Embedded finance has exploded, with global embedded finance payment volume projected to surpass EUR 6 trillion by next year. This market growth reflects the emergence of a dynamic ecosystem characterized by a wide range of offerings, user experience (UX) enhancements, and personalization opportunities.
In the United States alone, embedded finance transactions are expected to double from $2.6 trillion in 2021 to $7 trillion by 2026, elevating their share of total US transactions from 5% to 10% during this period. These numbers show a financial market that is primed to meet the increasing demands for near-instant, convenient, and accessible financial services. At the same time, banks are facing a new wave of pressure from regulators, as regulatory agencies worldwide scramble to manage the financial landscape’s rapid changes.
This guide offers practical insights into embedded finance, including its definition, ecosystem dynamics, partnership structures, risks, and opportunities. Whether you're a leader at a company seeking new revenue streams through embedded finance or a leader at a bank or fintech navigating embedded finance’s regulatory landscape, we wrote this guide with your sustainable growth in mind.
If you have ever received an offer for a payment plan or product insurance during checkout on an ecommerce website like Amazon or BestBuy, then you have experienced embedded finance.
Embedded finance lets companies extend financial products to customers without having to establish the same regulatory groundwork as a licensed financial services provider. It encompasses a broad range of use cases, including payments, loans, insurance, credit cards, and wealth management.
Embedded finance has roots stretching back to the 1920s, when Ford established an embedded lending program for car buyers through the Ford Credit Bank. Since then, embedded finance has taken place across a broad spectrum of industries and interfaces.
When leveraged correctly, businesses can use embedded finance to improve the customer experience and grow their revenue.
Embedded finance is when a non-financial business borrows a bank’s financial and regulatory infrastructure to extend a financial service to its customers. In essence, embedded finance brings the bank to the customer at just the right moment—with just the right offer.
It is not uncommon for embedded finance and banking-as-a-service to be used interchangeably. However, embedded finance and BaaS do have differences in meaning.
Embedded finance is “what” is being delivered: a custom, timely, and direct financial product offered by a non-financial company.
Think of it this way: Not all rectangles are squares, but all squares are rectangles. Similarly, while not every embedded finance offering falls under the category of BaaS, all BaaS products are indeed a component of embedded finance.
Within the embedded finance ecosystem, there are three foundational roles:
Sponsor banks provide the licensing that makes embedded finance possible. Also known as partner banks, these entities can include regional banks, enterprise banks, credit unions, and electronic money institutions (EMIs). Because sponsor banks bear the brunt of the regulatory liability for embedded finance, they can decide how they want to manage risk across their embedded finance program, including how they want partners to adhere to regulations. Sponsor banks are under increasing pressure from regulators to provide regulatory frameworks such as Know-Your-Customer (KYC) or anti-money-laundering (AML) to the end-brands they partner with.
Banking-as-a-service (BaaS) providers are fintechs that help banks and end-brands fulfill a variety of infrastructural needs related to embedded finance such as card issuance (like Marqeta), payment processing (like Sila), or deposits solutions (like Galileo).
End-brands, also known as “programs” in the context of the BaaS model, are the hosts of the embedded finance products. Often the innovators behind embedded finance use cases, end-brands interact directly with embedded finance end-customers. End-brands leverage behavioral data to deliver differentiated financial products in a non-banking context. End-brands can be fintechs, such as Chime and Revolut, or they can be companies completely outside of the financial services industry, including consumer brands like Apple or B2B brands like Shopify.
If embedded finance were a movie, it wouldn’t feature a bold protagonist, or even a romantic duo. It would be about a diverse ensemble of characters, all leveraging each other’s strengths to achieve a common goal.
Like with any good cast, these partnerships can also function in different formulations. For example, in one universe, the end-brand can have a direct relationship with a sponsor bank and BaaS provider. In another, the BaaS provider can be the one forming the embedded finance partnership. Banks can even offer embedded finance products of their own.
Here are the roles and responsibilities shouldered by key players in the embedded finance ecosystem:
Sponsor banks are federal or state-chartered banks with banking licenses in the US or EMIs in the EU. They are the backbone of embedded finance that empowers BaaS providers and end-brands with access to essential payment systems and card networks. By partnering with sponsor banks, BaaS providers and end-brands gain access to payment systems like Fedwire and ACH, as well as prominent card network associations such as Mastercard and Visa.
