Many financial institutions I speak with these days are intrigued by the possibility of becoming a sponsor bank, supporting embedded payments for corporates with high transaction volumes and their fintech partners.
It’s easy to see why.
By partnering with fintechs and solution providers, sponsor banks can effectively drive additional deposits, reduce the cost of funds, and add to their non-interest income.
Plus, those embedded payments represent a sticky benefit for high-value business accountholders as they enable corporate clients to focus on their core operations by leveraging the expertise of fintech partners to manage payments.
What’s not to love?
A Rapidly Expanding Market
The market for embedded payments and Payments as a Service (PaaS) platforms have seen significant growth over the past few years, with rapid expansion expected to continue in the coming years.
In 2021, embedded finance (which includes embedded payments) accounted for $2.6 trillion – nearly 5% of all U.S. financial transactions. By 2026, this figure is projected to exceed $7 trillion, representing over 10% of total U.S. transaction values.
It’s all part of a global trend where the embedded finance market is projected to grow at a compound annual growth rate (CAGR) of 32.8% from 2024 to 2030.
Overall, the embedded payments market is poised for substantial growth, driven by technological advancements and increasing demand for faster, more efficient payment solutions. So, why aren’t all Jack Henry™ financial institutions opting into embedded payments when the market is growing so quickly?
There Must Be a Catch
Where this becomes challenging, especially for community banks and credit unions, is the increased oversight of third parties by regulators. They’ve come down particularly hard on Banking as a Service (BaaS) and it’s more targeted cousin PaaS solutions.
In 2023, banks providing BaaS services (which include payments as part of their model) to fintech partners accounted for over 10% of severe enforcement actions issued by federal bank regulators – including prompt corrective action directives, cease and desist orders, consent orders, and formal agreements.
Despite representing a small fraction of the total number of banks, these sponsor banks faced a disproportionately high number of regulatory actions due to the complexities and risks associated with their fintech partnerships.
You may be wondering … how can community and regional financial institutions get a piece of the growing embedded payments pie while managing compliance, operational, and strategic risks?
Let Control Be Your North Star
The answer is straightforward: build for control.
Don’t add high-value programs without including sufficient personnel and infrastructure to support ongoing compliance efforts.
This infrastructure should include technology that can manage real-time embedded payments at scale with built-in compliance tools and subledger support for ACH, wire, and instant payments.
Side Core Vs. Single Source of Truth
There are two approaches you can take to serving this market:
- The implementation of PaaS using a side core that’s maintained by a technology provider.
- Tight integration with the banking core – making it the “source of truth” for the embedded payments program.
But which way is better?
Sponsor banks, which provide the necessary banking infrastructure for fintech companies and other third-party providers, often rely on these external partners to manage their PaaS programs. While this arrangement can streamline operations and reduce initial costs, it also exposes the sponsor bank to potential adverse consequences.
Outsourcing program management can lead to compliance gaps, such as:
- Third-party providers may not always adhere to the stringent regulatory requirements that banks must follow, which can result in legal and financial repercussions.
- Dependence on third-party applications, which can lead to operational inefficiencies.
- Issues such as system downtimes, data breaches, and inadequate customer support, which can impact your reputation and accountholder trust.
Core: The Key to Mitigating Risk
To mitigate these risks, you should consider keeping as much information as possible on the core because:
- Maintaining control of all payment processing activities within the core banking system ensures regulatory requirements are consistently met. By managing AML/BSA and transaction review activities, you can guarantee these transactions undergo the same level of oversight as all other activities.
- Keeping sensitive payment information within the core system enhances data security. You can implement robust security measures and have direct oversight of data management practices – reducing your risk of data breaches.
- Integrating embedded payment activities within the core banking system can streamline your operations. By reducing the complexity and potential points of failure associated with managing multiple external providers, integration supports smoother, more reliable payment processing.
While the use of a side core for supporting embedded payments provides certain advantages, it also brings significant risks – particularly for sponsor banks that outsource program management to third-party applications.
A strategy that keeps all information on your core not only supports cost-effective compliance with a single source of truth, but enhances your data security and operational efficiency, too.
Jack Henry’s strategic alliance with Victor Technologies provides financial institutions wanting a sponsor bank program with a robust platform that supports ACH, wire, and instant payments with built-in compliance tools and subledger support on the core.
The platform is in market today with three financial institutions, all of whom have worked with their regulators on appropriate compliance programs designed to withstand scrutiny.
As the digital payments landscape continues to shift, I believe community banks and credit unions that prioritize their payments strategies – including the potential to support embedded payments – will be well-positioned to meet their goals while maintaining a compliant posture.
All it takes is an understanding of what to outsource and when to keep your data close.
Learn more about our strategic alliance with Victor Technologies and how you can capitalize on embedded payments opportunities.
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