Embedded Finance and BaaS: From Marketing Buzz to Banking Bedrock

Embedded finance and banking-as-a-service (BaaS) are having their watershed moment. Banks and financial institutions (FIs) everywhere are increasingly integrating application programming interfaces (APIs) that unleash the power to manage our financial and consumer lives through seamless and intuitive digital experiences. Driving this change is a blend of evolving consumer expectations shaped by longstanding familiarity with modern technologies and competing nontraditional financial players that show a consistent knack for disrupting the financial services market. Despite their promise, these innovations present significant challenges. Smaller community banks and credit unions (CUs) in particular face hurdles ranging from security concerns to resource limitations and even a hesitation to take the lead — 64% of CUs, for example, opt for competitors to make the first move. Overcoming these obstacles is crucial for any FI aiming to successfully undergo a digital-first makeover and make the leap from disrupted to disruptor.

Embedded Finance and BaaS Are Banking on APIs

An Obstacle Course Stands in the Way of Embedded Finance and BaaS

The Future of Banking Will Be Built on Bridges, Not in Silos

A Tactical Guide to BaaS and Embedded Finance for Community Banks and Credit Unions

Embedded Finance and BaaS Are Banking on APIs

Banks and FIs are adopting embedded finance and BaaS to introduce seamless financial services into everyday consumer and business experiences, countering competitive threats and catalyzing growth. This is the future of banking.

Consumers demand more, and embedded finance could be the answer.

Banks and FIs increasingly view BaaS and embedded finance as conduits to future viability. A recent survey reveals that 41% of FIs have integrated embedded finance solutions, and 48% have augmented their BaaS capabilities — moves that boost their market responsiveness and begin to address the dynamic and often fickle preferences of digital-first consumers. The decision to do so appears to stem largely from a growing recognition of the transformative potential of BaaS and embedded finance to drive growth and revenue generation, particularly in the face of escalating competition from FinTechs and Big Tech.

79%

of banks globally predict banking will become deeply embedded in everyday consumer and commercial activities.

Big Tech is targeting retail banking customers. Can BaaS serve as a shield for FIs?

Big Tech, payment companies and even eCommerce players are vying for dominance over the consumer financial services market, leaving banks and FIs with little choice but to weave embedded finance and BaaS into their service offerings and operations ethos. Already 79% of banks globally foresee a not-so-distant future in which banking becomes deeply embedded in daily consumer and commercial activities, with 20% anticipating a transition toward BaaS-centric models that empower them to offer homegrown products and services.

Smaller community banks and CUs should take note of this trend because businesses are not sitting idle in the meantime. Accenture research finds that 44% of commercial bank customers are planning to connect their enterprise resource planning (ERP) systems with payment providers via APIs to harvest data-driven insights. This trend is expected to gain momentum as supplementary artificial intelligence (AI) tools enter the market.

FinTech APIs are the secret weapon that CUs aren’t using (yet).

Embedded finance is no longer just another offering on the menu of financial services; 70% of banks now consider it a cornerstone of their digital-banking strategies. Still, is this transformation reflective of an industry-wide change or just marketing buzz? According to IBM’s research, by September 2023, 71% of FIs were actively involved in embedded finance initiatives. The experience of an Italian bank underscores the appeal: Through effective integration of APIs, the bank aims to accomplish the remarkable feat of connecting with more than 80% of the Italian national banking system, positioning itself as the leader of digital payments in Italy. This achievement is notable because it showcases the opportunity to drive significant gains in operational efficiency and market positioning, even in a regulatory and bureaucratic environment not typically known for efficiency.

An Obstacle Course Stands in the Way of Embedded Finance and BaaS

Advanced digital transformation is no simple task, especially for banks and FIs. From security issues to outdated systems and regulatory regimes, banks and FIs face substantive challenges.

U.K. banks face at least 10 roadblocks to embedded finance adoption.

2 in 3

U.K. banking executives say more than 10 types of cost and risk are slowing the adoption of embedded finance.

More than 66% of banking executives in the United Kingdom identify at least 10 forms of cost and risk slowing the broad adoption of embedded finance. A staggering 99% acknowledge at least one barrier preventing them from moving forward, with 75% stressing the absence of a unified internal strategy as a primary obstacle. This raises critical questions about a potential knowledge gap between senior leadership in the financial industry and the complementary FinTech industry, which aims not to compete but to guide banking into the modern era. The regulatory landscape is also proving anachronistic, with 31% of compliance leaders reporting that they are paralyzed by uncertainty.

The industry’s broad lack of cohesive strategies and clear regulatory guidelines stands to have a disproportionate impact on the U.K.’s CUs and building societies. While the market’s larger FIs will likely find their footing, a key concern is whether these smaller FIs can adapt fast enough to remain competitive with the more agile and digitally advanced challenger banks — many of which partner with FinTechs.

European banks are waking up to the API security challenge.

European FIs face significant and troubling security challenges on their road to widespread use of APIs. Aggregating data on FIs and insurers into a single segment, a recent Fastly study shows that although 80% of this segment recognizes the paramount importance of API security, just 24% has implemented a consolidated security solution for web and API interfaces. Budget constraints, a shallow reservoir of expertise and insufficient time allocated to security planning collectively exacerbate this alarming discrepancy.

The severity of the issue is further underscored by the high levels of concern surrounding outdated APIs (cited by 57% of respondents), vulnerabilities in production APIs (24%, of which 38% pertain to authentication issues), and even the difficulty in detecting API attacks (29%). For resource-constrained cooperative banks and CUs in Europe, these security concerns may present a formidable barrier to entry into embedded finance and BaaS, suggesting that prospective FinTech partners will likely need to play some role in helping these FIs to bolster their security posture.

Legacy systems constrain banking innovation.

