Embedded finance represents a paradigm shift in the financial services technology industry, offering a seamless integration of financial products and tech into non-financial platforms.
This approach allows consumers to access banking, payments, insurance, and lending services directly within the ecosystems of their favorite brands and products, thereby enhancing the user experience and creating a more intuitive financial landscape.
With the potential to significantly expand financial inclusion and reshape consumer expectations, embedded finance stands at the forefront of financial innovation, promising to redefine the boundaries between traditional banking sectors and the broader digital economy.
Embedded finance refers to the integration of financial products such as banking, lending, insurance, and investment offerings into the ecosystem of non-financial applications and platforms. This integration is achieved through Application Programming Interfaces (APIs) that connect these platforms to services provided by financial organizations.
Historically, the concept of embedded finance isn't entirely new. An example is the "buy now, pay later" (BNPL) model, which essentially operates on discreet loans provided at the moment of purchase.
However, the widespread availability of APIs and smartphones has transformed the landscape, enabling consumers to access financial services on-the-go. This shift enhances customer convenience and allows businesses to foster stronger loyalty and open up new channels for revenue through their offerings.
Before going further with our analysis of embedded finance, there will be instances where we will refer to Open Banking. To make sure that we understand the difference between open banking and embedded finance, here’s a comparation between the two.
Open banking and embedded finance differ fundamentally in their focus and application. Open banking operates under a regulatory framework that empowers third-party providers to access and use banking data and functions via APIs, enhancing innovation and competition in the financial sector. Essentially, it involves banks sharing their data and services with external entities.
Embedded Finance, however, entails incorporating financial services into non-financial platforms, taking advantage of the open banking infrastructure to integrate banking and payment services into daily consumer and business platforms, thus expanding the financial ecosystem's reach.
There are multiple categories of embedded finance, all of them having a similar API model at their core.
Historically when we were referring to “embedded finance”, the first thought was in-app payments for marketplace apps such as Amazon or eBay, but new models appeared including: embedded payments, branded payment systems, embedded banking, embedded buy now pay later, embedded lending, embedded investing, and embedded insurance.
Embedded payments enable customers to complete purchases without leaving the app they're using, offering a frictionless payment experience. For instance, companies like Amazon and Uber incorporate payment systems that let users shop or ride and pay within the same app environment.
Similarly, platforms like Google Pay, Apple Pay, and Venmo allow consumers to store financial information securely, streamlining transactions across various services. Small businesses benefit significantly from this technology by using platforms like Stripe to accept payments instantly on-site, reducing the need for later invoicing and simplifying financial management.
Known also as merchant acquiring, this aspect of embedded finance empowers merchants to seamlessly accept payments from customers through various channels such as invoices, point-of-sale (PoS) systems, keyed entry, and web checkout. It caters to a diverse range of payment methods including credit cards, debit cards, Automated Clearing House (ACH), and digital wallets.
For companies with software solutions targeting small and midsize businesses (SMBs), embedding consumer payments becomes a critical initial step for their survival and future growth. This strategic move directly addresses the significant hurdles SMBs encounter in establishing payment acceptance mechanisms. By integrating consumer payments into their platforms, embedded finance solutions effectively remove the friction points, simplifying the payment process for SMBs and enhancing their operational efficiency. Since they may use the same embedded consumer payment system across many other services in their day-to-day lives, consumers also have better ease-of-mind while executing these payments.
Embedded finance revolutionizes B2B payments by integrating banking products into the operational platforms and systems that businesses already use. This integration eliminates the need for businesses to rely on traditional financial institutions or separate payment processing systems for managing their transactions.
Businesses can automate their accounts payable and receivable, access financial data in real time, and enhance cash flow management directly through their existing platforms, such as supply chain management, customer relationship management (CRM), or procurement systems.
Companies are increasingly leveraging branded payment systems to offer a more integrated financial experience. For example, the PayPal cash card enables instant access to funds within the PayPal ecosystem, functioning similarly to traditional debit cards but with the added benefit of loyalty rewards.
Amazon partnered with JPMorgan Chase to allow customers to use rewards points directly on purchases, blending loyalty with financial utility.
The evolution of buy now, pay later (BNPL) services represents a significant shift from traditional layaway plans, offering consumers the option to purchase instantly and pay overtime in installments.
