While many analysts were writing the obituaries for regional banks (“Too big to be personal”; “Not big enough to invest in modern technology”) some of these institutions have been quietly building platforms and strategies to enable them to exploit new opportunities.
Ohio-based KeyBank, for example, with $185 billion in assets, was early in acquiring and investing in fintechs. Several of those deals are now paying off, putting the bank on the inside track for what could be one of the most significant trends in financial services: embedded banking.
Embedded banking in a sense is a modern, tech-enabled version of private-label banking once typical of the credit card business. It is also part of the broader banking-as-a-service trend. Simply put, embedded banking involves incorporating specific financial services into nonbank companies’ products or software, becoming part of a bigger bundle of services.
The typical view of this strategy to date is that it provides a big opportunity for high-growth, low-margin banking business. Also, the consensus is that embedded banking risks disintermediating banks from customer relationships. Nevertheless, as McKinsey observes, it is an inevitable trend due to many factors, among them customer demand for integrated experiences.
Dentists, builders, law firms — all business verticals are being digitally disrupted, and payments and banking are being embedded into the customer experience solutions they adopt.
Senior KeyBank executives — including CEO Chris Gorman and EVP Ken Gavrity, Head of Enterprise Payments — have been closely tracking the embedded banking trend.
At an investor day presentation in March 2022, Gavrity discussed the strategy behind the bank’s launch of an embedded banking capability following a year of “incubation.” Gavrity and Jon Briggs, EVP, Head of Commercial Product & Innovation, Commercial Payments, went into more detail in an interview with The Financial Brand. Gavrity oversees all consumer and commercial payments operations for Key, including embedded payments. His operation generates $1.5 billion in revenue, representing 21% of the bank’s total revenue of $7 billion.
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Embedded Banking’s Huge Growth Potential
Predictions for embedded banking growth are quite striking. “We estimate the revenue pool by 2030 will be north of $400 billion across both embedded payments and embedded lending,” says Briggs. That growth would materially outpace growth of traditional payment or lending revenues, says Briggs. He says that the bank’s estimate is based on analyses done by Bain Capital and Lightyear Capital.
That large revenue estimate derives from an ongoing and rapidly developing trend in the small business/professional marketplace, where KeyBank is initially concentrating its embedded banking efforts. It all revolves around software.
In KeyBank's iteration of embedded banking, the bank adds a payment function to the digital CX platform sold to small businesses by a software-as-a-service provider.
Small businesses and professional offices have for years purchased business management software. What is new is that the companies’ client bases — business or consumer —expect a much more digital experience now, Gavrity explains, and typically that is not something their existing software can handle.
Enter software-as-a-service (SaaS) providers that provide a solution to handle the digital customer experience. These platforms are tailored to a particular industry’s needs and integrate with the existing software. Payments is one of the most important CX functions to incorporate.
That’s where banks come in. It is difficult for these SaaS companies to assemble the right technology, risk expertise and banking capabilities to meet this need. “We think there’s a great opportunity to be the bank powering these software platforms,” Gavrity states.
More than four in ten small and midsize businesses are using some sort of “verticalized” software offering, says Briggs. “In what we view as the client ecosystem, you have a consumer at the end of the value chain demanding a better user experience. You have a business sitting in the middle that needs a more automated workflow. And then you have SaaS companies delivering that technology to the small business. And at every step there is a component of financial services and banking opportunities.”
Bain's estimate of how many U.S. card payments will be embedded within software platforms by 202540%
Citing Bain data, Gavrity says that as of 2019 8% of U.S. card payments were occurring within software platforms. That figure is expected to rise to 40% by 2025. “That’s an extraordinary shift in where and how payments are processed, and we’re seeing this trend across every type of business we serve,” says Gavrity.
Real-Life Example of Embedded Banking
Dental practices represent a big market for KeyBank. Gavrity used that industry to explain the operation and potential of embedded banking.
The bank doesn’t call on each dentist office and say, “We really want to help you embed financial products into your practice software,” Gavrity notes wryly. Instead, the bank entered into a strategic agreement with Rectangle Health, a SaaS company that provides mobile technology for dentist offices to improve customer experience issues ranging from appointment reminders to cross-selling opportunities. KeyBank worked with Rectangle Health to embed payment capabilities into the fintech’s SaaS solution.
“We’re selling to the software company who’s then distributing our capability and our technology to their thousands of SMB clients,” says Gavrity. “That is an exponential growth model. We benefit every time Rectangle Health onboards a physician practice or a dental office or a veterinary hospital onto Key’s banking platform.”
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Briggs notes that the way SaaS companies monetize their software is through payments. “They’re garnering a much higher margin than the traditional merchant services or card acceptance margin by delivering software and payments together,” Briggs states. That helps to expand the overall market for card-based revenue, he adds, offsetting other factors that are reducing it.
In addition to payments, embedded banking can include credit products as well. Gavrity says SaaS platforms could give their clients the opportunity to provide credit, enabling a dental practice, for example, to seamlessly offer financing for implant surgery or other high-cost procedures. That could offset the spread of buy now, pay later plans into to medical-related payments or other areas.
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KeyBank has dentist customers that are not clients of Rectangle Health and it actively sells the fintech’s platform to these customers. So the relationship is symbiotic.
The bank has eight other fintech channel partnerships that it is working with to offer embedded banking including AvidXchange, Billtrust and Bill.com. Beyond that, the bank acquired Pacific Crest Securities, an investment bank focused on the technology vertical, which is now part of KeyBanc Capital Markets. That gives the bank access to thousands of technology clients to whom it can pitch embedded banking.
How Embedded Banking Helps Banks Compete
Fintech partnering is all the rage now, but the largest of them — the “paytechs,” such as PayPal, Stripe and Block (formerly Square) — are still regarded as major threats to banking.
Gavrity doesn’t downplay the impact of those big companies. “They’re digitally native and they’re analytically native,” he says. “They already have the skill sets of the future in abundance.”
But with fintech competitors more generally, Gavrity believes banks have an edge.
“Fintechs have an agile development mentality,” he explains, “but it tends to be around single products.”
When they get into the much more complex world of multiple payment types across multiple channels — with lending being embedded — that’s a capability most fintechs struggle with. Banks, on the other hand, can offer a more holistic relationship, Gavrity maintains.
That advantage is only applicable, however, if banks recognize how important it is to have the skillsets to compete in this new banking marketplace, Gavrity maintains, and to have them in-depth across the institution — not just in a “special forces team” off to the side.
Adds Briggs: “One of the limiters for the banking industry is that for a long time banks have focused mainly on front-end digital applications. In order to really drive embedded banking, you need to have digitization end to end.”