Understanding Embedded Finance and Its Revenue Potential
Embedded finance refers to the integration of financial services into non-financial platforms or products. For instance, when you use a mobile app to pay for a ride or order food, you're experiencing embedded finance. According to Alloy's 2024 State of Embedded Finance Report, this sector is proving to be a significant revenue driver, contributing over 50% of revenue for sponsor banks. However, despite the financial benefits, compliance issues create substantial challenges.
Compliance Challenges for Sponsor Banks
Sponsor banks are the financial institutions that provide services to fintech companies, allowing them to offer financial products, such as loans or payments, without a banking license. Alloy's report highlights that 80% of decision-makers at these banks find it challenging to meet compliance requirements, a concern exacerbated by increased regulatory scrutiny. Klaros Group data shows that 25.6% of the FDIC's formal enforcement actions since early 2024 targeted sponsor banks.
Financial and Reputational Risks
Failure to comply with regulations can lead to significant financial losses for sponsor banks, with 75% reporting losses over $100k due to compliance violations. More concerning is the reputational damage, which is deemed the most severe consequence by decision-makers. This reputational risk can undermine trust and result in losing current or potential clients.
Barriers to Compliance
The report identifies two main barriers: a lack of control over fintech partners' policy controls and a lack of auditability of these controls. This lack of oversight makes it difficult for sponsor banks to ensure their fintech partners adhere to necessary compliance standards. Alloy addresses these issues through its Alloy for Embedded Finance product, which provides banks with tools to manage and monitor compliance effectively.
Introduction of Audit Access Module
Alloy recently introduced a new module within its product suite called Audit Access. This tool allows sponsor banks to audit their fintech partners' compliance policies more effectively. As a result, banks can maintain stricter control over the compliance landscape, reducing potential regulatory risks.
Adoption of Compliance Technology
The ongoing regulatory scrutiny has prompted sponsor banks to invest more in compliance technology. Alloy's report suggests that many sponsor banks are turning to solutions like Alloy for Embedded Finance to strengthen their compliance frameworks. Grasshopper Bank, for instance, successfully implemented this tool to streamline compliance processes, as shared by their Director of Data, Teddy Gordon.
Survey Methodology
The State of Embedded Finance report was conducted by The Harris Poll on behalf of Alloy, surveying over 50 decision-makers from U.S.-based sponsor banks, each managing assets worth at least $2 billion. The data collection occurred between May 30 and June 5, 2024.
Conclusion
While embedded finance offers substantial revenue opportunities for sponsor banks, navigating the complex compliance landscape remains a formidable challenge. Tools like Alloy for Embedded Finance are essential for these banks to manage compliance risks effectively. As the sector continues to evolve, both sponsor banks and fintech partners must prioritize robust compliance strategies to sustain growth and protect their reputational integrity.
