In recent years, there has been a significant increase in the collaboration between major brands and technology platforms with banks in order to introduce embedded finance products. The primary goal is to enhance the value and overall experience for customers. For example, Toast partnered with WebBank to introduce a merchant cash advance, while Uber collaborated with Evolve Bank & Trust and Branch to launch a debit Mastercard for faster payments. This trend has been estimated to be worth $20 billion, indicating a substantial market for embedded finance in the United States.
Embedded finance pertains to the provision of financial products by non-financial entities within a broader non-financial framework. This approach provides banks with the advantage of expanding their reach with minimal operating costs through partnerships with various platforms and retailers. However, it also presents significant risks, as banks may lose direct relationships with customers and face potential commoditization of their products.
The risks and opportunities of embedded finance differ among various types of banks. Banks with less than $10 billion in assets are in a favourable position under the Durbin Amendment, which allows them to charge higher interchange rates on debit transactions. However, for smaller banks to effectively compete in embedded finance, they will need to upgrade their technology and partner with aggregators to distinguish themselves.
Larger banks that serve specific regional or niche markets have more flexibility to explore embedded finance opportunities, while the largest banks in the country with diverse offerings face challenges due to their cost structures and regulatory constraints. Nevertheless, the next wave of embedded finance could provide an opportunity for larger banks, particularly in lending and credit use cases.
Considering these opportunities and challenges, banks may adopt one of six postures to navigate the embedded finance landscape. These strategies include replicating the customer experience of embedded finance, acquiring or building a distributor, strategically partnering with large enterprises or ISVs and marketplaces, specializing in lending as a service, and offering balance sheet and risk services.
In conclusion, the rise of embedded finance presents a strategic crossroads for banks as nonbank players target core banking segments. It is essential for banks to carefully assess the trade-offs and make well-informed decisions on how to leverage the potential of embedded finance to drive growth and meet the evolving needs of customers in the digital era.