Embedded Finance: Should Banks Overthrow Intermediaries and Reclaim Control?

Banks could potentially transform the BaaS game by becoming providers and enablers in the scheme of things, simplifying the embedded finance supply chain by displacing intermediaries.

Well, everyone is talking about a $7 trillion opportunity in embedded finance. This colossal figure is enticing enough for several banks to hop on the bandwagon without even validating if they are truly prepared to be active competitors or if they're content to remain passive participants.

Recent news highlights a developing drama between banking as a service (BaaS) providers and traditional banks. Both banks and BaaS providers have garnered attention due to accounting slip-ups and prematurely terminated relationships with fintechs. It's a vivid reminder of the hurdles and mysteries banks encounter as they wade into the world of embedded finance.

So, what's the missing link when banks adapt to the ecosystem model of embedded finance?
It's a well-established fact that there is a notable shortage in the robust, core banking infrastructure necessary to handle the complexities of the evolving financial services supply chain.

The traditional banking model is straightforward. The bank functions as the central command, supervising all activities concerning deposits, payments, and accounting, which helps minimize unexpected issues and transaction oversights.

However, when intermediaries like BaaS providers and downstream partners come into play, it requires establishing connections between various systems and parties to maintain the fidelity of transactions. APIs, or application programming interfaces, provide the link, but their efficiency largely depends on the back end systems of these banks. The foundational infrastructure in most banks is fragmented and inadequately prepared to cope with the requirements of both the ecosystem model and the complexities of real-time processing.

Fintech companies are embracing BaaS providers as valuable intermediaries because they provide a seamless path for launching fintech products and enabling tasks such as customer account setup, payments, and virtual card services. BaaS players have successfully fulfilled fintech firms' expectations in this regard.

Nonetheless, banks frequently disappoint BaaS providers and fintechs due to their batch-oriented infrastructure's mismatch with the real-time needs of downstream actors. This is where the trouble starts: Accounts and transactions just don't add up correctly, both for the banks and the fintechs, leading to a bidirectional reconciliation failure, and a 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 shortcomings, including unrecorded reversals, declined transactions, missed refunds, and exceptions, which ultimately lead to accounting failures. News reports suggest this has already happened in at least one BaaS case.

Varying ledger structures among ecosystem players pose a significant obstacle to providing real-time transaction updates to fintech customer accounts, leading to discrepancies and manual reconciliation.

The most impactful solution to these challenges involves incorporating the infrastructure into banks, strengthening their vital roles as control centers in supply chains, which enables them to serve as unified providers and facilitators.

Several banks are adopting parallel real-time core systems like Finzly BankOS, that are designed to handle payments, account management and customer onboarding for all ecosystem participants, including banks' traditional customers. These cores are tailored for the embedded, interconnected and real-time economy, operating through APIs. They also feature a real-time ledger to record transactions, even when a bank's internal GL system experiences downtime.

Additionally, they enable banks to provide "ledger as a service" to 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 prompt accounting and notifications.

Banks have a strong incentive to prepare for the era of embedded finance, as it offers more than just a playground for fintechs brought in by BaaS providers. Corporate and commercial clients are actively seeking to seamlessly integrate financial services into their operations - treasury, AR/AP, ERP and other systems through embedded finance, aiming for maximum automation and minimal reconciliation.

Regardless of the target audience, essential attributes offered by the foundational infrastructure, such as the capacity to provide ledger-as-a-service via virtual accounts, event-triggered notifications, a unified API for seamless bank connectivity, and a centralized ledger for transaction maintenance, are pivotal factors influencing the outcome of these ventures. Whether it's 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 constantly evolving landscape, banks, given the right technological foundation, undoubtedly have the potential to outperform BaaS providers, transforming to both service providers and enablers in the grand scheme of things.

Source: Bank Director

About the author:

Booshan Rengachari, a renowned speaker and visionary entrepreneur, founded Finzly in 2012 with the mission to revolutionize banking technology. His focus on simplifying the banking experience through innovative design principles has led Finzly to deliver award-winning payment and international banking solutions.