How Financial Institutions Can Drive Profitability with Banking-as-a-Service & Embedded Finance

Banking-as-a-Service (BaaS) and embedded finance are part of an emerging trend within the financial services industry with the potential to shift how small and mid-sized financial institutions serve their customers.

According to research from Cornerstone Advisors, 7% of community financial institutions are already providing BaaS services and 4% are in the process of developing a BaaS strategy. Another 13% are considering the possibility of launching BaaS services.

Why? BaaS has the potential to drive growth for financial institutions. 

BaaS & Embedded Finance Poised for Rapid Growth 

A subset of BaaS, demand for embedded finance options is also growing. A study from Juniper Research found that the value of the embedded finance market will exceed $138 billion in 2026, from just $43 billion in 2021.

This projected increase is largely because financial institutions are increasingly competing with non-banks for market share in response to rising consumers’ expectations. Consumers have very specific financial needs, and they want them met quickly, cost-effectively and delivered frictionlessly. Another challenge traditional banks face is that most consumers today have little loyalty to their financial institutions and will simply move to another if their needs are not met.  

Non-banks have stepped up to meet these consumer expectations and continue to grab significant market share from traditional financial institutions. These non-banks have no legacy systems to hold them back, have significant expertise in enhancing the user experiences, and offer new and innovative ways to deliver products and services when, where and how consumers want to receive them on a level most financial institutions struggle to match. This has created panic among banks. How can they compete? 

The good news is that there are ways traditional institutions can leverage BaaS and embedded finance options for competitive advantages.

Understanding BaaS

To leverage BaaS, banks must first have a good understanding of it. At its core, BaaS is a back-end process that enables non-banks to provide branded banking products and services by using application programming interfaces (APIs) to access the core system of the financial institution in exchange for a fee. Transactions offered through BaaS are a form of “white-label” banking. For example, offering branded credit or debit cards is a common example of BaaS.

BaaS provides non-banks with a way to provide popular financial products and services, fully backed by the Federal Deposit Insurance Corporation (FDIC) and in full compliance with local and national regulations, without having to go through the expense of setting up their own bank with a physical infrastructure. BaaS allows non-banks to collaborate with financial institutions to embed financial services into their offerings, resulting in a win-win model. Rather than separate, fragmented experiences, customers seamlessly toggle between financial services and their daily life experiences.

This partnership between financial institutions and non-banks enables both parties to focus on what they do best. Financial institutions provide comprehensive financial services while the non-banks acquire new customers and manage the user-experience by delivering the most innovative financial products and services when and where consumers want in a seamless environment. This creates a new revenue stream that is both low risk and low cost for financial institutions through the fees charged to non-banks for access to their core systems and reduces the cost of acquiring new customers.

Embedded Finance vs. BaaS

Embedded finance is on the front-end of a financial transaction and is usually used to streamline and enhance the user experience. Although it seems similar to BaaS, embedded finance is not white-labeled, and customers are usually aware they are indirectly dealing with a financial institution. In most cases the digital infrastructure that makes up BaaS is needed to facilitate an embedded financial transaction.

Financial institutions participating in an embedded finance partnership with non-banks share data that can provide insights into consumers’ spending habits. This helps financial institutions develop new products and services that better meet consumers’ needs and deliver them more effectively. Financial institutions also benefit from sharing the responsibility of managing the relationship with consumers in terms of responding to customer service requests.

Popular examples of embedded financial transactions include offering buy now, pay later options in a retail environment or making a payment through a ride-sharing app.

Consider BaaS & Embedded Finance to Compete

To stay competitive – and relevant –  small- and mid-sized banks must consider BaaS and embedded finance as part of their overall long-term strategy. Currently, BaaS and embedded finance solutions are leveraged by a minority of financial institutions, but they are increasingly becoming more mainstream within the financial community and are proving to be popular with consumers. Buy now, pay later solutions are a perfect example of this.

Partnering with non-banks to offer these types of financial tools can provide banks with new and much-needed revenue streams, access to new customers, better retention of these customers, and access to data that can enable them to develop the next generation of financial products.

What Banks Should Know Before Making The Move 

For banks considering Baas and embedded finance opportunities, they must first ensure their core processing system can support these initiatives. This may mean it’s time to consider a core conversion. 

If this is the route, banks must convert to a core platform that is flexible, facilitates real-time transaction processing and offers greater access to data across product lines. 

Seek Out a Flexible Core Banking Platform

Using an “open” core system that connects with other financial services systems through APIs gives banks access to a world of new integrations, innovative technologies, greater efficiencies and better customer service. For any institution looking to leverage BaaS or embedded finance, this will be crucial. 

Ensure Access to Real-Time Transaction Data

Legacy cores are built around traditional business hours and process transactions in batches rather than in real time. However, real-time transaction processing is required for many of the digital commerce use cases that BaaS and embedded finance supports. 

The ability to use data effectively, appropriately and often instantly is key to meeting customer expectations. This simply isn’t possible with end-of-day or next-day transaction data. Instead, financial institutions need real-time data to compete, especially when it comes to the customer experience. 

Act Now to Maximize Opportunities 

The banks that act now will be positioned to compete and win, even as net interest margins feel the squeeze from higher interest rates and higher deposit costs. After all, consumers and businesses alike demonstrate strong interest in BaaS and embedded finance offerings. 

According to Cornerstone’s research, more than 50% of consumers want identity theft and data breach protection, subscription management, and bill negotiation services bundled with their checking accounts. Meanwhile, 65% of businesses (according to Juniper study) not currently offering an embedded finance solution are now considering offering one and 68% of those businesses would prefer to offer embedded finance services from a non-bank provider. Ultimately, banks must act now to avoid getting left behind. 

About Author:
Murthy Veeraghanta is chairman and CEO of VSoft, a global provider of innovative digital banking and payment solutions to financial institutions of all sizes.

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