Do you want a pension on that pizza?
Everyone needs an embedded finance strategy, not only banks.
Dateline Woking, 29th May 2022.
Banking-as-a-Service (BaaS) is a well-understood strategy to give non-banks embedded finance options to provide financial services to their own customers, exploiting the bank's licence and core capabilities such as account management, compliance, fraud management and lending. It is an incredibly cost effective distribution strategy, as measured by the return on equity (ROE) and return on assets (ROA) achieved by the banks taking advantage of it. Hence it is something of a no-brainer for many organisations to move into this space and as a consequence the embedded finance sector is a focus for growth.
As I am sure you all know, the heart of the proposition is that the consumer is not required to interact with financial institutions because third-parties can use open banking and open finance to get access to the financial services and products that their customers want.
To use an example given by Barclays, if you are buying a TV and need to borrow money to pay for it, the retailer could embed the loan process into the customer journey. This gives companies the ability to create really innovative financial offerings in a variety of fields, ranging from retail to healthcare and travel to entertainment. The opportunities that embedded finance present benefit not only the customers but, as Barclays say, the banks and the technology companies that are involved in the process.
Being interviewed at the Open Banking World Congress (2022).
That term “embedded finance” (which I rather like) is attributed to Angela Strange from the noted venture capitalists Andreessen Horowitz. She said that in the future “every company will be a fintech company” because every company will be able to use embedded finance. I am not the only person who thinks that the she was right to be bullish about the opportunity, partly because of the regulatory pressures around open banking and partly because it seems clear that many customers indeed do not want to break out of whatever experience they are enjoying to access a financial services provider. Those customers have a relationship with brands that they do not have with banks or credit card companies and for this reason estimates that brands expect embedded finance to add heading towards a trillion dollars in revenue over the next five years do not seem unreasonable.
Now, BaaS has been around for a while. BBVA, for example, launched its BaaS "Open Platform" in the US back in 2018 to allow third parties to offer customers financial products. Ron Shevlin wrote earlier this year about how embedded finance is driving BaaS and referred to a Cornerstone survey of US banks which showed that only a fifth of them were either pursuing or developing a BaaS strategy, since I would have thought that this should be a priority for a great many institutions: if they do not have a decent BaaS strategy, they run the risk of being bypassed as more and more customers obtain the financial products and services that they need from the brands that they know and trust rather than directly from the institutions.
This is a far from hypothetical threat. After all, the financial services incumbents have lost the trust advantage they had over fintechs while at the same time, as McKinsey note, many non-financial brands have considerably higher trust levels which they can leverage into offering financial services. In other words, banks can deploy BaaS to exploit consumer trust in other brands. Or, to put it another way, embedded finance means that some banks will end up being pipes, but being a high-volume low-margin pipe can be a pretty good business.
This has some serious implications for institutions that want to succeed in this mode because as any business school 101 on the topic will note, pipe businesses depend on a radical improvement operational efficiency and this may be difficult for incumbent financial services providers to achieve for all sorts of reasons, among them being the technology platform in place. Taking this old infrastructure and putting a Banking-as-a- Platform (BaaP) wrapper on top may not be enough to compete in the new world.
I think we are still in the early days of embedded finance and that there is incredible potential here, so I was interested to read Jeff Kauflin's excellent piece on William Hockey (a co-founder of Plaid) and the new bank, Column, that he is launching in the US with his wife Annie. Rather as Stripe attacked the payments space by focusing on developers, so Column will have what he says will be a "maniacal developer focus". The idea is to cut out the middleware providers that wrap legacy infrastructure (or what the Wall Street Journal called "rickety banking tech") and instead provide core bank services such as ACH, loan origination, card programmes and debt financing directly to third parties.
A recent report on the sector from Dealroom, a market intelligence company, and ABN AMRO Ventures (the corporate venture arm of the Dutch bank) projects the total market value of the sector at more than seven trillion dollars by 2030, which is more than the current value of all fintech startups and the top 30 global banks and insurers combined! Almost half of value will come from the retail and e-commerce sector.
I am particularly curious about the retail sector, because retailers have the customers and the touch points relevant to a variety of financial services (not simply Buy Now Pay Later and store credit). I couldn't help but note that in Jamie Dimon's recent letter to JP Morgan Chase shareholders he specifically mentioned Walmart's ability to bring "banking-type services" to 200 million people who visit their premises every week. Julia Unger, vice president of financial services at Walmart, talks about centralising all of their financial solutions into a single more cohesive, digital offering that can become a one stop financial services shop for their customers and I think that could be a pretty compelling platform for a great many people.
Similarly on this side of the Atlantic, a recent survey of European retailers carried out on behalf on the BaaS provider Vodeno found that three quarters of European retailers are already offering embedded finance solutions to customers (with cashback loyalty schemes, credit cards and debit cards being the most common products currently offered) and half of them plan to roll out more embedded finance solutions in the coming year.
I do no think it is hyperbole to say that the next generation of consumers may never interact with financial institutions at all! My kids will use their Nike credit card and Walmart mortgage and Dominos pension plan on the basis of their learned experiences of service, convenience and price without ever even wondering about whether it is Column or JP Morgan Chase or the First National Bank of the Kardashians actually providing the regulated financial service behind the brand.