Embedded Finance: The new B2B growth equation
By Miles Paschini, CEO of FV Bank
Embedded finance has been out there for quite a while, but those were the pandemic years when this disruptive paradigm rushed into our everyday lives. The necessity of supporting a comparable level of prior consumption levels during the periods of mass isolation became a great source of motivation for businesses to streamline the purchasing process.
As it turns out, both businesses and customers enjoy it. While customers have become attracted to the new seamless way of accessing products and services, companies that have adopted embedded finance have seen notable increases in revenue.
From the new trend of making purchases, embedded finance and Banking-as-a-Service (BaaS) have evolved into a market of their own, moving $22.5 billion in 2020, and are estimated to potentially generate up to $230 billion in revenue by the year 2025, according to Lightyear Capital’s estimations. Moreover, the same research shows that the market may grow into a huge $7 trillion industry within the next ten years, eclipsing the cumulative value of today’s top 30 banks.
What is embedded finance and its use cases?
At its core, embedded finance is a concept of incorporating financial products or services typically offered by banks into products or services offered by non-financial businesses. While all the actual transactions are performed via licensed banking services, the end user experience is seamlessly and conveniently embedded into the product they are using.
What an end user sees is money in their account available for sending anywhere 24/7 or goods accessible for purchase via the buy now, pay later (BNPL) method along with other financial products and services at their fingertips.
The opportunity to lay your hands on a long-awaited new gadget from an online store, before paying full price for it, is a great use case of embedded finance. But this is only the tip of the iceberg.
Convenient consumer payments
The idea of incorporating embedded payments is as simple and revolutionary as using your smartphone to order and pay for a taxi ride: to capture customers at a point of their most frequent interaction with businesses.
The world’s most famous taxi aggregator now offers a wide range of financial services, including wallet and payment services, as well as a flexible API that allows Uber’s partners to integrate them for mutual benefits. Uber’s rival Lyft follows the same path by partnering with Stride Bank and Payfare.
Why does this work so well? Because companies motivate drivers to stay within the same ecosystem for as long as possible, offering instant payments, cashback on gas, car maintenance, groceries, and other services.
BNPL and embedded lending
Today, buy now, pay later (BNPL) is one key point of intersection of e-commerce and embedded finance. A report issued by Wordplay states that 13.6% of all e-commerce transactions in Europe (4.2% of the global volume) will be BNPL payments, by 2024.
The concept behind BNPL, which is a form of embedded lending, is to provide a target loan that would allow users to acquire desired products or services, without the necessity of paying full price at checkout. The very idea of getting a loan at a point of purchase is not new, but BNPL’s edge comes from the seamlessness and flexibility that legacy financial institutions would never allow.
Business loans are another form of embedded lending where fintech companies have managed to turn the tables on incumbent banks. Small to medium enterprises were not in favor of traditional lenders who considered them high-risk borrowers with little understanding of their needs.
Embedded lending, on the other hand, benefits from a vast, secure, and transparent infrastructure allowing more businesses to get financing. At the same time, fintech lenders can tap into valuable predictive analytics while enjoying the low-cost distribution of their financial products.
However, embracing the BNPL practices, without making customers wait for approvals from their banks, is just the cautious first step. Unlike incumbent banks, with their service-centric approach, the ultimate goal of embedded finance is to make ever more complex financial products available to customers directly at a point of purchase.
Incorporating tailored risk protection into the customer journey is another promising use case of embedded finance. Insurance coverage can be integrated seamlessly into customers’ purchasing experience when they need it the most.
The rapid growth of embedded insurance pushes fintech companies to explore multiple opportunities when it comes to adding insurance services at a point of purchase. Whether it is online banking insurance products or in-app rideshare coverage, embedded insurance can be integrated in many ways:
- as add-on coverage offered separately at checkout as an additional revenue stream;
- as a feature included in the core offering, in order to create added value;
- as an additional benefit to make a business stand out among competitors.
Facilitating seamless access to the digital asset market, without the necessity of switching between apps, is becoming a new milestone for embedded finance. This is where incumbent financial institutions and fintech companies can capitalize on the rising demand for this type of asset.
