It was a surplus of molasses at Pittsburgh, PA molasses company P. Duff and Sons that led to the creation of boxed cake mixes in the early 1930s. Hoping to find a way to use up his company’s molasses surplus, John D. Duff dehydrated it, added in cake batter ingredients, and packaged the mix so that people had an easy and inexpensive way to bake cake. It wasn’t long before major companies such as Betty Crocker and Duncan Hines followed suit. Today, more than 186MM Americans regularly use dry cake mixes over baking cakes from scratch.Over the years, people’s desire for ease and convenience has gravitated to all areas of life. In the world of finance, that has led to the growing popularity of embedded finance and suggests widespread adoption in the near future.Gaining Speed As retailers and businesses constantly look for ways to provide more efficient customer service, the adoption of embedded finance — the seamless delivery of financial products ranging from payments to loans within offerings from non-financial institutions — has been rapid. Its value is expected to increase exponentially within the next few years. Well-known brands like Starbucks, which offers in-app payments through its mobile app, and Uber, which provides drivers with debit cards and financial tools, have successfully integrated financial services into their platforms. Its value is expected to increase exponentially within the next few years. According to Juniper Research, the global value of embedded finance, currently totaling $92B, is predicted to more than double by 2028 to $228B.While embedded finance provides an attractive revenue source and a low-cost way for community financial institutions (CFIs) to broaden their distribution reach, there are both pros and cons that CFIs should be aware of. Use Cases There are a handful of main focus areas where CFIs have the potential to provide value through embedded finance and access new, low-cost streams of revenue:
- Customized digital platforms. Embedded finance gives CFIs the ability to provide customers with an enhanced experience. This can be done by launching a challenger bank tailored to a specific demographic, such as KeyBank’s Laurel Road — a platform dedicated to healthcare professionals with offerings such as student loan refinancing.
- Commercial partnerships. Strategic commercial partnerships with major retailers or organizations give CFIs a way to expand their reach to these businesses and their customers through services such as employee checking and B2B payments, among others.
- Fintech distribution. The creation or acquisition of fintech software providers opens the way for CFI product distribution.
- ISV and online marketplace partnerships. Partnerships with online marketplaces or independent software vendors (ISV) — organizations such as Etsy and Shopify — provide an opportunity to enhance customers’ payments experience. Many of these marketplaces already offer customers financial products such as lending, checking accounts, and credit cards through partnerships with banks.
- Lending expansion. Increase niche lending opportunities through lending as a service, by partnering with distribution partners such as Square with large existing customer bases.
- Increase deposit and lending opportunities. For smaller financial institutions, access new streams of revenue by partnering with banking-as-a-service (BaaS) platforms, such as Bond and Treasury Prime.
ConsiderationsEmbedded finance integrations are not without their challenges, however. CFIs should be mindful of a few key areas that may pose a certain amount of risk:
- KYC requirements. Because many CFIs often have limited financial resources and less advanced technology and digital capabilities, meeting Know Your Customer (KYC) requirements for remote account openings can be challenging. However, these challenges can be addressed by partnering with or acquiring fintech software providers that already have the necessary infrastructure in place to manage KYC processes effectively.
- Product commoditization. By partnering with fintechs or third parties, CFIs may risk losing control over their direct customer relationships, which can lead to product commoditization, making their offerings less distinct from other providers. This loss of brand identity and customer connection could weaken their unique value proposition and result in long-term competitive disadvantages.
- Product cannibalization. The newer product offerings borne from embedded finance integrations might introduce new products that compete with existing offerings. This could result in a shift in revenue away from traditional products.
- Revenue splitting. Partnerships with non-traditional financial players often require CFIs to share a portion of their revenue with fintechs or other embedded finance platforms. The need to split revenue might reduce the profitability of certain services and make it harder for smaller CFIs to compete on price or grow margins.
As embedded finance is embraced by a growing number of retailers and merchants, CFIs would greatly benefit from beginning to determine how and where they can fold such offerings into their own businesses. Since the benefits of embedded financial applications vary for smaller and larger financial institutions, CFIs need to be thorough and deliberate in their review of what makes the most sense for them and their customers to make their venture into embedded finance the most worthwhile.