Sponsor banks assume a significant level of responsibility in embedded finance, as they are liable for risks associated with the fintech entities they do business with. They are ultimately responsible for shouldering the regulatory burden of their fintech partners and providing guidance on regulatory compliance to enforce these policies like government regulators do unto them. Often, sponsor banks will contractually obligate BaaS providers and end-brands to pay any fines they might receive as a result of fraud or other losses.
BaaS providers play a pivotal role in bridging the gap between banks and end-brands, offering technical and operational infrastructure to ensure seamless integration and functionality of banking products. BaaS providers may fulfill a variety of roles, including card issuance, compliance-as-a-service, and white-labeled UIs. These parties help reduce pressure on sponsor banks and end-brands while contributing value that enriches the overall customer experience.
While sponsor banks retain primary responsibility for risks associated with embedded finance, BaaS providers may take on specific responsibilities, including oversight, risk management, and governance. It’s up to sponsor banks to set expectations with their BaaS providers, and to dictate how much control and execution of the bank’s responsibilities the BaaS provider should have.
End-brands integrate financial services seamlessly into their existing platforms to enhance customer experiences and drive engagement. End-brands can harness behavioral data acquired through their platforms, allowing them to offer more inclusive and tailored financial products. These companies must establish and maintain partnerships with sponsor banks and BaaS providers to access critical banking infrastructure and manage embedded finance risks.
While sponsor banks and BaaS providers provide essential infrastructure and support, the end-brands offering embedded finance solutions have a responsibility to carry out practices that ensure the security and privacy of customer data, comply with financial regulations, and provide transparent and accessible information about financial products and services offered.
Embedded finance connects customers — including consumers and businesses — with financial offers from their favorite brands on their preferred channels. Embedded finance can occur at physical or digital touchpoints. For example:
Brick-and-mortar stores might leverage in-person embedded finance to encourage high-value or repeat purchases, like when a department store makes a branded credit card offer at checkout.
Embedded finance can be incorporated into company websites and triggered according to behavioral factors, like when a Buy-Now-Pay-Later (BNPL) offer by Klarna or Affirm gets triggered at the point of sale.
Branded apps, digital wallets, social media platforms, and even peer-to-peer messaging apps can all be sites of embedded finance. For example, a customer might use BaaS providers like Ally or Albert to access in-app budgeting and investment services.
Online and mobile channels have become a critical focal point for embedded finance. This aligns with changes to customer expectations, the growth of digital payments, and an increasing demand for digital and mobile optimization.
Even when simplified and distilled, embedded finance still has inherent complexities. This is due to the interplay of regulatory compliance, technological integration, and multi-party partnerships. Here is a quick rundown of the types of operational models that embedded finance partners might take on, from lowest to highest levels of a bank’s control over compliance policies:
In the bank-as-a-regulator model, a term coined by Fintech Takes’ Alex Johnson, the sponsor bank closely monitors and assesses processes and controls for its end-brand partners. Initially, the bank directly manages all its fintech programs. As the programs mature, the sponsor bank may gradually shift much of the first and second-line risk management and compliance duties, including frontline control operations, to its third-party partners.
BaaS providers help banks scale programs by taking up responsibilities. The bank outsources much of the risk, governance, and compliance work to a middleware platform. The bank gets some high-level reports on what its fintech programs are doing, but otherwise, the bank is fairly hands-off.
Fintechs use their sponsor bank’s existing risk, governance, and compliance infrastructure, meaning everything is controlled directly by the bank. As a result, fintechs don’t take on any of the frontline work of setting up and operating controls or back-office compliance monitoring and case management.
Banks are often tied to legacy systems and modes of operation, making it hard for them to add new, more customer-friendly revenue streams.
Embedded finance lets banks quickly add on new distribution channels for their financial products. And they can do it at a lesser cost by leaving the tasks of building and promoting new embedded finance products to their partners.
By establishing embedded finance partnerships, banks can experience benefits such as:
New sources of deposit revenue
With embedded finance, banks can secure new sources of deposit revenue, including commercial and retail deposits.
