April 15, 2022
Table of contents
Banking & Financial Technology Consultant
Historically, the abundance of strict regulations and outdated technologies have made consumers consider their financial service experiences cumbersome and uninspiring. This is the exact opposite of what every financial service provider wants to be. For example, every step of the conventional home buying journey is quite an endeavor involving different parties and requiring consumers to be both mentally and physically invested in every part of the process. By the end of it, consumers become experts in loan-to-value ratios and interest rates.
Aware of this, many fintech providers are now actively looking for new ways of embedding credit, insurance and banking services in their customers’ experiences outside traditionally financial ones. With the recent advancements of financial software development, this has finally become possible, so a new kind of financial service model has emerged – embedded finance.
While the term ‘embedded finance’ (sometimes also referred to as Banking as a Service or BaaS) may sound unfamiliar, there is a high probability that you’ve used or heard about services like ‘buy now, pay later’ or ‘just in time’ lending offered by B2C companies. To put it simply, embedded finance is a financial service that allows non-financial companies to provide lending or payment processing to their customers. Instead of going to a bank to borrow money to purchase a new TV, customers can access short-term financing at the point of sale via apps such as: Afterpay, Klarna, PayPal Pay in 4 or Splitit.
The majority of embedded finance services rely on APIs, enabling companies to seamlessly integrate them into existing systems. During the fintech boom in the mid-2010s, developers took pains to standardize APIs across financial services. This now makes it much easier for non-financial companies to provide payments, credit, reconciliation, and insurance for their clients.
Advantages of embedded finance for consumers, banks and merchants:
With embedded finance, consumers can access essential financial services without turning to a bank.
Embedded finance significantly improves customer experience, drives conversions, and increases customer lifetime value.
For banks and financial institutions, embedded finance extends the service range and expands the digital footprint.
In the past few years, embedded finance has rapidly gained traction. From basic consumer wallets to complex lending solutions, many digital natives now consider embedded finance solutions essential. Let’s figure out how embedded finance has become mainstream.
Technological advancements in fintech
One of the most apparent catalysts for embedded finance proliferation is the advancements in technologies like cloud computing and APIs. Initially, these technologies facilitated the growth of Software as a Service (SaaS), enabling many organizations to reimagine how they use and pay for their IT infrastructure. The SaaS approach has played a huge role in lowering the entry barrier for companies across industries wanting to tap into financial services provision.
Before BaaS or embedded finance, if merchants wanted to offer their customers financial services, they had to spend considerable resources on custom development. Moreover, operating such software also required special skills, so non-financial companies had to hire new talent. In the majority of such cases, these costs weren’t justified.
Embedded finance solves this challenge as the costs of partnering with third-party providers for API integrations are significantly lower.
Due to fintech disruption, the financial regulatory environment has changed significantly in the past five years. Forward-looking governments all over the world have made considerable efforts to democratize financial services. The introduction of PSD2 and the UK’s open banking initiative are notable examples of this trend.
Growing customer needs
Despite the apparent influence of the aforementioned factors, the most important driver of embedded finance proliferation is the ever-growing customer demands. Given that the absolute majority of client relationships involve financial transactions, embedded finance is a natural evolution towards more streamlined customer experiences.
The world’s most profitable companies like Apple, Microsoft, and Amazon are what’s often referred to as ecosystem companies. They are not solely consumer electronics, retail or tech enterprises, but multiproduct digital ecosystem companies that aim to address a gamut of customers’ needs and wants. It’s clear that such companies will continue to emerge, as the example of Ikea, recently acquiring 49% of its financial services partner Ikano Bank, confirms.
Given that the majority of businesses have financial transactions at their core, there are a myriad of use cases for embedded finance. Let’s look at the most potent of them across industries.
Uber can be considered as one of the pioneers of embedded finance. It revolutionized the taxi industry by digitizing payments and addressing one of the biggest customers’ pain points at that time – having cash to order a taxi.
While the adoption of embedded finance has made Uber stand out among the competitors, the company became one of the world’s most renowned consumer services companies by using embedded finance tools including Uber Wallet, Uber Pay, and Uber Cash. These services allow Uber drivers to get cash back rewards from buying gas and enable passengers to pay for rides later. Uber also proves the point that ecosystem companies always have a significant advantage over their competitors.
