How Banks Can Grow Low-Cost Deposits with Embedded Finance

The cost of deposits is rising — here’s how embedded finance can help banks find a new source for low-cost deposits and strategies.
Angela Bao
Angela Bao
August 16, 2023
low cost deposits

Key takeaways:

  • The cost of attracting and retaining deposits through traditional channels is increasing
  • Partnering with embedded finance companies can reduce acquisition costs and increase low-cost deposit acquisition strategy growth
  • Banks should view embedded finance companies as an access point for customers in new verticals

Growing deposits

The battle for bank deposits is heating up, putting smaller banks in a more vulnerable position. The abundance of cheap deposits that flooded banks during the peak of the COVID-19 pandemic has evaporated along with the Federal Reserve’s string of rate hikes. Overall deposits at four major banks that reported earnings in July — including Citigroup, Wells Fargo, and JP Morgan Chase — were down by 1% quarter-over-quarter and non-interest-bearing deposits were down 7%, according to the Wall Street Journal. This is sparking intense competition among banks for both retail and commercial deposits. 

Bank pressure — higher deposit costs

Meanwhile, deposit costs are increasing. Those same reporting banks saw the rates on interest-bearing deposits increase a fifth higher on average compared to the first quarter, signaling an accelerated pace of deposit-rate increases relative to the average federal-funds rate hike. 

Customers are looking for higher returns and a “safer” place to put their money, and the cost of attracting and retaining deposits is also increasing, according to Treasury Prime Vice President of Banking Jeff Nowicki. In a survey conducted by American Banker, 38% of corporate treasurers plan to “increase allocation of cash to money market funds.” Only 27% said they planned on increasing their bank deposits and one in four said they planned to reduce their bank deposits. 

Emerging banking API technology

Historically, banks have had to spend a lot of money to bring in significant new deposits, Nowicki says. 

“They either go out on Bankrate and offer the high rates, open new locations, build out new business line from scratch, acquire or invest in expensive and often inefficient marketing, all which can lower overall returns pretty drastically.”

Forward-looking banks have a new option, thanks to emerging banking API technology. By partnering with embedded finance companies, banks can gain access to new market segments and a lower-cost and stickier source of deposits. This innovative collaboration between banks, technology providers, and nonfinancial platforms constitutes the embedded finance revolution. 

This guide will delve into:

  • Why are embedded finance platforms growing?
  • How can partnering with embedded finance companies reduce acquisition costs?
  • How can banks increase low-cost deposit acquisition strategy growth through embedded finance partnerships?
  • What role does embedded banking software play in partnerships? 
  • What about compliance?

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How embedded finance has changed the financial landscape

During the previous sustained period of rising/high interest rates, embedded finance, fintech, and smartphones were not yet part of the financial landscape. However, with changing customer behavior, many small businesses and startups are bypassing traditional banks altogether. 

Now they are accessing banking through their e-commerce or accounting platforms, and can easily open deposit accounts, order debit cards, fulfill payroll, and most of their financing requirements. These platforms are typically not operated by banks; rather, they are software companies that collaborate with banks and banking as a service (BaaS) technology providers to seamlessly integrate financial products into their existing platforms, offering customers a convenient and user-friendly experience. 

For example, ZenBusiness, a business formation platform, offers online payments for their small business clients through debit cards and ACH.

Launching embedded finance programs

Many companies such as vertical SaaS, healthcare, real estate, or investment platforms launch embedded finance programs because they want to increase product stickiness by becoming centralized hubs for their customers. They do so by adding money storage and other financial features that encourage existing users to stay on their platform and return regularly. Features like white-label bank accounts and digital wallets reduce payment friction and save time by simplifying the payment process. With embedded finance, their customers can not only complete basic business-related tasks on their platform but they can also go a step further by having the ability to perform functions like sending and receiving payments.

Growth of embedded finance and its potential for banks

This convergence of commerce, banking, and business services has paved the way for the remarkable growth of embedded finance, which generated a staggering $20 billion in revenues in the United States alone in 2021, and is poised to double in size within the next three to five years, as indicated by McKinsey. The inherent value of this integrated approach has led to its widespread adoption and continuous expansion. 

While this may initially seem like competition, it can be an opportunity for banks to tap into a new source of low-cost deposits, says Nowicki. All these software companies need banks to gain access to the banking system. They bring with them a set of new customers and their bank accounts and deposits. With an embedded finance partner, banks can be more strategic in how they reach customers, cut acquisition costs, and capture the full client relationship.

How embedded finance platforms foster customer loyalty

Fintechs and embedded finance companies can offer a promising source of low-cost deposits due to their proficiency in retaining loyal customers by offering convenience and tailored features that cater to specific needs. For example, Guava, a digital community bank for black entrepreneurs, offers a built-in community networking ecosystem and other programming. Clientele are drawn by the unique services, transcending mere interest rates, thereby ensuring more stability of the customer base.