Reduced customer acquisition expenses
With their partners on the ground acquiring customers, banks can diversify their revenue while spending less on marketing.
Access to new customer bases
Embedded finance partnerships open sponsor banks up to customer bases they did not previously have access to.
Higher initial conversion rates
McKinsey research shows that embedded finance can increase conversion rates from 15% on average to 50% or more.
“Customers want a seamless, Netflix-like experience in every facet of their lives, and that absolutely relates to banking right now. They’re demanding personalization and intimacy. They don’t want to tell you more than once who they are or what services they require. And they want speed.”
In the embedded finance ecosystem, end-brands are the entities that host the embedded finance product and interact directly with the customer. End-brands leverage embedded finance to bring financial products to market without having to acquire the licenses required of traditional banks, streamlining their entry into the financial services arena.
Embedded finance also offers end-brands a way to enhance customer experiences, deepen engagement, and foster brand loyalty through the offer of personalized and data-driven solutions. From a marketing and growth standpoint, end-brands involved in embedded finance can also better position themselves to serve specific (and often new) customer segments.
Embedded finance empowers BaaS providers to monetize their platforms through various means, such as transaction fees, revenue sharing agreements, or licensing fees for access to their technology stack. The inherent scalability and flexibility of embedded finance also empowers BaaS providers to adapt to changing market needs, enabling increasingly expansive and relevant product offerings.
As third-party enablers of embedded finance arrangements, BaaS providers can position themselves as enablers of innovation, offering cutting-edge solutions that enhance the capabilities of both banks and fintechs. This positioning can lead to strategic partnerships, increased market visibility, and opportunities for growth and expansion in the embedded finance ecosystem.
Once an end-brand or BaaS provider establishes a partnership with a sponsor bank, these parties can work together to bring new financial products to market, including:
Embedded banking involves creating seamless banking experiences as a service. For example, Guava is a community banking platform offering embedded banking services to Black entrepreneurs. This digital platform offers custom value-adds, like financial resources and networking opportunities for members.
Embedded payments involve the incorporation of payment processing within other software or services, enabling transactions without the need for external payment gateways. For example, a BaaS provider like Marqeta can offer embedded payment solutions like prepaid virtual cards in partnership with Visa. This helps stand up BNPL or Buy-Now-Pay-Later platforms like Afterpay.
Embedded credit entails the provision of credit services within digital platforms or applications, allowing users to access financing conveniently. Tarfin is an embedded credit provider that uses its risk-scoring models to provide instant working capital for seed, fertilizer, or grain purchases in what’s being called buy now pay at harvest.
Embedded insurance involves the integration of insurance offerings within various products or services, providing users with insurance coverage tailored to their specific needs. Embedded insurance examples include AirBnB’s AirCover for hosts and guests.
Embedded wealth refers to the incorporation of wealth management services into other platforms or applications, facilitating investment and financial planning within existing digital ecosystems. For example, SoFi offers embedded wealth management services like its Insured Deposit Program. To make this program a reality, SoFi partners with a wide variety of banks, including Banc of California, Citizens Bank, HSBC Bank USA, Sallie Mae Bank, Bell Bank, Enterprise Bank & Trust, and more.
To understand how embedded finance works in practice, let’s look at other examples of embedded finance in action:
Extending an embedded finance product 30,000 miles in the air is certainly outside of the context of traditional banking. However, to a frequent flier who has spent the flight comfortably seated, watching vacation ideas zip by on the TV screen in front of them, the timing of a reward-packed credit card offer couldn’t be better — and the perks couldn’t be better tailored.
Meanwhile, on the backend, the airline’s sponsor bank — the financial institution that regulates and issues the cards (in this instance, Citi) — has successfully acquired a new credit customer, despite having little to no involvement in procuring that customer.
To order a car through Uber’s rideshare app, users can add funds to an in-app virtual wallet known as Uber Cash. Uber’s embedded finance product leverages the app’s historical data to extend timely loyalty rewards to its customers and drivers. For example, if a repeat rider makes a card payment that doesn’t go through, the app can enact a one-off BNPL service that orders the ride for them anyway. Not only does this keep customers from being stranded, but it also earns Uber staying power in terms of customer loyalty.
