Vertical vs. Embedded Banking: Same same but different?

Lars Markull
Lars Markull

This is my third post on Embedded Finance. This post was supposed to be published over the weekend, but as you can see, that did not happen. The good news is that I can and will continue to experiment with different publishing days.

In this post, I'd like to discuss another current Fintech trend: Vertical Banking. In a nutshell, this describes the trend of banking solutions that target a specific niche. As a result, niche banking solutions is another term that can be used. Vertical Banking and Embedded Banking have many similarities, but they are distinct solutions (I am using the term Embedded Banking instead of Embedded Finance as I will focus on banking in this blog post). Because these two topics are so closely related, I'd like to use this blog post to describe:

  1. What exactly is vertical banking?
  2. Examples of Vertical Banking solutions
  3. Why do we need Vertical Banking? Why now?
  4. Embedded vs. Vertical Banking
  5. When can a Vertical Banking solution be successful?

What exactly is vertical banking?

Historically, most traditional banks focused on a diverse set of customers. The bank could provide financial products such as bank accounts, credit cards, and lending to anyone who needed them. This made a lot of sense because building and selling such products used to be a big investment. Why would you limit your products to a specific demographic? However, this has changed dramatically in recent years, with Vertical Banking solutions on the rise. It is, as the name implies, a banking solution focused on a specific vertical. I will continue to refer to them as Vertical Banking solutions (instead of Vertical Banks) because almost all of them are not banks but rather operate without a licence and collaborate with a banking-as-a-service provider.

Examples of Vertical Banking solutions

What kind of verticals are these providers targeting? It could be any loosely defined group of customers who want a specific banking solution, whether it's a consumer or business banking solution. Consider the following examples:

These are a few randomly chosen Vertical Banking solutions from around the world.

This is only a brief overview; there are likely dozens, if not hundreds, of solutions available around the world. As you can see, verticals can vary greatly, and there are a variety of reasons why such verticals exist. But we'll get to that later.

Before I dive deeper, I'd like to clarify whether a digital neobank is a vertical bank. In some ways, a neobank could be considered a Vertical Banking solution because it caters to digitally savvy customers. Personally, I believe that this was an appropriate statement at the time when those companies - such as N26 in the consumer space or Penta/Qonto in the business banking space - were founded. However, the need for a digital solution is now widespread. As a result, I would argue that it is not a Vertical Banking solution anymore but mainstream. While writing this paragraph, I'm wondering if the Vertical Banking solutions focusing on sustainability-oriented consumers will continue to exist. Perhaps, like the neobank trend, we will see this need blend into the mainstream mindset? I believe that once an offering addresses the needs or concerns of multiple verticals, it should not longer be considered Vertical Banking. Most Vertical Banking solutions, I believe, have a very low chance of making this step, with sustainability-focused solutions possibly the only real contenders (at least today). Being mainstream and not just addressing a vertical is obviously a good thing, but it comes with its own set of challenges, especially with increased competition.

Finally, keep in mind that many (but not all!) Vertical Banking solutions began in the last 5-6 years. As a result, when compared to a traditional banking offering, the banking services provided by these solutions are typically limited. Such offerings typically include a bank account and a debit card, but not lending or other financial products offered by a traditional bank. In addition, features such as joint accounts for consumer Vertical Banking solutions are uncommon as well. That being said, the successful ones will undoubtedly expand their offerings and compete even more with traditional banks in the coming years.

Why do we need Vertical Banking? Why now?

This begs the question, why do we have vertical banking solutions? As previously stated, traditional banks serve a diverse range of customers. This could range from a young rebellious adult involved in political protests to a suburban woman working in healthcare to an elderly man living in a retirement home - and all using the very same bank. And, as the saying goes, 'when you address everyone, you don't address anyone'. Vertical banking solutions believe that by focusing solely on one type of customer, they can provide better products and services.

This would not have been wise in the past, but thanks to new infrastructure providers, the entry barriers to providing banking services have been greatly reduced. As a result, providing Vertical Banking solutions has become significantly less expensive. Furthermore, recent Fintech development has aided in educating customers about new banking solutions, and adoption of Vertical Banking solutions is much higher today than it was years ago.

