Embedded Finance a New Paradigm for a New Normal world and how it is Revolutionizing Financial Services.

The implanting or embedding of financial services onto non-financial platforms, technologies, or product mechanisms intends to provide financial products to customers right at the source. More and more non-banking companies offer financial services, such as wallets or bank accounts, payments, and lending. The companies’ embrace of embedded finance—banking-like services offered by nonbanks—aims to retain customers and increase their lifetime value. Venture capitalists, like Angela Strange at Andreessen Horowitz and Matt Harris at Bain Capital Ventures, for years have encouraged their companies to consider ’embedded finance’ as a critical monetization lever, “making every company a fintech company.”

Embedded finance uses financial tools or services — such as payment processing or lending — by a non-financial provider. Embedded finance is designed to streamline financial processes for consumers, making it easier to access the services they need when they need them. Now, with embedded finance, they can purchase and get credit at one place: ‘the point of service.’ Some of the well-known examples of embedded finance include Amazon’s EMI loan options. However, one of the most notable examples of digitization is in the fintech sector, mainly how traditional businesses engage finance on a new level by integrating financial mechanisms into their overall business plan. The era of embedded finance is taking over, and with an estimated market value of over $138 billion by 2026, it’s clear that it’s not just a financial fad. It is the future.

Anyone can be a banker these days, and you need the right code. Global brands, right from Amazon and Mercedes to Walmart and IKEA, are eliminating the traditional financial middleman and plugging in software from tech startups to provide customers everything from banking and credit to insurance. For established financial institutions, the warning signs are flashing. So-called the embedded finance – a fancy term for companies integrating software to offer financial services – means Amazon can let customers “Buy now pay later” (BNPL) when they check out. Likewise, Mercedes drivers can get their cars to pay for their fuel.

But, for now, many areas of embedded finance are barely denting banks’ dominance. Even though some upstarts have licences to offer regulated services such as lending, they lack the biggest banks’ scale and deep funding pools. But if financial technology firms, or fintechs, can match their success in grabbing a chunk of digital payments from banks – and boosting their valuations in the process – lenders may have to respond, say, analysts. Stripe, for example, the payments platform behind many sites with clients including Amazon and Alphabet’s Google, was valued at $95 billion in March 2021.

  • Embedded finance investment jumps in 2021, shows data
  • Buy now pay later (BNPL) deals take centre stage
  • Fintech market valuations leapfrog banks

Origin of Embedded Finance:

In the not-too-distant future, nearly every company will be a financial services company and get a significant portion of their revenue from financial services. It is the infrastructure driving this fundamental transformation and, more importantly, how it will fundamentally change banking for everyone. for startups, you’ll be able to launch your companies faster and cheaper. For existing financial service institutions, you might finally be able to launch new products quickly or spend less on IT maintenance. For every single company, even those that have nothing to do with financial services today, you’ll have the opportunity to launch FinTech for the first time. Finally, all of those benefits will accrue to us as consumers in the form of more choices, better products, and more affordable prices.

This change is so badly needed the current state of the industry is pretty poor. Many of us probably feel apathetic towards our banks, but if you’re part of the millennial or Gen Z generation who saw your parents go through the financial crisis, 28% trust their banks to be fair and honest. These institutions hold our money that is a far cry from providing delightful products, and that’s if we’re lucky enough to have access. Fifty per cent of people in the developed economy live paycheck to paycheck and often live in an entirely different financial services system. They need financial services more. They have fewer options, and they’re much more expensive. In these situations, you most definitely don’t love your banks. Therefore, why has the status quo persisted for so long despite extreme levels of customers dissatisfaction?

Innovation in any industry is complex. Innovation in the financial services industry is extremely tough. We take the existing institutions, many of which have been around for over a century. They have a large brick-and-mortar retail footprint. So it’s hard to cut costs quickly, think tons of long-term leases and then it’s hard to roll out new products rapidly. The businesses are training thousands of employees across the country. Then we read about these billion-dollar-plus IT budgets, but at some larger banks, seventy-five per cent of those dollars are spent on maintaining the products we don’t already love.

