Understanding Embedded Finance
What is embedded finance anyway? The concept entails a seamless integration (embedding) of financial services into the processes of non-financial companies within their own infrastructure.
Embedded finance involves three key parties — a fintech provider, a non-financial digital platform, and a financial institution like a bank. An ideal example is you paying for, let’s say, a food delivery, and accessing credit on the same app.
How Embedded Finance Is Reshaping Financial Services
Previously, slow and late payments have been a thorn in the flesh for most businesses, their suppliers, and customers. However, embedded finance is a game changer for companies offering products and services. It is changing the global financial ecosystem, as it can be applied to any business with a transactional element.
As embedded finance gains popularity, it deals with new regulatory spotlights and deregulations of financial markets. Consequently, tightening rules in various regions have significantly driven financial institutions to benefit from embedded finance innovations.
For instance, the Second Payment Services Directive (PSD2) by the European Union pushed the creation of open financial data. It laid a foundation for market development. Also, the Consumer Financial Protection Bureau (CFPB) has developed new vehicles to give fintech startups room to test new products without the threat of enforcement.
A Challenge For Traditional Banking
Embedded finance has and is still disrupting the role of traditional banking. It is trying to become a direct link between consumers and companies, eliminating the role of banks. A real-world example is Uber, a non-financial company that allows its customers to pay for the ride on the same app you requested. The company likewise introduced Uber Money which provides drivers with an account and debit card to pay their real-time earnings instantly.
Also, consumers no longer have to ask banks for loans since the option of “Buy Now, Pay Later” (BNPL) at the point of purchase is widely available on most merchants’ platforms. With such competition, traditional banking institutions ought to rethink how they survive and thrive in the financial ecosystem.
While enabling partners to distribute banking products could mean a low-margin, high-volume business for banks, digital transformation appears to be the most effective approach to offering BaaS, a solution for non-bank firms to embed financial services.
Among other benefits banks will enjoy from implementing a BaaS solution, they can attract new and retain existing customers, create new revenue sources from the latest products and services they offer, and lower the cost of doing business.
The end customers, in return, can enjoy a great experience and access financial products and services aligned with their needs.
The Future of Embedded Finance
Despite embedded finance being in huge demand in the financial market, it is an innovation with challenges. Apart from privacy issues and fraud concerns, embedded finance faces other limitations. For instance, fintechs depend on banks for money to fund loans. They also lack the infrastructure and therefore need banks’ existing rails to process payments.
Regulatory compliance for embedded finance players in various regions is likewise a concern. Since policymakers move slower compared to drastic tech growth, regulators are challenged to level the playing field for non-bank companies to provide financial services. For instance, on April 25th 2022, the CFPB announced its intention to begin using a “dormant” authority to bring nonbank financial services companies into the supervisory fold after alleging the pose rosk to consumers.
Data privacy is another challenge when creating embedded finance ecosystems. The tech has to earn a customer’s trust, given the significant power of APIs to transfer high volumes of complex personal data. The goal is to put the user at the centre of control over their data usage. A study by IBM identified finance and insurance among the most targeted industries by cyber criminals. Further, Salt Security State of API Security Q3 2022 Report showed that malicious API attack traffic surged 117% and 95% of organizations experienced an API incident over the past 12 months.
Nonetheless, embedded finance is forecasted to be the next big thing. It was valued at $43 billion in 2021 and is expected to exceed $138 billion by 2026. Open banking and embedded finance have proven excellent tools for solving consumer pain points; thus, we can expect more B2B and B2C companies to adopt them. And access to licenses, product expertise, and infrastructure from partnering banks will stir up embedded finance innovations and growth.
