Whether it is a business or private individual, getting an approved loan can be a long and complex process when going through traditional methods. Understandably, banks and other financial institutions need to be careful of who they lend to as there is risk surrounding how the money will be paid back. Embedded finance may be able to offer a solution to the difficulties surrounding borrowing as it facilitates a simple one click solution for those needing it at point of purchase. The need to physically go into a bank and fill out long application forms for a small short term loan is quickly becoming a thing of the past.
INTRODUCTION
Embedded finance is perhaps one of the most exciting areas of fintech at this moment in time. Embedded lending, in particular, is getting its time in the limelight. It has the potential to become a key driver in the future of financial access across many industries, enabling lending to become a lot more accessible. Financial exclusion is a huge issue, and for many SMEs, not having access to capital to grow their top line and fund fixed costs is stopping them from reaching profitability.
According to market estimates, the value of embedded finance is expected to exceed £7 trillion over the next ten years – making it currently worth double the combined value of the world's top 30 banks. Many fintech companies want to get in on the action and make the most of this opportunity, resulting in embedded finance quickly becoming a fierce place for competition.
Many fintech companies are now offering businesses embedded services such as buy now, pay later (BNPL) and trade credit insurance. As a result, those new to embedded finance may wonder why traditional business loans are no longer the preferred route. This article explores why embedded finance is the next big thing and how it will simplify the future of borrowing.
DIFFERENT TYPES OF EMBEDDED FINANCE
Embedded finance integrates financial services or tools – think of an online store offering short-term loans like BNPL or a digital wallet on a mobile device that enables instant contactless payments. These examples are just the beginning, as embedded finance has the potential to change the way consumers and businesses borrow money.
Fintech companies have already developed some very clever ways to streamline financial processes by reducing the obstacles to entry for various products and services. In the past, consumers would have to visit a physical bank to apply for a loan to make a substantial purchase. For a company to be granted a business loan, they would spend hours completing loan application forms to access any line of trade credit. It is now possible for these financial services to be made readily available at the point of purchase – saving a considerable amount of time and inconvenience.
Some of the most established areas of embedded finance include the following:
- Embedded payments – This handy embedded finance tool makes life much easier for consumers and business buyers by enabling instant payments at the touch of a button. Gone are the days of scrambling around struggling to find credit cards or cash. It is now possible to make purchases at a touch of a button through payment technology being integrated within the infrastructure of an app or eCommerce store. Furthermore, digital wallets enable contactless mobile transactions and instant online purchases.
- Embedded insurance – When a buyer was looking to insure a new purchase, they would have to go through the time-consuming task of finding and securing the best insurance for the product. However, in the modern shopping world, consumers can add insurance to their products at the point of purchase. As a result, the need for trawling through different insurance options or reaching out to brokers is rapidly becoming a thing of the past.
- Embedded lending – Credit and financing products are being added as a service line for many non-financial services companies. For example, retailers and marketplaces are allowing buyers to access deferred payment facilities as the point of sale without going to a bank or other lender. As a result, BNPL options are becoming increasingly popular with businesses and consumers. The B2B BNPL market is particularly seeing massive growth as it enables businesses to access a convenient digital version of traditional trade credit.
THE CHALLENGES OF LENDING
Before delving further into how embedded finance simplifies borrowing, it is worth examining the main challenges that come with traditional lending, apart from the cumbersome paperwork and lengthy approval waiting times. This will allow us to understand why there is a need for embedded lending and how it can drive financial innovation.
It is understood that all lending has one common challenge – how to get the money back. This is the central concern that impacts who is granted a loan, the amount that can be borrowed, the interest rate, and the repayment method. Unfortunately, the question of repayment can not be fully answered, which leads to an inherent risk of lending money to an individual or business.
Lending services currently use a variety of methods to help make their loan decisions. For example, for a small-scale personal loan, they may request a credit score check and ask for a bank state for a specific period of time. When it comes to a larger loan, they may also require collateral to be put against the loan, which you may lose if the payments are not met – such as a house or car.
These tactics to ascertain loan agreements have flaws. The level of accuracy obtained from a few bank statements is limited, and these documents can be easily falsified. Even the humble credit score check has weaknesses as it only captures a single viewpoint of an individual's financial situation. There are many people that have a poor credit rating despite having high salaries and never having missed a bill payment. This is a problem people who have recently moved to another country experience or those that predominantly pay for goods via cash. Inaccurate and incomplete data is a significant concern when it comes to making finance and lending more inclusive.
