What’s Embedded Banking and Why Does It Matter?

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The financial technology industry is notorious for its ever-changing nature. Silicon Valley’s breakneck pace is enough to make some industry veterans’ heads spin. Advancements in technology and changes in economic incentives can create ripple effects that shift the entire fintech industry at a moment’s notice. It can be a lot to keep up with: Web3, blockchain, crypto, NFTs, buy now, pay later, digital ID, know your customer and anti-money laundering laws, two-factor authentication… the list goes on.

Among the latest fintech phenomena to garner attention is embedded banking, a term that sounds both banal and confounding at first blush. Embedded finance has received some attention, but embedded banking remains a little-known concept among banks that have some of the biggest opportunities in the space.

Embedded banking is a model where banks can provide purpose-built digital services to their customers, including retail and small- to medium-sized businesses (SMBs). Embedded banking enables banks to offer a bespoke technology solution through an open framework that can meet the expanding business requirements of their SMBs customers. As opposed to embedded finance, where businesses access financial services through a third-party platform that is not a specific solution from a financial services company, embedded banking places the bank at the heart of an SMB’s operations. Embedded banking both helps strengthen an SMB’s technology and its relationship to their bank.

Embedded banking is not completely novel. The concept has existed for a few years now, but recent innovations have completely revolutionized the field. Embedded banking is moving from an “inside out” model to an “outside in” model. The inside out model of embedded banking used siloed digital channels per customer segment and direct integration with core banking systems. For example, each individual business segment — like SMB, commercial and treasury management — needed their own separate digital channel. Through an outside in approach, a bank can offer their SMBs one secure environment and a unified digital experience for integrating data from multiple backend systems.

The outside in approach to embedded banking is both more flexible and provides more robust services for customers. Outside in embedded banking also offers the customer an open view of multiple financial institution relationships and streamlines access to a portfolio of services through a unified user experience. This gives SMBs access to a much wider array of services to fit their unique needs, all through the bank’s digital channel.

Outside in embedded banking is the perfect solution for banks that want to provide top-of-the-line financial services in a constantly changing economic environment that requires small businesses everywhere to adopt more efficient technology. Inflation and interest rates increases means money is becoming tighter than ever; small businesses are the most at risk in an economic slump. In particular, SMBs want more payments options and faster access to their cash, while solutions like flexible invoicing options, expedited collection of payments and automated data exchange could become vital for a business’s survival.

Outside in embedded banking represents a chance for SMBs to modernize their digital experiences and streamline operations, and for banks to form stronger relationships with their SMB partners. Banks are perfectly positioned to throw a lifeline to their small business customers. Embedded banking might still be relatively unknown to many bankers, but it may just be thing that helps countless SMBs get through the imminent economic crunch.

Using Embedded Finance to Grow Customers, Loans

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Embedded finance is all around us, whether you know it or not.

Embedded finance is a type of transaction that a customer conducts without even realizing it — without any disruptions to their customer experience. Companies like Uber Technologies, Amazon.com, and Apple all leverage embedded finance in innovative ways to create impactful customer engagements. Today’s consumers are increasingly used to using embedded financial products to pay for a ride, buy large items and fill in cash-flow gaps.

But the explosion of embedded finance means that financial transactions that used to be the main focus of customer experiences are moving into the background in favor of more intuitive transactions. This is the whole point of embedded lending: creating a seamless customer experience centered around ease-of use, convenience and efficiency to enable other non-financial experiences.

Embedded lending extends embedded finance a step further. Embedded lending’s invisibility occurs through contextual placements within a product or platform that small to medium-sized businesses (SMBs) already use and trust. Because of embedded experiences, SMBs can get easier, faster access to capital.

All of this could put banks at a disadvantage when it comes to increasing their reach and identifying more and more qualified, high-intent SMBs seeking capital. But banks still have compelling options to capitalize on this innovative trend, such as:

  • Joining embedded lending marketplaces. Banks can capitalize on embedded lending’s ability to open up new distribution channels across their product lines. Banks can not only protect their services but grow core products, like payments and loans, by finding distribution opportunities through embedded lending partners that match businesses looking for credit products and lenders on a marketplace.