This approach is seamlessly integrated into the checkout process on mobile platforms, with companies like Afterpay, Zip Co, or Wisetack leading the charge by offering interest-free installment plans, thereby enhancing the accessibility to expensive products.
The advent of embedded banking has opened up exciting opportunities for businesses to offer banking-related services directly. With technologies like virtual IBANs, companies can manage funds in multiple currencies across various accounts, making operations and financial management much easier. Working with a custom software development partner can help tailor these solutions to your specific needs.
Embedded lending transforms the traditional loan process by integrating it directly into consumer platforms. Customers can now access loans without visiting a bank, directly within the app or service they're using. This is evident in the fintech sector with companies like Klarna, which partner with retailers to offer financing options at the point of sale, offering instant decisions and simplifying the payment process for large purchases.
Point-of-sale (PoS) lending integrates credit options directly at the point of sale, allowing consumers to apply for and receive financing in real-time as they make purchases. This method is especially common in online and offline retail environments for higher-priced items, such as electronics, furniture, and large appliances.
Unlike traditional credit options, PoS lending offers a seamless, immediate financing solution embedded within the checkout process, typically with clear terms and interest rates disclosed upfront. It can include various repayment terms, such as 6, 12, or more months, and is designed to make larger purchases more accessible to consumers by spreading the cost over time.
This lending model benefits merchants by potentially increasing sales conversion rates and average order values, as it provides customers with an immediate, flexible payment alternative to outright purchase.
The pandemic has fueled a significant rise in embedded B2B lending over the recent years. This surge stems not only from the constrained access to conventional bank lending but also from how the Paycheck Protection Program has energized the online direct lending market. As observed by a bank executive, securing loans poses a challenge for small businesses lacking collateral and maintaining accounting records that aim to reduce tax liabilities, leaving banks ill-equipped to underwrite small businesses efficiently.
In the past years, American Express made it easier for small and medium businesses to obtain a loan with their Business Blueprint platform – offering an online and automated business line of credit.
Investment platforms such as Robinhood, Acorns, Revolut and Cash App have made stock market investing more accessible by embedding investment services within their apps.
Users can buy, sell, and trade stocks without the need for a traditional investment broker or adviser, making investing an integrated part of their financial management toolkit.
Embedded insurance simplifies the process of getting coverage by integrating it into the purchasing journey. For example, when booking flights online, travelers can directly opt for travel insurance, making the process straightforward and ensuring they are covered without additional steps or consultations. This convenience extends to various sectors, offering customers peace of mind with minimal effort.
Another great example of embedded insurance is Armadillo’s partnership program, offering subscription-based home insurance and a way of integrating into partners platforms.
Embedded invoice factoring seamlessly integrates factoring services directly into digital platforms, streamlining the invoice management process for users. By incorporating these services within a platform's interface, it eliminates the need for separate, external factoring solutions, making the entire process more efficient and less visible to the end-user.
Factoring itself is a financing method where businesses sell their outstanding invoices to a third party at a discount, receiving immediate cash flow while the factoring company assumes the risk of non-payment.
Using embedded finance for factoring is a great solution for small and medium-sized enterprises (SMEs) that typically struggle with cash flow issues and lack the time or resources to explore other financing options for their day-to-day operations.
Businesses that have worked with a banking custom software development partner have successfully implemented similar solutions, like integrating factoring services with economic intelligence agencies and creating automated decision engines to simplify customer service tasks.
Embedded finance, marking a transformative shift in financial services, has rapidly evolved from a novel concept to a substantial sector within the broader financial ecosystem. Here's a detailed exploration.
Payments and Lending Dominance: While payments and lending continue to dominate the embedded finance landscape, the sector is seeing growth in adjacent value-added services, including insurance, tax, and accounting services. This diversification underscores the sector's potential to encompass a broader range of financial services, further embedding finance into the fabric of digital platforms.
Value Proposition: The "better together" proposition of embedded finance — improving customer experiences, enhancing financial access, and offering cost and risk reduction benefits to companies — fuels demand across the value chain. Besides the obvious benefits for the consumers, embedded finance can bring some competitive advantages for your business such as:
Embedded finance represents a significant shift in the financial services landscape, offering enhanced customer experiences, greater financial accessibility, and new opportunities for businesses and financial institutions alike.
We're witnessing an expansion in the embedded finance market's potential. Providers are extending their offerings beyond basic payments and loans to include additional services like insurance, invoice factoring, taxes, and payroll. The future looks set to embrace even more complex areas, such as regulatory technology and compliance.
