With low rates of interest impacting profits and Open Banking/ PSD2 making banks open up their information systems, financial institutions are navigating tricky waters. But these kinds of external factors are not the real reasons for their decline. They need to reconsider their business model. What if the next bank account you open, or the next credit card you use, is not from a bank but from your favorite brand? In this article, we take a look at the developments underpinning this paradigm shift in financial services.
In-branch financial services
We all need to use financial services in our daily lives. Historically, these services were only accessible via a network of bank branches. This was the bank in its original form, where accessing your account, checking expenses, and carrying out simple transactions involved endless forms to fill.
Besides this, the options for market entry were limited with barriers that prevented serious competition. For decades banks dictated how their customers should behave and their own processes and procedures, without any effort to understand the needs of their customers.
Unfortunately, many legacy banks still rely on this model and analogue processes, despite the digitalisation of the entire banking sector to reduce friction and enable better use of financial services.
The digital challengers: opening up banking to competition
The mass adoption of the smartphone and the rise of e-commerce revolutionised banking, heralding the first digital banks, like ING and Fortuneo. These mobile banks were the first generation of financial industry players to adopt a customer-centric approach offering an increased/unrivalled facility to carry out transactions and access expenditure information.
A second wave of independents appeared, like Revolut, Starling Bank and N26. They offered an intuitive user experience through revolutionary UX design, making banking convenient and attractive for millions of customers around the world. The acquisition cost for these digital challengers is far below that of legacy banks as they do not rely on a physical distribution network, instead using new cloud stack technology. These new players have seen explosive growth in Europe, raising record amounts of money and overtaking legacy banks in terms of valuation.
Out of this banking renaissance, new niche neobanks (the vertical bank) have appeared, with ecosystems of value-added financial and non-financial products built around a digital bank account. Stand-out examples of these specialist banks include Qonto for Small & Medium Enterprises (SMEs), Vybe for young people, sustainable neobanks like Tomorrow and even those with a community focus like Rewire and Daylight.
It is not just new technology that has made this change possible, but changes in banking regulations too—notably the advent of Open Banking through the European Commission’s Payment Services Directive (PSD2). New fintechs have emerged like Tink, Fintecture, and iDeal. Industry players with the ability to retrieve payment information from bank accounts and to initiate payments from these accounts, or even use transactional data to enrich new functionalities like PFM (Personetics) and cashback (Paylead).
Financial services embedded into everyday life 📱
Embedded finance takes the idea of Open Banking and pushes it further. The concept being to take banking and insurance functionalities out of the technological equation altogether; thus giving any brand or merchant the ability to embed innovative financial services into its offerings and customer experiences quickly and at a low cost. The major strength of these financial services is that they are available at any time or place they may be needed.
In the past, when an individual needed to borrow money, they had to apply for a loan with their bank or own a credit card. With embedded finance anyone can apply for and secure a loan at the point of purchase. This type of purchase is known as Buy Now Pay Later (BNPL) and is offered by Klarna and Afterpay. BNPL allows users to split the cost of their purchase into a number of payments. For example, a purchase of €100 is split into four payments of €25.
Embedded Finance: the GAFAs pave the way
Although the GAFAs have started to embed financial services into their product ecosystems and customer experiences, it is the Big Tech firms Uber and Shopify who are pioneering the trend for embedded finance. These tech firms have enriched their financial service products to include bank accounts, payment cards, and loans. Thanks to their impressive user base and high levels of engagement, they have seen increases in customer loyalty, number of contact points and additional revenue. In addition, the transactional data has enriched their existing customer data. They now find themselves in a position to offer bespoke financial service solutions to their customers, tailored to their way of life.
This phenomena goes much further than the Big Techs. Today, any brand has the means to strengthen its ecosystem by embedding financial services into its offering. This is the case with leading brands with strong customer ties, like Tesla, Starbucks, IKEA, Walmart and even Lufthansa. Trust is key in financial services. Should these companies start offering bank accounts and payment services in their fullest sense, or new features like cashback and BNPL on purchases, they will create many new opportunities to interact with their users and enhance the customer experience.
