Over the last two decades, software has become ubiquitous in traditional industries, such as media, entertainment, and retail. And banking is no exception.

The digital finance revolution has unleashed a dynamic flux of challenges for incumbent financial institutions. On the demand side, consumers are growing accustomed to interconnected, transparent and contextual digital financial products.

The supply of financial services is being upended by innovative and agile fintech startups and nonbank entrants, all of whom are using embedded finance to make the consumption of products and services seamless and frictionless. All this change has disrupted the financial services industry beyond recognition. And for legacy banks, this means finding their own place in the future of finance.

Fintech disruption: from unbundling to re-bundling

The fintech phenomenon came into being on the back of the bold notion of unbundling financial services in the aftermath of the 2007-8 global financial crisis. Fintech startups tackled specific pain points of underserved segments with the innovative use of new technologies and business models. From nibbling at the peripheral edges to taking a mouthful at the core of the industry, fintechs have emerged as a force to be reckoned with.

As of 2021, there were over 215 fintech unicorns with deep pockets, amassing huge customer bases and increasingly bringing complementary products by building internal capabilities, partnering with fellow innovators or even acquiring firms outright.

Over the past ten years, fintech funding has grown at a CAGR of 32.5%, and it is poised to grow further as more investors realize the potential of the segment. Clearly, fintechs are no longer one-time disruptors, but permanent fixtures in the industry.

Over the past ten years, fintech funding has grown at a CAGR of 32.5%, and it is poised to grow further as more investors realize the potential of the segment.

The role of embedded finance

Historically, nonbanks from specific industries (i.e. supermarkets and telecommunications) have attempted to offer a limited set of financial services, such as payments, prepaid cards, co-branded debit cards to their customers, etc.

Thanks to the digitization of the financial services industry, this trend has grown and expanded exponentially. But how have these nonbanks and challenger banks been able to break into the industry so quickly? With embedded finance, new industry entrants can integrate financial services — such as payments, investing and lending — into non-financial customer journeys at the point of purchase.

Traditionally, financial services, despite being contextual, have existed as isolated offerings from lifestyle products. While payments have been a natural extension of any economic transaction, core financial products like bank accounts, loans, investments and insurance have always remained the forte of financial institutions.

Thanks to embedded finance, this narrative is changing rapidly. Embedded finance is forecasted to generate $3.6 trillion of value in the United States alone by 2030, as per analysis by Matthew Harris, partner at Bain Capital Ventures.

Embedded finance is forecasted to generate $3.6 trillion of value in the United States alone by 2030.

And it’s no wonder why. Several nonbanks are embedding financial products in their core offerings to create seamless user experiences. With the ultimate goal of increasing customer lifetime value by boosting customer acquisition, engagement and retention, more and more nonbanks across industries are embedding complementary financial products.

Regulators facilitating competition

These trends are the outcome of supportive policies from regulators. In a bid to increase competition and lower barriers to entry in the traditionally concentrated financial services space, regulators are enabling facilitative policies for controlled experimentation of new products and business models.

While in some regions – such as the UK, European Economic Area, Australia and Brazil – the regulators are taking charge of the change, in other regions – like Hong Kong, Singapore and the United States – regulators are acting as facilitators to market-driven innovation.

The bank of the future

Amidst these advances in market dynamics, the role of banks in the digital economy is undergoing a massive transformation. However, the scope of reform is still wide open for incumbents to use modern technology and collaborative business models to create banking platforms with abilities to respond to these challenges at speed and scale.

Indeed, the disruption and rise of fintechs has presented challenges to incumbent players, but also opportunities. Partnerships with agile and young industry entrants help legacy banks to create new and exciting financial products and services. And with embedded finance, it also provides banks with an additional revenue stream, by offering the integration of their existing financial tools to TPPs.

The question for banks is, how do they navigate the challenges while also taking advantage of the opportunities? By working with an experienced partner like Sopra Banking Software, banks can modernize their technology stack right from the ground up by leveraging a modern banking platform built upon a service-oriented and componentized architectural approach.

Click here to find out more about our suite of digital and open banking solutions.

Hassan Nasser

CIO of Digital Banking Solutions

Sopra Banking Software