Embedded Finance Rolling in 2022
‘Financial technology (FinTech) is everywhere’ is a vast understatement.
Open your smartphone and scroll through its various applications — how many apps are able to accept payments? how many have their own card?
I have quite a few in folders on my homescreen — ranging from traditional banking (Chase, Bank of America), neobank or challenger banking (Chime, Dave), peer-to-peer payments (Venmo, CashApp), and specialty apps in crypto/investing/trading (Robinhood, Acorns, Coinbase). If I had taken a snapshot from 2015, it’d be drastically different as some these firms lacked the functionality they do today OR had yet to launch (e.g. Dave).
Just as digital/neobanks grew from disruptor to become part of everyday life, modern FinTech is influencing the variety of financial services available now. Beyond payments, apps are now able to hold deposits, issue cards, add funds to mobile wallets, accept and decision credit applications, facilitate stock trades, and convert/purchase between fiat and cryptocurrency. This emergence of Embedded Finance for non-financial companies came from the success of Embedded Banking (i.e. deposit accounts, cards, payments, transfers) over the last 5-7 years.
There are definite similarities between embedded finance and embedded banking as both programs can function with a direct to bank partnership or Banking-as-a-Service (BaaS) — let’s first breakdown how the banking side evolved.
REFRESHER ON EMBEDDED BANKING (or BANKING-AS-A-SERVICE)
Embedded banking integrates traditional banking products into non-financial companies (such as food delivery, grocery, pharmacy, and retail firms). These platforms deliver access to banking services in their app, alongside their main business offering. From 2015 to 2019, mobile banking usage jumped over 30% as the main connection between banks and customers (instead of in-person branch banking). The impact from the pandemic further accelerated the pace of mobile adoption (e.g. customers accessing stimulus payments remotely) and across industries (through ordering for delivery from restaurants, grocery stores, etc.).
Consumers have shifted daily expectations for both banking and shopping online as their default. Through Banking-as-a-Service (BaaS) providers, the leap from payment processing to holding deposits and issuing cards is now easier and faster than ever (within 2 - 6 months). Many non-financial apps observed key benefits in expanding beyond payment processing and ‘banking their customer’ — this included increased customer spend, boost to customer retention, and improvement in client satisfaction. Additionally, there are new ways to monetize on customer activity through deposit interest (on user deposits) and interchange revenue (from user’s card spend on a branded card).
Starbucks stands out as a premier example of what banking services can do for companies outside of the financial services sector. The app allows customers to hold balances in their Starbucks wallet and use the funds for purchases in stores — earning rewards and discounts on future transactions along the way. In 2016, it was reported that balances kept at Starbucks rivaled the deposit volume held at small/mid-sized banks. For added convenience, customers can order ahead on their app and avoid standing in line. Contactless payment methods such as paying through app wallets continue to grow in popularity. Who would have guessed that coffee + banking is a winning combination.
Other non-banking firms following this example are Walmart, Uber, Doordash, Walgreens. Through a seamless mobile experience and targeted offerings, customers already making purchases are willing to trust these companies with more.
MAKING THE CASE FOR EMBEDDED FINANCIAL SERVICES
More and more non-financial companies are jumping on the ‘embedded financial services’ train — not just large, brand names but also mid-size firms in staffing, payroll, and education. At a high-level, adding this functionality can help firms deliver an improved user experience, higher customer retention, and a new channel for revenue.
Besides these general benefits, here are specific targets/needs to consider in adding embedded finance to your roadmap:
Addressing unmet customer needs: users may need immediate access to funds — this can be accomplished through instant payout options (via card processing, wire transfers) OR spend cards;
Exceeding customer expectations: companies must be able to stay ahead of user demands — as an example, offering cryptocurrency (for savings, transacting, rewards, payroll) is gaining tremendous demand;
Boosting user growth: more products & services drive new user traffic and catapult the deposit & spend activity of existing users;
In-demand, customized rewards: beyond cash back, customers seek bonuses in the form of stocks, crypto, higher yields (on deposits);
Minimizing interchange fees: wallets and the ability to hold deposits lower operational costs through a closed-loop ecosystem of bank transfers (internal or ACH) between users; this can lead to a savings over paying card network fees;
Driving customer loyalty: The sum of more services, rewards, and access for clients builds long-term loyalty; customers are interested in sticking around and seeing what comes next;
Validating more customer data and insights: platforms can generate better insights from the banking activity taking place in their app — incoming/outgoing payouts, card spend, and other transactions can provide recommendations on strategic initiatives (i.e. what to offer next, partnerships to build);
Going through the list, which ones directly connect with your company’s focus in the new year? Two themes stick out the most — customer drivers (loyalty, growth, targeted offers) and profit drivers (reducing transaction cost and increasing revenue).
What can embedded finance deliver?