FIs are also confronting systemic obstacles that curb the adoption of modern cloud-based systems, which are essential for unlocking cutting-edge capabilities facilitated by APIs. Indeed, 67% of FIs remain heavily reliant on legacy systems. What stands in the way? Principal barriers include competing technical priorities (40%), insufficient technical resources (37%) and apprehension about lengthy implementation timelines (32%), the latter likely amplified by broader macroeconomic uncertainties that have cast a shadow over investment decisions. Modernizing core banking systems is a complex undertaking, especially for small community banks and CUs burdened by legacy systems and technical debt. For these FIs, a phased implementation strategy that incorporates scalable solutions will likely be key for attaining the flexible architectures necessary to fully embrace digital transformation and the embedded finance revolution.

The Future of Banking Will Be Built on Bridges, Not in Silos

FinTech partnerships can be game-changers for banks and FIs, allowing them to leapfrog obstacles and innovate faster. These partnerships can introduce cutting-edge technology, boost customer satisfaction and even redefine what is possible in banking. This is collaboration with real impact.

Gen Z’s push for innovation puts CUs on notice.

PYMNTS Intelligence research reveals a worrisome disconnect: While 41% of CUs have no plans to offer Zelle, a popular peer-to-peer (P2P) payment app, by 2030 and 23% say the same about digital budgeting tools, the urgency for offering API-enabled products nonetheless remains undeniable. Notably, 30% of Generation Z consumers — the future lifeblood of retail banking — are likely to switch FIs if their CUs fail to innovate.

30%

of Gen Z will switch FIs if their CUs do not innovate.

Recognizing the stakes, 80% of CUs are embracing the idea that FinTech partnerships are a linchpin for their digital transformation, with nearly half of this segment planning to invest in FinTech partnerships in 2024 and almost 30% anticipating partnerships with multiple FinTechs. For small community banks and CUs, whose innovation cycles often lag those of larger banks and FIs, these partnerships can be a lifeline, providing a shorter pathway to implementing embedded finance products — and a chance to further engage digital-native consumers.

HSBC aims to turn tax pain into loyalty gains with Ember’s API magic.

Ember’s collaboration with HSBC UK demonstrates the granular use cases achievable through adoption of FinTech APIs. Specifically, HSBC UK now offers business banking customers the option to access Ember’s tax and accounting services directly within the bank’s digital banking portal. This is an example of embedded finance addressing the critical pain points of accounting and tax compliance, potentially boosting customer loyalty for HSBC as a result.

Lendica and EBizCharge make SMB credit a cinch.

EBizCharge’s recent partnership with Lendica introduces an embedded business credit solution that is a boon for small to mid-sized businesses (SMBs). The collaboration facilitates a more seamless lending experience on the EBizCharge platform, effectively lowering barriers and accelerating access to business lines of credit.

Audax and Paymentology put branded card programs on the fast track.

The partnership between Paymentology and Audax Financial Technology is poised to reshape banking services in Southeast Asia and the Middle East by enabling banks to launch branded credit card programs through their cards-as-a-service (CaaS) solution. Merging Audax’s digital banking and BaaS capabilities with Paymentology’s card processing solutions, the collaboration allows banks to bypass much of the usual hassle associated with branded card offerings and potentially unlock substantial value. As the model gains traction, one potential outcome is that it expands beyond these regions to reach other markets where small banks and CUs struggle to compete with the branded card programs of larger FIs.

A community bank in the Midwest discovers digital agility through APIs — 950 of them.

First State Bank’s strategic partnership with FinTech Jack Henry has revolutionized its banking operations, in large part by gaining access to more than 950 APIs and the corresponding technology to reimagine its service delivery models.

These FinTech partnerships achieved two crucial outcomes: adoption of modern technologies and improved institutional agility, both of which will help these players to better meet the demands of the digital-first marketplace.

A Tactical Guide to BaaS and Embedded Finance for Community Banks and Credit Unions

Technology is dissolving the historical boundaries of banking, creating a dynamic frontier where embedded finance and BaaS are no longer trendy Silicon Valley startup ideas but a bedrock for resilient digital-first banking strategies. This is a big deal. It signals the beginning of an era in which financial services are embedded into the everyday digital routines of consumers and businesses. However, the scope and complexity required to fully implement these services have posed daunting challenges, particularly for smaller community banks and CUs — until now. Partnerships with FinTechs and the integration of APIs are bridging the technical gaps, offering a viable route to navigate this transformation. For these institutions, the path forward is clear: strategic integration and bold innovation.

PYMNTS Intelligence offers the following actionable roadmap for community banks and CUs:

Form a dedicated “transformation” team. Establish a cross-functional team dedicated to the advanced digital transformation of your institution. The team should include members from IT, operations and customer service to ensure a holistic approach to integrating BaaS and embedded finance. Empower this team to make agile decisions and drive innovation.

Assess FinTechs for strategic partnerships. Deploy cloud-based service adapters that function as intermediaries between your FI’s legacy systems and new BaaS platforms. These middleware technologies handle data translation and integration, enabling your FI to harness the benefits of BaaS with minimal disruption to your core systems.

Integrate API gateways. Deploy API gateways to manage and secure the data flow between your FI’s legacy infrastructure and cutting-edge or even emerging digital services. These integrations enable seamless operations and scalability while strengthening security protocols and broadening system capabilities such as rate limiting, caching and analytics.

Partner with a BaaS FinTech broker. Collaborate with a FinTech BaaS broker to access a suite of banking services ready for integration. This allows your FI to select and customize services tailored to existing system capabilities and customer needs, facilitating a smoother integration process without extensive internal technical upgrades.

The stage is set. FIs that innovate are those that will lead — and find their services woven into the very fabric of digital life.