Embedded Banking: The Imperative Transformation for Digital Success

Jim Marous (00:13):

The digital revolution is transforming banking as we know it. Consumers today want personalized, seamless financial services integrated into the platforms and apps they use daily. How can traditional banks adapt to this demand for embedded finance? On this episode, we explore the critical steps banks must take to embrace embedded banking and thrive in a platform economy. Our guest on the Banking Transformed podcast today is Shanker Ramamurthy, global managing partner for banking and financial markets for IBM Consulting. We discuss the key findings from IBM's latest research on this banking transformation imperative. While banks recognize the need for embedded banking, gaps remain in modernization, APIs, and aligning with customer demands. Banks must prioritize modern architecture, exponential technologies like AI, and collaboration across ecosystems to securely deliver the personalized experience customers expect and should receive. There's no better time to evaluate where we are today and where we'll likely be as an industry tomorrow than as the banking industry gets prepared to travel to Toronto for Sibos 2023. Shanker, before we get started, can you share a bit about yourself and your role at IBM Consulting, as well as how IBM works with financial institutions to be positioned for an increasingly embedded financial ecosystem?

Shanker Ramamurthy (01:45):

Hey, Jim. To begin with, thank you very much for the opportunity to spend some time with you. It's always a pleasure. I'm Shanker Ramamurthy, I'm the global managing partner for banking and financial markets in IBM Consulting. Financial services is the largest of the sectors for IBM. IBM Consulting supports and helps the largest enterprises around the world, and in banking and financial markets, we support almost all the top 100 financial institutions around the world, and it represents close to five billion dollars of consulting revenues for us annually.

Jim Marous (02:27):

The Banking Industry Architecture Network and IBM's Institute for Business Value just published a new study based on interviews with C-suite executives and over 1000 consumers globally. Shanker, what was the headline takeaway from the study?

Shanker Ramamurthy (02:44):

Hey, Jim, thanks for that question. Actually, we interviewed over 12,000 customers in 10-plus countries around the world. We also did do interviews with 1000 banking executives. We surveyed them, again, around the globe, and we did detailed one-hour interviews with about 25 executives. Really compelling study that we'll be releasing just in time for Sibos, together with BIAN, the Banking Industry Architecture Network, which is a dot-org open standards based organization, to ensure that banks and the industry ecosystem can collaborate to drive efficiency, effectiveness, and value for the entire industry.

(03:32)
A few key findings from the study, embedded finance is essential for modern banking strategies. Something like 70% of the bank executives said embedded finance is either core or complementary to their business strategy. Now, ecosystem-based business models are rising as well, and financial institutions are increasingly investing in the platform economy, with over 20% of the organizations already offering embedded finance-based solutions to their customers. Yet, we did notice in the study a kind of a disconnect between the priorities as the banking executives see them versus what the consumers are expecting in their demands. We can get into that as we get into this dialogue. Importantly, monolithic architectures and complex processes are hindering banks' ambitions in the space of embedded finance. When I look at it from a CXO standpoint, privacy and security challenges came to the top as areas that are slowing innovation across ecosystems in the context of embedded finance, notwithstanding the extraordinary opportunities being opened up by generative AI and exponential technologies.

Jim Marous (05:09):

When you look at embedded finance, why has it become an essential component for the future of financial services? Why all of a sudden is the financial institution needing to take a primacy role in the embedded finance solution?

Shanker Ramamurthy (05:28):

There are at least two major trends that are impelling financial institutions to double down on embedded finance. On the one hand, technology and options that competitors have, both traditional and non-traditional, are compressing the market opportunity for financial institutions, particularly when the tech-fins are getting into financial services. Financial enterprises have been really good at blunting the onslaught of the fin-techs. They've either co-opted the fin-techs or figured out how to compete with them effectively, but as the tech-fins, which are the large technology-based enterprises around the world, whether it's Alibaba or Tencent or Amazon or Google or Apple, and others, embed financial capability, financial services, products, and offerings into what they take to market, they're now cutting into some of the most profitable parts of the financial services value chain and ecosystem. That's on the one hand.

