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.

The Future of Commercial Banking

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Most of the attention around bank digitalization has focused on the retail experience. Retail banks have readily embraced technology to enhance the customer experience. But commercial banking can catch up, complete with business insights that increase customer engagement and add real value. In doing so, a bank can elevate its position from trusted transactional banker to strategic business partner.

In the U.S., there were more than 32 million small-to-medium size businesses (SMBs) in 2021, according to the Small Business Administration. Collectively they create 1.5 million jobs annually, according to Fundera, citing SBA data; this is around 64% of total new jobs. But the stakes of owning an SMB are high: almost half fail within the first five years and 20% fail within the first year, according to the Bureau of Labor Statistics. Most failures cite cash flow as a major contributor to failure. Banks can and should do more to help.

With a wealth of transactions data at their fingertips, banks can help SMBs understand their cash flow and manage their liquidity better. But transactional data is only part of the story. If banks can access their customer data held on internal accounting systems, they can obtain a holistic view of cash flow, gain unique insight into how their customer’s business is running, and offer help exactly when and where it’s needed.

Bank customers are increasingly willing to share their data: 82% of SMBs say they are willing to share data with their primary financial provider, particularly in return for business benefits, according to FIS research conducted in 2022. Moreover, we found that 66% of SMBs are interested in trusted advisory services. The time is right for such services.

Technically, it is quite simple for a bank to orchestrate data flows. Over 64% of SMBs in the U.S. use accounting software, such as Quickbooks, Xero, Sage and a handful of others, minimizing the amount of integration work and number of interfaces needed. So how can banks help SMBs businesses survive and prosper?

The Ideal SMB Banking Overview
A combined view of transactional bank data and accounting data allows banks to help an SMB understand exactly how much cash it has now and whether it has sufficient liquidity to meet upcoming obligations.

Incorporating accounting data can pull in open invoices and bills combined with cash flow forecast to build an accurate picture of how money is flowing throughout the business and compute standard accounting ratios. Such information can give an SMB owner, most of which don’t have much knowledge of accounting, some valuable business insight into how their business is performing.

A snapshot of cash flows allows users to modeling future performance by using “what if” criteria. Users can set thresholds of a minimum cash position to eliminate financial shocks to the business. If cash shortfalls seem likely, the user can be prompted to transfer funds from account, consider credit options or arrange to speak with a banker.

Benefits for Banks
All of this information that’s available to the customer can also be accessed by a banker, who can help with financial decisions and offer advice. Although this may be an opportunity for a bank to sell products, the real benefit is to add value to the relationship and build customer loyalty.

With all the relevant information in one place, bankers can be better prepared for customer meetings and, if required, can meet customers where they are. With many bank branches being repurposed as advice centers, bankers can use tablets to review customer business plans either in branch, at a remote location or in a virtual meeting. Whatever the location, this is relationship banking at its very best.

Millennials are currently the largest group of bank customers, according to the American Bankers Association. In the wake of Covid-19, many have reflected on their career choices; some have launched new businesses and entrepreneurship is a goal for 56% of the cohort. These individuals have bank accounts, and many will need business banking either now or in future. They see little distinction between retail and commercial banking. Banks must acknowledge that the retail customers of today are the business owners of tomorrow.

The Battle for the Small Business Customer

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Increasingly, small and medium-sized businesses (SMBs) are looking for digital banking and financial solutions to address specific needs and provide the experience they expect.

The preference for digital has allowed fintechs and big tech firms to compete with financial institutions for these relationships. While the broadened competitive landscape creates new challenges, this migration to digital channels creates new opportunities for banks of all sizes to compete and win in the SMB market. But first, banks need to think differently and redefine what’s possible.

