In today’s entrepreneurial world, the traditional bank may seem like a relic of the past for many small businesses. Instead, a new era of financial interaction is emerging, where entrepreneurs can seamlessly access banking services without ever setting foot in a physical branch. This paradigm shift is driven by the concept of embedded finance, where financial products are seamlessly integrated into non-financial platforms such as e-commerce or accounting software.
Gone are the days when opening a de- posit account or obtaining a business loan required tedious paperwork and countless trips to the bank. Now, entrepreneurs can achieve these tasks with just a few clicks within their preferred digital platforms. This convenience is made possible by the collaboration between software companies, banks, and technology providers, who work together to embed financial products into a single, user-friendly interface.
At the heart of this revolution lies the payments industry. Payments have emerged as one of the primary use cases for embedded finance, with numerous aspiring providers originating from this sector. The integration of payments into everyday business operations has proven to be immensely valuable, driving revenues in the embedded finance space to a staggering $20 billion in the United States alone in 2021.
Looking into the future, the potential for growth in the embedded finance market is substantial. Analysts predict that the market could double in size within the next three to five years, signalling significant opportunities for banks, fintechs, payments providers, investors, software firms, and other potential stakeholders.
However, despite the promising out- look, many players in the financial industry remain uncertain about how to embrace the embedded finance. Questions abound regarding what embedded finance entails, how to participate effectively, and what strategies are needed to emerge as leaders in this rapidly evolving space.
To seize the opportunities presented by embedded finance, industry stakeholders must embrace innovation and collaboration. Banks and fintechs must be willing to adapt their business models to accommodate the shift towards embedded financial services. Technology providers must continue to develop robust platforms capable of seamlessly integrating banking products into existing workflows. Investors must identify promising opportunities in the embedded finance space and provide the necessary funding to fuel growth and innovation.
Moreover, as the embedded finance ecosystem continues to evolve, it is essential for stakeholders to prioritize transparency, security, and regulatory compliance. Building trust among consumers and businesses will be crucial to the long-term success of embedded finance initiatives.
What Is Embedded Finance?
Put simply, embedded finance is the placing of a financial product in a non-financial customer experience, journey, or platform. In itself, that is nothing new. For decades, non-banks have offered financial services via private-label credit cards at retail chains, supermarkets, and airlines. Other common forms of embedded finance include sales financing at appliance retailers and auto loans at dealerships. Arrangements like these operate as a channel for the banks behind them to reach end customers.
What makes the next generation of embedded finance so powerful is the integration of financial products into digital interfaces that users interact with daily. Possibilities are varied: customer loyalty apps, digital wallets, accounting software, and shopping-cart platforms, among others. For consumers and businesses using these interfaces, acquiring financial services becomes a natural extension of a non-financial experience such as shopping online, scheduling employees to work shifts, or managing inventory. This more deeply embedded form of em- bedded finance is what has grown so significantly in the US in recent years.
The evolution of embedded finance has been enabled by fundamental changes in commerce, merchant and consumer behavior, and technology. The digitization of commerce and business management has massively expanded opportunities to embed finance in non-financial customer experiences. As much as 33 percent of global card spending—50 percent in the US—now takes place online, with a large portion of small and midsize companies in the US relying on software solutions for managing their business.
In addition, as digital natives came of age, they expanded the pool of consumers and businesses open to receiving all their financial services via digital platforms. Finally, open-banking innovation, supported by mandates in the European Union and market-led adoption in the US, has helped unlock latent demand by enabling third-party fintech players to access consumers’ banking data and even conduct transactions on their behalf.
Who Distributes Embedded Finance, And What Products Do They Offer?
Embedded finance is likely to emerge in any environment in which a critical mass of end customers (consumers or businesses) have frequent (often daily) digital interactions with the operator of the digital platform, which we refer to as the “distributor” of embedded finance. For a nonbank company acting as a distributor, embedded finance offers away to enhance the customer experience and create a new source of revenue without incurring the overhead associated with operating a bank.