Retail and e-commerce platforms are at the forefront, utilizing embedded finance thanks to their advanced digital setups and universally accepted payment methods. Marketplaces in food delivery, ridesharing, and other services are also heavily utilizing embedded finance, streamlining payments for a range of users from restaurants to gig workers, often earning from debit card transactions.
Yet not all industries are embracing digital advancements at the same pace. Some, like real estate, are held back by their reliance on traditional payment methods and high-value transactions, making them less accessible for embedded finance solutions due to regulatory and legal hurdles.
In an interesting shift, some larger platforms are considering custom developing certain financial solutions in-house to capitalize on their scale for additional gains. This could include direct customer services like automated collections and credit risk management, areas where platforms are already becoming more self-sufficient in payments to boost profits.
Despite this, enablers remain crucial, providing the expertise and guidance platforms need to navigate the web of regulations and technology. While core infrastructure and licensing might still be outsourced, large banks could find themselves at a disadvantage, especially given regulations like the Durbin Amendment, which affects interchange fees and benefits smaller banks.
This environment presents both challenges and opportunities for traditional banks. Historically, banks dominated the finance chain from product creation to customer relationships. Embedded finance disrupts this model, relegating banks to regulated roles amidst shrinking profit margins. However, banks could pivot, seizing the opportunity to reinvent themselves, possibly by moving up the value chain or investing in platforms to regain competitiveness.
Embedded finance is drawing significant investment, indicating growth and the introduction of more user-focused financial services. As the sector matures, it promises to reshape consumer finance interactions and trust dynamics, expanding the market further and offering platforms a variety of partnership opportunities to best meet their needs.
To craft a successful approach in embedded finance, banks must fundamentally reevaluate their risk management strategies, especially given the challenge of extending services to unbanked customers through real-time credit assessment systems. This shift needs comfort from banks and regulators with third-party platforms making crucial credit decisions based on external, real-time data, affecting traditional financial balances.
Banks might adopt a strategic portfolio approach to explore embedded finance opportunities, focusing on four main areas: maintaining their dominant positions, broadening their influence on other platforms, improving their technology and innovating to disrupt new sectors.
The advent of embedded finance introduces a competitive edge against traditional banking, pushing for openness in IT architectures. Banks are encouraged to leverage what they already possess, expanding their services outside traditional realms to integrate seamlessly into the digital finance ecosystem. Enablers play a pivotal role here, offering comprehensive services including regulatory and compliance support to ease platforms into embedding financial functionalities effectively.
The allure of embedded finance is significantly anchored in its unique value propositions and benefits, which cater to a broad spectrum of stakeholders from consumers and platforms to traditional financial institutions. Here's a synthesized overview:
Embedded finance revolutionizes consumer experiences by offering integrated financial services within the digital platforms they already use. This integration means consumers can enjoy an easy process for transactions, whether it's making a payment, accessing credit, or insuring purchases, without the need to navigate away from their current digital environment.
Beyond convenience, embedded finance also opens up greater financial access. By leveraging data from consumer interactions within platforms, financial services tailored to individual needs and contexts are more readily available, often with better terms than traditional offerings.
For digital platforms (digital services, marketplaces), embedded finance presents an opportunity to deepen engagement with their user base. By integrating financial services, platforms can enhance the utility and stickiness of their offerings, encouraging more frequent use and longer session times.
Moreover, embedded finance introduces new revenue streams for platforms. Through fees from financial transactions, interest from lending products, or premiums from insurance offerings, platforms can diversify their income and improve their financial sustainability.
While embedded finance might seem to pose a challenge to traditional financial institutions by disintermediating them from their customers, it also offers substantial growth opportunities. Banks and financial services firms can partner with platforms to reach new customer segments, leverage new data for better financial products, and innovate in product delivery.
Financial institutions can capitalize on their regulatory expertise, capital resources, and risk management capabilities to become indispensable partners in the embedded finance ecosystem. This role allows them to participate in the value chain in ways that align with their strategic strengths, such as providing banking-as-a-service (BaaS) platforms or offering white-label financial products.