Many banks have a one-size-fits-all approach to SMB banking. This approach is based on the shaky premise that what SMBs need are consumer banking products with slight variations. This leaves SMBs with two choices: Leverage the bank’s existing online retail banking products — an option that is easy to understand and use, but lacks the specific financial solutions they need — or use the bank’s more-complex digital commercial banking products. The impersonal experience most SMBs experience as a result of this approach can leave them feeling unsatisfied and underappreciated. But banks can capitalize on this underserved market by combining modern technology with a targeted segmentation strategy.

Businesses with fewer than 20 employees make up over 98% of American businesses, according to the U.S. Small Business Administration’s 2021 Small Business Profile. About half of SMBs feel their primary financial institution doesn’t understand their needs, according to Aite’s 2021 study, “Delivering the Experience Small Businesses Expect.”

Banks need to deliver more tailored solutions and experiences to differentiate themselves from competitors. To start, they should ask and honestly answer some key questions:

  • In what target markets (size, industry and location) can we compete and win?
  • What are the needs of the businesses in these target markets, beyond traditional banking?
  • What partners will we need to meet the needs of these account holders?

The answers start with the bank’s business strategy — not its technology strategy. Banks need to think in terms of outcomes first before creating the technology strategy that will help them achieve those outcomes.

SMBs Want Experiences Built for Them
User experience matters to SMBs; winning their business depends on providing fast, user-friendly, tailored experiences. They increasingly expect a single view of both their business and personal relationships with the bank.

But using nonbank firms has increased complexity for these SMBs. Banks have an opportunity to aggregate these relationships and provide a comprehensive set of solutions through fintech partnerships. They can tailor digital experiences that address the needs of each of their SMB by integrating their banking solutions with their fintech partner solutions.

Taking a customer-centric approach that pairs account capabilities to business needs allows banks to make their SMB customers feel appreciated, increasing loyalty. For example, a dentist practice may need products and services focused on managing cash flow, accessing credit and wealth management options. Gig economy participants can be focused on payments and nontraditional services through the fintech marketplace, such as bookkeeping or time tracking and scheduling.

The current leading digital services providers enjoy strong customer loyalty because they’ve created positive experiences and value for each customer. SMBs are leaving banks — or are deeply considering switching banks — because of these institutions’ inability to provide what they want: banking experiences and solutions that help them run their businesses more effectively.

SMBs need a compelling business case when selecting a bank; the bank must convince these businesses that it’s prepared to do what’s needed to meet their growing and evolving financial requirements. Banks that fail to focus on broadening partnerships and delivering a wider range of financial solutions through an extensible digital platform may have difficulty retaining existing business customers or attracting future new ones. As a result, these institutions may also find themselves with a higher-than-average percentage of less-valuable customers.

Conversely, those banks that offer solutions SMBs need, in an experience they expect, will emerge as leaders in the space. Banks need to understand the targeted segments where they can compete and win — and then deliver with a fast, easy, relevant, end-to-end digital experience. We’ve written an e-book, “The Battle for the Small Business Customer,” that offers an in-depth look at the factors shaping SMB banking today and ways banks can deliver a compelling business case.

Banks that can do this will be able to grow market share in the SMB market; banks that don’t can expect shrinking revenue and profitability. The time is now to redefine what’s possible in the SMB market.

Welcome to the Wild West for Small Business Management Technology

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Today’s small businesses are empowered more than ever by technology. Start-ups and emerging technologies are colliding with established financial institutions to create a true Wild West for business and financial management in the small and medium business (SMB) sector. But what approaches are different finance and technology players taking—and how will they impact the way small businesses manage their finances?

There’s no doubt that business owners recognize the benefits of technology—one recent survey found that 29 percent of all SMBs say technology is critical to improving business outcomes. The result is a mad dash by incumbents to catch up, keep pace and partner with innovators in the right ways to earn the loyalty of business owners.

Here are four different ways that financial companies are battling it out to help small businesses manage their cash flow, start to finish.

