Embedded finance has become a popular term in banking and
fintech circles over the past few years. What is it?
“The integration of financial services into non-financial
websites, mobile applications, and business processes.”
Across a range of financial services—including payments,
lending, and insurance—embedded finance (sometimes referred to as embedded
banking) will generate $230 billion in revenue by 2025, a 10x increase from
$22.5 billion in 2020.
Embedded finance is a threat to incumbent financial institutions,
but they don’t have roll over and play dead. Incumbents can:
1. Capitalize on the new distribution channels that embedded
finance creates for their products and services, and/or
2. Replicate the approach by embedding fintech products into
their own digital banking platforms.
It’s not an either/or choice.
Embedded Fintech Jumpstarts New Product Innovation
Banks can protect and grow their core products—e.g.,
payments and loans—by finding new distribution opportunities through embedded
finance. That might prove a difficult road, however, for mid-size financial
institutions that find themselves shut out of those deals by retail platforms
that partner exclusively with large banks.
According to a new report from Cornerstone Advisors, banks
can create new revenue streams from new products and services already created
by fintech startups—a strategy called embedded fintech.
There is confusion, however, between embedded finance and
embedded fintech. The difference is the direction of the service.
Embedded finance is about enabling non-financial services
companies to provide banking services. Embedded fintech, on the other hand, is:
“The integration of fintech products and services into financial institutions’
product sets, websites, mobile applications, and business processes.”
What kind of fintech products are we talking about here?
A new study from Cornerstone Advisors identified embedded
fintech opportunities for banks that included bill negotiation services,
subscription management, data breach and identity protection, wealth transfer
management, and cryptocurrency investing.
The Digital Products Imperative
Mobile banking adoption is approaching ubiquity among Gen
Zers and Millennials with 88% of the two generations accessing their bank accounts
using a mobile device.
For many, a mobile app is the primary way they interact with
their checking account (and, in essence, their bank).
So, as far as these consumers are concerned, the app IS the
product.
In order to remain competitive, then, banks needs a digital
product development and deployment capability that goes way beyond a digital
platform that only enables customers to manage their existing checking
accounts.
Banks’ New Product Development Efforts are Broken
Historically, launching a new product was a multi-year,
bet-the-farm proposition for financial institutions.
The new imperative is to quickly conceptualize, test,
launch, and operationalize a series of smaller products and services targeted
at specific segments of the market.
Why can’t banks do this?
Economics. The cost of developing, launching,
delivering, and marketing new products has forced banks to go for new product
“home runs”—products that will bring in millions (if not tens of millions) of
dollars in annual revenue. Launching products that only brought in hundreds of
thousands of dollars (or less) was simply not economically feasible.
Organization. Most mid-size financial institutions
don’t have new product design and development departments. In effect, their
technology providers are their de facto new product developers.
Technology. Relying on vendor-developed systems makes
launching new financial products and services hard for banks because of the
customization and integration required.
Banks Need an Embedded Fintech Factory
The Oxford dictionary defines a factory as a place where
“goods are manufactured or assembled chiefly by machine.” Financial
institutions don’t think of product design and development in a factory
context—but they should.
An embedded fintech factory consists of a:
1) Digital products organization. An embedded fintech
factory requires a chief digital products officer—with a supporting staff—to:
1) create and instill a new product design and development process; 2) identify
and prioritize new product opportunities; and 3) be accountable for new digital
product revenue and profitability.
For most financial institutions, the existing digital
banking department doesn’t do this. It’s typically focused on keeping the
online and mobile banking platforms—which support the institutions’ existing
products and services—up and running.
2) Digital products platform. An embedded fintech
factory requires a digital product platform—a technology platform than enables
financial institutions to rapidly and cost-effectively design, create, plug in,
and deploy new digital products and services. The digital product platform must
be: 1) component-based; 2) API-driven; and 3) cloud native.
Financial institutions could migrate to a new digital core
system upon which to build this new platform, but in the short-term, few will.
With roughly 60% of all financial institutions yet to deploy
APIs or cloud computing, the majority of banks need more than just a new core
to build this new platform.
Help is on its way.
A growing list of tech providers is emerging to help create
a digital product platform, including: Agora, Autobooks, Bond, Constellation,
Item, Moov, Nymbus, Sherpa Technologies, Railsbank, Strategy Corps, Synctera,
Technisys, and Treasury Prime.
Embedded Fintech Versus Embedded Finance
A recent tweet from venture capitalist Merritt Hummer
proclaimed “embedded fintech is old news.” In TechCrunch she wrote:
“In 2019, Matt Harris coined the term ‘embedded fintech’ to
describe how software-driven companies will embed financial services into their
applications, from sending and receiving payments to enabling lending,
insurance, and banking services.”
For sure, Bain Capital’s Harris deserves all the credit for
being on the forefront of this trend. But a close reading of his 2019 article
shows that—at the risk of mincing words—Harris was talking about embedded
finance, not embedded fintech.
Embedded finance enables non-financial services companies to
provide banking services. Embedded fintech, on the other hand, help financial
institutions integrate money management services into their existing offerings.
It’s not clear whether the platforms and brands embedding
payments, lending, and insurance are embedding money management services as
well.
If they don’t, they leave the window open for financial
institutions to find a value proposition to fight back against the embedded
finance trend.
If they do, the pressure on banks to come up with a
competitive response is even greater.
In either case, embedded fintech is far from old news.
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