Well, everyone is talking about the $7 trillion opportunity in embedded finance. This huge figure is attractive enough for many banks to do so without confirming whether they are actually ready to become active competitors or are content to remain passive participants.Thank you for reading this post, don't forget to subscribe!
Recent news highlights a developing drama between banking as a service (BaaS) providers and traditional banks. Both banks and BaaS providers have drawn attention for accounting irregularities and prematurely terminated relationships with fintechs. It’s a vivid reminder of the hurdles and mysteries banks face when entering the world of embedded finance.
So, what is the missing link when banks adopt the ecosystem model of embedded finance?
It is a well-established fact that there is a significant lack of robust, core banking infrastructure required to handle the complexities of the emerging financial services supply chain.
The traditional banking model is straightforward. The bank acts as a central command, monitoring all activities related to deposits, payments and accounting, which helps reduce unexpected issues and transaction oversights.
However, when intermediaries such as BaaS providers and downstream partners come into play, connections need to be established between different systems and parties to maintain transaction integrity. APIs, or application programming interfaces, provide links, but their efficiency largely depends on the back end systems of these banks. The infrastructure at most banks is fragmented and inadequately prepared to deal with both the requirements of the ecosystem model and the complexities of real-time processing.
Fintech companies are adopting BaaS providers as valuable intermediaries as they provide a seamless path to launch fintech products and enable functions such as customer account setup, payments and virtual card services. BaaS players have successfully met the expectations of fintech firms in this regard.
Nonetheless, banks often frustrate BaaS providers and fintechs due to the mismatch of their batch-oriented infrastructure with the real-time needs of downstream actors. This is where the problem begins: accounts and transactions do not link correctly for both banks and fintechs, leading to two-way reconciliation failure, and subsequent lack of control.
What’s behind this reconciliation mishap?
When batch processing is extended to cover real-time operations, it gives rise to operational deficiencies, including unrecorded reversals, declined transactions, missed refunds and exceptions, which ultimately lead to accounting failures. Reasons arise. News reports suggest this has already happened in at least one BaaS case.
Varying account structures among ecosystem players pose a significant barrier to providing real-time transaction updates to fintech customer accounts, leading to discrepancies and manual reconciliation.
The most impactful solutions to these challenges involve embedding the infrastructure in banks, strengthening their critical roles as control centers in supply chains, enabling them to serve as integrated providers and facilitators.
Many banks are adopting parallel real-time core systems designed to handle payments, account management and customer onboarding for all ecosystem participants, including banks’ traditional customers. These are designed for the embedded, interconnected and real-time economy that operates through core APIs. They also feature a real-time ledger to record transactions, even when the bank’s internal GL system experiences downtime.
Additionally, they enable banks to provide “Ledger as a Service” For fintech partners without relying on batch-processing cores or additional middleware layers, allowing banks to confidently process fintech transactions in real-time, maintaining an updated core system and ensuring instant accounting and notifications.
Banks have a strong incentive to prepare for the era of embedded finance, as it is not just a playground for fintech brought about by BaaS providers. Corporate and commercial customers are actively seeking to seamlessly integrate financial services into their operations – treasury, AR/AP, ERP and other systems – through embedded finance with the goal of maximum automation and minimum reconciliation.
Regardless of the target audience, the essential features provided by the infrastructure, such as the ability to provide Account-as-a-Service through virtual accounts, event-triggered notifications, An integrated API for seamless bank connectivity and a centralized ledger for transaction maintenance are key factors influencing the outcome of these ventures. Be it updating transaction records, monitoring payment statuses or seamless accounting, the underlying bank infrastructure must be equipped to provide these real-time updates to ecosystem participants.
In this ever-evolving landscape, given the right technological foundation, banks undoubtedly have the potential to outperform BaaS providers, turning into both service providers and enablers in the grand scheme of things.