Late Adopters of ‘Embedded Finance’ Must Play Catch-Up Fast

Becoming the engine behind nonbank companies' built-in 'banking' offerings can potentially expand financial institution opportunities and volume. But most financial institutions today aren't technologically ready to partner with the fintechs pioneering embedded finance technology.

It’s too late to get in on the ground floor of embedded finance. Companies from Uber to Stripe and Starbucks are making financial products available directly to customers, workers and clients. And leading fintechs have partnered with banking companies to form the technological backbone of the industry. All told, this produced $22.5 billion in revenue last year and that’s just for starters.

But this head start doesn’t mean the race is over and share locked up. There’s a huge amount of innovation — and growth — still to come. Market analysts predict the embedded finance industry could generate $230 billion in the U.S. alone by 2025, and $7.2 trillion globally by 2030, more than the combined annual revenue of the top 30 banks and insurers today.

Banks and credit unions will play a crucial role in the future of embedded finance. Those looking to expand into this area still have opportunities to do so — if they can expand into untapped corners of the market or exploit opportunities to differentiate their offerings from others’.

Why This Matters:

While traditional financial institutions’ direct sales might take a hit, retail brands and fintechs will rely on them to open accounts and clear regulatory hurdles. For traditional financial institutions, a new account is a new account, and a transaction is a transaction — partnerships mean growth.

For those banks who did get in on the ground floor, embedded finance represents a tremendous opportunity for expansion. For those who didn’t, it’s a question of how quickly you can get your technical house in order — and whether you have anything new to bring to the industry. Let’s consider both fronts.

Embedded Finance Includes Multiple Banking Activities

Much of the growth in embedded finance over the next decade will come from areas already seeing widespread adoption — digital wallets, branded credit cards, touchless payments. But embedded payments are just one sub-sector of embedded finance. Others include embedded financial tools and embedded lending.

And all present strong opportunities to meet consumers where they are — online and on mobile devices. McKinsey surveyed executives across the business landscape and found that because of Covid-19 “companies have accelerated the digitization of their customer and supply-chain interactions and of their internal operations by three to four years.”

The pandemic had an immediate impact on the financial sector. In April 2020, J.D. Power reported that 30% of consumers had increased their usage of mobile banking apps, and 35% were using online banking more. While these numbers may fluctuate as the in-person economy continues to reopen, the general trend of digital adoption will only increase as Millennials and Gen Zers become an ever-larger piece of the consumer audience.

What to Watch:

Embedded finance will be at the center of this digital-first financial sector, as companies realize the benefits of cutting out the middleman and managing their own financial products and services — from payments and payroll to in-the-moment lending to issuing their own credit or debit cards.

Big techs have led early innovation in embedded finance, the next stage of growth will occur at smaller companies who partner with fintechs or tech-savvy financial institutions to offer customizable solutions without requiring in-house teams to do the complicated work of development, coding and compliance.

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Partnerships May Be Best Approach for Smaller Players

Like most companies outside Silicon Valley and Wall Street, many banks and credit unions don’t have the resources to develop their own embedded finance infrastructure, or the marketing budget to launch a national distribution campaign behind these services. That’s why many financial institutions, realizing the potential of Banking as a Service (BaaS) — offering white label or co-branded products and services — are looking to intermediaries to enter the space.

Most financial institutions today aren’t ready to partner with the fintechs pioneering embedded finance technology — they are behind the curve. These partnerships require banks and credit unions to expedite their internal processes for opening accounts, approving loans or issuing debit cards. Beyond that, they must become ready to scale these services for a national or global market.

Institutions first need to integrate with fintechs, which requires a digital transformation of its own. It means building a data infrastructure that can be exposed to a third party. As an analogy, imagine handing over your desktop to a stranger and expecting them to find particular files, folders and data.

Bottom Line:

You may have a system, but it’s probably not intuitive to anyone but you.

Data operations at most banks run on legacy systems and spreadsheets that require internal expertise to use, with data siloed within the departments most likely to use it. And turning these systems into an intuitive and API-friendly data infrastructure requires significant time and investment — and probably a consultant to manage the change.

But that’s still a lot cheaper than the alternative, which is developing your own embedded finance technology and then funding the distribution and marketing to reach companies who might want to use it.

Growth Opportunities for Those Who Dig Deeper

Embedded finance is potentially as broad as the financial services sector itself, and opportunities for deployment exist in every consumer segment. Think phone companies offering instant microloans or prepaid debit cards or your local cafe managing its own payments system, rather than paying a cut to an outside vendor.

There’s a corollary in the growth of e-commerce. What began as a patchwork of vertical vendors selling particular items — books, diapers or fine wines — is now an online marketplace for everything. Entrepreneurs exploited millions of opportunities along the way, making new products available and then streamlining and consolidating the sales and delivery process.

For financial institutions looking to break into the embedded finance market, differentiation will be key.

  • What products and services can you facilitate that will expand the market for fintechs or consumer-oriented partners?
  • What services would make life easier for people — if only it were more easily and widely accessible?

As with e-commerce, the early entrants into embedded finance have a leg up — and may remain dominant players in the space for some time. But between the industry’s current $22.5 billion in annual revenue and the projected $7.2 trillion in 2030, there’s plenty of room for new players and new ideas.

For banks and credit unions who make the tech investment, opportunity awaits.

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