Embedded banking provides wallets/accounts for users (either through individual deposit accounts or omnibus account structures) that hold deposit balances, payment rails (ACH, wire transfers, remote deposit of checks, card pull or push, bill pay, physical checks, ATM access), and spend cards (prepaid, debit).
What can embedded finance offer? Here’s a list of innovative products rolling out:
Cash advances: made popular as alternatives to payday loans, these are non-recourse disbursements (typically under $500) with no APR that are repaid as a lump-sum within 30 days (or less); most platforms charge a monthly subscription fee for access to advances during the given month;
Paycheck-based lending: users can receive part of their paycheck early as a salary advance; during their standard payroll cycle, the advance would be deducted automatically from their salary. Payroll providers are partnering with platforms to enable this feature, which also benefits external credit providers looking to minimize default rates;
Buy-Now-Pay-Later (BNPL): the buzzword in eCommerce gives an additional checkout method in which users split a total purchase into 4 equal parts (one due at time of purchase and the other 3 every two weeks thereafter). If on-time payments are made, there are no additional fees paid by the user. Clothing to gym equipment and travel packages now have BNPL interest-free options. Under the hood, credit providers can structure these as short-term installment loans.
Credit builder products: both credit builder loans and credit builder cards have gained popularity in the last 5 years. The loan version allows a user to make monthly payments towards a pre-determined loan amount (e.g. $1000) — instead of this being disbursed upfront, it gets paid out at the end of loan term as a lump sum of savings totaling all the payments made (minus interest/fees). Credit builder spend cards (such as Chime’s) use funds in a deposit account as the available credit limit for daily purchases — as deposits are made/withdrawn, the credit availability changes. Both products report monthly payment history to credit bureaus to help users build/improve credit profiles.
Crypto or stock-based lending: the newest option in embedded finance leverages assets that users have as potential collateral for a lending product. Platforms have visibility to crypto, money market portfolios, or other illiquid investments, and then allow users a certain credit limit based on the asset’s value — as a personal revolving line of credit. When a customer makes a draw/purchase with the credit, the transaction is paid for upfront at point-of-sale by the platform and the respective amount is converted/settled from crypto/stock/equity to fiat on the back-end (2-4 bus. days for processing).
The common thread emerging for embedded finance is centered on credit and lending innovation — giving spend access to users on an as-needed basis (repaid with their next paycheck) OR daily basis through recurring salary and investments held. Unlocking and de-risking credit will be major themes as 2022 kicks off. Both fintech and non-fintech companies will be looking to differentiate themselves with the latest products that embedded finance can offer.
embedded FINANCE FOR ALL
Despite all the innovation and progress in the last 10-12 years, banks and financial institutions (holding charters or other licenses) still play a central role for embedded banking and finance. Without these entities, platforms would need to gain their own bank charters (to hold deposits), money transmitter licenses (to allow for funds moved between multiple parties), and/or state-by-state lending licenses (necessary for most loan and credit card programs). Besides lengthy application and approval processes, there’s also a cost and need to be audited on annual basis.
The alternative (which we’ve frequently discussed in the last 4 years) is a bank partnership that is white-labeled — offered directly with a regional bank or credit union, OR a Banking-as-a-Service (BaaS) provider that has a bank partner and tech layer (may also include a program manager and back-office compliance). Companies can brand their own card and app with this option. No-cost referral and affiliate models also exist (in which the bank partner retains branding and control over the user experience), but they are less common due to minimal revenue earned for each referred client and lack of owning the customer relationship.
As the new wave of fintech innovation moves past deposit to credit, demand for bank partners or licensed providers willing to operate and manage lending programs is quickly increasing. Only a handful of structured programs are currently serving this growing sector — most of which seek established platforms that are mid-sized or enterprise level. At the end of 2021, new startups and emerging non-fintech firms found it difficult to find an experienced partner both in banking and lending.
What’s coming soon in 2022?
Embedded finance will be a critical consideration on product roadmaps, especially for companies that have been sitting on the sidelines when it comes to offering banking. We are in a period in which a bank account and card for users has become a standard — what gets added on top or offered as an alternative is now an important differentiator for the numerous neobanks, savings, investment, crypto, and stock trading platforms out there.
Customers are continuously asking for ‘what’s next’ in determining what accounts to keep open, where to make deposits, and which card to use for spend. Not having a timely (or adequate) response from platforms will lead to dormant accounts and apps that fizzle out in terms of user activity. Expect a consolidation to take place for companies that see a declining trend of usage in early 2022.
The good news lies in the huge market size of users still unhappy with traditional bank offerings, which fail to deliver improvements to financial wellness. These are the customers in search for a better path to credit and long-term savings AND willing to continuously try out financial services offered by non-bank companies. Gaining a small footprint of 20K - 50K users actively using a new product can provide a path to scaling the next top financial app in the new year.
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