(06:42)
On the other hand, regulators through open banking standards are mandating that financial institutions open up their capability for both banks and others to access their information. On the one hand, regulators are trying to level the playing field, and thereby providing competitors options and opportunities. On the other hand, the tech-fins are backing into financial services, and so financial institutions have to take advantage of the information that they have around customers, including the kind of mind-share they have when it comes to security and reliability, to now take what they have and actually embed it into broader ecosystems so that the value chain extends beyond traditional financial services products into other ecosystems. That's the journey financial institutions are on today, and we've got some really compelling stories from around the world in terms of financial institutions doing that successfully.

Jim Marous (07:56):

Before we get into those stories, because I do want to touch base with that, in the study, with interviewing so many consumers, what surprises did the study find about what the consumers expect from their financial institutions in the context of embedded finance?

Shanker Ramamurthy (08:14):

Great question. I know there's probably an ancillary query you're going to have in terms of, what do you find surprising, and then, where are the gaps between customer expectations and where the investment's happening from a financial institution standpoint? I mean, the surprising thing for us was that consistently around the world, financial institutions, on the one hand, were looking at security and protection as important things, and equally, when I look at it from a customer standpoint, they trust banks from a security and protection standpoint, right? That is obvious, and probably not ... It's kind of intuitive. On the other hand, I expected going into the study that financial customers, meaning the consumers, would expect anonymity to be a very high requirement in terms of the information they provide to financial institutions and how that's handled. On the other hand, it turns out from the study that for consumers in particular, anonymity is not as high of a priority as I thought it would be going into the study. That's probably because they've been trained by a whole bunch of technology providers, whether it's the Googles or the Metas and the such, to share a certain amount of information and get value in return. That seems to bleed into the financial services landscape as well, which was truthfully a surprise for me.

Jim Marous (10:02):

It's a very interesting point, because we've seen in our studies as well, with the digital bank report, the exact same components, that said consumers are less afraid of sharing information if, as you said, they get value in return. It is why we actually pay Amazon for the right to shop on the digital platform, and we don't worry about it, because it's done well. In the most simplistic format, I look at the fact that when I'm getting on the freeway, I have the little box on my dashboard that immediately takes the payment out for the travel. That's completely intuitive, but you don't expect it to go wrong. For me, the value of them knowing my car and everything about who's in the car and everything else, that goes secondary to the fact that I can go through the line faster than anybody else. Even in the most simplistic way, consumers think that way. You mentioned in the last answer about some of the success stories you're seeing internationally. What are some of those success stories around embedded banking?

Shanker Ramamurthy (11:04):

Oh, there's a lot. Hey, before I get into that, maybe I should answer the second part of the question, which I realized I did not get to, which, the study also uncovered genuine disconnect between areas in which financial institutions were investing, assuming the priorities customers, versus what customers were thinking of as areas of real value and importance to them in the contact of embedded finance. If you look at it from a consumer standpoint, they focus on areas like, "Hey, give me great customer service, ensure that I get rich rewards." Again, they've been trained by a whole bunch of other industries to expect rewards when they provide their business to a particular entity. On the other hand, when I look at the areas where financial institutions are investing, they're focused on things like new products, buy now, pay later, paying peer to peer, and so on. Actually, it's not that they're deprioritizing, but they're putting lower down the priority stack things like good customers service and rewards and so on. The study demonstrated kind of a disconnect between things that are really valuable to customers in the context of embedded finance and perhaps the areas in which banks are investing today as a priority, so more work to be done there.

(12:36)
Now, having said that, there are a number of really successful examples from around the world in this area of financial institutions leveraging embedded finance and driving a lot of value. A lot of these examples do tend to come from what we call growth markets or rapidly emerging markets. When I look at AsiaPac, we've got markets like Singapore where DBS in Singapore has done some amazing work in multiple ecosystems in this space. When I look at India, banks like State Bank of India have done an amazing job leveraging their scale to provide e-commerce capability to all their consumers and customers, and bringing the power of the scale of State Bank of India, the largest bank in India, to their customers and SMEs when they interact in an e-commerce context.

