The embedded finance playbook: Partner banks need quality not quantity 

70% of consumers believe that more than half of financial services will be offered via non financial services platforms in the near future. And while rising consumer comfort with embedded finance is a good signal for the industry, its maturity has also come with certain complications: 25.6% of FDIC’s enforcement actions have been aimed at sponsor banks since the start of 2024.

A lot of this regulatory heat has been focused on smaller banks and FIs. For example, the FDIC’s order  against Piermont Bank stated that the regulatory body determined the bank to be engaged in “unsafe and unsound” banking practices concerning its controls and processes regarding third-party relationships. Similarly, Sutton Bank has also been ordered to create a plan for the assessment of its current and future partners.

So, banks have to find a way to build embedded finance programs that benefit their bottom lines but are also resilient in the face of rising regulatory scrutiny. One case study of note is by Grasshopper Bank, which surpassed $1 billion in program deposits and supported over $10.7 billion in transaction volume with over 20 fintech programs in 2023.

Grasshopper Bank launched its embedded finance platform in Q1 2022 using Treasury Prime as its technology provider. At the time the bank focused primarily on providing depository account enablement with payment processing. But it has since evolved its offerings to include FDIC insurance in response to the banking crisis in March 2023, said Lauren McCollom, Head of Embedded Finance at Grasshopper Bank.

For Grasshopper, deposit growth is a primary driver for its embedded finance program, and McCollom sees two types of fintech profiles emerge in the bank’s program:

1. Fintechs that want to avoid any single point of failures in their partner bank relationships and add redundancies by diversifying bank partnerships.
2. Fintechs that want to build their embedded offerings on long term and stable relationships with their bank partner.

How Grasshopper runs its embedded finance program

From the outset of the program Grasshopper’s approach was to be measured and deliberate. “While startups like to move fast and break things, we utilized our “crawl, walk, run” approach to launch our platform by developing our strategy, building our regtech stack, and selecting the right launch partner,” said McCollom.

This means that the bank takes stock before onboarding new fintechs and its partnership with Treasury Prime has played a role in its ability to “control the speed of growth,” said McCollom.

Grasshopper’s approach to running its embedded finance program has two main pillars:

Selecting the right technology providers: “When selecting [technology providers] – whether it is to help power our tech stack or as an end client program – we go through a selection process to align on cultural, strategic, operational, regulatory, and economic components. Treasury Prime checked all those boxes for us. From the beginning, we wanted to operate in a direct model with our end clients, and the relationship with Treasury Prime enabled us to do that,” she added.

Onboarding the right partners: For Grasshopper Bank, even as the industry grapples with the tightening of regulations, selecting the right fintechs to partner with has been the primary concern. “I believe partner selection is the biggest challenge facing Grasshopper. There are only so many partners we can work with, so it’s imperative that we stick to our strategy and ensure we continue to maintain our ‘quality over quantity’ mindset,” McCollom said. Grasshopper works primarily with“US fintechs serving US customers and those that serve businesses like the bank itself. “[Our] Ideal profile is a well-funded fintech or non-bank entity, US-based and US-focused, seeking to grow deposits of its end users while being able to operationalize a robust risk and compliance program,” she said.

When it comes to onboarding new partners, Grasshopper works to create cohesion within the internal teams at the bank by seeking approval from the firm’s senior leadership as well as cross functional teams for every fintech it intends to partner with, McCollom adds.

How to run your embedded finance program

Grasshopper is seeing embedded finance programs become more and more common and important for non-financial brands.

“We’re starting to see much more demand from vertical SaaS companies, marketplaces, insuretech, payroll services, eCommerce platforms, etc. From experience, we’re making the pivot from having to explain to an executive why they should consider offering banking products to now white-boarding with them how to implement because they understand the flexibility and possibilities that are opened up when you own the banking/payments stack,” said Vince Peterson, VP of Embedded Finance, at Grasshopper Bank.

The increased interest by prospective brands means that although partner banks have a lot of options for partnership, the expanding sprawl of relationships requires careful management.

Here is what partner banks should keep in mind:

Manage the spread: Rapid expansion of a BaaS platform and can result in deficient risk oversight or an inability to manage the partnership well, says McCollom. She adds that “effectively managing each partner’s program, such as their fund flows, end-user specifics, and risk profiles is already a complex task” so the addition of multiple partners can overwhelm a team and lead to “corner-cutting”.

Keep your core capabilities at the center: “When it comes to focus, banks really need to be asking themselves, “what are we already good at?” before they decide to partner with fintechs,” she said. Here, Peterson suggests following Grasshopper’s example and prioritizing partnering with fintechs whose target consumer profile is the same as the bank’s.

Proactivity over reactivity: Partner banks thinking of building out their embedded finance program need to anticipate what their program will need ahead of its growth and act accordingly. This is critical to avoiding any issues like inadequate or oversight or inability to dedicate resources to a partnership and helps banks steer clear from having to pay heavy fees due to an inability to meet regulatory standards.

“Banks really need to ensure technology and staffing is right-sized for fintech growth before that growth happens. It’s much easier to build a house on a foundation than it is to pour concrete when you’re already working on the second level,” said Peterson.

Sidebar: How fintechs should manage their embedded finance relationships

Sidebar is a member-exclusive section where we discuss stories tangential to the main story above. This sidebar dives into what questions fintechs need to ask when entering an embedded finance partnership. If you would like to read further please consider becoming a TS PRO subscriber by clicking below.