Here are some examples of how financial institutions are leveraging their position in the embedded finance sector:
The ecosystem of embedded finance is rich with diverse players, each contributing to a complex value chain that spans across financial services being integrated into non-financial platforms. Here’s an exploration of the key players and their roles:
Platforms, including e-commerce sites, gig economy platforms, and SaaS providers, have emerged as pivotal players in the embedded finance ecosystem. They own the direct relationship with the end consumer or business, embedding financial services like payments, lending, and insurance into their offerings.
Licensed or chartered financial institutions, also referred to as balance sheet providers, actively create embedded finance products. They handle regulatory and compliance services and provide the capital for lending and deposit offerings. To offer a comprehensive embedded finance solution to distributors, these providers often initiate partnerships with technology companies. For example, Stripe collaborates with Goldman Sachs and other banks to bring embedded finance to various platforms and third-party marketplaces.
Fintech enablers are the bridge between financial institutions and platforms. They offer the technology, software, and services required to embed financial services into non-financial platforms. This includes payment processing, risk management, compliance, and more. Enablers allow platforms that may not have financial expertise to offer sophisticated financial products.
For instance, companies like Marqeta focus on offering solutions for specific financial products, like issuing cards. Meanwhile, firms such as Unit, Bond, and Alviere run platforms that provide a variety of financial services to distributors, including deposits, transferring money, and lending options.
There are instances where a hybrid approach between banks and fintechs exists, for example American Express and their Business Blueprint platform fulfill both of the functions. They built their own technology layer on top of their own balance sheet, and they provide embedded finance products to small and medium businesses with no additional partnerships.
Regulators shape the environment in which embedded finance operates. Their role is to ensure consumer protection, financial stability, and compliance with laws and regulations. As embedded finance blurs the lines between different industries, regulators are tasked with adapting existing frameworks to new models of delivering financial services.
At the end of the value chain are the consumers and businesses that use embedded finance services. They benefit from increased convenience, access, and often personalized financial products. Their adoption and demand for integrated financial services drive the growth and evolution of the embedded finance ecosystem.
The embedded finance ecosystem is characterized by a complex web of collaboration and competition among these players. Platforms and fintech enablers work closely to integrate financial services, while traditional financial institutions must find their place within this new value chain, often through partnerships or as service providers. Meanwhile, regulators oversee the evolving landscape to ensure it serves the best interests of consumers and maintains financial system integrity.
The roles of key players in embedded finance are continually evolving. Platforms are increasingly taking on roles traditionally held by banks, such as offering loans or insurance. At the same time, financial institutions are exploring ways to leverage their assets and expertise in new, collaborative models. Fintech enablers are expanding their offerings and capabilities to support the growing complexity and regulatory demands of embedded finance solutions.
This dynamic interplay between various stakeholders is driving innovation and growth in the embedded finance space, ultimately leading to more integrated, efficient, and user-friendly financial services.
As the embedded finance ecosystem flourishes, it encounters a variety of challenges and considerations that stakeholders must navigate to capitalize on its opportunities effectively. These challenges span regulatory compliance, technological integration, and the strategic alignment of various players in the financial services and technology sectors.
One of the most significant challenges facing embedded finance is the regulatory landscape. As financial services are embedded into a broader array of platforms, ensuring compliance with a complex web of financial regulations becomes increasingly challenging. This complexity is compounded when services cross international borders, where differing regulatory regimes must be navigated. Platforms and their financial partners must ensure that their offerings comply with regulations governing data privacy (e.g. GDPR), consumer protection, anti-money laundering (AML), and more.
The integration of financial services into non-financial platforms requires sophisticated technology and infrastructure. This includes the development of robust APIs (Application Programming Interfaces) that allow for secure, reliable transactions and data exchange. For embedded finance software development, to make sure that everything fits in the right place during integration and to ensure the success of your project it is advisable that you find a reliable financial technology consulting partner or a technical team that is experienced in API development and financial data handling. The right experts can prove invaluable especially when dealing with a sector that's heavily regulated.
Platforms must also consider the scalability of their solutions to handle growing transaction volumes without compromising performance or security.
For traditional financial institutions, embedded finance presents both an opportunity and a strategic challenge. These institutions must determine how best to participate in an ecosystem where customer relationships are increasingly owned by non-financial platforms.
Embedded finance development fundamentally changes how financial services integrate with non-financial platforms. This emerging sector is quickly setting a new standard for retail, small and medium-sized enterprises(SMEs), and corporate companies, indicating a continuous need for updated technology and more sophisticated integration solutions.