(13:37)
We've got clients and banks like Bank of Baroda and others in India, and the most recent one I can think of, it's this piece of work we did for Bradesco in Latin America, one of the largest banks in that part of the world, and in Brazil, as you know, the agro economy is a substantial part of the economy. What Bradesco has done, working with IBM, is actually launched something called the E-agro platform, which extends the breadth of things they're able to provide the agro ecosystem. If you're a typical customer in an agro context, the agro ecosystem platform, E-agro, provides advisory services, live prices on agricultural commodities and products, of course financing, but also for farming, it's about access that consumers in an agricultural context might require, whether it comes to farm supplies, tractors, fertilizers, other inputs that they might need, providing them access to those things, logistics. A whole bunch of things that a farmer might need, all as part of a single E-agro platform. The idea here is that a farmer will go into the platform and get these capabilities and naturally have Bradesco's financial services capabilities embedded into it. That's a perfect example of embedded finance extending the value chain well into the ecosystem of a farmer, all the things a farmer might need.

(15:26)
We're doing some work, and it's under NDA now, in mature markets, including in the US, helping some large banks think through how to leverage embedded finance in the context of specific ecosystems. Now, whether that be the mortgage ecosystem, which then, think extending all the way into real estate brokers, real estate listings and so on, because you don't wake up in the morning saying, "I want a mortgage." You wake up first thinking about, "I want to buy a house," or, "I want to buy an apartment," and so the thing you would do is start looking at listings and so on. What if a financial institution can provide that capability and be the destination where the customer goes in to look at those things? Then naturally, as they're ready to buy something, the capabilities that a financial institution provides from a market and other capabilities gets embedded into that journey. That's what's happening in that space.

(16:31)
We're seeing some very interesting thinking happening in this whole ... Because the second most expensive thing that many mature market customers have is the automobile, and there's a lot of change in that ecosystem, as you know. There's a lot of thinking going on around this embedded finance notion in the context of that whole ecosystem, as an example. Some really interesting projects we're doing under NDA, and early proof of concepts and work sessions in North America and Europe, but they're under NDA because they haven't yet been launched.

Jim Marous (17:04):

When you're working with banks, what is the primary objective that you see that these financial institutions are trying to address with embedded banking? Is it revenue? Is it scale? Is it insight, picking up more data? If there was one primary objective the finance institutions had, what would it be with regard to embedded finance?

Shanker Ramamurthy (17:32):

The primary ... If you ignore the regulatory aspects, so in other words, if you look at UK or Europe and so on, open banking regulations are mandating a certain amount of embedded finance or open banking. If you ignore the regulatory imperative, the primary thing that financial institutions are looking for is deepening and strengthening the relationship with their customers, which then can be monetized in all sorts of interesting ways. In other words, if you're creating a consumer surplus, then monetization is a natural extension. In many markets, banks are not allowed to take a commission on third party products that they might be selling or enable sold, but you can actually provide a higher price point in which you're providing the bundler capabilities. In other words, make the banking products more expensive for the value created, and that's another way of monetization. It's all about strengthening and deepening the customer relationship, creating a consumer surplus, and then figuring out how to monetize some aspects thereof.

Jim Marous (18:50):

Those organizations, not everybody is doing embedded banking right now. What is the biggest challenge that financial institutions have around implementing and actually pursuing embedded banking solutions or embedded finance solutions?

Shanker Ramamurthy (19:06):

It's a great question, because you're right, it's a new capability. It's a new set of muscles, and with that comes a whole bunch of ... I would almost think, a back to basics set of issues as you launch something new, as you incubate and launch and innovate. In all the usual issues, when we interviewed the 1000 executives, here are some of the issues that came to the fore, right? Incentives not being aligned, because organizations are structured in product silos. Challenges in figuring out how to figure out who to partner with. How do I do the due diligence? How do I figure out who I'm going to partner with and onboard, given all the brand risks that I run if I partner with the wrong set of entities? Responsiveness or lack thereof to partners' requests, because you don't have an organizational construct to actually do the processing and the automation or the technology required to address the concerns and the priorities of partners. Balancing for monetization in the short term and client ownership, given that organizations are structured in many banks by product and not by customer segments.

