Embedded Banking and What It Means for Your Business

by Kieran Daly
October 18, 2023
Embedded Banking and What It Means for Your Business

Embedded banking platforms are rising in popularity. They increase website conversion rates, open up brand new revenue streams, and reduce the administrative burden on businesses.

Analysts predict a rapid growth in the uptake of embedded banking in the coming years. In this article, we explain what embedded banking is and:

  • How we use embedded banking in everyday life now

  • How embedded banking works

  • The advantages and disadvantages for a business and its end users

  • How embedded banking is regulated

  • The latest developments in embedded banking

What Is Embedded Banking?

To understand embedded banking, let’s compare how we pay for things now with how we used to pay for them.

For our example, let’s consider hailing a taxi. Before, you had to go out onto the street and flag one down or call the local provider’s office. You had to have cash to pay your cabbie, and they needed a float to be able to give you change. At the end of their shift, they’d sort through piles of notes and coins, splitting them into their sale and the taxi office’s share.

That sounds almost prehistoric now.

Today, you book a cab on your cellphone using an app. The app has a digital wallet that stores your credit card or debit card details. At the end of the ride, the app tells you how much the fare is, and you pay it within the app — no cash needed. The app also splits the cash between the driver and their company automatically.

This is embedded banking in action. Embedded banking streamlines financial transactions between businesses, contractors, and end users.

How Embedded Banking Is Now Part of Everyday Life

Other everyday embedded banking use cases include:

  • Mobile ordering and payments: Customers can order, for example, food and drink via the Starbucks or McDonald’s app, pay for them, and they’re ready for collection when they get to the store.

  • Immediate account access: Services like PayPal can link to your bank debit card so you can make purchases or withdraw cash from ATMs without needing to go on to your online banking site to transfer the cash to PayPal.

  • Point of purchase finance: With embedded finance, e-commerce and other retailers can offer alternative financing that allow customers to purchase products and services as part of the checkout process — no need to apply to your bank.

  • Point of purchase insurance: Tesla and other auto manufacturers offer to sell insurance to customers who buy their car without the need to go to an insurer’s site.

  • Banking-as-a-service (BAAS): Shopify, the online e-commerce platform, now offers bank accounts for their customers so they can access their account from within the standard Shopify control dashboard.

  • Automated investing: Not only do apps like Acorns and Stash manage your portfolios, they can also round up your purchases to the nearest dollar, investing the difference on your behalf.

  • Subscription services: Change or cancel subscriptions like Netflix and Quickbooks on their websites or apps without having to phone the bank.

We take scenarios like the above for granted, demonstrating how we all use embedded payment systems on a daily basis.

How Does Embedded Banking Work?

Embedded banking allows non-bank financial service providers like car dealers and Shopify to offer banking services and products.

These service providers do this by connecting with banks’ internal systems via application program interfaces (APIs). This means they can provide financial products to end users without being a bank themselves.

For example, let’s say you launch a fintech startup. You want to be able to offer your customers the ability to pay for your service via a credit or debit card, on a buy-now-pay-later basis, or from their bank account.

You can do this with embedded banking. You manage the customer experience via your website or app, and your banking partner handles the money.

In the past few years, the fintech ecosystem has innovated greatly, meaning that, subject to the correct safeguards, companies can provide banking experiences to their clients without a banking license.

The Advantages and Disadvantages of Embedded Banking

For businesses and end users, there are pros and cons to embedded finance.

From the Perspective of Businesses

For companies, the opportunities offered by embedded banking include:

  • Higher revenues: Insurers and loan providers pay commissions when vendors sell their products, meaning increased profit margins.

  • Fewer abandoned shopping carts: The less complex you can make the purchasing process by keeping customers on the same website throughout checkout, the more you sell.

  • Operational efficiency: Many embedded banking solutions plug in to popular accounting and inventory software, meaning less manual entry and improved productivity.

  • Commercial advantage: By letting customers pay using the method they prefer, they’re more likely to buy from you rather than a rival company.

The potential negatives of embedded banking to businesses are:

  • More rules: Payment processing is highly regulated. Although your banking partner will handle this, you’re outsourcing compliance to a third party that you have no control over.

  • Technical complexity: Wiring embedded banking into an app, website, or point-of-sale system isn’t easy. If you need to bring in outside help, the cost of onboarding will greatly increase.

  • Data security concerns: Retailers and vendors risk heavy fines if hackers get ahold of sensitive customer details. The size of these fines may be too large for a small business to pay.

  • Reliance on third-party platforms: You’re only as strong as your weakest link. If your provider’s system develops a fault, you may not be able to sell anything until it’s back up and running.

  • Variable pricing: You may have based your business model on what embedded banking transactions cost today. If, in the future, there’s an increase in your provider’s price, that may break your business model.