Banks can take advantage of this strategy and generate sustained growth by using platforms, like Lendflow, that bring untapped distribution opportunities into the fold. This allows them to easily reach qualified, high-intent businesses seeking capital. Even better, their applications for credit occur at their point of need, which increases the likelihood they’ll qualify and accept the loan.

  • Doubling down on traditional distribution channels. Another viable growth strategy for banks is to double down on providing better financial services and advice through traditional channels. Banks possess the inherent advantage of being in a position to not only supply products and services, but also provide ongoing advice as a trusted financial partner. Incorporating additional data points, such as payroll and cash flow data or social scoring, into their underwriting processes allows banks to leverage their unique position to develop more personalized products, improve customer experience and better support customers.

Embedded lending platforms can aggregate and normalize traditional and alternative data to help banks improve their credit decisioning workflows and innovate their underwriting processes.

  • Reverse engineering on digital banking platforms. Banks can replicate this approach by embedding fintech products into their existing mobile app or digital banking platforms. Consider a bank that decides to provide shopping access through their online portals. In a case like this, a customer may apply for a car loan through the digital bank portal. The bank can then connect that customer to a local car dealership with whom they have a partnership — and potentially maintain revenue share arrangements with — to complete the transaction.

Lenders’ Crossroads Choice
Embedded finance’s effective invisibility of its services and products poses the biggest threat — or opportunity — to banks and traditional lenders. The convenience and ease of access of embedded financial products through platforms that customers already know and trust is an ongoing challenge traditional financial services providers. Yet embedded lending doesn’t have to be a threat for banks. Instead, banks should think of embedded lending as an opportunity to innovate their product lines and expand their reach to identify underserved small and medium-sized businesses in highly profitable industries.

Embedded lending opens a new world of underwriting possibilities because it relies on smarter data use. Platforms can pull data from multiple third-party sources, so lenders can efficiently determine whether or not a customer is qualified. With better data and smarter data use, fewer qualified customers get turned away, saving lenders time, cutting down underwriting costs and increasing conversion rates.

Leveraging Embedded Fintech for Small Businesses

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Small businesses are increasingly looking for more sophisticated financial solutions, like digital payments. Yet, many community banks haven’t adapted their products and services to meet these demands. Banks that don’t address their small business clients’ pain points ultimately risk losing those customers to other financial providers. Derik Sutton, vice president at Autobooks, describes how community banks can bridge that gap with embedded fintech.  

  • How Small Business Needs are Changing
  • Confronting Competition 
  • First Steps to Embedded Fintech 

Autobooks’ cloud-based platform is built on Microsoft Azure.  

Unlocking Banking as a Service for Business Customers

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Banking as a service, or BaaS, has become one of the most important strategic imperatives for chief executives across all industries, including banking, technology, manufacturing and retail.

Retail and business customers want integrated experiences in their daily lives, including seamlessly embedded financial experiences into everyday experiences. Paying for a rideshare from an app, financing home improvements when accepting a contractor quote, funding supplier invoices via an accounting package and offering cash management services to fintechs — these are just some examples of how BaaS enables any business to develop new and exciting propositions to customers, with the relevant financial services embedded into the process. The market for embedded finance is expected to reach $7 trillion by 2030, according to the Next-Gen Commercial Banking Tracker, a PYMNTS and FISPAN collaboration. Banks that act fast and secure priority customer context will experience the greatest upside.

Both banks and potential BaaS distributors, such as technology companies, should be looking for ways to capitalize on BaaS opportunities for small and medium-sized enterprises and businesses (SMEs). According to research from Accenture, 25% of all SME banking revenue is projected to shift to embedded channels by 2025. SME customers are looking for integrated financial experiences within relevant points of context.

SMEs need a more convenient, transparent method to apply for a loan, given that business owners are often discouraged from exploring financing opportunities. In 2021, 35% of SMEs in the United States needed financing but did not apply for a loan according to the 2022 Report on Employer Firms Based on the Small Business Credit Survey. According to the Fed, SMEs shied away from traditional lending due to the difficult application process, long waits for credit decisions, high interest rates and unfavorable repayment terms, and instead used personal funds, cut staff, reduced hours, and downsized operations.