Once a loan has been granted, there is then the headache of sorting out the repayments. A lending service will constantly be receiving payments, but unlike a simple money exchange like that of a retail site, their payments require a lot more tracking. Each repayment will need to be matched to the customer and deducted from the loan balance accordingly. Incorrect payments can cause a lot of problems, including the need for manual reconciliations and inaccurate records. This can result in lenders wasting a lot of time chasing payments and correcting mistakes.
Traditional lenders tend to accept that the masses of administration are part of the cost of doing business, but it need not be. Embedded finance helps solve many of the problems lending companies face daily and can save them a considerable amount of time and money.
Within the fintech world, embedded lending is still a relatively new topic. The demand and need for lending to SMEs have seen a boom in technological advances in the last decade – leading to better decision making and operational efficiencies. However, none of these advances has had the impact that embedded lending has the potential to bring.
FACTORS DRIVING FINANCIAL INNOVATION
As mentioned above, embedded finance has emerged due to the advances in fintech. There is an ongoing trend toward wanting innovative financial offerings to source a loan at the point of sale or via the click of a button. Some of the main driving factors behind embedded finance include:
- API integrations – API (the acronym for Application Programming Interface) is a software intermediary that allows two applications to communicate with one another. API integrations allow for faster, cheaper, and more secure financial service enhancements. In the past, new capabilities would require extensive programming resources and could take months or even years to develop into a usable tool. There was also the issue of getting through stringent governance, risk and compliance (GRC) analysis. API integration simplifies the process of adding new interactions, and while GRC is still fundamentals, rigorous protocols are helping to clarify the security requirements and streamline adoption.
- Open banking – The trend toward open banking was initially due to regulatory requirements. It has recently become a competitive advantage for financial institutions with the mindset and resources in place. Open banking refers to the regulations, technical specifications, and implementations needed to improve the consensual and secure sharing of customer financial information. It did not take long for financial institutions to realise that they can monitories the gathering of customer financial information. As a result, there has been a shift in attitude from no longer needing to be the sole owner of the client – instead, they are becoming more open to forming partnerships with financial service providers. As financial innovation accelerates, there will be no single institution which can provide all the best opportunities. Open banking can facilitate the mix and match of services to meet customers' needs.
- Digital-first consumers – In the past, the finance sector has been a little slow to adapt its business models and practices to meet customers' evolving demands. Due to their risk-averse strategies, they tend to be more cautious in their business offerings. In addition, the rigid mindsets of many banks complicate potential change – no matter how positive that change may be. On the other hand, modern consumers have become used to instant gratification and have a vast array of options at their fingertips. For example, it is now feasible to open a new account in a matter of minutes, and new financial services offered by non-traditional banks appear on the market every day thanks to fintechs. It is not uncommon for customers to have several financial apps. They are open to sharing their information across multiple accounts as long as security and trust are established and maintained between the provider and customer.
Simplifying and speeding up access to financial innovation drives consumer acceptance. Embedding finance into other functions is the easiest way to access new consumers. In the current landscape, depending exclusively on core offerings will not be enough to keep traditional financial institutions ahead of their competitors. Embracing fintech and offering value-added financial services in addition to their core offering will help build a strong foundation for their future growth.
In the digital age, business expansion should be about helping customers grow as the financial company grows. With this mindset, embedded lending has the ability to elevate, rather than eliminate, companies across industries. In addition, B2C embedded finance can play a massive part in B2B growth with BNPL at its core. BNPL enables customers to access credit at the point of sale and pay in instalments over a pre-agreed time period.
The demand for B2B SME lending in the UK and Europe has sored in 2022, making embedded lending more popular than ever. The more comfortable consumers and businesses become with BNPL, the greater the confidence they will have in the technology that facilitates embedded lending.
While the growth in BNPL is well documented, less is known about the rapid growth of eCommerce platforms and payment service providers offering alternative lending solutions to businesses. New fintechs are introducing advanced technology to risk assessment and credit checks – resulting in improved outcomes for SEMs. They are now able to access more tailored and affordable financing. Risk modelling that adopts a broader source of data allows for a higher number of businesses to get loan approvals.
Embedded lending also offers the potential for SME revenue-based repayment options – instead of the current fixed amortisation repayment schedules provided by traditional lenders, which provide limited flexibility during revenue fluctuations.
