How embedded finance is changing the future of financial services
- What is embedded finance?
- The importance of Banking as a Service (BaaS)
- Benefits of embedded finance
- Embedded finance trends to watch
- What embedded finance is doing for SMEs
- The future for banks and financial services providers
- Closing Thoughts
- Frequently Asked Questions (FAQs)
Embedded finance is completely changing the future of financial services. It is no longer the banks and financial institutions which are offering the vital financial products and services we have all become so reliant on to live our day to day lives and run our businesses. Pretty much any company can now offer bank-like services to their customers through fintech systems.
The financial services industry needs to adapt and find ways to appeal to its customers and quickly. It is incredibly challenging for them to stay ahead of the technological advancement and tools being offered by non-finance companies. They are held back by stringent rules and red tape.
An increasing number of alternative banking companies provide financial services, such as bank accounts, wallets, payments, and lending. These companies are embracing embedded finance by offering banking-like services with the aim of retaining customers and increasing their lifetime value.
Embedded finance can be a key monetisation lever for companies as it essentially makes them into fintech companies. There is a recent wave of companies of all types and levels of maturity considering and preparing to launch embedded financial services. This appeals to many customers as it means a consumer will be able to pay via the retailer, or a small business will be able to get a bank account from its accounting software.
The rising demand for embedded finance has seen banking as a service (BaaS) being offered by financial institutions in the form of bundle offerings. These are often white-labelled or co-branded services so that non-banks can use them to serve their customers. This article explores the basics of embedded finance and how it is impacting the future of the financial service industry as we know it.
What is embedded finance?
There are many explanations of the meaning of embedded finance, but they all boil down to the same thing – simplicity and a move away from conventional banks. To put it simply, embedded finance is when non-financial companies adopt and integrate financial services into their business offering. Companies embracing embedded finance are merging with financial service providers to offer services like payment processing, insurance and lending, which helps streamline financial services for consumers. It makes it much simpler for them to access these services when they need them.
In technical terms, embedded finance is when banking as a service (BaaS) is used to embed a financial application programming interface (API) into a website or app. The purpose of this is to combine financial services within other environments and ecosystems. This means that brands or companies "lease" access tools and services offered by embedded financial providers and use them to build their own financial products. Through technology, non-financial companies can provide financial products without the associated development and compliance costs.
One of the main reasons embedded finance tempts non-financial service firms is due to the way it can augment their existing revenue streams, launch new ones, and reinvent services they offer their customers – all integrated through an additional finance layer offering improved user experience.
It requires new technologies and capabilities to be able to make embedded financing possible as BaaS is usually to clients via APIs. This means there is a need for strong risk and compliance management of the embedded finance partners. Some fintech companies are now coming onto the market that offers to look after the intermediation of BaaS relationships. Banks also need to establish new business models – such as pay-for-use monetisation, B2B2C and B2B2B distribution capabilities, and careful consideration of branding
The importance of Banking as a Service (BaaS)
As touched on above, BaaS refers to a model in which licensed banks can provide non-financial companies with embedded integration of banking services. In the past, financial services (such as payment and lending) were exclusive to traditional financial institutions. These types of services require a banking licence which takes a lot of capital and the need to follow some strict regulations.
Non-financial companies may not be interested in becoming a bank, so going through all the red tape is not in their best interest. Instead, they want to focus on providing customers with their own alternative services – which is where BaaS delivers a solution. With BaaS, almost any business can provide their customers with a seamless user experience that incorporates financial features into their platform. As a result, non-financial companies can enjoy the benefits of an enhanced user experience without being subjected to any of the regulatory duties that fall to financial institutions.
Understandably, many banks are becoming increasingly concerned that distributing their products through partners may threaten their client relationships. However, if end-users continue to adopt embedded finance in such high numbers, banks will have little choice but to launch BaaS business lines. On a positive note, enabling partners to distribute banking products can be a low-margin, high-volume business for banks.
It is common for banks to struggle with cost structures as they are often based on legacy technology and managed through manual processes and operations. As a result, banks have to undergo some intensive digital transformations to be able to facilitate BaaS offerings. It is estimated that over two-thirds of banks have already undergone the required digital transformation and modernisations to be competitive in BaaS.
How the market will evolve is yet to be seen. One possibility is that BaaS and API banking will become as common as online and mobile banking – a channel that all banks will need to build and maintain. In that instance, it will be hard for banks to distinguish themselves with BaaS, so they will need to differentiate themselves based on their product offerings, rates, reach, and other competitive dimensions.