In the future, there could be hundreds of different verticals. But why do they exist and how do they differentiate? Personally, I think the following categories can help with that:

a. Providing a unique feature or functionality

When a bank is targeting a wide range of customers, it is understandable that it cannot provide functionality that only a small subset of those customers require - especially when there are numerous subsets. Many business Vertical Banking solutions fall into this category because their functionality is tailored to the needs of the customers they serve. A business banking solution aimed at freelancers, for example, is likely to support tax savings, whereas a solution aimed at construction companies may support invoice financing or insurance. A Vertical Banking solution aimed at crypto-focused consumers is likely to include crypto investment functionality, while a Gen Z banking solution may include a social network component.

b. Focusing on a specific demographic

In the previous bucket, I mentioned Gen Z banking solutions. Such a solution will distinguish itself not only through a feature or functionality, but also through different messaging and branding. In fact, the functionality may be standard banking offerings, but the main differentiator may be the way it speaks to their customers, as well as design and branding aspects. The typical example of a demographic focus is the target group of Gen Z or overall younger customers; however, it could also be older people or people with a specific background (e.g. immigrants).

c. Concentrating on a specific community

Finally, a banking solution could target a specific community. This is similar to the previous point, but in this case it is based on a group of people who share the same beliefs or values rather than a specific demographic. For example, this could be Vertical Banking solutions focusing on sustainability (such a solution might also have specific functionality, as described in the first bullet point). Other groups could include residents of a specific region or supporters of a football club. Such banking solutions are typically founded by a team from that community and are likely to provide (sooner or later) other services aimed at the same community. This could include assistance with fundraising for business banking solutions or a community information portal.

I'm sure there are numerous other ways to divide Vertical Banking solutions. The one above described works well for me, but as pointed out, it is not always possible to put each solution only into one bucket.

Embedded vs. Vertical Banking

Because you (hopefully) read my first blog post about when something is an Embedded Finance solution, you may already understand why Vertical Banking differs from Embedded Banking: Banking is core for a Vertical Banking solution. On the other hand, banking is an add-on for an Embedded Banking solution. But what does that mean? While this is not always true, but a Vertical Banking solution provider would likely think and act like any other bank. This means for example monetisation of the banking functionality is often crucial for Vertical Banking (for example direct charges, indirect fees such as interchange, or cross-selling/affiliate commissions). The provider of an Embedded Banking usually does not need to monetise the banking features directly, but can create sufficient benefits while increasing customer stickiness and new touch points (but of course they can monetise it too).

However, the lines will become increasingly blurred especially when a Vertical Banking solution provider expands its offering to include non-financial services. As a result, I believe a Vertical Banking solution can very well become an Embedded Banking solution and vice versa. The key question, in my opinion, is: What is the core offering, and what are the ancillary services to increase usage of the core offering? If banking is core, then vertical banking and otherwise embedded banking. But I don't judge you when you think this.

The mindset behind an Embedded and a Vertical Banking solution is frequently similar. Both address a specific customer group and recognise that standard banking solutions are not ideal for meeting the needs of these groups. Instead of creating a single product that is supposed to serve everyone, these two approaches aim to create significant value for a specific group of people, which frequently involves connecting banking with non-financial functionality.

When can a Vertical Banking solution be successful?

Personally, I am a big fan of a few Vertical Banking solutions and believe the market will continue to grow in the coming years. However, there are numerous challenges. To conclude this blog post, I want to highlight my personal factors for determining whether or not a Vertical Banking solution can be successful:

a. Size of the vertical

Because a Vertical Banking solution will always address a smaller group of people, this group must be of a certain size (exact size depends on the other factors). It is also important to understand where the target customers are present. The total size of a certain vertical might be big enough but if it is spread around the whole globe, then it may be much harder since a new provider is likely to start in only one jurisdiction.

b. How long does a customer has "vertical needs"

When a Vertical Banking solution targets customers between the ages of 28 and 30, the lifetime customer value is unlikely to exceed the costs of customer acquisition. While this is an extreme example, other areas, such as a banking solution for immigrants, may exist. How long will an immigrant have different demands than a native-born person? It may or may not be viable, but it is critical to understand how long the Vertical Banking solution will provide value to the target customers.

c. Opportunities for cross-selling

It is extremely difficult to charge for banking services. Consumers in particular are unwilling to pay, so selling additional products to these customers is an important revenue stream. However, this may not be feasible for all providers. Especially when the target group has limited financial resources or few other needs. A small vertical size combined with a low chance of cross-selling opportunities necessitates a high willingness to pay for the offering; otherwise, it will be difficult to sustain.

d. (The significance of) differentiation

The Vertical Banking solution must be distinct from existing solutions, and the target audience must value this distinction. This may seem obvious, but it may be difficult to achieve, especially when the solution primarily differs in branding and positioning (for example when addressing a specific community).

I'm curious what you think about Vertical Banking solutions and whether you use any of them. Please send me your favourite Vertical Banking solutions as I am interested in what is going on in different markets.

I hope you enjoyed this deep dive into Vertical Banking and feel free to subscribe so you don't miss any further Embedded Finance posts!

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Lars launched Embedded Finance Review in December 2022. He is an independent Embedded Finance advisor and Fintech investor.