Recently, we connected with the Alviere team. They discussed licensing in the embedded finance sector.
According to Alviere, licensing in embedded finance is one of the most important areas in the financial industry.
As explained by Alviere, the OCC is watching banking-as-a-service (BaaS) and embedded finance’s unfettered growth – as is evidenced by its scrutiny of Blue Ridge Bank a couple of months back – and is “calling out its underbelly.”
Namely, some embedded finance companies largely serve as “agent banks,” and thereby put all the other players in the ecosystem at risk.
- Traditional Banks: Banks assume the financial and regulatory risks associated with embedded finance companies serving as their agents, without the ability to ensure the fintech stays in compliance with existing regulations. And banks assume all of this risk without the opportunity to build end-user brand affinity. Sounds like a bad deal to me.
- Brands: Are putting the reliability of their offering and customers at financial, operational, liquidity, counterparty and credit risk; thereby significantly jeopardizing their customer relationships. In short, a dangerous proposition.
- End-Users/Consumers: Are dangerously unaware of what entity to which they are entrusting their assets, putting their hard-earned money at risk.
While licensing may seem like a drag, the OCC clearly doesn’t think so, the Alviere team noted.
It’s worth noting that Alviere has just become “the only embedded finance provider to eliminate this problem – it has become the first fully regulated and licensed embedded finance company across all mainland U.S states and Puerto Rico, following a multi-year effort to secure these money transmission licenses.”
This means Alviere is “not serving as an agent bank, which minimizes risks for all parties, as it is federally and state-licensed to assume responsibility for the transactions it enables”.
Our conversation with Luis Trujillo, Alviere’s Chief Compliance and Risk Officer, is shared below.
Crowdfund Insider: With the embedded finance sector projected to be a $7 trillion market by 2030, it’s apparent that many organizations see tangible benefits in offering financial services directly to customers. What’s the appeal?
Luis Trujillo: Offering financial services under their brand opens a new path to revenue and allows brands to further engage and retain customers. There are a few drivers to this for large brands:
Unlike startups and neobanks that need to find and acquire customers, large established brands have immediate access to an established, and often loyal, customer base.
Offering financial services provides marquee brands an opportunity to create a new line of revenue through interchange and interest fees that typically would flow to a traditional bank.
Financial services is one of the most intimate business relationships that both a business and individuals can have. Customers that acquire financial services from a brand are less likely to leave them for a competitor, resulting in higher customer lifetime value and revenue from the brand’s core services.
Crowdfund Insider: What impact do you foresee this having on traditional banks?
Luis Trujillo: Many pundits go out on a limb and say that traditional banking is going to disappear on the heels of a fintech takeover. This can’t be farther from reality, in my opinion. What will happen is that there will be a fundamental change in the business relationship structure: Customers (both consumers and small businesses) will have better and more attractive financial services options being offered by large brands they like and trust.
Traditional banks are very much in play, even if they are not the ones directly engaging the customers. Embedded finance providers enabling these services for large brands are still reliant on traditional banks and will continue to be for the foreseeable future. And some banks will evolve to provide an embedded finance offering themselves. The market opportunity affords enough room for many to participate, and traditional banks will be front and center, even if behind the scenes.
Crowdfund Insider: Can you outline the typical relationship between embedded finance organizations and banks?
Luis Trujillo: In the current landscape, embedded finance companies partner with banks for a variety of reasons:
- To secure the bank accounts that they need to store funds, access a treasury management ecosystem, and process settlements for the programs they enable.
- To access federal payment schemes like ACH and check clearing, which are only accessible by banks. In markets outside of the U.S., like Europe, there is a similar structure to be able to access systems like SEPA and Faster Payments. Banks provide the pathway to these systems that fintechs require.
- To issue cards for their credit programs. Card issuing activities in certain countries, like the U.S., require an issuing financial institution that is a principal member of a card scheme.
- To provide regulatory coverage for those embedded finance companies that are not licensed (NB: Alviere is licensed).
Embedded finance companies establish themselves as program managers and/or service providers of the bank that provides them access to these needed services. While this serves their purposes as a more immediate path to offering financial products, it brings a level of dependency and obfuscation to the fintech clients and, ultimately, users.
Crowdfund Insider: Are there any dangers or risks associated with these arrangements?
Luis Trujillo: Yes there is, and that risk is much greater for embedded finance companies that are not licensed and, therefore, fully dependent on a bank to enable their business. Recent developments in the market range from failing fintechs, some of which are even being prosecuted for fraudulent activities (FTX), to banks with poor controls and oversight over their fintech partners.
This is a bad combination for the non-regulated / non-licensed embedded finance companies because regulators are realizing the unmitigated third-party risks inherent with the business model when these companies are not regulated, and banks are facing regulatory pressure to decrease the risk in their operations and portfolios.
Crowdfund Insider: With that in mind, what should organizations consider when looking for an embedded finance / BaaS provider?
Luis Trujillo: Organizations need to have a thorough due diligence process before partnering with any embedded finance company. Find out who their partners are, who their existing clients are, and how they do business. If the embedded finance company is not licensed and reluctant to provide a viable reference, look elsewhere.
Choosing the wrong embedded finance / BaaS provider can have a material implication on the brand, ranging from having to shut down the financial program they’ve invested in and dealing with the resulting customer fallout, to managing reputational damage because the embedded finance provider that they’ve partnered with, or the underlying bank(s), are subject to public scrutiny, regulatory enforcement, fines, penalties, and/or shut downs.
Crowdfund Insider: What innovations can we expect to see in embedded finance in 2023? Any parting thoughts?
Luis Trujillo: To date, embedded finance has been very regional. This is more a reflection of the current state of fintech capabilities, versus demand. So, the biggest innovation we’ll see in embedded finance in 2023 is how global companies leverage a single embedded finance provider to align their strategies, connect their customers to their finances globally — across multiple regions. This is a big focus for Alviere in 2023 and we can’t wait to see what’s in store.