Another possibility may be that the market will be susceptible to returns to scale – similar to that of cloud computing which a few big players dominate. Suppose it ends up being a winner-take-all dynamic. In that case, the few BaaS providers ahead of the competition in terms of technology, analytics, and cost structure will likely form an overwhelming advantage which will be hard to beat.
Benefits of embedded finance
One of the great things about embedded finance is that it is for everyone – no matter the business size or sector. It provided non-financial brands with the opportunity to offer tech-savvy customers new and exciting opportunities. Embedded finance services can offer simplified transactions, new revenue lines, and the potential to strengthen existing customer relationships.
Embedded finance does not only help bridge the gap between businesses and customers, but it also brings B2B closer. As a result, several fintech companies are now dedicating themselves to facilitating payments and loans between buyers and suppliers. There is, however, much more to embedded finance as it does not limit itself to payments – it also includes insurance, lending and even investment. It has the potential to provide SMEs with an opportunity to access alternative forms of financing, which in turn will strengthen economies.
The growth of the embedded finance and fintech industry is paralleled by the increasing benefits it brings to both customers and businesses. For example:
- Resolves consumer pain points – One of the main benefits of embedded finance is how easy it is for consumers to use. By removing the consumer pain points, like a need to look for credit somewhere else, customers are more likely to complete the purchase and experience greater customer satisfaction. This is essential for achieving brand loyalty in competitive industries.
- Is financially profitable – For businesses, being able to offer embedded finance services leads to the opportunity to make a higher profit. The ease of service results in the likelihood of more consumers making purchases of an item or service and returning to do so again and again.
- Delivers usable business insights – As great as the convenience embedded finance offers is, it is not all about improved accessibility. It is also a tool for better understanding consumers, their spending habits and their developing needs. This data can be used to develop products and services which will sell well in the future.
Embedded finance trends to watch
The benefits embedded financial tools bring to businesses and customers are apparent, but how they can be implemented is a challenge. Here are a few of the top embedded finance uses which are changing the future of the financial services industry as we know it.
Buy now, pay later
From Amazon to Klarna, the buy now, pay later (BNPL) systems are creating a new line of credit for the modern shopper. Giving access to a broader range of products that can be paid for overtime empowers consumers to shop as they have never before. In addition, they can now invest in higher quality goods when they need them with the help of this integrated payment system.
POS (point-of-service) lending
Evolving from the buy now, pay later systems, integrated lending takes loans one step further. These kinds of financial tools can be embedded by businesses that are looking to finance larger or more significant purchases. Therefore they may need further information about the customer, such as data on their creditworthiness, to ensure they lend responsibly. By integrating lending tools with the technology provided by experienced software developers, businesses can safely and quickly allow customers to access credit while mitigating risk, all in one place.
Integrated insurance services
When consumers buy new products or services deemed valuable, they often want to protect them and ensure that their investment will not go to waste should the worst happen. This is where integrated insurance becomes relevant. By offering embedded insurance financing tools, a business can provide their customers with quick insurance coverage and help them select the best protection for their needs at the time of purchase.
Investments and trading
Investment banking has come a long way over the years. New fintech platforms enable clients to engage on a whole other level with the industry and invest in a way that suits them. In addition, embedded finance tools being added to investment applications allow users to connect with their brick-and-mortar banks and invest in ways that meet their financial needs and spending habits.
New finance technology-as-a-service tools are quickly emerging to offer solutions for invoicing, customer acquisition and everything in between. These sleek tools are added to company offerings to simplify their customers' journeys. It results in consumers being able to make financial transactions and complete their purchases without needing to leave the shop they are purchasing with.
What embedded finance is doing for SMEs
In today's market, powerful platforms use embedded finance tools to offer SEMs financial services to support their growth – such as transaction banking, payments, and loans. These platforms allow SMEs to have a smooth, transparent experience with integrated financial services to encourage a unique banking relationship.
The new trend of embedded finance enables contextual opportunities to be created – providing BaaS that businesses and their customers need and when they need them. A study by Plaid reported that 88% of companies that have implemented embedded finance had seen an increased engagement with their customer, and 85% stated that it is helping them win a more significant portion of market share.
It is not such great news for traditional banks, as the new wave of embedded finance has brought with it an increased competitive threat to the SME market. However, if they are willing to make some significant technological investments, there is an opportunity for the banks to grow too. The technological companies which are operating in the different sectors (such as collaborative tools, accounting software and marketplaces) are already well-positioned in the market. They can offer financial services to SMEs that bring added value to their everyday operations.
