orchestrator needs to invest in specific, targeted nonfinancial services sectors and sector expertise and create the technological ability to be directly placed at the point of customer interaction. This requires an agile organization with a scalable operating model to improve, adapt and evolve functionalities continuously. The bank must be able to measure the success of the platform and how best to retain customers and drive brand recognition.

The problem facing most banks today is that many customers are choosing embedded channels to conduct relatively simple finance services such as payments, digital loans and buy now pay later (BNPL) financing. As a result, they are migrating from traditional bank channels such as branches or online banking websites. With this, banks must find a way to still engage with these customers through new, embedded channels, or else suffer from high turnover.

However, it’s worth noting that not all products are the same. The more complex the product, the more challenging it is to embed it and for nonfinancial services firms to replicate it – for example, pension planning. Overall, banks have an opportunity to create a differentiated offering to competitors, while capturing additional value from any new distribution model.

The future is frictionless

Ultimately, the evolution of financial services toward invisible, interconnected customer experiences is not one that financial institutions will dictate. Instead, it will be mainly driven by innovation outside the sector that looks to financial services as an enabler. However, most financial services institutions are reluctant to take a back seat.

The juxtaposition of what brands and customers demand from embedded finance propositions against the traditional financial services modes of generating profitability creates a dilemma that is only solved through a clear articulation of how, and where, a financial institution will compete to capture growth in the space, or if it will at all.

Banks have a choice to reimagine offerings in an embedded world and compete on differentiated customer propositions. Alternatively, banks that are happy to play a utility role, will require a distinct set of scalable technological capabilities that will allow them to compete in a hyper-connected world.

Resting at the heart of it all is the need to explore new platform business models, harness partners as assets to open new distribution channels and embrace new, non-traditional revenue streams, while amplifying complimentary offerings that remain highly relevant, e.g., cash and treasury management.

The path to a lucrative embedded finance proposition requires the proactive definition of an institution’s strategic ambition, a willingness to innovate, and appetite to invest significant capital ahead of the curve.

The tectonic shifts underpinning this fundamental change in the provision of financial services continue to expand and accelerate, and in turn, taking a wait-and-see mode is not a viable option.

Jochen Kaempfer, Principal, Strategy and Transactions, Payments and Banking, EY-Parthenon, Ernst & Young LLP, contributed to this report.