So this is an opportunity for startups. But there are enormous challenges. Here too, it’s a highly regulated industry; you’re dealing with multiple regulators across state and federal, and then it has a very complex infrastructure. So given all of these challenges, why am I so optimistic about the future? There’s a parallel here. It used to be quite hard to start a software company. Many of you probably remember 10 to 15 years ago; your first step would be driving to a computer store. You’d buy physical servers; you probably load them up in a truck that you’d borrowed. You go them back to your office to rack them in a server room. You’d buy some software licenses; you write some code for a database hundreds of thousands if not millions of dollars later, you could finally start building the product that you wanted to bring to the market. Now, this sounds anachronistic.

Today, anybody can get started with a credit card on the laptop sitting anywhere. Why? “Amazon Web Services” brought all of this ‘Infrastructure-as-a-Service(IaaS).’ It dramatically reduced the cost of complexity but what it really did was unleash thousands of experiments. Amazon Web Services Era is Coming to Financial Services.

For centuries, financial services have been the birthright of banks and allied financial institutions. Consequently, it was challenging, albeit practically impossible, for others to offer these services with numerous restrictions in place. However, as days went by, the industry saw the rise of the Open Banking movement, followed by the uprising of fintechs Globally. As a result, entry barriers for non-financial players were relaxed, and other non-banking institutions could function on par with the banking industry. The embedded finance buzz started with payments where the user could pay for the ride or product without navigating to another app. Today, banking, insurance, wealth management, and consumer lending have also come under the umbrella of embedded finance. These advancements have opened avenues for non-financial entities to provide financial services with APIs as the driving force. As a result, they don’t need to go through the painful process of setting up a fintech division or overhauling their systems.

Growth drivers:

The growth drivers listed below make embedded finance the most avant-garde innovation in the Fintech world-

  • The radical change in customer expectations and behaviour
  • Willingness to try non-traditional channels for credit
  • Less hesitancy in sharing personal data
  • Ongoing COVID-19 Era

Why is Embedded Finance beneficial for every business?

Embedded Finance is all about being where your customers are. So let us look at some of the tenets of Embedded Finance in its new form.

  • Delivering the value of financial products within the captive ecosystem
  • Simplifying the customer interaction with the financial ecosystem
  • Enabling financial transactions using customer footprint
  • Capturing value for the core business offering
1. Better Payment Experience:

One of the significant obstructions e-commerce businesses face is losing control during the customer checkout journey. Instead of redirecting consumers to external portals, they must ensure that the entire process happens in one place. Embedding payment APIs in the e-commerce platform comes with a dual advantage. Firstly, delivering a superior payment experience and secondly, understanding customer payment habits. Additionally, financial interaction between the players will be well-synchronized, leading to faster checkout and settlement process.

2. Growth in revenue and key revenue metrics:

Showcase platforms could unlock new sources of revenue by offering alternative payment methods to their customers. E.g., if the target customers are Gen-Z, then offering BNPL solutions would make perfect sense. Besides, they can also deliver an increase in Average Order Value (AOV), Customer Lifetime Value (CLTV), and a happy customer leading to customer retention.

3. Automated Bookkeeping:

Financial bookkeeping in order is the primary responsibility of every organization, given that this process is manual, error-prone, and time-consuming. They resulted in the loss of receipts, mismatched entries, and other critical errors. By embedding financial APIs, businesses can automate bookkeeping, enhance operations strategy, deter fraudulent activities and free up resources for strategic initiatives.

4. Increased Margins and Cost Reduction:

Embedded finance provides financial institutions access to the most lucrative set of customers. They can tap into the distribution capabilities of the eCommerce platforms by offering niche credit and payment experiences. Additionally, the effective management of the credit life-cycle and the underwriting process would significantly increase the customers’ margin and reduce costs.

5. Affordable, Customized, and Niche:

In today’s day and age, customers are looking for customized yet affordable choices. Embedded finance offers consumers an assortment of flexible, user-friendly, and cost-effective financial services. Furthermore, they can be modified to fit the requirements by making them contextual finance offerings.

Getting started with Embedded finance needs clarity on the following areas.
  • Customers: Who is your target market, and what are their business needs?
  • Needs: What are the most critical financial needs of your customers?
  • Experience: What is the customer experience (CX) you envisage?
  • Business: Which business will benefit from adopting & providing finance?
  • Impact: What is the impact of this adoption on your customers?
  • Operations: How much effort you’re ready to handle?
  • Technology: How well does the tech stack convene with the core business?

What are some of the key manifestations of Embedded Finance?

