In the ever-changing landscape of the financial industry, traditional banks have reached a critical crossroads. After the mad rush that financial institutions had on going digital and undertaking massive transformation programs, one of the most exciting developments emerging in recent years has been the rise of Embedded Finance and Banking as a Service (BaaS), which are transforming the way businesses offer financial products and services.

Embedded finance, the integration of financial services into non-financial products and services, is rapidly becoming the norm, leaving banks with an existential question: To BaaS or not To BaaS? In this article, we will dive into the evolution of embedded finance, weigh the pros and cons while providing examples from different industries and continents, and analyse the impact of this phenomenon on future-proofing business models and customer experiences.

What is it all about?

Embedded finance is not a new concept; in fact, it has been around since the days of the Medici family. What is new, however, is the speed and scale at which it is happening. Technological advancements and the proliferation of digital platforms have propelled embedded finance to the forefront of the industry, forcing banks to confront their own obsolescence in the eyes of end customers. This has been evident in the rapid adoption of new payment channels (Apple/Google/Samsung Pay), the rise of Buy Now Pay Later as a new product innovation, and new digital banks challenging the status quo and taking away not only market/wallet share but also heart share of users.

At first glance, Embedded Finance might seem similar to digital or challenger banks. Both offer a range of financial products and services, often with a focus on providing a better customer experience than traditional banks. However, there are some important differences between the two.

Digital and challenger banks are typically standalone entities that offer financial products and services directly to consumers. They often rely on modern technology and innovative business models to provide services more efficiently and effectively than traditional banks.
Embedded Finance or BaaS, on the other hand, is a model where financial products and services are integrated into existing non-financial products and services. This means that customers can access financial products and services without having to leave the platform they are already using.

For example, an e-commerce or ride-hailing app could offer loans or insurance to its drivers through an Embedded Finance solution, allowing drivers to access financial services without having to leave the app. This creates a seamless customer experience, which can lead to higher engagement and loyalty.

The rise of embedded finance has numerous implications for both consumers and businesses. On the one hand, it offers a seamless, frictionless customer experience, increases access to financial services, and fosters innovation. On the other hand, it raises concerns about security, regulatory compliance, and the potential for market monopolies.

Benefits and Risks for Banks/non-banks

One of the key benefits of Embedded Finance and BaaS is that they allow businesses to offer financial products and services without having to build and maintain the infrastructure themselves. This can save massive amounts of time and money, allowing businesses to focus on their core competencies. While this might mean that banks would yet again share another chunk of revenue with non-finance players, this expands the bank’s reach to new clients, segments, and has the opportunity to significantly increase user engagement with FIs.
This also has a big benefit for non-banks, which gives them a cost-effective entry into the financial ecosystem. Other approaches which proved to be expensive:

• Purchasing a bank (e.g. Welab purchasing Bank Jasa for its entry to Indonesia)
• Applying for a new license (e.g. Grab partnership in getting its banking license in Singapore, and expanding further in Malaysia) and building a new bank and having to compete in an already crowded marketplace.

Another benefit is the ability to offer a seamless customer experience, as financial products and services can be integrated into existing non-financial products and services. This creates a more convenient and efficient customer journey, which can lead to higher engagement and loyalty.
While there are significant benefits to investing in Embedded Finance and BaaS, there are also some potential drawbacks to consider. One of the main cons is the potential for increased regulatory scrutiny, as businesses that offer financial products and services through these solutions may be subject to additional regulations and compliance requirements. This can be complex and time-consuming to navigate, especially for legacy banks with established regulatory frameworks. This has recently happened with Solaris bank in Germany where the regulator (BaFIN) has to now give permission before expanding to any new customer, putting it under a lot of scrutiny.

Another potential con is the risk of reputational damage if a third-party provider experiences a data breach or other security incident. Legacy banks may be held responsible in the eyes of their customers, even if the breach was caused by the third-party provider.

The Apple Goldman Sachs Example

The most famous example of embedded finance is Goldman Sachs and Apple’s collaboration. This has resulted in a mutually beneficial partnership that combines the financial expertise of Goldman Sachs with Apple’s technology and brand appeal. Launched in 2019, the Titanium Apple Card has been successful in attracting a significant customer base, primarily iPhone users, who appreciate the seamless integration of the credit card within the Apple ecosystem.
Apple Titanium and digital Card (https://appleosophy.com/2022/09/22/100-in-daily-cash-being-offered-for-new-apple-card-customers/

The Apple Card has distinguished itself from traditional credit cards by offering a simple and transparent fee structure, real-time spending tracking, and instant rewards. The user interface and design, combined with Apple’s focus on privacy and security, have resonated well with customers, leading to increased adoption and brand loyalty.

For Goldman Sachs, the partnership has allowed the investment bank to enter the consumer credit card market and tap into a vast and diverse customer base. This collaboration has also strengthened Goldman Sachs’ position in the consumer banking sector, as it continues to expand its offerings beyond traditional investment banking services. ​​Goldman’s credit card business, anchored by the Apple Card since 2019, has arguably been the company’s biggest success yet in terms of gaining retail lending scale. It’s the largest contributor to the division’s 14 million customers and $16 billion in loan balances, a figure that Goldman said would nearly double to $30 billion by 2024.

The growth and scale of such partnerships is massive as compared to how other digital banks have been able to grow (it took Revolut about 6 years to reach the same number of customers). While this offers an example of the massive impact the partnership model has, it has come under fire in Q4’22 due to business fundamentals.

Embedded finance has manifested differently in various industries and regions with other new examples like:

• GreenDotBank providing BaaS for Uber solving for the financials painpoints for their drivers
• Solaris Bank enabling businesses in Europe to offer financial services
• Audax powering Standard Chartered Bank partnering with Bukalapak in providing easy financial access for unbanked / underbanked customers in Indonesia

What the future holds for BaaS

Embedded finance is a critical driver for future-proofing business models and enhancing customer experiences. However, as with any new technology, there are risks and challenges to consider. For legacy banks, the decision to invest in embedded finance boils down to assessing the opportunity cost of not doing so.

By not investing in embedded finance, banks risk losing market share to competitors, both traditional and non-traditional (players like e-commerce, wallets, fintechs). The inability to keep pace with the changing landscape of financial services could result in reduced customer loyalty, lower revenues, and ultimately, a shrinking market presence.
For banks, the decision to invest in embedded finance is not simply a matter of survival; but also an opportunity to thrive and redefine their role in the industry and create new value for customers and stakeholders. By leveraging their existing infrastructure, resources, and expertise, banks can play a pivotal role in shaping the future of finance.

The rise of embedded finance has brought the industry to a tipping point. Banks must decide whether to embrace this change and seize the opportunity to redefine their role in the industry, or risk being left behind. As the saying goes, “fortune favours the bold” — and in the case of embedded finance, the bold are those who recognise the transformative power of this trend and act accordingly.