For those outside of the financial services industry, Embedded Finance sounds like an opaque concept.

The reality is that it’s actually something we’re all familiar with in some form.

Requesting a ride from Uber or ordering from Doordash. Driving for Uber or Doordash (and getting paid instantly).

Purchasing coffee from Starbucks by loading their digital wallet from your bank account or card.

An option for Buy-Now-Pay-Later (BNPL) at time of checkout for those vintage sneakers that just became available.

In shopping off of a store branded card (i.e. retailers), you’ve experienced embedded finance: a financial service (payment/transfer, account issuance, depositing funds, etc.) that is traditionally offered directly from a bank or financial institution is being delivered through an alternative (non-bank) channel.

BANKING-AS-A-SERVICE (BaaS) vs. EMBEDDED FINANCE

There’s confusion between BaaS & embedded finance as both terms are utilized as a catch-all for any slice or function involved in delivering a banking service.

For BaaS, the emphasis is driven by back-end, infrastructure — vendors that include themselves in BaaS: Know your Customer & identity verification (ex. Onfido, Socure, Alloy, etc.), bank account aggregation (ex. Plaid, Yodlee), core banking (ex. FIS, Jack Henry, Mambu), and payments (ex. Dwolla, Stripe, CurrencyCloud, TabaPay).

For embedded finance, there’s a combined emphasis of infrastructure (back-end) AND customer-facing experience (front-end) as one whole package. Providers go beyond orchestrating fragmented functions (with BaaS) towards a holistic solution managing design, program approval, compliance requirements, implementation, and ongoing maintenance.

The ability to embed these services seamlessly through the existing customer experience of non-banking firms is the future of financial services.

why the shift is happening now

For consumers, there’s an expectation that digital experiences will continue to improve and become even more seamless.

Being able to increase & maintain user engagement is a ‘north star’ priority for companies across a varierty of verticals, especially as competition heats up.

Adding financial services in existing customer journeys is the next level for multiple business sectors.

Many companies delayed the exploration of banking programs due to the heavy lift involved — building the technical infrastructure, securing bank approval, addressing compliance requirements + risk monitoring, and program management. The progress from BaaS providers & bank partners in the last 8 years addressed many of these concerns.

The future leaders of embedded finance will push the envelope further than BaaS in terms of adding a compliant and modern user experience. The new age of providers will seamlessly embed targeted offers into custom products to the degree that clients won’t be able to distinguish what’s outsourced or native to the platform (except in required disclosures). This improvement of integration will have both established firms & non-banking enterprises adding financial products more often.

Benefits for enterprises adopting embedded finance

The core value proposition comes to down to simplifying a user’s experience. Does the addition of multiple payment methods, digital wallet, account, card, etc. generate more user activity? New activity can be more purchases, spend, transfers, deposits — all which can be measured. Incentives and discounts can help encourage this usage from clients.

We can also look at a new initiative through the lens of customer loyalty. How can established brands take their current level of loyalty and build towards customer affinity? Affinities are personal / emotional connections between consumers and companies, which can help achieve rapid growth in user activity. If embedded finance triggers customer affinity, the investment is worthwhile. Increasing user activity on a recurring basis leads to a sustainable & scalable lift in revenue.

Revenue streams & growth are ongoing priorities for executive leaders. Being able to diversify towards new sources increases the overall lifecycle of companies. For firms with large volumes of users, there’s a lower cost of acquisition by cross-selling new products to existing customers.

There’s also a clear understanding that maintaining current clients is cheaper than acquiring new ones. In verticals with a massive user base (e.g. retail, eCommerce, healthcare, telecommunications, payroll, insurance), managing customer churn & acquisition is crucial to growth targets. Embedded finance can do both.

Challenges for new Platforms integrating banking

The main struggle is ensuring that the addition of embedded finance is the right move for a company, especially one that is new to financial services.

If there’s no uptick in new activity, there’s likely minimal (or no) positive impact to a customer’s journey. Embedded finance may be more of ‘nice-to-have’ instead of a key value driver.

A ‘one-size-fits-all’ approach would be a miss. The best examples of embedded finance are the ones in which a user doesn’t feel the difference between a brand & banking provider AND the new product/service makes life easier. Establishing a compelling use case for customers from the start is vital — here’s a quick list on how companies can do so (further context for each in this post):

• Addressing unmet customer needs;

• Exceeding customer expectations;

• Boosting user growth;

• Minimizing fees (such as interchange, or transaction costs);

• Validating more customer data and generating client insights;

In terms of business model, the increase in revenue-generating activity from embedded finance needs to surpass the fixed & incremental cost in offering the financial product. The key calculation is if the annual revenue per user (ARPU) exceeds the yearly cost, then the new product is generating profit for the platform. Similar to BaaS, embedded finance will have a break-even point comprised of active users AND user activity (e.g. card spend, deposit balances, subscription fees).

Banks as partners in Embedded Finance

Financial institutions as licensed entities able to hold customer deposits and sponsor card programs remain a foundational part of banking’s future. No longer working in isolation, banks have become accustomed to operating alongside emerging players that take on key functions in providing financial services. From user interfaces, back-end infrastructure, onboarding & account opening, identity verification, and compliance oversight — modern banking has evolved towards a distributed, digital model.

Operating a network of retail branches and staying within a physical footprint is no longer feasible. The movement towards digital-only and increased competition within banking pushed many mid-sized, regional banks to explore a future as partners in Banking-as-a-Service programs. Some of these smaller financial institutions have gone so far as building their own BaaS channel and prioritizing how they can bridge technical gaps (like fintech companies).

As the mindset for banks continues to expand, embedded finance is the path forward in adapting & thriving to the financial services landscape of the future. Here’s why:

• The pressure from regulators for increased 3rd party oversight & controls reduces the number of traditional banks interested in building a direct-to-bank channel themselves.

• The BaaS 1:1 model of one bank behind all components of a fintech program is challenging due to technology gaps (from outdated banking stacks) and varying levels of risk appetite from banks.

• With embedded finance, financial institutions can participate as a single feature/function provider instead of an all-in-one infrastructure partner. To put it plainly: banks of all sizes can choose how much (or how little) of the pie that they want to embed based on their risk tolerance. This can be focused on only payments, as a BIN sponsor for card programs, holding deposits, issuing account numbers, or a combination of features.

The more experienced financial institutions may still pursue a full-stack, direct BaaS model that includes a modern stack and licensing. The challenge comes down to flexibility and customization of program offerings, which is critical for non-banking firms embedding financial products. An end-to-end, holistic model that’s vertically integrated + customizable is still unavailable.

when the industry shift takes place

Embedded finance continues to gain momentum throughout the financial services industry. Consumers and businesses are willing to bank through the brands & companies they use on an everyday basis.

The lines between digital engagement and banking will continue to blend with one another for the benefit of a customer’s experience. The speed in this shift will be directly tied to the next generation of service enablers — embedded finance providers.

These players will go beyond Banking-as-a-Service and bundle a compliant, customer-facing experience that is customized and seamless. There will be a combined proficiency in user experience (UX) design and solving for compliance requirements (such as disclosures, user agreements, onboarding, Know Your Customer details, customer acknowledgements).

Above all, maintaining and building trust with users needs to be an ongoing priority. Traditional banks took decades to build high-levels of trust with their clients through in-person interactions. Non-banking companies and embedded providers will need to do the same virtually through brief , digital engagement.

It’s still early days for embedded finance, but multiple industries with adjacency towards banking can quickly benefit: retailers, healthcare, travel, automotive, and benefits & wellness platforms.

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