The banks have a massive opportunity to play a significant role in this emerging trend of embedded finance. There is even the prospect that the banks themselves become the platforms allowing SMEs to plug into the bank APIs and offer added value services. In addition, banks can monetise access to their API and distribute their financial products and services via third-party providers.
The future for banks and financial services providers
The financial services industry is feeling the pressure of embedded finance. There is the concern that many of their previously lucrative services will fade into the background as BaaS providers develop technology which can be seamlessly integrated into non-financial services companies. If this ends up being the case, several existing financial firms will likely abandon the B2C component of their branding. Instead, they will need to focus on B2B vendor relationships with the companies that are embedding their services.
Financial companies that will not be jumping onto the embedded finance train will likely need to nurture their financial advice services. Many customers value this service line and prefer to go to established and trusted financial firms. They want to be able to think about their finances, and financial service providers should be prepared to offer them actionable insights. In addition, customers want to know their financial service providers have a detailed understanding of their financial goals and wellbeing and be able to provide the tools needed to reach their financial goals.
Embedded finance makes the world an even easier place to spend money. As a result, financial service providers can play the essential role of holistic advisers. They can give consumers a complete picture of how their finances and spending activities stack up against their money goals.
One of the big goals is the development of super apps which will provide more than financial services – they will allow consumers to conduct almost all their transactions seamlessly from one place. Unfortunately for traditional banks and financial services providers, they have little hope in developing super apps due to their legacy systems and regulatory hurdles. However, the lofty goal does remain a possibility for non-financial platforms.
For banks and businesses alike, embedded finance can offer tremendous opportunities. It reduces our reliance on individual banks but opens the doors for forward-thinking institutions. These fintech companies are creating new routes to market and more efficient business models based on technology, value and customer service.
In the changing financial services market, platforms, institutions and service providers will need to be able to adapt to survive. The embedded finance future means traditional banks and institutions alike will need to align their services with the needs of their market. In addition, they will need to work with partners to create a compelling and valued proposition– which starts with a willingness to innovate.
Frequently Asked Questions (FAQs)
Does embedded finance pose a threat to banks?Research shows that an increasing number of SMEs are interested in embedded banking products to help them run their day to day business – such as accounts and cards. The banks may lose a significant SME revenue to embedded finance companies because their small commercial customers start to use the new tools available for their standard transactional banking. The banks are unlikely to be at risk due to the loss of primary accounts, but they will share part of the wallet as their customers use embedded finance services for more of their banking needs. SMEs will likely build custom product bundles through multiple providers to create financial tools which work best for their needs.
Why will small businesses use embedded finance services?One of the major advantages of embedded finance services is convenience. The admin that goes into managing the practical sides of business banking can be incredibly time-consuming for business owners – such as logging into another secure website to make a simple bank transfer or having to fill in various online loan applications. Through a digital embedded finance platform, it can include pretty much everything they need in one login, even financial management and analytics tools. There are already non-bank payment processors that offer merchant analytics tools that can be used to drive customer insight out of transactional data.
What types of businesses can implement embedded finance?Almost any business that sells a service or product can embed finance into their sales. However, embedded finance tools are designed for those that trade online or via an app. There are virtually no limits to the type of non-financial transactions into which you can embed finance. For example, a small jewellery business can sell insurance, a local carpenter could offer payment plans, or a bookkeeper could offer a savings account to their clients. Embedded finance opens so many new service lines that small businesses can offer their customers, whatever their size or industry.
Are embedded banking and embedded finance the same?It can be easy to misconstrue that embedded banking and embedded finance mean the same thing. Embedded finance is an umbrella term that encompasses all financial services. These services can be provided by both banking and non-banking businesses and have been designed with the customer's perspective in mind. On the other hand, embedded banking integrates banking services such as digital wallets, BNPL plans, and banking services into non-financial businesses.
How are Fintechs becoming part of the embedded finance revolution?Fintech effectively assists banks and other businesses in launching financial solutions in a fast and economical way. They offer unique platforms for B2B and B2C companies based on their individual requirements. The B2B businesses working with fintech are enjoying all embedding finance has to offer – as they get to exercise control over their product deployment, feature set-ups, and product flow. In comparison, B2C companies are able to adopt retail banking platforms and a more direct-to-customer approach.
What is embedded fintech?Embedded fintech is the term used to describe the adoption of fintech services into the business processes of financial institutions. Examples of these services include money management, data security, and identity protection. Banks need to keep up with the abundance of fintech companies emerging by offering their customers a more digital and integrated experience.