The core of delivering embedded finance solutions lies in the integration of advanced technologies. Application Programming Interfaces (APIs), which are already considered an industry standard in traditional banking, are showcasing their importance in embedded finance too by facilitating the intricate communication required between financial and non-financial entities. This technology enables a wide range of digital platforms, from e-commerce sites to digital wallets, to offer banking, payments, and insurance services.
The embedded finance ecosystem is characterized by five key elements: interoperability, data containment, complex partnerships, vulnerable customers, and distributed risk. Each element represents a unique side of the embedded finance tech framework:
To manage the risks, organizations must develop comprehensive risk management frameworks that include:
We see three main sources of differentiation for embedded-finance distributors, balance sheet providers, and technology providers:
A strategic approach observed among distributors involves initially embedding basic financial services like payment processing or account deposits within their platforms. This strategy gradually incorporates more sophisticated services such as lending, aiming to fulfill a broader spectrum of customer financial needs.
Distributors vary in their approach; some create comprehensive financial ecosystems with a single technology partner, while others collaborate with multiple providers to diversify their offerings and mitigate dependence on a single entity.
For instance, Charles Schwab, a top investment firm, provides house mortgages through Rocket Mortgages and has enhanced its banking services by introducing a credit card for investors in collaboration with American Express.
Certain providers concentrate on developing specialized expertise within specific segments of embedded finance, like payment issuing, to dominate niche markets.
These specialists innovate by developing unique functionalities—for instance, enabling instant fund deposits to cards or integrating cryptocurrency payments—thus carving out new financial product niches for end-users.
However, the growing demand for integrated financial solutions suggests a shift towards offering a broader range of services to remain competitive and maximize synergies across financial categories.
For many entering the embedded finance space, navigating the creation, sales, and management of financial products presents a daunting challenge, compounded by regulatory and reputational risks, particularly in lending.
To address these concerns, technology providers are increasingly offering comprehensive support in sales, service, and risk management, or facilitating connections to partners who specialize in these areas. Such program management capabilities are emerging as a crucial differentiator, ensuring distributors can effectively deploy and manage financial products.
The future of embedded finance is poised for significant expansion, promising to further integrate financial services into the digital experiences of consumers and businesses alike. Here's an overview of what lies ahead:
Retail and E-commerce Leadership: Retail and e-commerce platforms, already ahead in utilizing embedded finance, will continue to lead the market. Their widespread acceptance of digital payments and the seamless integration of financial services into their platforms set a precedent for other industries.
Emergence of New Verticals: As embedded finance matures, we might see its adoption in less digitized sectors like real estate, albeit at a slower pace due to regulatory challenges and transaction complexities.
Platforms and Enablers as Primary Beneficiaries: The competitive edge will increasingly favor platforms that control customer relationships and enablers that provide the technological and regulatory infrastructure for embedded finance. Large enablers could use their scale to secure a significant share of the market profits.
Strategic Moves for Traditional Banks: For banks, the future involves navigating the unbundling of their traditional value chain. Success might involve moving up the value chain, offering enabling services, or investing in platforms to maintain relevance in an increasingly platform-dominated landscape.
Increased Adoption Across Industries: The adoption of embedded finance is set to grow, with innovations likely to come in areas like BNPL (Buy Now, Pay Later) and POS (Point of Sale) lending. These areas will continue to evolve, offering consumers more flexible payment options and financial services.
Navigating Regulatory and Operational Complexities: As the embedded finance ecosystem expands, navigating regulatory frameworks and managing operational complexities will expand too – proving to be a challenge. Success will depend on the ability to adapt to these evolving requirements while ensuring the security and integrity of financial transactions.
New embedded finance solutions developments are shaking up the banking world, bringing tough competition to the scene. For institutions and platforms already facing challenges with outdated technology, diving into embedded finance might seem too daunting as they try to keep up. However, some will flourish as they move from traditional to more open, flexible IT systems. The trick lies in crafting clear, practical monetization strategies, aiming to hit the scale that makes new investments worthwhile. It's smart to pinpoint where you can join in from the start, leveraging your strong points and what you already do well. Banks often have much of what's needed, so sharing these abilities externally can be a great starting point for their strategy.
If you are looking for a banking technology partner or guidance to help you with growing your embedded finance capabilities, we encourage you to schedule a call with our team of experts and see how we can help you achieve your targets.
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