Integrating POS with Financial Management
In a recent report by technology provider Wasp Barcode, a majority of small business owners said that their number one priority for technology investment this year is to replace hardware. For a great many SMBs, this includes front end equipment like cash registers and credit card processing devices. Square was the primary innovator of integrating credit card swiping with iPads, but today the bar is much higher in terms of payment hardware technology design, performance and accessibility.

Take Bank of America’s Clover Point-of-sale (POS) solution, for example. As opposed to Square, which only allows for card swiping, Clover is a fully integrated POS, cash drawer and receipt printer. BofA supplements the basic hardware and software with an app store, where businesses can add extra layers of functionality and customization based on their unique processes. The POS software is then able to communicate and send data back to financial management software, so that the two are seamlessly integrated.

Offering End-to-End Cash Flow Management
Other companies are approaching small business management technology with the goal of providing complete, end-to-end financial management. This means that everything from payments, checking, savings, credit, insurance and investments are all handled by one technology platform. This is the logic behind Capital One’s Spark Program for small business finance, that offers a different Capital One Spark product or service for each of those areas, all tailored towards entrepreneurs.

That isn’t to say businesses can pick and choose from different products within the Spark ecosystem (such as checking, corporate credit Cards and 401(k) account management), but the goal is to have everything tightly integrated so business owners can access everything in one place. The ancillary part of the pitch is that it makes customer service that much more convenient, as you only have one partner to contact if multiple issues arise. The challenge will be for a medium-sized mainstay like Capital One to innovate on a pace with both fintech start-ups and mega-bank competitors that acquire or partner with these new players.

Creating a Best of Breed Ecosystem
Having an all-in-one suite is great in theory, but there are certain small business tools that will always be known as being the best at what they do. Accounting and financial management is an area that Quickbooks has traditionally dominated; it still occupies 80 percent of total market share for SMB accounting. But rather than building additional features onto the Quickbooks product, companies like Intuit are building out tightly integrated ecosystems consisting of first-class applications across the breadth of business management needs.

Intuit is an interesting case also because it owns another hugely popular brand, TurboTax. It has been in Intuit’s best interest to keep these successful brands, and add others like the hugely successful personal finance app Mint.com. The intent is to not only make the business easier to manage, but to handle the business owner’s personal finances as well.

SalesForce.com’s strategy is another great illustration of building out a comprehensive ecosystem under one umbrella. Any business that uses SalesForce.com can purchase proprietary financial management apps on the firm’s cloud platform, and perform multiple functions without leaving the SalesForce interface. Businesses can utilize the Financial Force app for payroll, Accounting Seed for accounting and so forth. In these cases, SalesForce often provides resources and guidance to these start-ups to make the software on their platform as competitive as possible.

Innovating the right way
Fintech startups have the stated goal of disrupting a financial services sector that has become known as overly traditional and lacking in personalization. But as startup technologies for small business management begin to scale, like the example of Mint.com, these companies often face a crossroads in terms of how and where to expand. Some choose to be acquired, as in the case of Mint.com, while others seek partnerships with big banks to gain additional marketing exposure while retaining control of their product.

David Gibbons, managing director at Alvarez & Marshal financial consulting, recently told CNBC that “Banks are partnering to keep in the game and keep relevant. I think they’ve caught up fairly well.” On Deck Capital is one of the foremost innovators in small business lending, using technology to gauge creditworthiness based on the performance of an entrepreneur’s business instead of personal credit score. But rather than be acquired, On Deck has partnered with JP Morgan Chase to build a new lending product for small businesses, under the Chase brand. This is a great example of some “quick win” technology partnerships taking place in the small business space that combine the benefits of innovation with the security and scalability of big banking to better serve SMBs.

And these are just a few of the innovations, technologies and trends that are constantly emerging in the small business sector. The bottom line is big banks now realize that adopting new technologies is critical to retaining SMB clients. With so many startups and established players evolving to offer more services with less hassle, it’s a pretty good time to be a tech-savvy small business owner.