For this month's update, we decided to do something a bit different and focus on innovations that are happening behind the scenes in payment services. While these developments may not be as widely known to those outside the industry, it is having a fundamental impact on how goods and services are being paid for.

Read on for more information and check out the link at the bottom of the page to hear our recent podcast on software under-licensing.

New horizons for e-commerce, financial services and customer payments

Innovation in payment methods, more conveniently accessible financial services, budgetary constraints and the accelerated shift towards e-commerce since the covid pandemic have all contributed to changes in the ways that retailers and businesses shape their customer payment and finance journeys to retain and grow their customer base. In this blog we look at some of the business opportunities enabled by Embedded Finance Solutions and how the related Banking-as-a-Service (BaaS) model works from a legal perspective.

1. What are Embedded Finance Solutions?

Embedded Finance Solutions are financial services solutions such as current and deposit accounts, digital wallets, Buy Now Pay Later (BNPL) loans, foreign currency exchange services and insurance products that are provided by an authorised bank or financial institution to end customers accessible via the digital, mobile and face-to-face channels of a retailer or business whose trade is the supply of goods and/or non-financial services.

Put another way, Embedded Finance Solutions enable retailers or businesses to provide finance solutions direct to their end customers.

In some instances, the end customer will be required to navigate away from the retailer or business' platform to the authorised bank or financial institution's website (such as an insurer or a bank); however the benefit of Embedded Finance Solutions is that they can be made available directly on the retailer or business’ own platform as part of the checkout process (for example, BNPL payment methods offered by firms such as Klarna and PayPal are often displayed on retailers' e-commerce platforms) – notwithstanding the fact they are provided by the financial institution.

2. What is BaaS?

Banking-as-a-Service (shortened to BaaS and having similarities with the acronym for Software-as-a-Service (SaaS)) is a business model that enables financial institutions to empower retailers and other businesses to integrate digital banking and financial services directly into the end customer’s payment and finance journeys.

The BaaS model usually has four participants:

  • 1) Consumers / Customers as the end user of the financial services provided by the financial institution.
  • 2) Distributors namely the retailers or businesses who offer the financial services to their customers by making them available via their existing channels whether mobile, digital, or in-store.
  • 3) Tech / Platform Enablers namely the fintech firms which provide the technology (cloud platforms and software) and related support and maintenance services needed to embed the financial services into the retailer or business' platform through the use of application programming interfaces (APIs) which enable links to be made to the financial institution's banking and payment platforms and services. APIs are important because they simplify and enable the flow of data between the consumer and the financial institution via the distributor.
  • 4) Financial Institutions the banks or financial services companies which have the requisite authorisations, banking licence, core banking technology, compliance capabilities and the systems necessary for the provision of banking and payments services. A financial institution may also fulfil the role of an enabler, this could be a technology company which provides an embedded finance platform and has its own banking and e-money licenses (such as Solarisbank). 

The flow chart below illustrates the contractual relationships between the participants in BaaS:

3. Opportunities Created by Embedded Finance Solutions and BaaS

BaaS and Embedded Finance Solutions enable retailers and businesses to provide their end customers with convenient, low-friction and direct access to financial services to enable them to purchase the goods and/or services of their choice, on demand and taking account of their individual financial circumstances, personal preferences, and expectations - crucially they maintain a link between the end customer and the retailer or business in the whole payment and financial services journey.

The opportunities for consumers and businesses created by Embedded Finance Solutions and BaaS span across the banking, point-of-sale finance and payments sectors and include:  

a) Card payments: increasingly there are partnerships between BNPL providers and card issuers which allow consumers to make purchases using a virtual card stored in a digital wallet on their mobile device (such as Apple Pay or Google Pay) at any retailer or business which accepts the relevant card payments. An example of this innovative payment method is the 'One-time' card from Klarna which operates as a single use pre-paid card that is linked to the consumer's personal debit card or credit card. Once the purchase has been made using the credit provided by Klarna, payments are automatically withdrawn from the consumer's bank or credit card account according to the payment plan that has been agreed with Klarna.

b) Open banking: in February 2023, Open Banking Limited reported that combined CMA9 data shows 7 million consumers and SMEs used Open Banking services during January 2023 which shows a growing tendency towards 'pay by bank' solutions. This upward trend makes embedded open banking solutions increasingly relevant for consumers and financial institutions as consumers have more choice over how to pay for goods and services. It is important for retailers or businesses to be aware of new embedded finance opportunities so they can accept popular payment methods and potentially reduce spending on card payment transaction fees.

c) Cryptocurrency: virtual currency such as Bitcoin and Ethereum can also be made more easily available to consumers via Embedded Finance Solutions. For example, the PayPal mobile app facilitates the custody of and trading in certain cryptocurrencies through its arrangements with relevant third-party service providers.

d) New customers: the BaaS model arguably provides financial institutions with a quick and cost-effective route to a large pool of new customers who could be more willing to take financial services relevant to their purchase of goods or services when offered under a retailer or business' trusted brand. Behind the scenes, the use of cloud architecture and the fact that the financial institution remains responsible for its regulatory and internal policy compliance as well as the provision of the financial services, means that Embedded Finance Solutions can be selected and deployed swiftly. Cost savings and speed to market could be pivotal in the context of traditional banks competing with the also rapidly evolving fintechs and neobanks. 

4. A Look to the Future

It has been reported that BNPL firms are seeking to transform their apps into e-commerce destinations where consumers can start their shopping journey with certain brands. This appears to be a reversal of the 'traditional' embedded finance arrangement described above. The success of this approach remains to be seen and is expected to hinge to some extent on the effectiveness of targeted advertising.

Growth in the adoption of the BaaS model will depend on the strengths of the strategic partnerships between the financial institutions and their enablers, and in turn the distributors. This may be linked to the cost savings and rewards for end customers for using Embedded Finance Solutions as well as their overall security, convenience, and speed.  

It will be interesting to see whether retailers and other businesses become increasingly eager to offer Embedded Finance Solutions to create a more streamlined and comprehensive service to keep their customer base engaged as API technology and payment methods continue to evolve.

New Podcast Series

AG is hosting a new podcast series for Technol-AG.  The short episodes explore common commercial and legal issues experienced by businesses relating to tech. They are based on AG's extensive experience of advising businesses on tech contracts and disputes. The most recent episode hosted by Nadia Stephenson (Associate, Commercial) and Anouj Patel (Associate, Commercial Disputes) is on software licensing, has a runtime of just over 7 minutes, and can be found here

If you'd like to talk through any of the topics raised on the podcast, please let us know.