Banks have quietly underpinned the financial services offered by nonbank entities for decades. But the use cases for
"Effectively renting out your charter to a lot of small fintech programs comes with reputational risk that many [large banks] aren't willing to entertain," said Jonah Crane, a partner at Klaros Group.
Recent months have seen an uptick in enforcement actions against banks engaging in banking-as-a-service strategies. Observers are split on whether that enhanced scrutiny is temporary or terminal.
But as comfort with digital banking and online commerce increases, and especially as more businesses are working with independent software vendors whose platforms are prime places for products such as checking accounts and merchant cash advances, there is a widening audience for embedded finance, said Brian Pike, a partner at McKinsey.
As fintechs achieve scale, they are also more viable targets for embedded finance.
"Anecdotally, I've spoken to a handful of larger banks figuring out how they can participate," said Crane. "Banks are trying to think of creative ways to find new customers."
One notable use case is business-to-business payments.
"If you're a large bank, you have to worry about continuing to acquire and retain payments volumes as the channels that businesses and consumers use to access payment services change," said Alex Johnson, founder of the Fintech Takes newsletter.
Large banks are generally less pressed for deposits than small institutions. They may find lending use cases carry more compliance and reputational risk than payments, which do not impact a bank's balance sheet the way accruing deposits or lending out money would.
"They have the pipes," said Johnson. "Embedded finance is a way to drive more volume through those pipes," whether that means originating ACH transactions, issuing cards, or acting as a merchant acquirer.
Vertical software-as-a-service companies are also ripe for embedded finance. For instance, a startup for self-managed homeowners associations that recently came across Johnson's radar would be an ideal candidate for embedded banking, he feels.
Moreover, there are opportunities for banks to mine the troves of data about their embedded finance partners' end users, and market bank products and services to those segments.
"You have information about those users you may not have been able to acquire through normal marketing channels," said Kirsten Muetzel, who advises banks on financial risk management and compliance as founder and principal of KLM Advisory.
Community banks with fewer than $10 billion of assets tend to dominate the BaaS space because they are not constrained by Durbin Amendment limits on the interchange fees they can charge for debit transactions. But, "the Durbin interchange aspect is a small sliver of the embedded finance trajectory," said Muetzel. "There are a lot more revenue levers for banks that are greater than $10 billion in asset size to explore."
Larger banks are often better equipped from a technology angle as well.
"The more sophisticated banks going after embedded finance opportunities are building or buying the technology to wrap their payments services so they are easy to integrate with software companies," said Johnson.
Fifth Third Bancorp in Cincinnati has a dedicated shop for such partnerships. The $215 billion-asset institution rebranded its embedded payments business as Newline in 2023 after it
"Concentrating these clients and prospects within one distinct group under treasury management helps us manage the risk better," said
Newline employs dedicated sales and relationship management, product, and client success teams.
"Our philosophy was, to compete in this space we have to effectively build an internal software organization that is rooted in banking and payments," said Tom Bianco, general manager of Newline.
J.P. Morgan is firmly rooted in the embedded finance space as well. The firm offers digital know-your-customer and onboarding, the ability to collect, manage and disburse funds, and other services through its J.P. Morgan Payments business.
"We see embedded finance as a pivotal strategy as many commerce websites, software-as-a-service platforms and organizations are transitioning to a marketplace business model," said Lia Cao, head of embedded finance and solutions at J.P. Morgan Payments, via email.
Macy's Marketplace, an online marketplace for sellers from the Macy's department store chain, uses J.P. Morgan Payments services to manage the flow of funds between Macy's and its sellers. SalonCentric, a distributor of professional salon products from L'Oreal, uses J.P. Morgan's Merchant Services platform to process transactions and receive and settle funds.
J.P. Morgan Payments is exploring opportunities in the automotive space.
"With electric vehicles and connected cars taking off, auto companies are considering how to directly connect consumers and enable commerce in their vehicles," said Cao.
In 2021, J.P. Morgan
"Embedded finance at its core is not new," said Cao in her email. "What is notable is that we're seeing continued and increased demand for integration of comprehensive financial services directly into client ecosystems."
Software vendors and payments firms may also gravitate toward large banks as their partners in light of
"You can't have a sponsor bank getting impacted by a consent order, which is less likely with larger banks," said Ryan Christiansen, executive director of the Stena Center for Financial Technology at the University of Utah.
Still, Pike finds the sector is growing at a moderate pace.
"Embedded finance for large banks in particular has the steepest tradeoff," said Pike.
Financial institutions are grappling with the knowledge that they will be
"You might get access to incremental customers. You may also access customers you would have had otherwise, but now you've put a partner between you, which reduces your ability to serve the customer wholly and reduces revenue share," said Pike. "For large banks, it's a very delicate balancing act of where to play in embedded finance."
Crane isn't convinced this is a real drawback.
"It's only a risk if you think you will obtain that end customer anyway," he said.
Some banks are creating products that could not strictly be defined as embedded finance, since they are owned by the institution, but they share some of the same features and functionality. Some examples are American Express's version of buy now/pay later,
"We expect the large banks to absorb the lessons of embedded finance and evolve their own go-to-market and client service models," said Pike.
Chayt, of Fifth Third, has seen other benefits feed back into Fifth Third.
"Initially in these partnerships, the bank was the clear strength. It brought the customer base, distribution, capital and brand," she said. "What's exciting is nonbank partners can bring a very strong value proposition to the bank with their digital distribution and the brand recognition they've built quickly."
For big banks, "BaaS and fintech is a distraction," said Johnson. "Embedded finance is the prize."
