Banks must redefine their business models for a future of embedded finance and payments

The run-up to EBAday is a great time to take stock of where we are and where things are heading in banking and payments. Given the current pace of change, innovation and disruption, I think the opportunity this year is greater than ever. Though defined as an opportunity, without the right strategic intent banks also face the risk of struggling in market positioning with an unclear value proposition and market positioning.

Breaking up the banking value chain

For an example of the disruption that’s underway, take banking business models. Most industries have a clear-cut divide between the players who do the manufacturing and the ones handling advisory services, sales and distribution. But banking – especially retail banking – has evolved differently, with market participants looking to control the entire process, value chain and customer experience.

We’ve seen some decoupling in corporate banking, with fintechs, internal corporate solutions and large and global wholesale banks, coming in to break up the value chain. But up to now the industry’s overriding mantra has remained very much end-to-end.

No longer. Perhaps banking business, and operating, models need to change, and that banks must decide whether to focus either on manufacturing or on sales, distribution and advisory services. Now we’re seeing technology – together with other drivers like regulation, consumer behavior and the rise of fintechs– really bring this about.

Embedded finance: moving to Banking-as-a-Service

However, the question remains: how will banks make money with the new disaggregated model? In the past, as banks have moved to collaborate with fintechs, they’ve perhaps paid too little attention to this. A big part of the answer is banking-as-a-service (BaaS).

The underlying enabler of BaaS is “embedded” finance or payments – a concept that has caused a degree of confusion. Some people think it refers to models such as banks insourcing other providers’ payments engines to gain scale. In my view it’s actually something quite different: enabling non-banks offering banking capabilities to their end-customers.

We’re working with many non-banks looking to do this, like the insurance company that’s not only offering embedded payments, but also using insights from banks core banking data to enable the entire customer journey from onboarding to premium payment to claim, and to shape pricing and product offers along the way.

As banks collaborate in this way around BaaS, are they fully appreciating the potential to become distributors of these services? Currently, most banks I speak to still seem to be focusing on manufacturing, as they feel providing payments products is their differentiating capability.

But they could be missing a trick. Think of the deep pool of trust that the banks have built up with consumers: trust that might be used to its full potential when someone considers opening a bank account with a supermarket, fast fashion chain or football clubs. Could banks and the companies they collaborate with capitalize on this trust – by showing the bank’s trusted brand is standing behind the BaaS capabilities, and thereby strengthening consumers’ confidence in (and take-up of) embedded services?  

Three predictions in my crystal ball

Everything I’ve talked about so far is happening today. But EBAday is more about the future. So, what’s coming up? Looking into my crystal ball, I see three big developments.

The first is central bank digital currencies. While their full impacts won’t be seen for another three years or so, the centralized control that CBDCs introduce will ultimately transform the industry’s dynamics, not only in payments but also potentially in bank deposits. Why? Because with CBDCs every individual customer may be entitled to hold central bank money. Which begs the question of whether holding deposits will be relevant for a commercial bank– or even whether it’s something they would want to do, given today’s low interest rate margins. This will increasing be raising the discussion on the difference between central bank and commercial money.

Instead, banks might prefer to focus on packaging deposits and credit, and maybe distributing these products rather than holding them. This will be a huge shift driven by blockchain technology. That said, I think cryptocurrencies may not sustain over the long term, given central banks’ concerns about sovereignty and issues like KYC and fraud protection. I suspect the central banks will be hitting back in these areas very soon. Also in Europe we have SCA, which doesn't really address cryptocurrencies to further ensure the wide adoption as means of payments.

The second image looming in my crystal ball is around channels. Back in the 1990s and early 2000s we assumed a web browser would be the place to do banking, but it only really happened 10 years later. Now we think an Apple or Samsung phone is the primary channel. But fast-forward 10 or 15 years, and I can’t see us still using a physical device to do banking and payments. Instead, the channels coming on stream in five to 10 years’ time will be centered around the Internet of Things, with transactions embedded seamlessly into whatever we happen to be doing at the time. This will drive the volume, value and pricing of transactions, as well as transforming the entire payments experience.

That’s where embedded finance is heading – and that’s the third image in my crystal ball: embedded banking and payments. While this touches on both the other developments, my main point here is that BaaS is not itself a megatrend. Instead, it’s being driven out of bigger things happening in the economy and regulation, because without Open Banking and the ability to give banking licenses to more actors BaaS couldn’t happen. So rather than a megatrend in its own right, it’s a mega response to other trends in society.

Whether you agree with me or not, I look forward to discussing all these ideas and more at EBAday. See you there!

Join us at EBAday 2021 where we will be discussing this topic and much more in our panel session: Modernising the financial regulatory system