Capturing the embedded finance opportunity: the trends influencing EMI and bank relationships

As the financial services markets have evolved over the last decade, Electronic Money Institutions (EMIs) and Electronic Payment Institutions (EPIs) have come to prominence. They’ve filled a gap left by incumbent banks unwilling or unable to support the fintech sector, and now, play a significant role in how financial services are delivered.

According to recent research from Celent, produced in collaboration with ClearBank, as the number of EMIs increases and individual EMIs grow, customer funds safeguarded by EMIs in the EU and the UK almost doubled in the last four years, standing at €35bn by the end of 2022.

It also reveals that, traditionally, many fintechs had no option but to work with or even become an EMI. Incumbent banks either viewed these firms as too small or too risky to service or were unwilling to support them as they could cannibalise their own service offerings.

However, as firms are looking to capture emerging embedded finance opportunities, the relationship between fintechs, banks and EMIs is evolving. That’s due to both changing market conditions and strategic priorities, as I'll explain in more detail below.

While a more relaxed regulatory framework is often viewed as a benefit to delivering greater agility, there are potential downsides to the EMI model. The increased attention paid to these firms by regulators should not be underestimated, leading some to revoke their licences due to significant Know Your Customer (KYC) and Anti-Money Laundering (AML) failings.

In the UK, the FCA has raised its concerns via its “Dear CEO” letter on four separate occasions in the last four years, each highlighting safeguarding as an area in need of improvement. Its most recent letter to EMIs and Payment Institutions suggests that banks are still best placed to do this, as they have the regulations, backing and protections to hold funds safely.

It’s no surprise to see operational resilience and scrutiny move up the agenda. The financial ecosystem has evolved since EMIs first came to market and is now increasingly open and interconnected. Problems in a single supplier can ripple through multiple other providers as we’ve seen with recent high-profile collapses.

Participants across the industry are now evaluating whether their networks of partners and, according to the Celent research, looking to add new partners. In some cases, the intention is to enhance the product range, but often it is to provide redundancy, mitigate against potential risk, and improve resilience.

Related to the above, investor expectations over the timeline and scale of returns, coupled with rising interest rates, have put significant stress on many business models. EMIs, Banking-as-a-Service (BaaS), and fintech players have been heavily affected in some cases, which has caused a ripple effect across the market. Some have been forced to adjust their business plans to prioritise revenue over customer growth, while others have had more difficult challenges to overcome.

As a result, EMI clients are paying closer attention to safeguarding practices during due diligence, which is forcing firms to be more transparent over their arrangements and reevaluate their safeguarding partners.

However, in response to recent failings, EMIs are concerned that finding a safeguarding partner could be difficult as banks may choose to work with a fewer, larger EMIs, rather than serve the entire market. That, in turn, could see further concentration of clients, and therefore customer deposits, at the larger firms.

While it’s obviously important for EMIs to ensure they are meeting the requirements of any new regulations, it’s also important that banks serving them understand their role in maintaining a healthy fintech ecosystem.

It could appear that EMIs and banks are often direct competitors for payment capabilities, but the reality is more nuanced. As banks are looking to capture embedded finance opportunities, should they be viewing EMIs as competitors, collaborative partners, or perhaps both?

Something that should be noted is that while funds worth €35 billion are held in safeguarding arrangements, EMIs are primarily about enabling transactions, and the value of these transactions will be many times higher. As EMIs generally cannot operate without partnering with a bank, it’s an incredibly valuable opportunity. Banks also need to understand that they can't meet every need, and working with EMIs provides a route to support customers they don’t serve directly.

But, as Celent found, EMIs don’t always find it easy to find a partner. While banks may well recognise the power of collaboration, they need to look closely at the frustrations some EMIs reported when selecting a partner. They sometimes struggle to find a banking partner with a risk appetite that aligns with their business. There are also technology concerns, such as the lack of API-based integration, as well as the need for virtual accounts in multiple currencies, and seamless customer onboarding.

The findings align with ClearBank’s ethos of being a new type of provider that addresses the gap in the market between the stability of a fully regulated bank and the agility of EMIs for firms to deliver innovative services without the cost and complexity of acquiring a banking licence themselves. We’re also proud to partner with many EMIs because we believe that cooperation and collaboration are both critical to delivering what really matters: better services for consumers and businesses.

Keen to learn more about the changing bank and EMI relationships?

John Salter is the Chief Customer Officer at ClearBank, where he leads the commercial team. With over 30 years of experience in the banking sector, he has a deep understanding and passion for payments and innovative financial services solutions that can benefit his clients.