an article written by Chris Dean, Co-founder & CEO of Treasury Prime
Despite the recent drama and economic challenges, I am bullish on embedded finance for fintech and enterprises, as non-financial companies across industries like Walmart, Buildertrend, and many more adopt banking products to enhance their offering and drive customer retention. Looking at the bigger picture, embedded finance reached $20 billion in revenue in 2021 just in the U.S., according to McKinsey, which estimates that the market could double in size within the next three to 5 years. While the momentum may have slowed down, the industry will continue to build. I’ll even go out on a limb and say this: I think that you’re going to see some new embedded finance players break the top 10 fintech companies list by the end of the year.
Doing banking as a service (BaaS) partnerships sustainably while following the rule of law will be the order of the day. Last year at this time I predicted more regulatory scrutiny would be coming down the line and that is exactly what has happened. Regulators are catching up to the segments of the industry that were operating a lot like a shadow banking system, they have made it clear that you can’t outsource compliance away from a bank.
In August, the Office of the Comptroller of the Currency (OCC) struck a public agreement with a community bank over its fintech partnerships, where it found “unsafe or unsound practices” relating to third-party risk management. This is the first action of its kind, but it will not be the last.
The OCC is staffing up with more fintech expertise this year and is establishing a new Office of Financial Technology to oversee bank-fintech partnerships. The newly appointed office, set to open in early 2023, is meant to “promote responsible innovation,” and “ensure that the federal banking system is safe, sound, and fair today and well into the future” as bank-fintech partnerships continue to proliferate.
What regulatory actions will come down? Specifically, I can foresee possible changes to call reports, which all banks have to publish every quarter with the FDIC. This public regulatory document outlines information about a bank’s financial health and takes a lot of work. I would not be surprised if the regulators start adding equivalent documents to establish the health of fintechs – how many deals they have, what kind of clients they serve, and the like. Whatever shape it takes, more reporting will be required.
For enterprises and banks, the message is loud and clear: it’s time to start getting your risk management act together.
Compliance sounds intimidating, but if you work with an embedded banking software team with deep banking experience, you can stand up a top-notch compliance program of your own in partnership with your bank. At Treasury Prime, we have helped many companies design compliance programs with built-in control over customer experience — from onboarding to disputes — while meeting regulatory expectations. Unlike other BaaS providers, we do not offer to take on all compliance for the fintech or enterprises with little bank oversight, because that’s how you get into trouble with regulators. There are no shortcuts to compliance.
A BaaS provider that takes on compliance and risk functions for the fintech or enterprise, effectively acting like a charterless bank faces risk in this shifting regulatory environment. Because the chartered bank has the final say on compliance matters, one sure way to safely offer services is to become a bank. To address that issue, at least one BaaS provider will try to consolidate, buy a small community bank and move their fintechs to that chartered bank. Both Column and Lead banks have started their own BaaS banks to manage the compliance problem and have a direct integration with the U.S. banking system. The problem with a one-bank set up is that it doesn’t address the central issue: it’s risky for enterprises to partner with just one bank. If something happens to that bank, it could disrupt your operations.
Treasury Prime has built a different technology model by creating an embedded banking marketplace where enterprises can have direct relationships with a vast network of bank partners. This reduces risk and provides flexibility to add banks and the ability to pick products across multiple banks in the network to take advantage of the best pricing and products to meet shifting needs as you grow, through a single API.
We do extensive due diligence with more than a dozen top banks and growing such as Grasshopper Bank, Piermont Bank, and Emprise Bank, along with our integrations with core providers FIS and Jack Henry.
Unlike other BaaS providers, we build direct integrations with bank cores, and connect you directly to a bank in real-time without the reconciliation problems that come through sharing flat files at the end of the day. Our unique marketplace model offers clients the ability to pick products across multiple banks in our network to take advantage of the best pricing for products and services across different banks, and even transfer money seamlessly between them. You can only do this if you have built out a deep real-time integration with each bank.
Every fintech will also have to build direct relationships with their bank rather than having the BaaS provider handle most of the communications. This means every fintech and embedded banking enterprise will work closely with a relationship manager at the bank and communicate with each other regularly.
A lot of fintechs don’t have that direct relationship with a bank right now and they need to start taking a different approach because the regulatory agencies are going to demand it sooner or later.
Direct relationships have always been the standard model at Treasury Prime, based on our deep experience working inside banks. Companies connect to bank cores through our software, and we facilitate a direct relationship between the fintech and the bank so that there is complete transparency and both parties can address issues quickly and efficiently. We help the partners establish a joint compliance program that is safe, with clear processes and protocols. This is the most responsible way of handling compliance. Going into the future, this type of model will be the new normal.
At least 11 fintech companies — including neobank Bank North, and real estate tech startup Reali — have shuttered their doors this year, mostly because they couldn’t raise new capital, according to CB Insights.
Many tech startups had been leaning heavily on the capital markets and focused more on growth rather than profit margins. Now that capital is not so easily available. The previously strong economy propped up flawed business models and without the artificial supports, I anticipate more small fintechs will fold this year because their business models and profit margins failed to meet the expectations of investors.
Those that manage to survive will emerge leaner and more efficient, with a focus on profitable growth. Companies will need to improve their margins on existing products and create more product lines so that they can get the most value per customer.
Some of our clients that are performing well despite challenging times include Purpose, a socially responsible neobank, and Zeta, a financial platform for couples. Well-run fintechs that have found a specific niche will continue to thrive.
I predict a few new corporations will burst onto the embedded finance scene by the end of 2023. They won’t be the pure financial technology companies of yore like Affirm and Chime. Instead, the new titans will be non-financial companies that we don’t traditionally think of as fintech companies. Take Starbucks as an example; it’s primarily a coffee company, but through its rewards app, Starbucks holds more deposits than most banks in the U.S. Each year, customers load more than $10 billion on the card program. That’s 40-45% of their sales.
We’re going to see more household brands and large corporations start offering financial products to their offering as they realize the payoffs to the effort. And this new breed of embedded finance companies will go toe to toe with the established fintechs.
Typically, it’s the smaller banks that enter into partnerships with fintechs. They are being pushed out of the market by larger banks and need new revenue streams to compete. Also, because they are exempt from Durbin Amendment limits on debit card fees, they can offer fintech partners more favorable interchange rates on card transactions.
These partnerships are proving to be profitable, and a recent report shows that community banks that do fintech partnerships are beating industry deposit trends with many on track for double-digit total deposit increases.
Now, larger regional banks with plentiful resources are taking note as well. Wells Fargo issues credit cards for fintech startup Bilt Rewards, and Goldman Sachs is the credit card issuer for Apple. But that’s just one payment rail. For the ability to offer more products like accounts and electronic payments to fintechs, banks need to build out a more sophisticated BaaS tech stack. While banks perform day-to-day operations like account maintenance and risk management very well, their technology is outdated, and building out new tech is a heavy lift. What they lack is a technological communication layer that allows them to work with enterprises, which BaaS companies specialize in building out. I anticipate that these larger banks will start to work with embedded banking software companies like Treasury Prime and deploy API banking for a quicker and more cost-effective way to enter into partnerships.
We’re still in the early stages of the embedded banking industry; 2023 will be a year of maturation, and it will serve the industry well in the long run. Adulting is hard to do, but it pays off in the end.
Banking 4.0 – „how was the experience for you”
„So many people are coming here to Bucharest, people that I see and interact on linkedin and now I get the change to meet them in person. It was like being to the Football World Cup but this was the World Cup on linkedin in payments and open banking.”
Many more interesting quotes in the video below:
