The dizzying speed of change in financial services, especially in banking, has increased the need for third parties to help financial institutions with data analytics, modernization of core technology, and extension of customer reach beyond traditional banking channels. This change primarily results from opportunities in embedded finance (placement of a financial product or service in a nonfinancial customer experience, journey, or platform) and banking as a service (offering banking services to unlicensed financial players). Another factor is speed, as banks seek to sharpen their make-versus-buy choices to save time and money.
Increasingly, banks are seeing the relevance of focusing on their core capabilities while collaborating more with third parties in areas where banks have no unique selling proposition. The many benefits include boosting first-time conversion rates for loan applicants while lowering customer acquisition costs and loan loss ratios. According to our research, the cost of customer acquisition for a bank with a qualified lead can drop from around €4,000 to about €200, and conversion rates can increase from an average 15 percent to 50 percent or more. Already, embedded finance and banking as a service are becoming major distribution channels for financial products.
To gain a deeper understanding of the opportunities, challenges, and innovations within the embedded-finance landscape, McKinsey's Financial Services Practice spoke recently with leaders on the front lines of this change: Diego Caicedo, the cofounder and CEO of KLYM, a data-driven lender; Sabrina Dar, chief of staff to the CEO at Mambu, which provides modern core banking technology; Steve Naudé, managing director of foreign-exchange fintech Wise Platform; Ray O’Brien, COO of Quantexa, which provides data analytics; and Benedikt Voller, the chief revenue officer of Raisin, a deposit brokerage platform. All five panelists were at the 20th Global Digital Banking Conference held earlier this year in Barcelona, where leaders in digital banking gathered to discuss the business’s next imperatives and ways to capture value for the long term.
In our conversation with these leaders, they described how banks can juggle three key objectives: offering the services and personalization their customers want and need, modernizing their core technology, and competing with digital disruptors. What follows is an edited transcript of the discussion.
McKinsey: What effect do you think the as-a-service economy and embedded finance generally will have on the financial services industry over the next three to five years?
Sabrina Dar, Mambu: 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.
The pace at which you have to address that as a financial institution is just going to increase. That’s why we are seeing more nonfinancial institutions entering the space. It’s really about having the core functionality and then, as we see innovation in the market, having the ability to plug and play best-of-breed services into your core architecture. Speed is going to be what really impacts us the most.
Ray O’Brien, Quantexa: Financial institutions are evolving quite rapidly, and most banks realize they need to stick to key elements such as service to their customer. But when it comes to specific things like payments or KYC [know your customer], you can actually buy those services and get the best of breed now. There is a fundamental change happening in banks. Historically, they used to build everything themselves. Today, though, trying to do everything is probably silly. Banks are thinking more today, “We should focus on the things we really care about, and we can get other companies to help us do the rest, weaving it together into one platform.”
Benedikt Voller, Raisin: A big trend we’re seeing right now is as-a-service going more into core services, compared to the first iteration of as-a-service being more about different product categories. It’s going deeper into the processes. You have what we might call substitutes for the core banking systems, the brokerage systems, and similar areas. It’s going from the lighter touches of handling one product category and going one level deeper. And banks are more open to potentially substituting those systems with offerings from others. I think we’re going to see complete substitution of certain business areas. For example, for Raisin, we offer the deposit brokerage, but we could also take over the deposit function of a bank for that bank.
Diego Caicedo, KLYM: We’ve had a phase recently where every company has wanted to become a financial company, and now we’re seeing them find out that creating a financial company is hard. And at the same time, we’re seeing banks and financial institutions saying, “OK, I want to have access to these new channels.”
Now what we’re seeing is a two-sided street. Core service players [distribution platforms such as e-commerce or travel and hospitality companies]—let’s call them channels—understand that they are great channels for products and that they have to partner with financial institutions. And credit players are saying, “Look, I need access to those flows of assets and clients. I need them to reduce my CAC [customer acquisition cost].” What we’re seeing now is a bridge-making period. We have more banks playing in more channels, and more products are being fed into the current stream of the banks.
Steve Naudé, Wise: We’ll see more banks focusing on what their core is, which is generally serving a domestic customer base, whether that’s retail, small business, or corporate, and really focusing on their core competencies for serving those customers in that country. Generally, that’s not cross-border payments or cross-border money management—receiving and sending internationally. That is a need, but it’s just one of many. For example, one bank CEO I was talking to said they offer 250 products, and cross-border payments is just one or two of them. It is very hard to build that and 248 other things at the same time. So I think we’re going to see banks really try to focus on the five competencies out of the 250 that are core to them and make such a difference to their customers, and they’ll look for best-in-class providers for the other products, rather than trying to build them all.
McKinsey: How can emerging technologies in AI improve embedded finance and as-a-service offerings? And how are you thinking about using AI at your company?
Benedikt Voller: We started to really use AI intensely as part of the development team process, using it to program and review code faster. It helps make developers’ tasks more efficient, faster, more accurate, and higher quality. That is only the first step, though. For Raisin Bank’s as-a-service proposition as a regulated entity, we see that the tech is not yet there to be able to bring lots of AI to operations where you have to know exactly what’s happening. You have to tell the regulator what you are doing, so the lack of transparency is holding us back. I think guidance will be needed to establish what you can and can’t do and how you’re going to explain it.