Uber’s embedded finance functionality also extends to drivers, who can access their earned wages and account balances directly within the Uber app. They can choose to leave their earnings within Uber or withdraw the funds according to terms set by Uber’s sponsor bank, GoBank.
GoBank may be Uber’s sponsor bank, but it isn’t the rideshare giant’s only partnership. Uber’s embedded finance products are powered by a broad tech stack, including payments infrastructure by Stripe, the Uber Pro debit Mastercard powered by Branch, and issued by Evolve Bank. By extending its embedded finance partnerships to not just sponsor banks, but also BaaS providers, Uber can offer increasingly attractive financial services to its global customer and driver base in support of its revenue goals.
A host of global factors have influenced the growth of embedded finance in recent years. Here’s a brief rundown of the events that have molded embedded finance into what it is today.
Post-2008, community banks faced a low-interest environment, compelling them to diversify revenue streams away from interest income to fee income. The Durbin Amendment allowed smaller banks to enjoy higher interchange rates compared to larger counterparts, rendering them attractive partners for fintech startups launching bank accounts with debit products.
Internet connectivity has been a major driver of the embedded finance market's development. Major life events, from home purchases to pharmaceutical transactions, are happening online more and more often. This shift holds even more true since the Covid-19 pandemic, creating unprecedented opportunities for monetizable and rapidly available digital value-adds.
According to the World Bank, two-thirds of adults worldwide now make or receive digital payments, with the share in developing economies growing from 35% in 2014 to 57% in 2021.
BaaS enables fintech startups to provide banking services without the need for extensive infrastructure development. The advent of codeless software development kits (SDKs) has streamlined the integration of financial amenities into products and websites, facilitating quicker time-to-market for innovative solutions. This concept has evolved significantly in the last decade, with providers such as Plaid, Synapse, Stripe, Marqeta, and Razorpay leading the charge.
Embedded finance has created a whirlwind of opportunity and energy in banking. At the same time, it has also created a lot of confusion. It seems like not a week goes by without a regulatory slip-up landing a sponsor bank in hot water.
Embedded finance challenges like adhering to regulatory compliance, assuming operational risk, and creating transparent policies remain major concerns for sponsor banks, end-brands, and BaaS providers. These parties also struggle with limited visibility into risk management and inefficient coordination processes.
As a result, companies are struggling with suboptimal performance, manual reviews, and fragmented systems. Rising regulatory scrutiny, weak risk mitigation protocols, and challenges related to oversight all necessitate strategic solutions to ensure the smooth functioning of embedded finance initiatives.
Here are a few of the most common challenges faced by embedded finance providers today:
Remaining compliant is time-consuming, but essential for sponsor banks, brands, and BaaS providers alike. Currently, sponsor banks are nine times more likely to receive regulatory enforcement actions than non-partner banks. This year, US regulators are following through on their promise to prevent bank failures by increasing bank supervision.
The increased focus of regulators has another unpleasant side-effect: increasing fixed costs significantly for fintechs and sponsor banks. As fintech pundit Simon Taylor observed, “Add this against a backdrop of fraud and suspicious activity report (SAR) volumes growing 31% and 15% year-over-year (YoY), and becoming a partner bank becomes uneconomical” — that is, without scalable identity risk management controls in place.
For sponsor banks, handing compliance entirely over to fintechs and other non-bank end-brands is risky because it can lead to a lack of oversight and control for the sponsor banks who are ultimately on the hook to regulators in the case of noncompliance. In 2023, a significant proportion of severe enforcement actions from federal bank regulators (13.5%) targeted banks involved in BaaS partnerships with fintech companies. Greater scrutiny and more aggressive compliance enforcement means a greater need for banks, BaaS providers, and end-brands to work collaboratively.
During break-out fraud attacks, financial losses are generally assumed by the end-brand. While sponsor banks may not be directly on the hook for fraud loss, it is still important for banks to keep fraudsters out of their system. Too much fraud in any given embedded finance program could result in the program being shut down, causing the sponsor bank to lose an entire revenue stream.