And while there is unmet demand from SMEs, there is also excess supply. Over the last few years, the loan-to-deposit ratio at U.S. banks fell from 80% to 63%, the Federal Reserve wrote in August 2021. Banks need loan growth to drive profits. Embedding financial services for SME lending is not only important for retaining and growing customer relationships, but also critical to growing and diversifying loan portfolios. The time for banks to act is now, given the current inflection point: BaaS for SMEs is projected to see four-times growth compared to retail and corporate BaaS, according to Finastra’s Banking as a Service: Global Outlook 2022 report.

How to Succeed in Banking as a Service for SMEs
There are three key steps that any institution must take to succeed in BaaS: Understand what use cases will deliver the most value to their customers, select monetization models that deliver capabilities and enable profits and be clear on what is required to take a BaaS solution to market, including partnerships that accelerate delivery.

BaaS providers and distributors should focus on the right use case in their market. Banks and technology companies can drive customer value by embedding loan and credit offers on business management platforms. Customers will benefit from the increased convenience, better terms and shorter application times because the digitized process automates data entry. Banks can acquire customers outside their traditional footprint and reduce both operational costs and risks by accessing financial data. And technology companies can gain a competitive advantage by adding new features valued by their customers.

To enable the right use case, both distributors and providers must also select the right partners — those with the best capabilities that drive value to their customers. For example, a recent collaboration between Finastra and Microsoft allows businesses that use Microsoft Dynamics to access financing offers on the platform.

Banks will also want to focus on white labeling front‑to-back customer journeys and securing access to a marketplace. In BaaS, a marketplace model increases competition and benefits for all providers. Providers should focus on sector‑specific products and services, enhancing data and analytics to enable better risk decisions and specialized digital solutions.

But one thing is clear: Going forward, embedded finance will be a significant opportunity for banks that embrace it.

Why Embedded Finance Is the Next Area of Digital Revolution

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The four decades after the internet made information readily accessible has led to inventions and innovations like smart devices, mobile apps and the ability to be constantly connected. Today, companies are focusing on harnessing technology to build smoother, richer and deeper customer experiences.

As the information age evolves to the experience age, the next digital revolution will be embedded finance. Embedded finance enables any brand, business or merchant to rapidly, and at a low cost, integrate innovative financial services into new propositions and customer experiences. Embedded finance is driven by consumers’ desire for more convenient and frictionless financial services. Several use cases that underline the demand for embedded financial experiences include:

  • Billing payments as part of the experience. Businesses are already using payment options, like buy now, pay later, to differentiate their offering, increase sales and empower buyers at checkout.
  • Growing popularity of Point-of-Sale financing. The volume of installment-based, flexible payment and instant credit options has increased significantly in the past five years, indicating a desire for instant access to short-term borrowing.
  • Mainstreaming of digital wallets. As more people use their mobile phones to purchase products and services, it makes sense that consumers want to access other financial services seamlessly within apps.

There is potential for embedded finance in almost every sector; in the U.S. alone, embedded finance is expected to see a tenfold revenue increase over the next five years. Financial institutions are in a position to provide branded or white-label products that non-banks can use to “embed” financial services for their customers. Banks must evolve rapidly to take advantage of this new market opportunity.

The front-runners will be institutions that can offer digital real-time payments or instant credit with minimal friction and optimum convenience to customers. But providing this requires new core technologies, cloud capabilities and flexible application programming interfaces, or APIs and other infrastructure to support new business models. Banks will also have to become much more collaborative, working closely with fintechs that may own or intermediate the customer relationship.

Embedded finance allows nonbank businesses to offer their customers additional financial services at the point of decision. Customers can seamlessly pay, redeem, finance or insure their purchase. This can look like buying, financing, and insuring a TV from a store’s shopping app, securing a mortgage through the estate agent’s website as part of a house purchase or obtaining health insurance from a fitness app. This does not mean that every retailer or e-commerce business will become a bank, but it does mean that many more will be equipped with the potential to offer more financial capabilities to customers as a way to compete, differentiate and engage more effectively.

In May 2021, Mambu surveyed 3,000 consumers and found the following:

  • 81% would be interested in purchasing health insurance via an app, and almost half of these would pay a small premium.
  • 60% would prefer to take out an education loan directly from their academic institution rather than a bank.
  • 86% would be interested in purchasing groceries from a cashier-less store.

