By Rakefet Russak-Aminoach, managing Partner at Team8

Since the global financial crisis (GFC) of 2008, banks around the world have been confronted with heightened regulatory scrutiny, while contending with an influx of new competitors that are disrupting the financial services landscape with innovative, consumer-driven solutions.

The parameters of banking are broadening to reflect the new reality of niche neobanks, open banking reforms and non-bank competition. Relatively speaking, these trends are in the early stages of development, but their respective growth trajectories will be intrinsically linked. While the emergence of neobanks and open banking initiatives have forced the financial services industry to be more consumer-centric, I believe the sector’s future may very well be driven by embedded solutions. Let’s explore that future in more detail.

Neobanks and Market Fit

Most emerging neobanks use a playbook that includes challenging traditional bank pricing and complexity. To win customers’ trust, they offer greater transparency through a digital banking experience defined by ease of access, convenience and low to no fees.

Indeed, many neobanks have successfully implemented this type of strategy, serving up a new digital offering that resonates with certain demographics. However, one of their main hurdles has been customer acquisition, a process that is extremely difficult in financial services, and even more so for new entrants that lack brand awareness. In the banking sector, establishing a history of trust and credibility among customers is critical, and legacy institutions have a significant advantage over newcomers in this regard.

While acquisition is hard, adoption is even harder – at the end of the day, neobanks need to prompt users to actually start using their services. A 2020 Accenture Global Banking Consumer Survey revealed the magnitude of this challenge: while 23% of survey respondents maintain a neobank account, only half of them are actually using it as their primary account.

These low adoption rates can be partially attributed to a lack of advanced services offered by neobanks, especially when compared to the offerings of larger incumbents. Limited access to lending products is one notable explanation for relatively low levels of customer adoption, but there are also gaps when it comes to joint accounts, cross-border payments, loyalty programs, and many others.

After years of allocating massive marketing budgets to fuel “scale at all costs” growth, neobanks are now on a mission to improve their unit economics and drive ROI. To do so, they need to both reduce customer acquisition costs and increase the value generated over the customers’ lifetime. Selling lucrative financial services such as loans and cross border payments – not just deposits and payments – is one potential path towards profitability.

Confronted with this customer adoption problem, many neobanks have honed in on niche verticals where I believe offering dedicated products for specific personas has helped them gain traction.

Embedded Finance makes Financial Sense

Due to all the challenges around customer acquisition in financial services, it makes sense to embed and sell financial services where customers already are. Embedded finance presents unique opportunities for non-financial players to implement financial services within their native offering. Doing so allows them to expand their scope of services while creating new revenue streams.

By embedding payments within an app or website, companies like Uber or Airbnb can accept payments from customers, without requiring users to leave their platform. While payments is perhaps the most mature vertical in the embedded finance space, embedded lending and insurance offerings are starting to gain momentum. Tesla, for example, offers auto insurance at its online point-of-sale. Embedding financial products, including Banking-as-a-Service solutions, into non-financial platforms does more than optimize processes. It enables a frictionless purchase experience for consumers that helps companies improve conversion rates.

For the reasons outlined above, the embedded business model holds tremendous promise. Instead of forcing customers to migrate, you cater to them where they already are in a seamless, streamlined fashion. Shopify is an excellent example of a company that has embraced an embedded finance model. Shopify Payments, Shopify Installments, Shopify Capital and Shopify Balance, provide sellers with a comprehensive offering to accommodate their financial needs. For e-commerce platforms, in particular, the benefits are obvious. The platform owner already has significant insights into sellers’ revenue streams, risk exposure and ecosystem, and is therefore well-positioned to provide financial products that are tailored to their clients’ specific needs.

Quickbooks has also jumped on the banking-as-a-service bandwagon. Their launch of Quickbooks Cash, an embedded banking service for SMBs, aims to solve the biggest pain point for their target market, liquidity and cash flow management, by offering instant deposits, streamlined payments, and cashflow projections for their clients. Quickbooks combines accounting records with actual, real-time cashflow data to deliver more value to their customers with customized insights and recommendations.

Payments, lending, insurance and banking-as-a-service offerings are only the beginning. We are about to witness a gigantic wave of embedded finance that extends to investments, taxes and a slew of other sectors.