A lack of access to third-party data sources can harm embedded finance providers’ ability to respond to evolving threats, leading to large fraud losses. Whether it’s due to tech stack limitations or inefficiencies, not having visibility into how partners manage risk hinders sponsor banks’ ability to discern where and how changes should be made to their risk decisioning workflow. Differences in risk appetite and gaps in experience can also make it difficult for sponsor banks, BaaS providers, and end-brands to agree on procedures for identifying and mitigating fraud on an ongoing basis.
While layered partnerships are a source of strength when it comes to embedded finance innovations, they also reduce inter-operational visibility and muddy accountability.
Coordinating compliance controls and risk policy changes across partners can be labor-intensive due to manual processes. Not only can these practices add to operational overhead, but legacy systems often also hinder prompt action and adaptation to evolving regulations and partner needs.
When selecting embedded finance partners, companies should prioritize partners with a solid track record in compliance and regulatory adherence. Assessing their industry expertise and capacity to offer customized solutions tailored to specific needs is crucial. By thoroughly evaluating their reputation and overall reliability, companies can confidently identify partners best poised to contribute to a successful, collaborative embedded finance venture.
When approaching embedded finance partnerships, it is important for all parties to look for things such as maturity, risk appetite, and partnership history. Transparency and effective communication are foundational, so sponsor banks, fintechs, BaaS providers, and end-brands should opt for partners who prioritize collaboration and offer clear insights into their operational processes and policies. Banks, BaaS solutions providers, and end-brands should assess the programs that their desired partner has worked with before. It's essential that their technological infrastructure be both compatible and scalable.
Identity risk is even more complex in embedded finance than it is in traditional banking. Embedded finance is not as well-regulated as other channels, meaning that it is prone to unique vulnerabilities.
While mobile is a huge driver of embedded finance growth, it is also a huge channel for fraud attacks and risk exposure. Alloy’s 2024 State of Fraud Benchmark Report found that authorized push payment (APP) fraud was the number one type of fraud reported globally in 2023, with 22% of global users ranking it as their top fraud by case volume. Despite their prevalence, digital verification processes like knowledge-based authentication (KBA) are easy-to-crack, and tend to put online users at risk while also causing friction for good customers.
When attacks do happen, strategic measures are needed to avoid steep fines and maintain a positive brand image. Sponsor banks, BaaS providers, and end-brands need a more effective strategy for managing all risks (including compliance, fraud, and identity risk) to give both their own interests and customers the degree of protection they deserve.
When partnering to build an embedded finance product, sponsor banks, end-brands, and BaaS solution providers all want to create profit-driving service offerings. Even so, they may appear to have competing needs.
A sponsor bank might want more visibility and control to best manage risk but may not have the agility and flexibility in their tech stack to achieve this level of oversight. At the same time, end-brands might not be positioned to manage compliance in a way that is aligned with the sponsor bank’s risk appetite. The answer to this challenge is a holistic identity risk platform which can allow sponsor banks, BaaS providers, and end-brands to connect directly with each other’s systems for streamlined solutions and increased operational efficiency.
With the right technology in place, sponsor banks, BaaS providers, and end-brands can achieve the right balance of real-time oversight across all partnership programs — including customized permissions — in a single, centralized platform. By leveraging partner SDKs and embedded finance APIs, these parties can accommodate nuanced use cases while ensuring optimal risk management protocols.
For example, sponsor banks can establish parent-child accounts that give them visibility into or control over their fintech partner’s risk management flow. This structure also allows them to quickly adapt to any changing compliance protocols and universally apply new rules across all child accounts. This makes for better compliance, fraud prevention, and risk management across the customer lifecycle (plus stronger communication within the bank-fintech partnership).
Alloy is an omnichannel identity risk solution that keeps sponsor banks, BaaS providers, and end-brands compliant while solving for fraud at the same time. Embedded finance providers use Alloy to achieve full transparency and oversight across their partner portfolio. Alloy’s platform has the flexibility and technology to support any type of commercial agreement that embedded finance providers have in place.
Alloy works directly with banking and non-banking partners to build, launch, and enforce compliance policies and identity decisioning flows at scale. Our embedded finance solution and vast network of data partners help sponsor banks, BaaS providers, and end-brands manage their shared customer risk so they can get new financial products to market, efficiently and safely.
Alloy empowers the entire embedded finance ecosystem to stay compliant and fight fraud.
