Editor's note: this is a guest post from venture investor and banker Alan Vaksman.
People don’t like banks or banking anymore, they like goods and services. The notion of client-centric banks is fading and banks need to revise their retail model. Everything is shifting towards banks becoming regulated SaaS companies. To put it simply, the entire infrastructure of retail banking should eventually turn into transparent consumer software.
Despite short-term fascinations with colourful plastic cards and fun-looking digital banking applications, retail banking has little underlying value to people apart from being the funding source for a product or service they want to buy or use.
To maintain their position, banking institutions need to look for new points of contact with customers through products and services that can integrate their core traditional functionality, such as payments and loans.
These can be marketplaces, aggregators, accounting programs, business forecasting apps, games, streaming, and so on — essentially, any digital space in which users are concentrated and are consuming goods or services. This option would allow banks to simultaneously service millions of transactions and reduce the cost of attracting customers while maintaining retail infrastructure, even as banks close ever more retail locations, accelerated by the pandemic. This means that banks are becoming SaaS companies.
Embedded finance, or simply the ability to integrate a financial service with a traditionally non-financial service, product, or technology, will allow enterprises to open up new revenue streams and reinvent core customer services.
At the same time, embedded finance will enable customers to enjoy the convenience of easily buying additional products or services across an ecosystem of apps and services, delivering secure banking as a service that everyone will soon be taking for granted. Digital Horizon is not alone in this view. Many experts see “embedded finance” (which is the ability to embed financial services into non-financial services, products or technologies) as the main trend that will shape the future of the financial industry over the next decade.
The synergy of fintech and corporate IT solutions opens up new vertical markets centered around specific industries. According to Lightyear Capital, by 2025, profits in the embedded finance segment will grow more than 10 times - up to $230 billion, while experts from Bain Capital Ventures believe that by 2030, the volume of this segment will reach $3.6 trillion.
There is no need for banking as a discrete service anymore
There is no real love from clients for banks, just as most consumers find it hard to love utilities, be it energy, telecommunications, and others. Yes, there are ups and downs with strong brands when customers like a banking product, but as practice shows, this feeling disappears pretty quickly.
The simplest example is credit cards. It was long believed they provided banks with strong customer loyalty because customers used them often, and they were the only real alternative to cash. Today, we see how the pandemic has accelerated the development of contactless payments using smartphones. It doesn't matter who has issued the card underneath — a bank, a Buy-Now-Pay-Later (BNPL) service, Apple, Amazon, PayPal, or other payment services. What’s important is that the payment for the desired product is done quickly and effortlessly.
To buy a product or service, you don’t need to use banking services directly. The payment process, including the use of credit funds, can be integrated into other products - from a marketplace to a computer game. We already see payment processes embedded in all kinds of apps, but often these are from new players or payment processing services, rather than traditional banks. For example, you can pay for your purchases with Klarna, PayPal, Apple Pay or others, as these are much more convenient than traditional banking services.
The opportunity here is for banking institutions to step up their game, deliver banking-as-a-service, and through secure APIs, ensure their platforms are open to any app or online service — as explained further below.
Retail banking is transforming into an auxiliary tool. Even the recent boom in mobile banking has not influenced this trend: users pay where they shop, and if they log into the banking application, it is mainly to check balances or transfer funds from one account to another, and with time, you won’t need a separate app for these functions too. An example is in being able to send money to a relative or friend more conveniently using a messenger app with this functionality, such as with iMessage and Apple Pay. Previously, this was done only through banks and banking apps, but today, better and faster options are already widely used.
Successful fintechs long ago realized how important the new financial paradigm is: if you place a financial instrument in the right place and offer it at the right moment when the user really needs it, the conversion increases many times over. Based on this principle, BNPL solutions such as ZipPay and AfterPay have boomed with consumers and stock markets in places like Australia and the US, while there are also services that offer you an advance payment before salary. Meanwhile, the aforementioned Swedish company Klarna was recently recognized as the largest European fintech company.
One of the Digital Horizon portfolio companies, Aximetria, offers Swiss finance services to anyone, anywhere through their mobile app that can be connected to the user’s traditional credit or debit banking accounts. The customer can use the app to make payments, buy or sell currencies, send digital assets to other users, via mobile number - no other account numbers needed - and they can do it quickly, effortlessly and securely. This is an example of a digital wallet from the future available now, with its integrated banking as a service offering additional add-ons like marketplaces, donations to social causes and other options directing you to from one app and to another without taking extra steps to connect to your bank - and doing it securely. Though this is still an example of a basic service already known to us, embedded finance of the future will be massively integrated not only vertically within the same brand, service or industry but more horizontally, across many industries.
While retail banks will continue to play a major role in the regulated function of keeping deposits, even there the tone of retail banks is in question. This function may be gradually moving to applications for personal finance management, advising how to manage your finances effectively. These services will not become banks, and will not need a banking license, as they will use a partner bank’s “banking-as-a-service” APIs and back-end to deliver the needed financial rock-solid trustworthiness and security.
This enables online apps and services to offer a front-end to a user’s finances within the context of whatever products or services they are consuming, while the physical banking side and storage functions including storage of savings takes place in the bank.
The bank becomes an outsourced B2B financial service that lets services or apps perform their B2C functions, without that service or app needing to become a bank of its own, which is beyond the purview or desire of most app developers.
Bank as a service
The bank of the future is software that will be bought and embedded by non-financial services, such as taxi aggregators, food delivery, and online stores, like the already existing Railsbank, Clearbank and Solarisbank solutions. Banks will offer their infrastructure for a fee or a B2B subscription to provide access to sets of financial services, including payments, transfers, installments, loans, and more. The configuration of such packages will become the subject of competition by financial organizations.
I know for a fact that almost anything can be automated in a retail bank. However, this transition must be done quickly, or players will begin to lose even more market share over the next 3-7 years than they have already.
Many banks will find it hard to accept separation from the consumer, but when push comes to shove, customer focus is not something that is written in the DNA of regulated financial institutions. The reality for those institutions is that customer service has always been a secondary concern, and with banking-as-a-service, banks can focus on app makers and service providers as their real customers, who can then confidently offer rock-solid banking services to their users.
There is no sector that cannot be positively disrupted due to customer dissatisfaction, and banking is no exception. While disintermediation from a client is seen as bad for banks, there are distinct advantages to this evolving model. Banks that embrace the embedded future will benefit, bringing higher returns to shareholders. Those who choose to keep fighting for the “love” of the consumer will end up in no man's land, trying to convince us the “easy loan application process” is much more rewarding than getting a new bike for their child.