(20:31)
Difficulty in sourcing talent for this capability, right? It's an entirely new set of capability, if you think about it in a financial institution context. Concerns about, or rather, gaps in controls and security frameworks as you open up the financial services capability to all these partners. Lack of funding, which is an ongoing issue, and then, relatively monolithic processing systems. Insufficient APIs, insufficient modularity in the core banking systems, and this is part of the reason why BIAN did this study. This is where the work we're doing as part of the Banking Industry Architecture Network, the dot-org organization, is helping lower the complexity for banks to operate not just in embedded finance, but in other areas where they need to work in partnership and in an ecosystem context.

Jim Marous (21:30):

Let's take a short break here and recognize the sponsor to this podcast. Welcome back to Banking Transformed. It's interesting, Shanker, we had a recent interview with your counterpart, John Dignan, from IBM, and we talked about the importance of partnerships and collaborations and integrated finance for a ChatGPT or a generative AI solution. It's actually the same with the solutions around embedded finance. I don't know if anybody can go it alone and implement an embedded finance solution without a really strong partner that has the capabilities of IBM to not only take case studies from within the financial services industry, but can put it within the context of things such as generative AI, data, hybrid cloud, quantum computing. You mentioned a lot of things, but I think the importance is going to be around the importance of actually bringing partners to the table that can implement at speed and scale.

Shanker Ramamurthy (22:40):

Yeah, and by the way, when we think about partners, there's partnership at multiple tiers as well, and if I step back and think about this from an IBM standpoint, our chairman and CEO, Arvind Krishna, has been very clear that there are three things that we as IBM are going to focus on to help our clients be successful. One of them is around the hybrid cloud, and intermediated by Red Hat. Red Hat is open source, and the whole idea there is to enable financial institutions in the context of our discussion to handle their processing capabilities across multiple heterogeneous cloud environments, including their private cloud and their own data center, without having to worry about all the complexity that entails and all the regulatory and security issues. That's around the hybrid cloud and Red Hat.

(23:40)
The second big area is all around data and AI and generative AI. That's a huge area of focus, an area in which we are making a huge amount of investment, and we are launching this capability we call What's Next to help our clients take advantage of this emerging generative AI technology. I'll come back to that point in a minute. Of course the work we are doing in Quantum and Quantum Save our clients are going to see in the next two to three years, not just now, but that's, again, is going to have dramatic impact for our clients. The third point I wanted to make, beyond hybrid cloud, generative AI and AI, data and AI, is partnerships. We are clear that we're going to succeed by working with the partner ecosystem in bringing a broad range of capability to our customers, and in the financial institution context, they need to do the same. They've got to select a range of partners that can work with. Some of them are going to be standards based organizations. Some of those are going to be organizations like IBM that can provide a broad range of capability to enable them to take advantage of today's technology and emerging technology from tomorrow in a secure environment in a regulated industry like financial services.

(25:01)
That's where IBM comes to the fore, and we are doing a ton of work in the generative AI space right now, leveraging What's Next capabilities and the consulting capabilities that we have. The top three case studies or use cases I can think of in a global context, one is everything to do with supporting customers across multiple channels. Think about it as inbound. Anything that a customer needs to have a very effective ... Back to the point I made, customer service is a top requirement that customers have that financial institutions might not be prioritizing as high in an embedded finance context. Generative AI plays a huge role, particularly these new multimodal models that can do speech and text and understand what customers are saying, and help respond to them. All this is about augmenting the capability from a customer standpoint.