Ray O’Brien: The emerging technologies let us make better, quicker decisions. For example, KYC takes a lot of people to do, and they send out lots of repetitive questions to customers, who are not happy about it. Can we in some way automate it and make it better? We came up with a thing called perpetual KYC, where, instead of reviewing a given customer every three to five years automatically, you actually use analytics to create risk-based triggers of individuals and companies that you should review. You still have a KYC process, but it’s much more effective and efficient.
Sabrina Dar: We’re looking at the new technologies from three angles. One is the pure engineering sense: What is it that AI could be doing to develop higher-quality, faster code? How can it be helping us on engineering excellence and productivity? The second angle is how the technology can help partners interact with Mambu. We’re constantly looking at providing best-in-class interfaces and APIs and experiences for developers. And AI can probably help make that quicker, better, easier. And the third angle we’re looking at for new technology is our overall operations, such as how we provide documentation on how to use our technology interfaces into our support model. These are all areas where taking friction out, making the experience seamless, is going to be valuable to our end users and customers.
Diego Caicedo: We’ve really been trying to figure out how this looks for smaller data sets and how we think about underwriting. These are things that black boxes and large language models have difficulty doing. Eventually, the technology is going to provide a lot of incremental value from the perspective of virtual agents, service, and sales. But the value that is being driven today is for the internal teams. For example, cohort analysis can be done much faster now, saving a huge amount of time for the team.
From a client-facing perspective, the next advances with large language models are going to allow us to talk better in our service channels, write better emails, and solve more complex problems. But it’s still going to take a long time for it to have a big impact. And we’re still going to be using the machine-learning models that we use today, and we’re going to continue to improve and build upon them.
Steve Naudé: Maybe five years ago, one of the major blockers was banks’ core systems and their ability to integrate with external providers. It’s much, much easier for these institutions today to plug third parties into their systems and to integrate with external providers. That underlying complexity of the systems you’re integrating into becoming simplified is a game changer. The ability for banks and others to do these kinds of partnerships is maybe not a sexy, exciting, emerging technology, but that foundational change is having far more impact than we see day to day.
McKinsey: What are the critical success factors for providers and partners to develop a successfully embedded finance and as-a-service proposition?
Ray O’Brien: You have to have a clear benefit case. And you have to stick to it. You need to find a business partner who really has a need; you need an end result that’s going to benefit that business partner. Creating something for the sake of it—for the technology, for the sexiness of it—normally fails. You have to create something that really has a benefit such as an uplift in efficiency, effectiveness, or profitability, for example.
Benedikt Voller: I think it’s about having the technological base and cultural processes inside the company to be able to do those partnerships. You have to be able to share data, for example, and that’s a cultural thing, basically, and also a technology thing. Customer data is going to be moved around a little bit between different companies. But it’s also about building the base in terms of being able to integrate, have APIs in place, scale operations with automated processes and with an infrastructure that also scales. It takes groundwork to engage in good partnerships.
Diego Caicedo: It’s always, “Is there a real business case?” You have to understand what it takes to succeed, because if it’s not profitable, it doesn’t move the needle for the partners. Also, it takes focus. It’s hard to gather attention when you have 300 priorities inside of a bank and limited resources. And if I’m a channel player or a marketplace for something like this, the question is, “What is the right type of partner I need to bring in?” It might not be the big brand bank, because they don’t have the credit appetite for what I’m doing. It might be the middle-market player, the regional player that does have a credit appetite.
So it’s really understanding what is it that I really need. What is the business case built around it? What do we actually need to get out of this? Do we need clients to get money? Do we need money to get to clients? It sounds like the same problem, but it’s not.
Steve Naudé: We’ve definitely had partnerships that have been wildly successful and some that haven’t worked out as well as we might have expected. And it’s interesting when you start to look at the reasons. Honestly, the main reason is clarity on what problem they’re solving and why they want to do this. It’s amazing how many companies come to us and want to do a project and launch something, but when you start digging into why they’re doing this and what they’re trying to solve, you find it’s often not that clear yet. The most successful cases are where there’s a very clear problem to solve, a very clear reason for doing this, and a clear mandate within the organization to make it happen.
One of the oth1er major success factors is trust. You have to have that mutual trust and belief that if we say we’re going to deliver something, it will be delivered. And that trust takes time to build—sometimes months or much longer. And it takes just seconds to destroy that trust.
Sabrina Dar: You always want to have front of mind the question of what the joint value proposition is that you are addressing with the other company. So we spend a lot of time, effort, and energy on the strategic technology partners that we’re going to market with. And we have a long-term commitment to be in this together. It’s not a one-and-done thing, because the market is changing so quickly, the trends will be disruptive, and the partnership has to work in that context. They have to have that joint value and commitment. We are investing in it from both sides. That can be different in terms of resources or time or technology, but there has to be that investment.
Diego Caicedo is cofounder and CEO of KLYM, Sabrina Dar is chief of staff to the CEO at Mambu, Steve Naudé is managing director for Wise Platform, Ray O’Brien is COO of Quantexa, and Benedikt Voller is chief revenue officer of Raisin. Leorizio D’Aversa is a senior partner in McKinsey’s Milan office; Sarina Deuble is an associate partner in the Frankfurt office where Harald Kube is a senior partner; Brian Ledbetter is a senior partner in the London office; and Diana Pritscher is a partner in the Munich office.
Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or positions of McKinsey & Company or have its endorsement.
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