THE FUTURE OF EMBEDDED FINANCE
Embedded finance has the potential and momentum to revolutionise the loan industry completely. In addition, it has the flexibility and universality to be applied by any company or industry with a transactional element. Even the incumbent financial institutions recognise its value and are slowly taking up new practices as they have begun to appreciate the opportunities embedded finance can provide.
The banks are aware that their legacy systems and processes cannot make the real-time decisions needed to sell embedded finance products. Although they can migrate to new technology, it would be a massive investment and challenging to achieve. So instead, they are choosing to partner with talented fintech start-ups and achieve their goals through collaboration.
Embedded finance requires what is known as a "paradigm shift" in thinking. The finance product is supplementary to the underlying sale and not the main thing the buyer was initially looking to purchase. For example, a consumer goes online to buy a new sofa, not purchase furniture protection plans, and sign up for a BNPL option, although they might buy all three. In addition, many banks and insurance companies have distribution networks whose purpose is to push products. Vice versa, embedded finance depends on a "pull" logic where customers sign-up for the financial product at the point of need.
This has resulted in embedded finance providers needing their partners to view their financial products through a technical lens. They are offering digital products that combine the underlying financial product and API integration to make it available to partners. Banks and businesses looking to capitalise on new opportunities need to assess their existing processes and tools to figure out which can be readily enhanced through an embedded solution. They can then research and reach out to relevant fintech parties to provide a modern and frictionless embedded finance solution.
CLOSING THOUGHTS
Embedded lending has the potential to change the way both businesses and consumers borrow money. It is making many services and products more accessible to customers, allowing companies to flourish. The work being done by fintechs is also assisting banks and financial institutions in moving towards a more modern approach to their service offerings. Customers are able to access loans when needed, in a quick and simple way.
It is projected that the number of companies offering embedding financing services will continue to grow in the UK in the coming years. However, European fintech providers will likely catch up, wanting to make the most of the opportunity to consolidate their market position and challenge existing competition.
The growth in embedded services is not limited to eCommerce platforms as it also opens some exciting opportunities for B2B providers. For example, businesses will be able to access loans quickly and easily from their providers to access products and services to allow them to make and increase sales. The embedded finance sector is a space to watch post-pandemic.
FREQUENTLY ASKED QUESTIONS (FAQS)
How big is the embedded finance market? Embedded finance is seen by many as the next big thing, with the market estimated to exceed £7 trillion in the next 10 years. Already the global embedded finance industry is enormous and expected to have grown by 39.4% annually to reach over £241 million in 2022. Furthermore, the embedded finance industry is anticipated to increase steadily by 23.9% from 2022 to 2029.
Why are non-financial companies embedding financial services? The incentive for non-financial companies to embed financial services into their business model is not the aim to become a bank or compete directly with financial institutions. Instead, it is motivated by focusing on its customer's needs and determining a set of services to offer the customer. Innovative non-financial companies are not choosing to embed cash accounts or provide payment services because they want to become financial entities – it is because they want to assist their overall goal of attracting customers.
What is embedded business finance? Embedded business finance is the seamless integration of financial services adopted by non-financial companies. Fintechs are creating new and exciting ways for companies to access loans in a way that saves time and money. Many companies and consumers choose to utilise embedded finance rather than go through the traditional bank route. This is resulting in banks reaching out to fintech partners to try and stay relevant to their modern customers.
Is there a difference between fintech and digital banking? Yes, there is a difference between fintech and digital banking. Fintechs compete against the old traditional banking systems to provide new technology-led financial products and services. On the other hand, digital banking is the digitalisation of conventional banking services, activities and products. They are often offered via multiple online channels, applications and mobile platforms.
What do you need for a business loan? When applying for a traditional business loan, a company will need a lot of paperwork to back up its application. For example, they will be required to provide profit and loss and balance sheets for the past two years, most recent financial statements, business plan, tax returns and details of their bank statement. The process can be very tedious and time-consuming.
When might a loan be suitable and not suitable? Loans can be suitable for those wanting to pay for assets, requiring start-up capital, or instances, where the amount of money needed will not change. However, it may not be wise to take out a loan for ongoing expenses as it can be challenging to keep up with the payments. It is vital that the terms and price of the loan are fully understood before agreeing to one. This rule applies to both traditional bank loans and embedded lending services.
