How embedded finance and BaaS are influencing financial services

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A few years ago, the automotive industry underwent a transformation. Cars were no longer just sedans, hatchbacks or estates but evolved into new multi-purpose, cross-segment and highly-customized vehicles. Similarly, the financial services industry has also morphed.

Non-bank companies increasingly offer financial services, such as digital wallets, accounts, payment methods and financing options, making most companies fintechs. The ultimate goal is customer retention and to increase customer lifetime value.

Today, companies in all industries are considering launching embedded financial services. The embedded finance market is predicted to exceed $138 billion in 2026, up from $43 billion in 2021, according to a new study from Juniper Research.

In response to the demand, banks and financial institutions are increasingly providing banking as a service—bundled offerings of technology and services that allow other businesses to offer banking solutions under their own brands.

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What is BaaS?

Banking as a service is a term that describes the technology and services that allow other businesses to offer banking solutions under their own brands.

BaaS providers offer application programming interfaces, allowing third-party developers to access banking features and functionality to build financial products and services on top of existing platforms. This enables companies to launch new financial products quickly without building everything from scratch.

SEE: Hiring kit: Back-end Developer (TechRepublic Premium)

This white-labeled platform allows companies to focus on their core competencies while offering valuable financial services to their customers. Banks and financial institutions benefit from BaaS by expanding their customer base and increasing revenues without incurring the costs of developing and marketing new products.

BaaS is quickly becoming a beneficial solution for fintechs and traditional banks as they adapt to the changing landscape of finance. Companies no longer need to own a bank or financial services company to offer financial services.

There are a number of common use cases for BaaS, including:

  • Allowing companies to offer branded payment cards to their customers
  • Providing financing options for businesses
  • Offering loyalty programs and rewards
  • Embedding payments into websites and mobile apps using APIs

What is embedded finance?

Embedded finance is a term that describes the integration of financial products and services into other non-financial products and services. For example, a customer might be able to sign up for a subscription service and pay for it with a monthly payment that includes their mortgage, car loan and other debts. Embedded finance is designed to make financial products and services more accessible and convenient for customers.

Common use cases for embedded finance include:

  • In-app payments
  • Paying bills through a chatbot
  • Making international money transfers through a social media platform
  • Buy now, pay later in retail
  • Automatic discounts or cashback for transactions

Understanding and monitoring trends in the embedded finance and BaaS arena can help banks and non-bank companies to identify opportunities and make strategic decisions about product development, partnerships and go-to-market plans.

The rise of openness

The rise of openness in the financial services industry is being driven by a few factors:

  • Customers are demanding more transparency and control over their data and finances.
  • New technologies such as artificial intelligence and mobile banking have made it easier for consumers to compare products and services from different providers.
  • Regulatory changes such as the European Union’s Revised Payment Services Directive (PSD2) have placed pressure on banks to open up their data to third-party providers.

In response to these trends, banks are increasingly adopting open banking technologies such as open APIs. Open APIs enable third-party developers to build applications that interact with a bank’s core systems, giving consumers more choice and flexibility in managing their money.

SEE: Open Banking—Reshaping Financial Services (PDF) (TechRepublic)

While open banking presents some challenges for banks, such as increased competition and the need for greater investment in security, it also presents many opportunities. For example, banks can attract new customers and drive growth by offering new and innovative products and services.

The rise of challenger banks

The rise of challenger banks has been one of the most significant trends affecting financial services in recent years. Challenger banks are digital-only banks that have seen rapid growth in Europe but less enthusiastic adoption in the United States.

However, the COVID-19 pandemic has precipitated a fast uptake in the U.S., with challenger banks being used for COVID-19 stimulus payments. As a result, seven of the top 20 challenger banks are currently U.S. companies.

challenger banks by country pie chart in shades of red
Image source: cfte.education/CFTE Fintech Unicorns

These challenger banks are influencing financial services by providing an alternative to the traditional banking system. They are typically more nimble and customer-focused, resonating with consumers looking for more personalized service.

In addition, they often offer features that traditional banks do not, such as free overseas withdrawals or fee-free overdrafts. They also offer better rates and fees than traditional banks, making them a more attractive option for many consumers.

As challenger banks continue to grow in popularity, it is likely that they will have an increasingly significant impact on the financial services landscape.

Demand for integrated experiences

There is a growing demand for integrated experiences in the financial services industry. This is driven by consumers looking for more seamless and convenient ways to manage their money.

In response, banks and other financial service providers are increasingly offering products that are integrated with each other and with other non-financial products and services. For example, Walmart recently announced that it is launching a fintech startup with partner Ribbit Capital to offer customers modern, innovative, and affordable financial solutions.

IKEA also recently acquired a 49% stake in Ikano Bank, its banking partner. Ikano was part of the original company before it was spun off into an independent business in 1988. This tells us that IKEA has seen the value in having a financial service offering that is integrated with its core product offerings.

Ecosystem orchestrators that offer customers as much integration as possible will be best placed to succeed in the future.

Changing trust levels in financial services

One of the most interesting trends in financial services is the changing trust levels between traditional banks and fintechs. For many years, banks have had a trust advantage over fintechs, but that is no longer the case.

In reality, many non-bank brands now have higher trust levels than banks, which they can leverage to offer financial products. This presents an opportunity for banks to white-label or co-brand their products with partners who have high trust levels. By doing so, banks can tap into the growing trust in other brands and distribute their products more effectively.

Of course, banks won’t necessarily need to white-label all of their products and services; rather, they may identify markets or products where leveraging the trust of non-banks would be most beneficial. Either way, it will be interesting to see how this trend plays out in the coming months and years.

Opportunities for banks and non-banking companies

There is a lot of opportunity for both banks and non-banks in embedded finance.

Non-banks should consider whether adding banking makes sense within the user experience or journey they offer, whether their embedded-finance offering will reach the necessary volume to justify the expense, and whether they have the technical and operational capacity to work with a bank.

On the other hand, banks should consider whether they can realistically transform themselves to offer banking as a service, what products and geographies they should offer BaaS in, and what advantage they have against the integrated user experiences likely to emerge from retailers and big tech companies.

Embedded finance is a growing area with a lot of potential for both banks and non-banks. By considering these questions, both groups can make the most of the opportunities presented by this new landscape.

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