Banks should finally tackle embedded finance

This article first appeared in Börsen-Zeitung (in German).

BNPL, which stands for ‘buy now, pay later’, is key to the success of embedded finance. With this payment option, which is now offered by all major online retailers, customers receive a loan when purchasing a product – without having to contact a bank. Embedded finance is a term to describe the seamless integration of financial services into the products offered by companies whose business focus is not primarily on finance or banking.

Although this instalment purchase option is extremely popular when purchasing items, it’s just the beginning. Other financial products – from credit cards and insurance to investments – are also increasingly being offered by online merchants or other platforms, often even without the need to consult a bank. A quick glance at Asia or the US shows how far-reaching this trend currently is and how far it could extend in the future.

In China, for example, it is already possible to invest money and even buy real estate via the super-app WeChat. In the US, big brands like Walmart offer customers the option to open an account and take out a credit card. The banks work behind the scenes in all of these examples.

Industry observers have assessed such products, and the results highlight the potential of embedded financial services: the US private equity firm Lightyear Capital estimates that the embedded finance market will grow from its current level of around EUR 22.5 bn to around EUR 230 bn globally by 2025. This corresponds to average annual growth of almost 60 %. Industry experts estimate that the market could even be worth up to USD 7 tn by 2030.  

If embedded finance is used in the right places, it creates a win-win-win situation for all parties. Customers experience a user journey without interruption, just like when using platforms such as Amazon or Lieferando. Dealers can increase their closing rates, and financial service providers can tap into new high-volume revenue streams at low acquisition costs. Last but not least, banks benefit from their products being integrated into digital platforms and the constant data generation as a result of this, which they can in turn use to develop new business models.

Missed earnings opportunity

Nevertheless, traditional banks are hesitant and are leaving this lucrative business area to challengers such as Solarisbank, a tech company with a banking licence in Germany and one of the leading providers in the embedded finance sector. Thanks to the company’s Banking-as-a-Service platform, non-banks can integrate the desired digital banking service into their own services or products. Solarisbank acts invisibly behind the scenes and manages the processes, settlement and regulation. In recent years, Solarisbank has increased its turnover by between 80 % and 90 % year-on-year, according to its own figures. Going forward, it is aiming for revenue growth of between 40 % and 60 %.

Why do traditional banks pass up these enormous opportunities? One reason is that they are afraid of losing their interface with customers. In many embedded finance models, the bank is no longer presented as a brand and there is a fear that customer loyalty and trust will suffer as a result. However, this argument is not a valid one, because it is clear that customers want this new type of financial service. This service will therefore become more significant, whether traditional banks are involved in the process or not.

A further challenge lies in combining business, organisation and technology. APIs – the technical interfaces required for embedded banking – should be viewed more as a digital product. Compared to traditional services, however, it is not the end customers who are the users of this product, but rather the developers, and this target group needs to feel enthusiastic about using the API. For the banking IT organisation, this means that API development and delivery must be more strongly aligned in order to be able to react quickly to customer needs.

Banks should also not integrate new API products into their existing processes, as old banking processes are usually strongly interconnected with the outdated core banking system, which means that the new product loses speed and flexibility. New, simple processes therefore have to be set up.

Time to rethink

In order to take advantage of the opportunities, banks urgently need to learn the required expertise, and those responsible must get involved in API-based business models and value streams instead of just thinking in terms of account fees, loans and share trading. They have to ask themselves which services they want to make available to which players for a profit – for example, they may want to provide access to customer onboarding (incl. anti-money laundering and know-your-customer processes), make their corporate risk assessment available to third parties or offer insurance – because embedded finance also presents enormous opportunities in B2B business.

One example of this in the small and medium-sized business sector is Shopify, the leading cloud-based, multi-channel commerce platform. This platform already provides short-term loans to businesses in the US, which is highly convenient for them. Thanks to the extensive data that Shopify has access to, credit decisions can be made easily.

Banks that want to develop such new business models should look for partners and start initial pilot projects together with them. For example, if their corporate clients want to sell a machine, the financing could be arranged directly through the manufacturer without the client having to contact the bank. Innovative pay-per-use models can then be considered for the financing of machines on this basis.

In any case, it’s crucial that the first steps are taken soon, because future possibilities often only become apparent when partners start working with APIs. Traditional banks should also cooperate with start-ups, consider spin-offs or get involved in new companies. After all, they can still win over clients with their trusted name and market power and also secure their place in the growing market of embedded finance.