We recently caught up with Sarah Howell, SVP of Partner Programs at Infinant, a financial technology company that provides pioneering infrastructure to help banks build embeddable financial products above their legacy banking technology.
Sarah Howell shared her insights on the origins of the ecosystem strategy, a partnership model where banking institutions work with third parties to provide innovative services and products, and how the finance industry can benefit from this shift in mindset and operations. Howell also discusses the potential pitfalls of this approach and advises banks to look for embedded reciprocity when implementing an ecosystem strategy.
Our conversation with Sarah Howell is shared below.
Crowdfund Insider: What has caused the banking industry to shift from a market strategy to an ecosystem?
Sarah Howell: Well, in my opinion, I don’t think the banking industry has entirely shifted from a market strategy to an ecosystem strategy. In fact, given the macro trends occurring in the digital economy—economic activity created from online hyperconnectivity—I think banks should develop strategies for both. This is one of the reasons I’m so intrigued by this topic.
The digital economy has enabled embedded finance, which is the ability to embed financial products into digital experiences at the point of need. This is causing a significant shift in the banking industry. And embedded finance requires an ecosystem strategy because you’re co-creating an experience for end users that includes financial products within a non-financial digital platform.
However, some banks have pivoted into the embedded finance space and are still applying a traditional market strategy—instead of an ecosystem strategy. They do this by referring to card processors, program managers, and banking as a service (BaaS) middleware providers as ‘distribution’ partners for the banks and subdelegating compliance to these entities.
The sub $10B banks (keen endorsers of BaaS due to their increased interchange revenue courtesy of the Durbin Amendment) had to adopt this model because they didn’t have the technology that enabled them to create embeddable products safely and securely. The larger banks, who already had a payments hub, would repurpose this for commercial card-embedded products to control the technology stack through which their embedded products were offered. This control gave them greater leverage over the financial products offered through the ecosystem.
Crowdfund Insider: What were the catalysts that brought on the onset of the ecosystem shift?
Sarah Howell: Digital disruption is most definitely the primary catalyst. If you track the progression of digital disruption in other industries, like the less regulated entertainment industry, against the banking sector, you’ll see it occurred in three phases:
Disruption of Products, Processes, and Creation of New Form Factors
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- Entertainment: Advances in movie production and form factors, from film reels to VHS and DVDs.
- Banking: Back office automation, digital credit underwriting, virtual cards.
Disruption of Delivery Channels
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- Entertainment: Consuming entertainment at the movie theaters expanded to new delivery models via Blockbuster video stores and Netflix postal service delivery.
- This was enabled by the new form factor of VHS/DVDs created in the first phase.
Banking: Online banking and mobile banking.
Disruption of the Supply Chain
This phase was where the last-mile delivery of the product was completely altered. The introduction of cloud computing accelerated digital transformation in every industry and created new business models, ushering in the age of the platform economy.
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- Entertainment: There was a general move to streaming services and the creation of Netflix streaming, which aggregated content. Then Roku gained adoption by aggregating streaming services.
- Banking: The rise of neobanks and embedded finance began embedding financial products into non-financial digital platforms.
Crowdfund Insider: How will the banking industry benefit from this new shift in perspective?
Sarah Howell: Applying an ecosystem strategy to a bank’s BaaS strategy enables banks to increase their contribution to the ecosystem and mitigate risk, which will protect the financial system. Banks have always had influence within BaaS because they are essentially deputy regulators within embedded finance models. However, they have lacked contribution, which in a digital ecosystem is always synonymous with a technology contribution.
However, now, because of technologies like Infinant’s embeddable product development capabilities, banks can begin to increase their technical contributions within the ecosystem. The higher the influence and the contribution a partner has, the greater their ability to mitigate risk across the ecosystem.
Crowdfund Insider: Do you see any challenges to this ecosystem approach in the near or long-term future?
Sarah Howell: If banks continue utilizing the existing approach to embedded finance, I definitely do. Sub-delegating compliance to an entity with a business incentive to grow at all costs is a fundamental business model conflict for banks whose charters were granted to protect the US financial system.