BNPL has gained immense popularity in the past few years. While payment models vary, the general idea is to provide customers with convenient purchasing options both in-store and online. Embedded finance providers, typically fintechs, get their cut from merchants’ fees, allowing customers to pay minimal or zero-interest repayments. For example, one of many BNPL providers, Affirm, now integrates with some of the world’s biggest brands including Walmart and Amazon, providing millions of consumers with the option to pay in installments with zero interest rates for as long as 12 months with an annual percentage rate ranging from 10% to 30%.
These BNPL offerings gave fintechs a significant advantage over incumbent banks. But the good news is that the market rarely fails to adjust. Currently, innovative companies like Jifiti are helping incumbent banks to stay competitive in the BNPL space. While banks often have elaborate consumer loan programs, they lack the technological capability to integrate them into merchants’ systems. The Jifiti platform allows banks to streamline access for various loan programs like lease-to-own and split payments for customers at any merchant’s POS.
However, BNPL models have one apparent drawback. Given that BNPL models usually source users’ financial data from credit bureaus, the reliability of users’ financial stability assessment can be questionable. But again, the market rarely fails to adjust. Realizing the need for a more reliable method to assess user ability to pay, Lean, an innovative fintech platform, now allows evaluating a customer’s transaction history in real time, significantly increasing the accuracy of financial risk scores.
Importantly, BNPL and other embedded finance services also play a huge role in fostering customer relationships and increasing customer engagement. For example, according to McKinsey’s 2020 research, BNPL customers have twice as much average annual transactions per account that private-label credit cardholders.
Insurance at the physical in-store checkout has been around for many years. However, with the recent advancements of API technology, digital marketplaces have become able to offer insurance services as well. Embedded insurance significantly simplifies customer journeys, as there is no need to engage with a dedicated insurance company or agent. According to The evolution of embedded finance report by Salesforce, 35% of general insurance sales are expected to be embedded within five years.
But even now, Uber drivers can obtain personal injury and vehicle insurance using Uber’s official app, while British Airways offer travel insurance when you purchase a flight ticket.
Embedded insurance also has proven extremely beneficial in spaces like vehicle rentals, where insurance may be an afterthought for customers, but essential for service providers. In such industries, conventional insurance journeys are often cumbersome, which can lead to customers stopping from converting. Embedded insurance allows customers to proceed quicker, resulting in fewer cart abandonments and increased satisfaction.
As for businesses that want to streamline access to financial products for their customers, implementation comes down to two factors: defining goals and choosing the right partner.
Companies that are looking to enhance customer journeys with embedded finance need to determine what exactly they are trying to achieve. Whether it’s enhancing customer experience, expanding customer base, or launching a new service that can benefit from embedded finance, it’s paramount to define KPIs and desired ROI. For example, companies that want to transform into ecosystem companies should look into embedded insurance, while organizations that prioritize customer satisfaction should invest in BNPL implementation.
When choosing your embedded finance technology provider, it’s paramount to ensure that the vendor’s technical proficiency is sufficient to achieve your specific business goals. While APIs have been rapidly advancing in the past few years, it’s still critical to ensure that your partner’s technology can successfully integrate with your existing systems. Lastly, given that the demand for embedded finance services is growing rapidly, it’s important that the solution you choose can support high volumes of customer traffic.
For merchants, embedded finance also offers an exceptional opportunity to gather valuable data about their customers. Data collected with the help of embedded finance services can tell a lot about consumer preferences and spending patterns. This, in turn, is extremely helpful in determining what financial products and services will be most relevant for your target audience. Ideally, this important part of work should be performed by a well-versed third-party vendor experienced in predictive data analytics in finance.
In a nutshell, regardless of the industry, financial interactions are a crucial part of the majority of customer journeys. Enhancing this important aspect of consumer experiences is a great way to stand out from competitors and foster customer loyalty.
This is why leaders in various industries have already made embedded finance an integral part of their business model. As we’ve seen with many other technologies that are getting rapidly adopted, not capitalizing on this opportunity will leave you in a losing position. Seamless customer experiences have proven to be one of the most, if not the most important factor in achieving business success.
Undeniably, for banks, embedded finance is also a crucial opportunity for increasing their revenue. According to this McKinsey report, economic profits of world’s top banks have been in continuous decline since 2015.
Amid an increasingly unstable geopolitical situation and unclear consequences of the pandemic, embedded finance can be a long-awaited lifeline for banks and other struggling industries. With the world’s most reputable consulting enterprises very vocal in their praise of embedded finance, implementing this technology is a certain way to give your business a new lease of life.
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