What is Embedded Finance
Traditional banking and finance are gradually becoming a thing of the past. With rapid digital transformation, businesses, both B2B and B2C, are adopting modern practices regarding financial matters. One of these practices booming by leaps and bounds is embedded finance.
The term has enveloped a wide range of financial services as well as applications in the context of business. According to Juniper Research, the embedded finance market is poised to cross $138 billion by 2026. That’s a huge number, considering it’s just $2 billion shy of the total GDP of Hungary.
So what is embedded finance, exactly? What benefits can it offer for your business, in particular? And how can you implement it? Well, all these important questions will be answered right here!
What is Embedded Finance?
While there are different forms of embedded finance, the basic definition of embedded finance is that it’s the integration of finance into non-finance companies. It encompasses financial tools and services provided by non-finance companies, which financial institutes traditionally provide.
With embedded finance, businesses can offer credit to their customers (other businesses or end consumers) without needing to go through a bank.
You’ve probably seen instalment payment options with ecommerce stores these days that a third-party company covers. For instance, Klarna, a Swedish fintech company, is one of the most popular providers of embedded financial services. It’s not just a payment processor but also allows businesses to offer instalment payments to their customers for their purchases.
Embedded finance is not just limited to ecommerce stores as other businesses, such as Software as a Service (SaaS) providers, are also increasingly adopting embedded finance.
In simpler terms, it brings everything to the point of service for customers. They don’t have to go to the bank to get credit to buy something. They can just do so with the business they are buying from.
There are different applications of embedded finance. However, the gist of all these applications is that non-finance companies provide financial services.
For all its intents and purposes, embedded finance has disrupted some parts of the banking services, as far as the finances of businesses with their customers are concerned.
How Does Embedded Finance Work?
Embedded finance works in different ways depending on the business niche and the kind of financial services they are offering. To understand embedded finance better, let’s take a look at an example.
Ella runs a small luxury scented candle business with just 10 employees from her hometown. Her candles are produced using high-quality soy wax. Following strict quality and safety standards, she produces beautiful jars of candles in exquisite themes. With her costs high, her products also have a higher price tag.
Now, to get more customers to buy her candles, she thinks, what if they could pay her in instalments? But how can she provide such a service when she’s just a small business owner? She’s not running a bank with capital ready for her business or being able to offer credit to worthy businesses.
She’s sure, though, that with such a financing service on offer, she’s likely to get more customers who may not be able to pay for her products upfront.
Lucky for her, she hears of a company that offers software that integrates with her payment system on her website and offers customers the option to pay in instalments. The company handles all the finance part, including running a soft credit check, and partners with the banks. She doesn’t have to do anything other than manage the payments on the platform.
Well, that’s just one example of how embedded finance works.
Embedded finance typically involves services of a non-financial company, who in turn, may partner and work with a business. However, for businesses using the services of such a company, there’s no need to directly interact or work with a bank.
All the financial services offered by the business, for instance, instalment payments, are handled by the provider.
The payment system is integrated with their business systems, such as their website or mobile application.
Banking as a Service (BaaS)
When we talk about embedded finance, you’ll also hear the term Banking as a Service (BaaS). Since it’s directly related to embedded finance, it’s important to discuss it to fully understand it.
BaaS is a banking model where banks allow non-financial companies to offer financial services. Digital banks integrated their services with other businesses through APIs as a white label product or even co-branded.
This is an integral component of embedded finance as BaaS essentially enables non-banks to be able to offer some of the traditional banking services. Businesses can directly work with a bank and embed financial services in some mode or form. Alternatively, they can work with a provider that, in turn, works with a bank.
According to McKinsey, BaaS is inevitable in the future of banks, as when more and more businesses adopt embedded finance, banks will have to offer their services in this way. It also argues that such partnerships can be beneficial for banks as well, as it can be a low-margin but high-volume business for them.
All of this is only possible thanks to technology, specifically FinTech ventures that are paving the way for businesses to embed financing in one way or another.
This also means that banks also need to adopt modern technology to be able to provide such a product to businesses of different kinds and scales.
Uses of Embedded Finance
There are different implementations and implications of embedded finance. This is one of the reasons why this concept and technology is taking off, as it offers meaningful solutions to different types of businesses.
Here are four applications of embedded finance:
Buy Now, Pay Later (BNPL)
Buy Now, Pay Later, or BNPL, is the most common application of how embedded finance works. The example above is what BNPL is all about.
It basically allows retailers and businesses to offer their products or services to customers immediately without needing the whole payment upfront. Customers can pay for it later, commonly in small instalments or perhaps at the end of the month when they get their paycheck.
Many finance companies, particularly FinTech companies, are offering BNPL services to merchants and affiliates. The exact way the process works may vary based on the company, but the core idea is the same.
This essentially allows customers to buy products they may not be able to pay for at that moment or would simply like more flexibility with payment. They don’t even have to go to a bank or credit provider, as the very store they are shopping from provides this service.
Modern payment processing tools and services can rightly be considered embedded finance. These payment processing providers handle payments from customers from different channels. Rather than having a bank process the payments, a payment processing system handles the payments.
With payment processing, businesses can take payments from customers through different channels, such as debit/credit card, PayPal, bank wire, etc.
The payment processing company acts as a middle man between your bank and your customer’s bank, ensuring the swift and secure transfer of payments. It also brings all the payments under one system, making things easier for businesses.
Both brick-and-mortar and online businesses can use payment processing software.
Point-of-service lending is similar to BNPL, except this term is used for larger purchases. Unlike a baby stroller or a dress, point-of-service lending caters to more significant purchasing that requires verifying creditworthiness as well (for example, heavy machinery or a car).