(26:03)
The second big area, it's a very broad area, is augmenting the employees of a financial institution to be more productive, whether they be people doing internal work or people ... What we call agents, agents who are supporting customers, making them more productive, whether it be customer service, whether it be wealth management, private advisory, or any of the internal things that they're doing. In every process that you can think of, know your customer, anti-money laundering, regulatory issues, internal audit, trade finance transformation. At Sibos, we're going to launch a whole platform around trade finance transformation, and that's an end-to-end process that requires processing a lot of paper-based documentation. Generative AI is playing a dramatically large role in that. Of course, underwriting, whether it be loan or others, with lots of paper involved, generative AI plays a big role.

(27:06)
Last but not least is the whole software development lifecycle. For example, what's next for the Z stack, software just for Z stack, code that's just for the Z stack, enables customers to take these monolithic backend core systems and make them flexible and nimble and modernize them to react to the opportunities in domains like embedded finance. Generative AI has a very broad range of applicability and we couldn't be more excited about the opportunities ahead as we look at the next three to five years.

Jim Marous (27:46):

Well, what's interesting when you look at ... You mentioned hybrid cloud, you looked at the whole concept of generative AI and AI in general. You look at the capabilities of What's Next, and you look at the future of computing and all that involves, those all play a role in embedded banking solutions. I mean, because the processing of data, the ability to deliver in a cloud environment, quantum computing, you look at generative AI's access. When you look at AI in general, what role does that play in the embedded banking solution?

Shanker Ramamurthy (28:26):

Yeah, every one of these things have a major role to play in embedded finance, right, because embedded finance is going to stress every part of a traditional financial institution's value chain, whether it be front office, middle office, or back office. The banking model is getting flipped on it. If today, two thirds of the focus is on middle and back office and about a third customers and the front office, tomorrow's banking model is going to flip the pyramid on its head, with two thirds of the focus on customers and ecosystems and partners, and only a third on the middle and back office. That requires a massive amount of automation, by taking advantage of digitization and everything generative AI and hybrid cloud and quantum is able to provide, to make employees more productive, so that you can take that capability and really invest it where it really matters, which is on customers, partners, and ecosystems. That means not just deconstructing complex processes, but also using APIs and microservices and taking advantage of all this new capability that you have to build partnerships and ecosystems and have an end-to-end value chain that extends way beyond what the traditional international institution is doing today.

(30:00)
That's how banks are going to blunt the onslaught of the tech-fins and take advantage of what technology can provide to drive superior customer experience and customer value, and take a slice of the surplus that's been unlocked to drive greater shareholder value, which is really one of the issues, one of the imperatives that banking CEOs are dealing with right now.

Jim Marous (30:27):

Shanker, there's a lot of organizations that have not really started thinking about or implementing against the embedded banking opportunity in the marketplace. If you are walking into a financial institution today, a small-medium size, even a large financial institution, that have really not thought deeply about what role they can play in embedded banking, where would you suggest they start to build for that future?

Shanker Ramamurthy (30:58):

It's a great question. By the way, I'm seeing kind of two ... There's a spectrum. On the one extreme, I'm seeing big guy innovation, where some banks are saying, "This banking model is changing and I've got to very aggressively invest on the customer front-end and ecosystems and platforms." Read, banks like DPS in Singapore or Bradesco, or State Bank of India. If you look at what the chairman of State Bank of India has said, what they call YONO, You Only Need One, their mobile platform, has driven tens of billions of dollars of market cap. There are some that are doing what I call big guy innovation, right, which is driving massive amounts of customer surplus and an extraordinary amount of shareholder value. Then, there are others that would much rather prefer doing what I think of a smaller innovation. Those are taking specific areas, and in markets which might not be core to them, to experiment in the context of embedded finance.

(32:11)
Regardless, recognize you've got to start now, at a minimum with pilots and proof of concepts, and can kind of learn your way. Try, fail, figure out what works, innovate, get on that innovation circle, to accelerate your path to the future. This is not going to happen overnight. Embedded finance is not something that you need to do overnight. There's probably a three to five year window in which you can blunt the onslaught of the tech-fins and take advantage of everything that exponential technology has got to offer, including generative AI and hybrid computing, hybrid cloud computing, to provide value to your customers. The time to start the first step on this journey is now, whether it's a small step or a giant leap. Start now, because otherwise, [inaudible 00:33:06] is going to become the enemy.

