Banking-as-a-service (BaaS) vs embedded finance

Banking-as-a-service (BaaS) and embedded finance have become two of the biggest buzzwords/solutions. However, there seems to be a confusion about how they differ from one another.

FinTech Global spoke to Currencycloud’s director of strategic partnerships David Reiss and head of EMEA banking sales Samuel Head to get to the bottom of the confusion and see which one is best for clients.

Reiss explained that it is common for people in the market to mistake the two. He said, “I’ve been to conferences where, if you were to ask people to produce a Venn Diagram of BaaS and embedded finance, they’d probably draw a circle. Given the nature of BaaS and its interoperability through APIs, they may even see themselves as service providers for embedded finance solutions.”

Head explained that the main differences between the two lies in their focus. He explained that embedded finance is more front-end and focuses on the customer experience and providing financial solutions in conjunction with buying other goods or services. Whereas BaaS is a back-end process, providing financial services that allow digital banks and non-banks to offer these products for themselves.

Reiss agreed with this differentiation. The most common example of embedded finance is Uber, he explained, as the person orders a taxi and once you end the journey the transaction is embedded and takes place in the background.

BaaS, on the other hand, is a bank-like service that is consumed more digitally. “It is driven by the developer experience and generally to FIs. In many cases BaaS is an enabler, or indeed a prerequisite, for embedded finance.”

These BaaS solutions differ around the world, Reiss added. For example, in Europe they are typically a collection of third-party providers that help create a solution to challenge traditional banking. Whereas in North America, BaaS providers tend to be created so the traditional banks encumbered by legacy technology can access newer technology.

However, Reiss offered an easy rule of thumb to differentiate between the two. “Embedded finance is for organisations who aren’t regulated, whereas BaaS is specifically trying to be a regulated activity.”

Their pros and cons

Both embedded finance and BaaS are expected to take the world by storm over the coming years. According to a report from financial firm Bain, the transaction value of embedded finance will double to $7trn by 2026. The technology is already used by the masses. Composable banking platform Temenos found that 60% of UK adults are already using embedded financing when shopping.

BaaS is also experiencing strong growth. According to Juniper Research, total BaaS platform revenue will exceed $38bn by 2027, rising from $11bn in 2022. However, the technology is not yet perfect. A report from ClearBank claims that one in five FinTechs are losing out on a potential $11m each year in product delays because BaaS suppliers cannot keep up with the FinTechs’ growth. Despite the issues of keeping pace, many FinTechs are looking to extend their use of BaaS and it is no surprise when BaaS-services represent an average of 45% of a FinTech’s overall revenue stream.

With both BaaS and embedded finance experiencing strong growth, many firms will be thinking what the best route for them is. Unfortunately, there is not a correct answer.

Head said, “They each have their benefits and it’s less about ‘cons’ and more about what is appropriate for what you’re trying to solve for your customers.” He explained that BaaS allows people to build financial services quickly, while embedded finance is taking financial services and making them invisible in the daily lives of consumers.

“For me BaaS allows people to build financial services quickly. Embedded finance is then taking financial services and making them invisible in the day-to-day activities of the end user. Embedded finance is therefore super interesting to consider “what next” for the end user. As such, it’s more exciting and easier to consider.”

Reiss agreed with Head that both solution types have their pros and cons. The ultimate deciding factor is down to what the user wants. If they are looking to enable seamless checkout experiences, embedded finance is better. But if they want a customer-centric, financial service that allows a customer to manage, hold and spend money, BaaS works better.

“In reality, there’s probably space for both as they’re not competing directly with one another (at least in my eyes). BaaS is trying to win customers away from more traditional banks while embedded finance is seeking to keep customers using their core (non-financial) products or services by offering a more seamless transaction behind the scenes.”

With both types of services able to compete in the market, Head was more interested in how they will evolve in the coming years. He was particularly interested in how embedded finance will look in the future.

“Payments and simpler services like BNPL are already being embedded and becoming the norm. Many times the black cabby has had to chase me down the street as I assumed the payment was taken care of like my Uber experience.

“The next stage of embedded finance could extend to more complex financial services .  Perhaps I’ll be able to learn if I’m eligible for a mortgage as I enter a house I want to buy.  If the decision is NO the mortgage provider will automatically identify what I can afford.” This type of service could be integrated with a real estate portal that can provide the customer with other properties in the area that meet the customer’s affordability.

Going even further, Head explored whether it would even be a bank that provided the property hunter these services. For example, a company like Meta could notice the activity and show the customer houses via a VR headset or help them compare alternative lenders.

“The rate of change could be great now that slower, older organisations are less in control of banking apps and interfaces, and it’s likely to be the FinTechs that continue to set the pace for change. This is assuming they can continue to innovate and take risks in a more volatile economic environment.”

Consolidation of the market

As mentioned, both types of services are booming. A strong market always begs the question of winners and losers, but Head and Reiss believe this might not be the case. Head added, “I think the days of one winner are over. There are so many possible embedded services, from lending to payments to wealth management, it would be tough to see a single dominant player.”

Reiss agreed with this mindset. While he doesn’t see one company dominating the market, he also doesn’t see the market being composed of lots of little players. Instead, there will be a couple of bigger players that will rule, but they will need to balance scaling quickly enough to win market share, but doing so sustainably. “A company throwing money at customer acquisition, then figuring out how to monetise once they’re there is asking for trouble.”

Reiss said, “I suspect, if any one company or solution rises to the top, a huge factor will be down to the trust placed in them by the end consumer. I may not like my traditional bank but do I trust a BaaS service to look after my money better? It depends. I also may not trust an eCommerce provider with performing my financial transactions so any lack of friction in a checkout experience seems too good to be true – and what else are they using my data for?”

Choosing between BaaS and embedded finance 

Head said, “A company considering embedding financial services simply needs to consider how much ownership they wish to have. And what their end users’ needs are. In the main, if you are not in FinTech, find a FinTech company you can trust to embed a quality service that helps you sell more of your core product or service.

“If you are a FinTech, think about using a BaaS supplier. It’s actually a good time to build in redundancy and to be very careful when selecting your partners.”

Before a firm can make a decision, they will need to assess what they want to achieve in the long run, as well as what their customers are looking for. Reiss concluded, “An extra layer of complexity is that you want to pick a solution that leaves some agility. Consuming either via API gives you some latitude. Ultimately it’s about knowing your end customer and understanding what their needs are! There will be a myriad of added factors to consider – from the geography they’re in, to what kind of service they provide, to what’s the regulatory environment and, of course, not forgetting that whatever you do has to fit into your core strategy and overall purpose.

“However, it all goes back to first principles: what’s the problem you are trying to solve.”

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