More than just 'nice-to-have', this is a big opportunity! 🚀
According to a study by Matt Harris from Bain Capital Ventures, the embedded finance market could reach $3,600 million over the next ten years, and that is just in the United States! As consumers become used to the on-demand, customer-centric services offered by Google, Amazon and the other Big Techs, so their expectations around financial services will increase. Over the last ten years, banks have been steadily losing market capitalisation, and now innovative fintech and payment champions have started to eat away at the core business of historic banking institutions. As the number of non-financial players deciding to take this route increases, the trend is only going to grow.
And rightly so! There are big advantages to brands embedding financial services into their products. What is less apparent, is how they can do this successfully. There are two options for brands that want to offer financial services:
1- Become a regulated financial institution
This deceptively simple plan is actually complex and resource-heavy. A number of obstacles need to be overcome to design and operate banking products. In Europe, businesses offering financial services, such as deposits, payment, or even loan services, are subject to the conditions of their licence which include anti-money laundering regulations, capital requirements, regular audits, not forgetting reporting to the central bank and supervisory authority.
Becoming a financial institution is also a technological challenge. To embed a competitive banking offer into your products, your technological infrastructure needs to be state-of-the-art, scalable, and digitally embedded into the heart of your business. Building and maintaining a payment register with the requisite levels of resilience and compliance requires high levels of investment and internal knowledge.
This is where Core Banking Platforms come into play. These technological providers offer a banking platform and open APIs to build the infrastructure of the future non-bank financial institution (e-commerce companies or any other brands). As the name indicates, the modular, scalable architecture allows access to banking modules, like current accounts, payment and loan services, whilst also allowing brands to integrate these into their product ecosystem and user experience.
For brands, becoming a regulated player is an important step that allows them an increase in their:
- independence (no need to work with an authorized partner),
- agility (improvements to the speed of execution),
- credibility (customer reassurance), and in
- profitability (opening up their range of business activity without having to pay commission to a regulated partner).
So all the regulatory processes are under control, but they can easily develop new financial products tailored to the needs of their customers, enjoy greater autonomy in developing strategic partnerships (both technological and product partners), and grow their income per customer.
Thanks to back-office automation, this platform approach offers impressive levels of responsiveness. This immediacy transforms the customer experience and delivers a competitive advantage through the creation of first-rate customer experiences. Skaleet can work with you on a platform approach to enable you to create efficient ecosystems that guarantee fluid interactions between financial services and tech players. A true frontrunner in terms of financial service modules, our solutions will allow you to choose the best partners and solution experts (including payment, credit, BNPL, insurance and cashback services), so you can offer complete, increasingly personalised customer experiences.
2- Partner with a regulated financial institution (BaaS)
This option bypasses the additional cost of regulation but not necessarily further technological costs. A legacy operator may be able to offer interfaces that allow brands to connect with its banking infrastructure, but unfortunately these traditional players rely on an inherited technology that was not designed to offer the necessary flexibility, an understanding of the functionalities or an attractive cost to create a competitive proposition. In addition, banks do not want to allow these new entrants to the market to use their infrastructures to cannibalise their own market share.
This is where Banking-as-a-Service platforms are an option. These technology providers based on APIs allow their non-banking partners (again, e-commerce or brands) to choose the banking components they need, (e.g. current accounts, payment, and loan services) and embed them directly into their applications.
The BaaS provider handles all the regulatory processes in the background, including payment processing (namely AML, or anti-money laundering, account management, arranging loans, regulatory reporting, etc.), while customer relations remain entirely under the control of the brand. So they can offer digital banking products within their user experience, with compliance risk, capital requirement, and general technical costs being delegated to the Banking-as-a-Service (BaaS) provider.
This approach, based on APIs, offers a much quicker and more affordable alternative to non-financial players who wish to create first-rate financial experiences in new environments, without the risk of the banking partner failing to attract their customers. Skaleet offers a BaaS platform with a licensing partner so you can access our full range of financial services.
It is clear that any business wishing to invest in customer loyalty and experience must look to embedding financial services. The question is not if, but when brands will do this. We are at the very beginning of the embedded finance journey, but time is pressing for larger brands if they want to steal an advantage over their competitors. However legacy banks choose to position themselves, one thing is sure; with BaaS, every business can become a fintech company, and Skaleet can support you in this transformation.