1. Embedded Payments:

With the advent of ‘Digital Wallets,’ most often, we leave our physical wallets back home. Paying with dollar bills causes consumers’ physical pain. In some cases, that pain could be sufficient for the customer to reconsider a purchase—embedded payments enable hassle-free buying for customers. Instead of digging their wallet for a credit card or cash, embedded payments make that purchase possible, and painless using an embedded payment app with just a few clicks is all that is required to alleviate that pain completely.

Following are some of the use-cases of embedded payments: Ride-sharing apps like Uber or Grab, where you do not require to hand the money to the driver for the ride. Instead, you pay for the ride on the app once you reach your destination. Even Starbucks or Coffeday offers an app where people can order and pay from their phones. The customers also get an incentive of rewards that can be redeemed against future purchases.

2. Embedded Banking:

Embedded Banking is not another term for Embedded Finance. There are instances of companies offering banking services designed to replace traditional financial institutions’ checking or savings accounts. E.g., the ride-sharing app Lyft provides a debit card to its drivers, thereby enabling them to get instant payment. It also gives them the choice of setting up a separate savings account through its program. Likewise, Shopify’s banking feature encourages the merchants on its platform to set up a different bank account for business revenue instead of using their personal savings account.

3. Embedded Lending:

Traditionally, lending means visiting any allied financial institution or bank and filling out a tonne of paperwork. However, today, ’embedded lending’ allows a customer to avail credit facility right at the ‘point of purchase’ without any hassle. E.g., Afterpay and Klarna let customers divide their purchases into Equated Monthly Instalments (EMIs), and club other offers to enhance customer stickiness to the platform.

4. Embedded Insurance:

An insurance agent, broker, or website are the options available when buying an insurance policy. It is a painstakingly long process with its literature, which often can intimidate the customer. However, today, ’embedded insurance’ simplifies this process by offering it part of the purchase experience. E.g. Tesla offers its customer insurance as part of the purchase. In addition, these embedded insurance are way cheaper when compared to a third-party insurance provider.

5. Embedded Investment or Wealth Management:

The last decade of technological innovation has opened up several avenues for building wealth. Many individuals have started to build a portfolio to grow their wealth. However, wealth management still remains a mystery to many due to its complicated nature. Embedded investment programs intend to transform that challenge by providing easy and affordable access to funds and stocks. A classic, e.g., would be Acorns, an embedded investment app that rounds a user’s spare changes from purchases. The app user is set free from tracking the stocks and their behaviour to manage their wealth. Acorns automatically adjust the portfolio as per the current market condition. Some of the other use-cases of embedded investment apps include Small-case, Ind Money, or Zerodha.

The Rise in demand for embedded finance in the market:

Many trends have ignited the need for embedded finance offerings. Understanding them will help businesses to know why there is a rise in demand for embedded finance. A few critical trends are listed below.

  • Customer’s today seek holistic experiences facilitated by an integrated ecosystem of products, people, and financial offerings on a single platform.
  • With the rise of fintech, there has been an exponential growth in the adoption of emerging technologies. But banks are restricted from offering innovative customer-friendly services for payments and lending for several reasons, including regulatory authorities. Hence Banking-as-a-Service(BaaS) has emerged as the most viable alternative.
  • Over the last few years, directives like the Payment Services Directive (PSD2) and Open Banking have popularized the development and use of APIs. Companies are modernizing IT and BaaS to upsell and cross-sell product offerings.
  • Businesses are looking for ways to transcend traditional revenue streams and increase profits based on targeted offerings and payment experiences.
  • Digital experiences have become paramount, and non-financial entities are offering embedded finance as part of their product module.
  • Partnering with upscale brands that boast brand loyalty has become the perfect platform for banks to reach the Gen-X target market.

To summarize, embedded finance offers the customer the ease and convenience to transact without any interventions. Additionally, it enables businesses to maintain a unique individual identity for enhancing customer experience. Besides, Embedded finance also provides opportunities for industries to upsell and cross-sell financial products. In a nutshell, embedded finance will dramatically change the traditional way the business works. Embedded finance brings about collaboration and sustained innovation among banks, businesses, and fintech. They bring a fresh perspective to enhance the user experience by simplifying and transforming cumbersome processes. As a result, Fintechs will be able to form strategic partnerships and, at the same time, be competitive in their offerings.