Businesses can embed buying, selling, paying, and holding crypto directly into their ecosystems, without building and maintaining the infrastructure for payment processing, custodial services, and meeting other essential requirements.
Both banks and retailers can benefit from partnering with crypto-as-a-service platforms making operations with cryptocurrencies more accessible to the general public. It can disrupt the payment industry and foster mainstream crypto adoption, including everyday payments, savings, investments, and cross-border payments.
Core drivers of embedded finance
The introduction of PSD2 and other similar directives all over the world has made it possible for non-financial organizations to get direct access to their clients’ financial data (with their permission). This enabled fintech companies to disrupt the banks’ monopoly on their user data and get access to financial licenses like payments, card acquiring, or FX accounts from local regulators.
The deep integration of APIs has provided non-financial businesses, like retailers, with tools to retrieve customer data from their banks and take over all formalities regarding each particular purchase on their behalf. This pivot toward an API-first mindset allowed for the creation of seamless payment experiences that users value so much.
The regulatory paradigm shift and rise of fintech and blockchain companies have become a solid launchpad from which embedded finance and Banking-as-a-Service were able to take off. There are several reasons why this market is here to stay and has a lot of potential to grow beyond current limits:
- Problem-solving. Embedded finance helps people without direct bank relationships engage in business relations and receive payments while eliminating the aspect of dealing with excessive paperwork. At the same time, it streamlines the payment process making purchases available to a wider audience.
- Producing more added value. Direct access to purchasing habits and payment preferences allows companies to approach users with tailored offerings. On the other hand, customers themselves can analyze their financial activities and receive timely recommendations to optimize their spending.
- Generating extra revenue. Fintech companies and SMEs have an unprecedented opportunity of generating extra profits by offering financial products at the point where they are less likely to be ignored. The nearly instant insurance program offered by Tesla is a sound example.
Main trends in embedded finance
While booming in popularity, the embedded finance and BaaS market is still in the early stage of its development pushing banks and non-bank financial service providers to experiment in pursuit of finding the most profitable niches. There is, however, a number of strong trends in the industry which can provide new players with an idea of where the market is going.
- Redistribution of trust in the financial services market. A survey conducted by international management consulting firm McKinsey shows that incumbent banks have already lost the trust advantage in the United States, while other non-bank companies keep exploring opportunities to convert their higher trust levels into additional revenue by offering financial services.
- Rising demand from the crypto and fintech sector. While cryptocurrencies continue to mature as an asset class, the appetites for complex financial products and access to banking infrastructure are growing exponentially. At the same time, fintech companies grow in numbers offering more and more sophisticated bank-level products. In order to keep up the pace, fintech companies require access to the BaaS infrastructure, without the necessity of becoming banks themselves.
- Exploring alternative distribution channels and revenue models. In order to compensate for the negative trend in banking revenue and profitability, incumbent financial institutions keep searching for new growth opportunities and offering their infrastructure and licensing to non-bank businesses. Especially those capable of scaling up fast.
- Demand for seamless, fast, and embedded payment experiences. Research shows that customers tend to flock around brands that offer mutual integration of their products and services into a single well-balanced ecosystem. From this perspective, embedded finance looks like the final piece of a puzzle that complements this model perfectly.
The road ahead, stumbling points, and market potential
The rise of openness in the banking sector and the search for new revenue models push even the most conservative and slow incumbent banks towards testing the unknown waters of the embedded finance market. Many of them face the inability to migrate from their legacy systems and choose to partner with tech startups, in order not to miss their cut.
To fully embrace the potential of embedded finance, the traditional banking sector is required to change the way it perceives itself and its relations with existing and potential customers.
While its current distribution logic demands banks and insurance companies to spread the word about their products in order to “push” them towards customers, embedded-finance companies let their customers learn information about the financial product only at the point of purchase.
Sometimes, it may require shifting from direct sales to offering white-label solutions or developing indirect models of interacting with the end user. Traditional financial institutions often perceive this as a drawback that reduces their brand awareness and affects their client relationships.
The fact that they are missing is that through incorporating the BaaS model and offering partnering non-bank businesses to distribute their financial services, banks could create a solid, high-volume, and cost-effective revenue stream.
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