The types of businesses well placed to offer embedded finance include retailers, business-software firms, online marketplaces, platforms, telecom companies, and original equipment manufacturers (OEMs). All these categories have seen high levels of activity and innovation in embedded finance during the past year or two.
Among embedded-finance distributors and their end customers, demand is al- ready maturing for a range of deposit, payment, issuing, and lending products. In addition to these tradition- al financial products, nov- el use cases are emerging.
For example, embedded-finance distributors are offering prepaid cards to employees as part of earned-wage access programs; giving merchants the option to use their deposit accounts for instant-payments settlement. Some are providing just-in-time funded debit cards for gig economy workers to use when making purchases for members of delivery-service platforms.
The Enablers of Embedded Finance
The distributors of embedded finance rely on two sets of providers to manufacture the embedded-finance offering and grant access to it. Technology providers (fintechs) provide the platform through which distributors can access, customize, and offer embedded-finance products. Some, including Marqeta, provide point solutions for specific categories of financial products, such as card issuing. Others, including Unit, Bond, and Alviere, operate platforms that offer distributors multiple financial products, such as deposits, money movement, and lending.
Balance sheet providers (licensed or chartered financial institutions) are responsible for manufacturing embedded-finance products, providing risk and compliance services, and offering access to funds for lending and deposit products.
Balance sheet providers sometimes partner directly with technology providers to create an integrated em- bedded-finance offering for distributors. For instance,
Stripe is partnering with Goldman Sachs and other banks to offer embedded finance to platforms and third-party marketplaces.
A few banks and fintechs, including Cross River Bank and Banking Circle, fulfil both of these functions. Having built their own technology layer on top of their own balance sheet, they provide embedded finance to distributors such as retailers, business-software providers, marketplaces, and OEMs by themselves, with no need for additional partnerships.
Key Decisions for Embedded-Finance Market Entrants
Although leaders are already emerging, the embedded-finance market still has ample white space for new entrants; we expect it to double in size over the next three to five years. The long-term winners are likely to be those that are already building the table stakes technology, expertise, and relationships needed for a future leadership position.
Financial services firms and fintechs looking to stake their claims in the embedded-finance business would be well advised to commit themselves to implementing four initiatives: choosing a strategy, establishing a developer experience, building capabilities to support distributors, and developing support and risk services.
Choosing where to compete. For most banks with proprietary distribution, embedded finance represents a significant cannibalization risk. However, banks with limited footprints or localized relationships, such as community banks and regional banks, may see it as an attractive way to expand their revenue base.
Some may be comfortable with growing deposits and earning revenues relatively passively, at least early on, but many will look for opportunities to differentiate themselves and boost revenues through more advanced products and support. At the moment, payments-focused technology providers are leading the charge on embedded finance, using their money movement capabilities to attract distributors and then expanding into products that have been the strongholds of banks, such as lending.
Building and enabling a modern developer experience. Many banks and legacy financial services infra- structure firms are not yet equipped to externalize their processes and workflows to allow distributors to seamlessly integrate embedded-finance products into their journeys or distribution platforms. Distributors wanting to scale up quickly will need to build a modern develop- er experience, including the necessary technology to enable it. To do this, they should provide third-party developers with self-service access and well-documented APIs.
Adapting to B2B2C and B2B2B sales motions. Although some financial institutions operate with channel partners, many are accus- tomed to serving end customers directly. Those using direct channels will need to build a new set of capabilities to support distributors in selling embedded-finance products to their consumer or business customers.
In all, the embedded finance revolution represents a paradigm shift in the way financial services are accessed and delivered. As payments emerge as a key battleground in this transformation, stakeholders across the financial industry must collaborate, innovate, and adapt to capitalize on the opportunities presented by embedded finance. By doing so, they can position them- selves as leaders in the next era of payments and finance.