Banks Will Bend or Bust as Embedded Finance Transforms Centuries of Traditional Commerce

Banks must adapt to embedded finance as it transforms commerce as we know it.

January 19, 2023

For as long as humans have traded goods, the services associated with money or the exchange of legal tender have been the bedrock of banks and financial institutions. In recent years, as embedded finance has become mainstream, banks have either joined the revolution and adjusted their offering to customers or face an exodus in favor of faster, more convenient options when it comes to conducting transactions, observes Pavel Livshiz, General Partner at Hetz Ventures.

It is clear that the drumbeat of digital advancement alongside the changing demands of customers have forced the hands of banks, which aren’t always the most nimble of beasts. Time will tell whether the seats of traditional banking will be swept up with the future of fintech or swept aside as clunky financial relics of yesteryear.

Reacting to Change

Embedded finance does what it says on the tin – it is when financial products are implanted in financial or nonfinancial environments to benefit the customer experience. This can mean the integration of previously exclusive bank-based offerings such as loans, insurance or debit cards into everyday transactions at the supermarket or high street. 

No longer would someone need to approach the bank for a loan or complete the arduous process involved to achieve one when there is now an option to make purchases on credit or in installments on a store’s website. With a couple of clicks, we can buy pretty much anything, using every financial lever at our disposal to streamline the process.

Banks have found themselves one step behind as the market, in general, has become more digitized. Notwithstanding the digital channels a bank provides – typically a mobile app – a customer may encounter dozens of touchpoints where banks have no footprint. This is where gaps are widening, and banks are looking to innovate in order to close them. A 2022 surveyOpens a new window showed that over half (54%) of the 300 C-suite banking executives surveyed said their employers have “faced greater competition over the past three years from digital alternatives.”

Embedded finance has encouraged banking leaders to metamorph their product offers and the way they do business to keep pace with the glut of fintech services which do it better, quicker and are more accessible. According to some industry leaders such as Ron Shevlin, chief research officer at Cornerstone Advisors, a major problem in embedded banking right now is that a lot of banks just don’t have the technology chops to deliverOpens a new window .

See More: Composability: The Key to Digital Transformation in Banking

Moving Away from ‘Just Going to the Bank’

It’s estimated that embedded financial services will produce $230B in revenuesOpens a new window in 2025—a 10-fold increase over the $22.5B in revenues in 2020. Most of us make use of embedded finance, even if we don’t realize it. Some services have been around for a while, like car rental insurance and payment plans for high-priced items, and now e-commerce retailers are offering banking capabilities directly on their websites without re-routing customers to a bank. 

This convenient user experience creates strong brand loyalty, and different reward schemes enable exclusivity and therefore guaranteed repeat custom. For instance, the ride-sharing app Lyft offers a checking account and associated debit card purely for its drivers. This means drivers are paid immediately after every ride, rather than the protracted timeframe they normally would endure. 

There is little doubt that embedded finance has moved the dial for banks, and that has resulted in many being introspective and conducting a deep analysis of how legacy functions can be modernized, leading to an evolution in innovation to ensure customer retention.

Technological Shift

It is apparent banks are investing in new customer-centric technology or partnering with third-party providers to help accelerate embedded banking, and with 30% of customersOpens a new window claiming they would consider switching banks, traditional models need to be adjusted. Banks are slowly joining the game, but they must develop a playable strategy. 

First and foremost, banks should be protecting and expanding their core products – e.g., payments and loans—by finding new distribution opportunities through embedded finance. This could prove difficult for smaller financial institutions, which are side-lined by retail platforms that partner with the larger banks, but there are still many new revenue streams to realize from new products and services already created by fintech startups. These can be built into banks’ product sets, websites, mobile applications, and business processes.

Targeting specific clients with unique embedded finance services would be a more efficient and effective tactic. Accenture studied more than 2,500 SMEs around the world and found that embedded finance offerings to such businesses could boost global bank revenues by as much as $92 billionOpens a new window in the next three years. In partnership with leading digital platform providers, banks can supply the fundamental architecture for the digital platforms to deliver their own branded embedded finance offerings. This approach allows banks to retain their historical influence by curating digital credibility.

Banking as a Service (BaaS)

It isn’t just the options on offer direct from a bank that are being refashioned, but the banking services which are integrated into non-financial businesses. BaaS is the provision of banking products and services through third-party distributors and offers specialized propositions and simplified access to bank functionality through APIs. This can be seen in the improvement of global transactions. 

Embedded finance cloaks myriad industries and regions, and there is a growing need for more compatible payment options that can accommodate multiple currencies. Compared to traditional banks, which own the entire value chain, BaaS players largely focus on only one to two stages of the value chain. Working alongside these and similar providers will enable banks to maintain leverage in the sector and continue wielding control of financial interactions, even if at a distance.

Collaborate or Become Outdated

There is plenty of value to be gained for banks through working with fintechs and others in their distribution channels. This doesn’t necessarily mean reshaping the offering in its entirety but simply bringing in useful tech at different parts of the customer journey. Banks are already collaborating with fintechs by setting up both incubator and accelerator hubs that pump out new technologies to deliver more innovative, digital-first solutions. 

As consumers’ expectations are revised on how they make their payments and embedded finance opportunities proliferate, traditional banking systems will need to capitalize on the wave of innovation by replicating the approaches in their own platforms and services or risk falling under the wheels of change and never quite matching what the slicker, more malleable alternative financial solutions can afford.

How are you adapting to embedded finance? Tell us on FacebookOpens a new window , TwitterOpens a new window , and LinkedInOpens a new window .

MORE ON EMBEDDED FINANCE

Pavel Livshiz
Pavel Livshiz is General Partner at Hetz Ventures. He is an aerospace engineer by education, with over nine years in the Israeli military, working for elite technological intelligence units. Pavel previously served as an investment banker at Goldman Sachs, a Consultant at Bain & Company in Amsterdam, and a C-suite executive at an IoT start-up.
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