Nearly all community bank leaders see the integration of embedded finance as crucial to the long-term survival of their institutions, a new report published Tuesday revealed.
Sixty percent of respondents deemed embedded finance as “extremely important,” according to the report from banking-as-a-service platform Treasury Prime, which highlighted how community banks are thinking about embedded finance.
For these banks, embedded finance enables the creation of new revenue streams, acquisition of low-cost deposits, and enhancement of the customer experience by partnering with fintech companies, according to the report.
Embedded finance allows banks to integrate financial services, such as payments, lending, or banking services, into non-financial platforms and applications.
Not all banks are looking to grow deposits through embedded finance, since each bank’s strategic priorities vary significantly based on its size, growth objectives, and regulatory considerations, said Jeff Nowicki, chief banking officer at Treasury Prime.
Some banks focus primarily on deposit growth, while others approaching regulatory thresholds like the $10 billion mark may not, Nowicki pointed out. Many financial institutions prioritize fee revenue generation, while some measure success by client acquisition metrics, he noted.
“In this embedded space, you can tailor the opportunities to what you want to do,” Nowicki said.
BaaS has garnered headlines in the last couple of years due to shortcomings — highlighted through enforcement actions against banks implementing the programs — leading to heightened scrutiny. But the report found that smaller, regional financial institutions are ready to leap.
More than half of bank respondents indicated they were considering offering BaaS or embedded banking capabilities. At the same time, compliance-related solutions, such as fraud detection, know-your-customer, and anti-money laundering solutions, ranked lower.
Although compliance-related factors, such as risk management approach, strong security and data protection, and regulatory and compliance adherence, were rated highly by bank leaders surveyed, technological concerns, including seamless application programming interface integration and scalability or growth potential, followed closely – all above 30%, the report found.
Community banks have an edge over larger established banks since their local insights serve as a “competitive superpower,” especially for embedded finance, said Yaacov Martin, CEO of embedded lending platform Jifiti.
“Moreover, the fact that they are designated community banks means that their ‘feedback loop’ can also work swiftly – so that they are quickly able to assess the value that they are creating with these projects,” Martin said in an emailed response. “Working with a fintech partner enables them to effectively test out their offerings, get feedback quickly and iterate as needed,” he added.
Treasury Prime surveyed executives at more than 300 U.S.-based community and regional banks and credit unions with assets of less than $100 billion between March 23 and April 8.
Adoption challenges
“Legacy systems are rarely API-ready,” Martin said, adding that most community banks weren’t built for real-time data exchange or for embedded finance.
“Then there’s cultural resistance – the fear of disrupting the traditional community branch model. Finally, the fintech partner ecosystem can be overwhelming, as firstly identifying what technology they actually need as well as which providers are the most relevant and compliant can require specialized knowledge and market analysis,” Martin pointed out.
Banks new to embedded finance need to revisit existing policies and procedures to align with a digital-first approach. Traditional banking policies often include requirements incompatible with digital banking, such as physical signature requirements, in-person document verification processes, and business documentation procedures designed for branch interactions, Nowicki said.
Recent industry developments, including Synapse’s bankruptcy and enforcement actions in the banking space, have led to increased scrutiny, while banks have become more cautious about launching embedded finance initiatives, he noted. Though this thoroughness extends timelines, it’s the appropriate approach in the current regulatory climate.
“Every t needs to be crossed, every i needs to be dotted before bringing a single client on,” the banking chief said.
‘Compliance is key’
Maintaining risk management and compliance standards throughout the lifecycle of an embedded finance program is challenging, the report found. Survey participants flagged consumer protection law compliance (38%) and open-banking and data-sharing compliance (37%) as the compliance pain points around embedded finance adoption.
“Compliance is key,” said Brandon Oliver, principal at BankTech Ventures, an investment fund focused on community banks.
Community financial institutions need to develop a separate cultural framework for embedded finance initiatives, while their “internal thinking” for this business line must differ from other banking operations, Oliver said in an email.
“Embedded finance is also not for the faint of heart,” he said. “To see success, banks will need to launch multiple partnerships over time. The idea that a bank will hit a home run on its first at-bat is a bit of a pipe dream.”
Oliver said community banks should ensure fintech partners are “as buttoned up from a compliance standpoint as they can be” and make them give 90% to make the partnership work, especially when partnering with multiple fintechs, since fourth- and fifth-party risks are heavily scrutinized.
“Be pragmatic in your timeline of launch and make sure the fintech partner has the financial backing to walk hand-in-hand with you throughout that timeline,” he recommends. “Above all else, communicate daily with that partner and be as transparent as you can be with them throughout the journey of an introduction, launch and program monitoring.”
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