However, all of that is happening at the point-of-service, i.e., with the business the customer is interacting with.
This is still a gradually growing application of embedded financing as more and more big companies adopt such services in their sales models.
Another popular use of embedded financing is embedded insurance. This way, businesses are able to offer insurance on purchases, even though they themselves do not run or own an insurance wing in their company.
Basically, just like how a business can integrate with a bank to use BaaS, they can embed insurance financing in their systems, allowing customers to purchase insurance directly from them.
Normally, people have to buy insurance directly from insurance providers. In this case, they can get it from the same place they are getting the product. It’s a win-win situation for both businesses and insurance providers.
Advantages of Embedded Finance
So why consider using embedded finance for your business? As it turns out, there are many potential benefits to taking this route:
Convenience for Customers
Whether your business sells to other businesses or consumers, clients are going to appreciate the convenience of financing through the point-of-service.
For instance, with BNPL options, customers can easily finance their purchases through the business directly without going through time-consuming forms or background checks.
For businesses, it adds another step closer to closing the sale. To target consumers that may not have the money right away or may be hesitant to spend it, such a financing option can be embedded into the website or app.
It’s clear that customers prefer the availability of such options. As many as 56 percent of Americans have used BNPL services.
For businesses, a bigger advantage of using embedded finance is that payments are processed quickly. Whether they are using the BNPL solution or offering integrated insurance or lending, with powerful APIs built into their merchant systems, they are able to process transactions faster.
As discussed earlier, this is also the highlight of using payment processing software. Merchants can process payments from different channels and sources in one place, and that too in a matter of seconds.
This also translates into more sales because customers are more likely to convert if there are fewer steps. With an integrated system, they don’t have to wait too long or fill out a lot of forms.
According to one study from Harris Poll, an overwhelming 88 per cent of respondents said that they wanted a faster checkout process. Here’s the deal: speed is the name of the game in the digital era.
With better speed comes more revenue. Combining with built-in financing options, that can allow businesses to increase their revenue and hit their target goals. By leveraging different embedded financing solutions, businesses can drive more sales regardless of size and niche.
Thanks to systems like BNPL, more consumers can be brought into the sales funnel. More customers are likely to purchase the product or service with such convenient options available.
Similarly, with swift and easy payment processing, customers are likely to come back for more. Slow payment processing or limited processing options can put off customers.
Thanks to powerful APIs, paired with intuitive front-end, embedded finance makes the financing services offered at the point-of-service seamless. In fact, many providers allow co-branding, so the whole process is uniform in terms of design.
For customers, that translates into a quick and easy process of buying products or services. Even the not-so-tech-savvy consumers can use the financing options provided by the business independently or with the help of a third party.
Challenges of Embedded Finance
The pros of leveraging embedded finance are many, but, at the same time, there are a few challenges as well that businesses and FinTech companies must address.
In most cases of embedded finance, businesses would be requiring customers to provide private data. For instance, some BNPL services may need more information from customers to verify their creditworthiness, especially when it comes to lending.
Not all customers may be willing to provide such data to a non-finance entity. According to statistics, the trust in organisations storing and using data in the UK is decreasing.
There’s clearly a need for businesses to ensure they can gain the trust of their customers when offering financial services within their platform, which brings us to the second biggest challenge.
Privacy and Security
When it comes to anything related to money, businesses need to double down on security. Any business utilising embedded finance will need to ensure they are following stringent security measures as well as complying with data privacy and protection regulations, such as GDPR.
Data breaches are becoming increasingly common, and businesses using BaaS may become easy targets without proper cybersecurity measures.
Ensuring small businesses and large enterprises are able to implement the same level of security as traditional financial institutes is a big challenge. However, it’s not one that cannot be accomplished as we have seen major strides in security in the FinTech sector.
Integrating more complex financial services may be a big undertaking for businesses still stuck in the past with technology. That would require major digital transformation efforts.
In other words, such businesses may need to retire or upgrade legacy systems so they can work with the APIs that connect with financial services.
This also means that such businesses would have to invest in upgrading their technology and adopting new systems.
How to Decide If Your Business Needs Embedded Finance?
Regardless of the many potential advantages of embedded finance, it’s worth noting that it’s a major business undertaking. Whether you’re a small business or a large organisation, offering financial services to your customers is a major undertaking.
Like any other big business decision, you may want to take a step back and evaluate whether your business needs or can benefit from incorporating embedded finance.
First of all, embedded finance can be used by big or small businesses alike. The difference is just the level of integration, as a bigger organisation may have a more complex payment system in place for its customers.
A good indicator of whether your business needs such an addition is consumer behaviour. By analysing consumer data, you can evaluate your consumer pain points and see if any of those pain points can be resolved with the help of embedded finance.
For instance, if your business sells products or services at a high price point, you may benefit from buying now and paying later service. Similarly, having integrated lending options for businesses dealing with other businesses may allow their customers to buy what they need in advance and fill their inventory.
Finally, you should do a cost analysis to determine whether any costs related to adopting embedded finance will pay back better in the long run.
Many experts believe that FinTech will become a part of every business, and embedded finance may just be enabling that. With embedded finance, even regular businesses can offer their customers services they would otherwise need to go to a bank for.
With the staggering growth of this sector for FinTech, it’s clear that embedded finance is not a fad. Businesses are eager to implement such solutions, and customers want more integrated experiences.
If you believe embedded finance is the next step for your business, Embed.io provides the opportunity to make your own financial services. Designed to empower businesses for growth, Embed.io allows businesses to customise banking, create financial products, and easily implement APIs to integrate with the existing user interface.