How these capabilities are delivered and consumed is changing constantly. Consumers want to use intuitive and fast financial services via online and mobile banking channels. Digitalization and cloud services are reinventing back-office functions, automating and streamlining processes and decision-making. At the same time, legislation, open banking and APIs are driving new ecosystems. These changing markets and increased competition make it more difficult for banks to meet evolving customer demands, prevent churn and sustain growth.

We are living in the world of the continuous next. Customers expect financial service providers to anticipate and meet their requirements — sometimes even before they know what they want — and package those services in a highly contextual and personalized way. At the same time, new digital players are setting up camp in the bank space. Tech giants are inching ever closer to the banking market, putting bank relationships and revenue pools are at risk. On an absolute basis, this could cost the industry $3.7 trillion, according to our research.

Incumbent banks need to adopt a foundation oriented toward continuous innovation to keep pace with changing customer preferences. Embracing innovations such as embedded finance is one way that banks can unlock new opportunities and raise new revenue streams.

The Unlimited Potential of Embedded Banking

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With fewer resources and smaller customer bases, community banks often find themselves on the losing end of a tug-of-war game when getting involved in emerging technologies. But that’s where embedded banking is a game-changer.

Embedded banking offers every financial institution — regardless of size — a chance to grab market share of this relatively untapped, billion-dollar opportunity.

Embedding financial services into non-financial applications is a market that could be worth almost $230 billion in revenues by 2025, according to a report from Lightyear Capital. That means forward-thinking community banks could see a big upside if they make the strategic investment — as could their non-bank partners. And those companies that are orchestrating integrations behind the scenes could also reap rewards in the form of subscription or transactional services. And ultimately, end users will benefit from the seamless experience this technology provides. While it’s a winning proposition for all, a successful embedded finance operation involves preparation and strategy. Let’s take a closer look at the four players who stand to benefit with embedded banking.

Community Banks: Building Reach
As community banks retool their strategies to adapt to more digital users, they also face growing challenges from digital-only neobanks and fintechs to retain their existing customers. They will need innovative features on-par with their big-budgeted competitors to thrive in the space.

Embedded banking is a legitimate chance for these banks to stake out a competitive advantage. Embedded banking, a subset of banking as a service (BaaS), allows digital banks and other third parties to connect with banks’ systems directly via application programming interfaces, or APIs. Today, 70% of banks that sponsor BaaS opportunities have less than $10 billion in assets. The cost to compete is low, and the services that non-bank entities are seeking are already available on banking platforms.

To start, institutions work with a technology company that can build APIs that can extend their financial services, then identify partners looking to embed these services on their digital platform. A best-case scenario is finding a digital banking partner that can deliver the API piece and has connections with potential embedded banking partners. Once a bank has an embedded banking strategy in place, expansion opportunities are unlimited. There are numerous non-bank partners across many industry verticals, offering entirely new customers at a lower cost of a typical customer acquisition. And these partnerships will also bring new loans, deposits and payment transactions that the bank wouldn’t otherwise have.

Nonbanks: Retaining Customers, Bolstering Satisfaction
Companies outside of the finance industry are rapidly recognizing how this technology can benefit them. Customer purchases, loans or money transfers can all be facilitated using services from a bank partner via APIs. Companies can offer valuable, in-demand financial services with a seamless user experience for existing customers — and this innovation can fuel organic growth. Additionally, the embedded banking partnership generates vast amounts of customer data, which companies can use to enhance personalization and bolster customer loyalty.

Consumers: Gaining Convenience, Personalization
Making interactions stickier is key to getting consumers to spend more time on a website. Sites should be feature-rich and comprehensive, so users don’t need to leave to perform other functions. Embedding functionality for relevant financial tasks within the platform allows users to both save time and spend more time, while giving them valuable financial products from their trusted brand. They also benefit from data sharing that generates personalized content and offers.

Tech Companies: Growing Partnerships, New Opportunities
Technology providers act as the conduit between the financial institution’s services and the non-bank partner’s experience. These providers — usually API-focused fintech companies — facilitate the open banking technology and connections. By keeping the process running smoothly, they benefit from positive platform growth, the creation of extensible embedded banking tools that they can reuse and revenue generated from subscription or transaction fees.

Everyone’s a Winner
This wide-open embedded banking market has the potential to be a game changer for so many entities. The good news is there is still plenty of room for new participants.