From the Perspective of End Users

The main pluses for end users of embedded banking are:

  • Smoother purchasing: It doesn’t take end users as long to get through online checkouts if every payment option they could possibly want is offered in your checkout.

  • Time-saving: Amazon started it, and it’s now everywhere. Customers really appreciate when they don’t have to enter their payment details on every order because you already have that information saved.

  • More payment options: By offering banking products like “buy now pay later” (BNPL) financing and so on, what might not be affordable today in one lump sum becomes affordable.

The minuses of embedded banking are:

  • Privacy concerns: Some clients might worry that you’re trusting a third party with their data. They may also be concerned that this may dilute the control they have over their own data.

  • Potential overspending: Embedded financial service options like BNPL offerings increase the temptation to buy. If customers don’t monitor their spending, they may exceed their budget.

  • Customer support issues: The presence of third parties in a transaction may make it harder for clients and companies to settle disputes quickly, which could harm the overall user experience.

The Regulation of Embedded Banking

When new legislation is passed or existing legislation is amended under the advisement of bodies like the Federal Deposit Insurance Corporation (FDIC), embedded banking arrangements are also covered by the rules.

Embedded banking regulation, like financial regulation in general, focuses on the following four areas:

1. Consumer Protection

The nature of embedded banking systems is that two or more companies have access to customers’ personal and financial data. This is an issue because the threat posed by cybersecurity and data breaches grows every year.

Retailers and financial institutions involved in embedded banking systems have had to toughen up their cybersecurity to conform with data protection legislation like Europe’s General Data Protection Regulation and the California Consumer Privacy Act.

2. Chargeable Fees

To keep in line with existing acts like the Consumer Financial Protection Act of 2010 in the United States, embedded banking service providers must be clear and transparent in what they charge businesses, consumers, and other users.

3. Data Sharing

Open banking allows authorized third-party developers secure API-based access to customers' financial data directly from banks and non-banking financial institutions.

To encourage the take-up of open banking in the U.K. and the EU, the relevant governments introduced the Payment Services Directive Two (PSD2), whose purpose was to require financial institutions to open up their client financial data to third-party developers while improving payment authentication processes.

The U.S. is catching up on open banking, but progress has been slower. This is because the U.S. market is more fragmented and reliant on legacy systems.

4. AML Regulations

There has been an increased focus in the last few years on money laundering and other financial crimes. Regulators want financial institutions to apply anti-money laundering (AML) laws just as rigorously when they provide banking capabilities to third parties in embedded payment partnerships.

Financial services providers need to run due diligence exercises on all clients to check that they are not politically exposed persons or subject to U.S. sanctions. They also need to track and analyze transactions to look for suspicious or unusual behaviors or patterns.

The Latest Developments in Embedded Banking

The embedded banking sector is currently attracting high levels of investment to take advantage of the growing trend toward digital payment processing.

This has led to many innovations and other trends, three of which we detail below:

  • Plug and play APIs: Financial service providers are building easier-to-integrate API-based connections to lower the technical barriers to implementing embedded banking solutions for small and medium-sized businesses.

  • Integration of artificial intelligence (AI) and machine learning (ML): As well as helping financial institutions more easily spot instances of money laundering, providers are working on ways to use AI and ML to offer clients extended funding options at checkout that they will be almost certain to be approved for with their credit score.

  • Continued growth of buy now, pay later: Apple has announced that it’s launching its own BNPL offer, and PwC expects the size of the global BNPL market to reach $437 billion in 2027, a 291% increase from 2021.

Embedded Banking and Backd

Embedded banking is now part of daily life. We use it when we shop on Amazon, buy cars from Tesla, and even order coffee at Starbucks. All of this is made possible by the API-driven technology that financial institutions and software providers have invested so heavily in recently.

There are advantages and disadvantages to both businesses and consumers. Businesses benefit from higher sales and greater operational efficiency but must wrestle with technical challenges and a reliance on third parties for core business functionality. Consumers have more choice over how they pay for goods and services, but regulators have raised concerns about overspending and data privacy.

Take-up of embedded payment technology is currently low. Just 5% of businesses have invested in it, but analysts predict significant growth in the sector in the coming five years. For example, the B2B BNPL market is expected to be worth more than $124 billion by 2027. 

Backd has launched a B2B BNPL service to allow you to take advantage of this expansion in the size of the market. The partners who have signed up for our service have already seen order values increase by 150%. Depending on the order value and repayment terms, we may even be able to pay you a commission for putting the deal through us.

With our intuitive backend system, you can check the status of ongoing BNPL applications we’re processing at any time. When we’ve approved a deal, simply send out the link in your control panel to your customer so they can complete their order.

To offer buy now pay later to your business customers, visit our BNPL partner page.

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