Embedded finance is not a new concept, but it has existed for many years without being given much attention until today. Embedded finance started with payments, where a customer can pay for a product or service through a simple application without navigating to another application to benefit from the product or service.
Today, embedded finance is gaining popularity and momentum among BigTech and non-financial companies as they look to launch their own personalized embedded financial services to create customer satisfaction. The recent increased interest in embedded finance is because of competition from new players, new customer expectations, and the decomposition of the banking stack through application programming interfaces (APIs), Banking-as-a-Service (BaaS) providers, and the need to access emerging and untapped markets.
Embedded finance has the ability, capacity, and potential to disrupt traditional banking as non-finance companies can embed or incorporate financial products and services into their platforms, providing their customers with financial products and services by connecting banks and FinTech to their platforms through APIs, which is a significant departure from the idealized FinTech model and that of traditional banking.
The ability to incorporate banking products and services into non-financial company platforms has massive implications for conventional banking and financial industry services as well as the evolving FinTech industry.
However, research has indicated that academics and economists have disregarded and ignored the emergence and opportunities availed in embedded finance. Many argue that open banking has been foundational to enabling embedded finance to provide convenience to their customers. They discuss program success through API integration with banking data, financial products, and services into the applications and products of non-financial companies united with embedded finance partners.
[Other] academics suggest that some criteria should consider embedded finance partners and collaborating with an embedded finance provider with a global footprint, such as a global banking license, a global network, a large balance sheet, multiple payment capabilities, and a diverse business so that embedded finance providers can support embedded finance partners as they grow.
Defining embedded finance
Embedded finance is defined as the incorporation of a financial product or service into the platform of a non-financial company, institution, or organization, allowing the integration of debit cards, insurance, savings and investments, and loan instruments into their platform or process.
More simply, embedded finance is a merger between embedded financial services and non-financial companies that involves providing the financial services of a non-finance company through a partnership with a technology provider other than with a bank or traditional financial institution.
The benefits and opportunities of embedded finance
Firstly, embedded finance has the ability and opportunity to transform traditional banking and financial institutions’ products and services, which enables the integration of low-cost innovative financial services into new propositions and customer experiences, easily achieved by creating sophisticated embedded finance offerings through BaaS platforms.
Secondly, embedded finance can increase revenue for parties involved in an embedded financial arrangement enabling businesses in every sector to generate new revenue streams or expand their existing revenue streams.
Thirdly, embedded finance can make every non-finance company become a financial provider, made possible by APIs. As such, any non-finance company can obtain a license and the regulatory approvals required to become a financial services provider.
Furthermore, embedded finance leads to better payment experiences, as [embedded finance]can improve the customer experience by using the payment API offered on the application or website of the non-financial company. Embedded payment improves the payment experience, ensuring the entire payment package (purchase and checkout process) is seamless and located in one place.
Additionally, embedded finance assists in automating bookkeeping processes. Embedded financial accounting APIs help non-finance companies to effortlessly automate these procedures, monitoring payment inflows and outflows and immediately detecting fraudulent activities. Moreover, embedded finance generates valuable consumer data, enabling an understanding of consumers and their buying behaviors and giving companies a competitive edge in a [overcrowded] marketplace while strengthening the core business of financial institutions and non-financial companies.
The challenges of embedded finance
Firstly, a significant challenge of embedded finance is that embedding financial services can create ambiguity about who should take responsibility for regulatory violations, with the regulators needing to determine who is ultimately responsible for consumer data privacy violations.
Secondly, the complexity of commercial relationships arises from adopting embedded financial services. For example, when a non-finance company gives loans through its platform, the bank does not know who the borrower is, leading to issues when a loan defaults. Subsequently, precious resources are redirected to recover the [bad] debt, especially when the loan is embedded into a non-financial institution’s platform and does not have a [direct] relationship with the end customer.
Another challenge is customers’ complex commercial relationships engaging with products or services from two separate organizations. This creates customer confusion because they do not know which organization is responsible for the different parts of the product purchase experience.
If the customer needs to complain, who do they complain to? Which leads to regulatory challenges concerned with data security.
Additionally, a traditional bank may refuse to promote a third-party’s API to the financial ecosystem, which embedded finance can make banks lose their market share. A lack of partnership adds to this issue, limiting the progress of embedded finance. Financial institutions may have cause to refuse partnerships with API providers and non-finance companies, notwithstanding that embedded finance needs partnership: partnership with API providers, financial institutions, end users, and regulators.
Furthermore, using embedded financial services may require lowering anti-money laundering and know-your-customer (KYC) regulations which can expose businesses to payment fraud.
In conclusion, the future of embedded finance and Youtap
Embedded finance increases revenue, gives opportunities for every company to become a financial services provider, and provides better payment experiences. Embedded finance automates bookkeeping processes and other benefits.
Some embedded financial challenges include ambiguity about who should be responsible for regulatory compliance, the complexity of commercial relationships, the loss of market share for banks and other financial institutions, and a lack of partnership.
When considering a partnership, think Youtap
Youtap is an infrastructure FinTech that provides cloud-based financial services software. It enables central, traditional, and emerging banks to complement and transform their infrastructure with innovative financial services and software. Their real-time processing platforms provide an extensive payment processing and aggregation solution that enables central banks, payment processors, and retailers to centralize their payment processing and aggregation networks.
Youtaps’ global networks support thousands of consumers and merchants with their software, White-Labelled by banks and payment service providers in developed and emerging markets, making embedded finance an integral component of their offerings.
Academics, policymakers, researchers …
However, academics, economists, researchers, and industry pundits unanimously conclude that the embedded financial revolution links to developments in digital finance (DF), decentralized finance (DCF), open banking (OPB), open finance (OPF), and finance, meaning that a strategy for embedded finance needs to be able to leverage existing DF, DCF, OPB, OPF, and finance systems.
Soon, there will be a greater emphasis on digitalization and openness in banking and finance to tap into the globalized opportunities of embedded finance fully.
Consumers and customers, academics and practitioners, economists and policymakers, and regulators and researchers have respective roles in the future of embedded finance. Consumers and customers can take advantage of the convenience that embedded financial services bring them.
Businesses and practitioners can reinvent their business models and find ways to integrate embedded financial technology into their business models to generate additional income by creating new revenue streams.
Policymakers and regulators must assiduously review existing embedded finance infrastructure, especially API security, data-sharing arrangements, and the construction and design of embedded products and services to ensure compliance with existing consumer protection and data privacy laws and regulations.
Furthermore, policymakers and regulators should create an enabling, nurturing environment that encourages growth and innovation for embedded finance products and services.
Academics and researchers can use available data and glean information to establish relationships between embedded finance and economic aggregates to determine the pros and cons that embedded finance has socioeconomically. Specific research should consider target markets, particularly the vulnerable, to give financial inclusion to the unbanked and underbanked and those in developing countries.