Jim Marous (33:07):

That's a great lead into my last question, Shanker. What's interesting about embedded finance is, number one, you don't have to be a bank to be a major player. I mean, you look at what PayPal's doing, you look at what Elon Musk wants to do with X. You look at what Google and Amazon are doing, but you even look at organizations like Uber that have had embedded finance in their solution, but then they've taken their solution and recently have expanded tremendously to include not only food service and delivery, but recommendations for restaurants, hotel recommendations. They're now looking, at least, I'm getting emails around, "Build your travel plans on an Uber platform." Everybody's going after the data because that's the holy grail. The more a person knows more about me, is going to probably serve me better and deeper and make more money on my behalf. I'm wondering, when you look at the near term future, let's say in the next 12 to 18 months, where do you see embedded finance going beyond where it is today?

Shanker Ramamurthy (34:18):

It's a great question, Jim. By the way, this point about data is an important one, because for financial institutions, data is a natural and unfair advantage, I would say, because they've got decades plus worth of data on their customers, and it's on them to figure out how to take that data and understand the customer journey, and embed themselves more into the value chain of the customer, further up the stack, to blunt the onslaught of the tech-fins. I would say every financial institution over the next 12 to 18 months will have to look at the customer segments that really matter to them, and then figure out how they have either small experiments or large initiatives to take advantage of embedded finance, leveraging all that exponential technology can provide. If they do not do that, they're going to be playing catch-up. They're going to be playing catch-up in a world where the tech-fins have got almost unlimited amount of capital to play this game.

(35:26)
The fight is going to be between the tech-fins, like you said, whether it be X now with Elon, given his PayPal background, Shopify, PayPal, all these guys, backing into financial services, versus financial institutions with the natural advantage they have, on the one hand, with all the data, and the relationship that's hugely trusted by the customer, but then they've got to get on the front foot to actually take advantage of what technology and digitization can offer, to take the path [inaudible 00:36:04] in the embedded finance direction. That's the fight you're going to see between the tech-fins and financial institutions getting on the offensive. I would bet that there are going to be a number of successful financial institutions that figure out how to get on the front foot to take advantage of the capability that embedded finance can provide to drive superior value to the customers, and take a slice of that to go into the pockets of their shareholders.

Jim Marous (36:36):

It's interesting, Shanker, we've had a few conversations with other finance institutions. One was Coastal Community Bank in Everett, Washington, that built a partnership with an organization called One, which delivered a really good integrated banking solution, and that was the beginning of an embedded relationship. What was interesting is, One recently got purchased by Walmart to be their primary provider of banking services for the Walmart financial product. What is interesting is, embedded finance does not necessarily get dictated by the largest. It gets dictated by the people that are out there first. Coastal Community Bank is not a very large financial institution, but they could end up with relationships with 300 million consumers indirectly through embedded solutions. We've had another relationship, or another conversation, I should say, with Michigan State University Credit Union, that has built a number of fin-tech partnerships, but are also looking at embedded finance as a route to go to build scale without having to change their geographic footprint. Shanker, it's always great to talk to you. I really appreciate your time and your insights as we look at this solution that's really on the beginning stages of innovation, but it's going to quickly ramp up to be a very important solution for the financial services industry. Thank you so much again.

Shanker Ramamurthy (38:06):

Thank you. Thank you very much. I enjoyed the discussion much. Cheers.

Jim Marous (38:12):

Thanks for listening to Banking Transformed, the winner of three International awards for podcast excellence. If you enjoy what we're doing, please take 30 to 45 seconds to show us some love in the form of a review. It really helps us get guests like we have today. Finally, be sure to catch my recent articles on the financial brand and check out the research we're doing for the digital bank report. This has been a production of Evergreen Podcasts. A special thank you to our senior producer, Leah Haslage, audio engineer, Chris [inaudible 00:38:39], and video producer, Will Pritts. I'm your host, Jim Marous. Until next time, remember, embedded finance integration is imperative for banks wanting to win in the platform economy.