Not only are they directly addressing the specific needs of a niche audience, they also excel at focussed marketing to acquire those customers. 

Banks, on the other hand, rely on broad traditional location-based marketing and the business of pre-existing customers, Nowicki says. Although online banking has narrowed the scope somewhat and some banks are focused on niche markets, most banks still have a very wide spread. To reach the same customers, banks would have to spend a lot of time and money on marketing or offer competitive rates, both of which can erode their potential returns

“Smaller banks face challenges in developing new products or loyalty programs to retain customers at a larger scale, whereas businesses dedicated to serving specific segments or demographics tend to naturally cultivate stronger customer loyalty,” says Nowicki. 

Lower acquisition costs and low-cost deposits with embedded finance

Banks have a valuable opportunity to expand their customer base through strategic partnerships with embedded finance companies that align with the bank's overarching strategy and core values. According to Nowicki, treating embedded finance companies as collaborative partners in acquiring customers across new verticals can prove advantageous.

“Banks can partner with the best embedded finance programs that do the marketing for you — focussed on a certain segment — and go deeper than a bank can,” Nowicki explains. “Partnering with these companies can bring in lower cost deposits that are more stable.”

Working with banking as a service companies to capture the entire banking relationship

The quickest and most economical way of partnering with a fintech or embedded finance company is through a BaaS provider. BaaS companies build banking API software that connects bank cores to other businesses. 

When the partnerships are set up correctly, it can lead to impressive results. According to a recent analysis by S&P Global, small community banks which collaborated as partner banks for fintechs and enterprises, experienced double-digit growth in their deposit volume.

Experiencing this phenomenon firsthand, Grasshopper Bank achieved remarkable results in its initial year of collaboration with the embedded banking software platform, Treasury Prime, garnering an impressive total transaction volume of over $7 billion exclusively for banking as a service. 

However, not all BaaS providers are the same. It is crucial to select one with extensive banking expertise that has a proven track record of helping banks and fintechs adhere to compliance requirements.

What about BaaS compliance?

BaaS companies are not uniform in how they handle compliance. Some BaaS companies act as an unregulated middleman to handle important compliance functions. This is a precarious model; recent consent decrees by regulators show that it is risky to offload compliance to anyone other than chartered institutions. When banks don’t have clarity into what their fintech partners are doing, that’s when they run into problems with regulators.

By contrast, Treasury Prime’s embedded banking software platform follows an entirely different model than other BaaS providers. We foster a direct relationship with fintech/enterprises and the banks and help both parties stand up a fully transparent compliance program, supported by product partners in KYC, transaction monitoring, and other automated solutions. Our 4-point compliance framework has a strong focus on responsibility and collaboration between banks and fintechs to help partners better fight fraud and withstand regulatory scrutiny together. 

Finding the right embedded finance strategy for your bank

Nowicki says that banks have two main options when figuring out an embedded finance strategy: “whale hunting” or taking a portfolio approach.

With “whale hunting,” banks can choose to pursue only one or two big embedded finance opportunities to get their deposit base. Typically, this strategy is more feasible with larger banks that have a well-known name. The pros are that the bank doesn’t have to invest as much time and resources in pursuing and negotiating a large number of deals. The cons are that there is more concentration risk, and it can take much longer to get large programs to market.

Unlike with whale hunting, the portfolio approach targets multiple, smaller deals and is generally more successful, says Nowicki. The pros of this approach are that your risk is more diversified and provides more stable growth. The cons are that banks may have to invest a little more time and resources in pursuing multiple deals and have a team knowledgeable of every program for oversight

Regardless of the strategy, embedded finance is a win for banks looking to grow their deposits cost-effectively. Especially with BaaS partners like Treasury Prime, tapping into embedded finance opportunities is very feasible, no matter the size of a bank.

Opening up banking services to new access points

Ultimately, Nowicki says banks should view BaaS and embedded finance as extending their existing banking services to new distribution channels and getting exposure to clients that historically would have been difficult to acquire. That could mean allowing existing corporate clients to easily pull banking data to their platforms through banking APIs, or establishing an affiliate banking relationship with a non-financial company.

“BaaS and embedded finance are just new access points for a bank, and these access points have the ability to be very narrow in their scope and target market,” explains Nowicki. “And where these specific niche products are being offered, that's where consumers and businesses are going." 

Note: The contents of this article are informational only and should not be relied upon as legal or regulatory advice.

Wondering how embedded banking could help your bank? Contact Treasury Prime — we have established fintech and embedded finance clients and extensive compliance experience. Read more about our $40 million Series C Funding and why Tearsheet named us the Best Banking as a Service company two years in a row. Talk to the best embedded finance team in the industry.

Related embedded financial services content:

How Community Banks Can Stay Competitive with Embedded Banking

How to Make Bank Fintech Partnerships Profitable with Treasury Prime

Future of Banking: Grasshopper Bank

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