The $7 Trillion Embedded Finance And BaaS Gold Rush

OBSERVATIONS FROM THE FINTECH SNARK TANK

Make no mistake about it: Embedded finance has jumped the snark…uh, shark. It’s a full blown gold rush, and everyone and their mother is jumping on the bandwagon. Here are some recent headlines from:

• Synovus. The company will launch Maast, a money-as-a-service (get it?) offering, later in 2022, and announced a strategic investment in Qualpay to leverage the fintech’s payments technology.
• Adyen. Adyen announced its expansion beyond payments to build “embedded financial” products to help platforms and marketplaces create tailored financial experiences for merchants.
• lemon.markets. The Germany-based neo-brokerage raised €15 million to accelerate its product development that would enable non-financial firms to integrate stock trading into their services.
• Column. This fintech acquired a one-branch bank and built its own banking platform, with a direct connection to the Fed’s payments network. According to Fintech Business Weekly, it was “designed to be made available to third parties from day one—let’s call it a third-gen or native BaaS.”

And this is just the tip of the iceberg.

Embedded Finance Estimates

How big is embedded finance? There’s a growing number of estimates for the global embedded finance opportunity. A December 2021 pymnts.com article reported:

“A new study, the Next-Gen Commercial Banking Tracker, reports that embedded finance will reach a $7 trillion value globally in the next 10 years.”

The report, however, contains no references to this $7 trillion estimate (there are 17 instances of the number 7, none of which is preceded by a dollar sign or followed by the word “trillion”). Sadly, people cite this number as if it was scientifically proven.

Not that embedded finance aficionados have any inclination or incentive to know the “real” number. Generally speaking, they’re happy to hear as large a number as anyone is willing to provide.

I found another article citing the $7.2 trillion number on Fintech Switzerland. It says the source of the number was a report published by Mambu, so I downloaded that report. It references the estimate with a link to one of my own articles. Only problem is, there’s no reference to a$7.2 trillion embedded finance “valuation” in my article.

The Fintech Switzerland article has some interesting graphics, however. Finally! A source and breakout for the $7.2 trillion estimate. What a coincidence that the projected market value of embedded insurance, lending, and payments is nearly equal to the valuation of today’s fintech startups and the top 30 global banks and insurers.

But who exactly comprises the components of embedded finance on the 2030 side of that graphic? Wouldn’t it be the fintechs, banks, and insurers playing in the embedded finance space? And when was fintech valuation of “today’s” fintechs calculated? Bet it was before the recent decline in valuation.

Which leads us to another question: How do you forecast “valuation” eight years into the future? I can see forecasting transaction value and volume, but not market value.

Below is another graphic from the Swiss Fintech publication showing venture capital funding for fintech, and the year over year growth between 2020 and 2021. According to the chart, embedded lenders raised $300 million, and embedded insurers raised $800 million in 2021—orders of magnitude less than the $6.1 billion raised by embedded finance and BaaS players.

Can you tell me why embedded lenders and insurers aren’t included in the embedded finance category?

According to the article, “these two sub-segments are still rather nascent, despite their huge potential.”

Wait, what? Embedded lending and insurance is “nascent”? Cover Genius and Qover—two of the embedded insurers included in the graphic—were founded in 2014 and 2016, respectively. Liberis, an embedded lender was started in 2007.

If these two segments represent “huge potential,” wouldn’t VCs invest a lot there?

Perhaps the most incredulous thing in the Swiss Fintech article is the reference to the open banking and core banking segments as “other trends comprising embedded finance.” Core banking=embedded finance? No way.

Embedded finance=$7.2 trillion in 2030? No way.

The Embedded Finance Opportunity

That said, I don’t doubt that there’s a huge opportunity in embedded finance.

A new consumer survey from Cornerstone Advisors and Bond (who commissioned the study) asked gamers, gig workers, creators, small business owners, and other consumers about their involvement and interest in getting financial services from non-financial brands.

The survey results show a strong pattern across product categories including gaming, electronics, home fitness, home improvement, automotive, fashion, pharmacy, and general retail:

• Category interest is an imperative. Consumers who are highly engaged with a product category are the most likely to be interested in embedded finance. Category interest varies widely, making embedded finance more attractive for some categories than for others.
• Brands need an engagement mechanism. Gaming companies have a head start in embedded finance—their customers (i.e., gamers) interact with them digitally on a frequent basis. Fashion aficionados might wear their favorite brands’ jewelry and clothes regularly, but that doesn’t give the brands much opportunity to digitally engage and integrate financial services. Merchant mobile apps will be important for the delivery of embedded finance.
• Embedded financial services need a value proposition. Consumers won’t get financial services from a brand just because they like the brand. They’ll get them because the brand’s financial product offers some combination of superior convenience, personalization, or cost. Different consumers place different levels of importance on those factors making product design and customer experience critical success factors.

Picks, Shovels, and Mining Equipment

Like the gold rush of yore, the embedded finance gold rush is drawing it’s share of pick and shovel providers—they just have a fancier name: Banking as a Service (Baas) platform providers. As the number of players in this space grows, embedded finance-minded banks and brands evaluating BaaS platform providers should consider:

• Brand-bank fit. A brand should choose a BaaS platform provider that already supports consumers aligned with the brand’s customer base. Easier said than done.
• Product specialization. A brand should choose a platform provider that aligns with (or enhances) the embedded finance products it intends to offer—platform providers are often strong in either lending or payments, and sometimes, not even strong in all payment offerings.
• Brand-bank relationship. Many BaaS platform providers won’t let a brand and bank interact directly, which is not desirable, and may even cause the bank some headaches with regulators. With a direct relationship, brands have better oversight, control, and flexibility in program terms.

There Is Gold in Them Thar Hills

Logic and data isn’t going to dampen the embedded finance gold rush. Just as there were plenty of would-be miners panning for gold in all the wrong places—and doing all the wrong things—during the gold rush of the 1860s, plenty of brands, banks and fintechs will do the same during the embedded finance gold rush of the 2020s.

While some (and perhaps, many) brands, banks, and fintech pursuing an embedded finance strategy won’t strike gold, others will. Who will succeed?

• The brands that: 1) seamlessly integrate the application for and management of financial services into their business processes, apps, and websites, and 2) truly understand the economics of providing embedded financial services so they can price both financial services and their existing products and services to optimize profitability and customer loyalty.
• The banks that make the cultural, strategic, and technological shift from a B2C (or direct-to-customer) business model to a B2B2C model. In the embedded finance world, brands are the customers. Taking care of consumers is still important, but banks will do that to keep their primary customers—the brands—happy.
• The BaaS platform providers that best balance technology quality and support with the magnet and matchmaking capabilities that a good platform needs. I’m concerned that some platform providers are focusing too much on the technical side and not enough on building out the business capabilities.