However, I see a first-mover advantage for the many banks that recognize the current BaaS model is unsustainable long-term and move to own their own embedded finance technology. As with any pivot, technology is a key aspect of the transformation, but it doesn’t solve every operational issue and cultural challenge that this new business model brings.
To overcome the issues of the new ecosystem, I’ve seen some banks create a separate unit for their embedded finance or BaaS market offerings, while keeping their regular business that has their direct customers who know their brand name. So, I think one of the main challenges is that once you overcome the tech hurdle, the next challenge becomes overcoming the typical operational and cultural issues that any business would have when making a major pivot.
Crowdfund Insider: Will any particular sectors within the banking industry struggle to implement this transition?
Sarah Howell: Community banks are one sector that has been agile in achieving early adopter status in BaaS and embedded finance models. However, their lack of technical resources has required them to innovate their business model to minimize gaps in their technical capabilities.
While community banks can move quickly and adapt to an ecosystem strategy, their infrastructure providers have limited their technical agility by bundling their core technology. So, from a tech perspective, it could be hard to pivot if the intent is to repurpose existing infrastructure providers for an ecosystem strategy.
Another struggle is that balance sheet management strategies always play a factor in embedded finance models. Concern over whether the balance sheet can support accelerated loan growth without a reliable source of low-cost non-brokered deposits is always a consideration. As is the converse effect—high-cost deposits with limited loan growth.
But that’s where an ecosystem strategy comes in. Community banks that are collaborating to support balance sheet strategies across a network of banks have a much greater chance of adapting and implementing this transition.
Crowdfund Insider: The EY CEO Imperative Study on Ecosystems found that the top reason for ecosystem skepticism was ‘concerns over cybersecurity and privacy’: How do you think this issue can be tackled?
Sarah Howell: This skepticism is not unwarranted. However, banks in partnership with their technology providers, have always had to manage cybersecurity and privacy concerns.
Financial services are such a highly regulated industry, and it’s actually this fact that allowed banking to stave off digital supply chain disruption and embedded finance for as long as it did. The barriers to entry were just too high, but with advanced technology and a lot of VC money being pumped into the sector, fintech began to unbundle banking.
Then, we saw a shift where some fintech re-bundled banking while using a bank’s charter to act like a bank—without really being a bank. This means the financial industry has already had its share of cybersecurity and privacy challenges in ecosystem models.
I don’t think we’re by any means out of the woods. Nevertheless, I believe using bank-owned technology that provides digital platforms with a bank-controlled prefab or widget to manage privacy and disclosures for each embedded financial product is a step in the right direction. Affording banks greater control of the end-to-end embedded financial product exponentially increases our chances of mitigating risk in ecosystem models.
Crowdfund Insider: What advice would you give companies looking to create new ecosystem relationships?
Sarah Howell: Always look for opportunities to engage in something I call embedded reciprocity. This is the ability to embed a company’s capabilities into your platform, as well as opportunities to embed your capabilities into their platform.
A good example of this in commercial banking is an account payable (AP) provider embedding their solution into a bank’s digital banking app, while the bank embeds payment capabilities into the AP provider’s platform for reselling to the AP’s direct customers. It’s a win/win.
Crowdfund Insider: Do you think accepting this new ecosystem is the only way for banks to survive in the current climate?
Sarah Howell: Well, to use my previous entertainment example, let’s just say that I don’t think there’s much demand to resurrect Blockbuster. Once digital supply chain disruption has impacted an industry and a platform economy has been introduced, rolling back this macro trend would be tough, if not impossible.
Due to digital disruption and global commerce embracing a platform economy, I think that banks, in the long term, will have to have two strategies.
One is the traditional market strategy, where their end customers know their brand. They might engage through digital channels, but it’s a bank-owned channel. Whatever that distribution model looks like, end to end, the bank owns both the product production and the distribution of those financial products.
And the second strategy is the ecosystem model. This will allow banks to engage in the platform economy, utilizing embedded finance products that they own and manufacture but simply embed into a larger platform.
This way, banks can still benefit from their tried and tested revenue streams while keeping up to date with and benefiting from digital age trends and innovations. Industries do bundle and unbundle, just like some fintech business models did in banking, but the embedded finance ecosystem spans multiple industries, and banks would be wise to recognize the trend.