Open Banking: The Data Enabler In The New Banking Landscape

The great promise of open banking is the transfer of ownership of financial data from banks to their customers. This potentially will increase competition between financial institutions, resulting in lower prices for consumers, and can also provide customers with hyper-personalized products and greater control over their information and assets.

However, the success of the open banking initiative requires a high level of commitment from three critical stakeholders – regulators, banks, and customers – whose respective agendas haven’t traditionally intersected in the financial services venn diagram.

Open banking initiatives have been driven by regulators in some parts of the world like the UK, EU, and Australia. But even in these territories, where you would expect to see greater commitment, open banking initiatives remain largely localized. Non-uniform legal frameworks and API specifications make it difficult for Fintechs to easily integrate these APIs into a unified product.

From the banks’ perspective, open banking poses a threat. In many aspects, it means forfeiting ownership over customer data, and some fear it will encourage customers to seek financial services outside of their ecosystem. In addition to the lack of incentives from a competitive viewpoint, implementing open banking initiatives is complex — it requires a substantial amount of IT resources and is extremely costly. According to Tink, the 2020 median open banking investment by European financial institutions was between €50-€100 million. Even in regions where open banking is driven by regulators, banks are continuing to resist the pressure to comply. Significant pushback from UK banks like HSBC and Barclays illustrates how major players generally lack both the will and incentives to play ball in the open banking playground.

Last but not least, customers have also proved reluctant to embrace open banking. A study by De Nederlandsche Bank shows that while half of Dutch people are willing to share financial information with their banks, less than 4% are willing to share this information with an organization that is not a financial institution.

In light of the challenges described above, open banking has a long way to go before reaching its full potential. However, it is already a critical initiative that is broadening the contours of data accessibility. Open banking initiatives do  play a significant role in pushing the industry forward by making data accessible for new fintech offerings and novel business models. I believe it will be a major enabler of the embedded finance trend, providing non-financial players with both the infrastructure to sell financial services and greater access to their customers’ financial data. We are already beginning to see this happen in regions where open banking has been  driven by regulators (the EU and the UK) and in locations where it is driven by market dynamics and fintechs (such as  Plaid, which standardized the use of open APIs in banking).

The Future of Fintech is Embedded

Although the mainstream presence of large incumbent banks will endure long-term, the very definition of banking is being tested by the emergence of neobanks, open banking, and embedded finance. Forward strides on each of these fronts, in tandem, will drive meaningful change in the banking landscape.

As such, the big picture outlook will see many fintechs adopting an  “embedded finance” go-to-market strategy, and selling their financial products via a B2B2C model. This means that fintechs  will need to identify synergies, collaborate, and integrate with larger partners that have a well-established customer base. By embracing embedded finance models, fintechs can easily scale and achieve greater success in this highly competitive market. The next decade is going to be its most exciting and challenging, paving the way for an even more competitive, innovative and consumer centric financial services model.

About Author:

Rakefet Russak-Aminoach is a managing Partner at Team8 where she is directly involved in building and supporting fintech startups that are poised to redefine the financial services landscape. Rakefet is a visionary in the global digital banking arena, listed on Fortune Magazine’s “100 Most Powerful Women” three times since 2015. In 2016, she was named as one of the “10 Most Innovative CEOs in Banking” by Bank Innovation for the second year in a row and was also listed among the BBC’s “100 Most Inspirational and Influential Women” of the year.

Prior to joining Team8, Rakefet served as President & CEO of Leumi Group between 2012-2019. Under her leadership, Leumi established itself as Israel’s leading bank in profits, market cap and innovation. Rakefet led this turnaround via digital transformation, enhanced efficiency and a culture change. She established LeumiTech, the Group’s Hi-Tech arm, and launched PEPPER – Israel’s first and only neobank. During her tenure, Rakefet led key creative steps to improve the Bank’s capital adequacy. While serving as the bank’s Chief Credit Officer, Leumi attained a credit portfolio with minimal credit loss expenses, one of the best of its kind. Her transformative work at Leumi resulted in a Harvard Business School case study, “Leading Bank Leumi into the Future” (October 2019). Rakefet holds a BA in Accounting & Economics (summa cum laude), as well as an LLB and an MBA in Finance & Insurance (cum laude), from Tel Aviv University. She is also a CPA.