Embedded Finance

Embedded Finance – A Demand Driven Phenomenon

Embedded finance is the integration of financial services (payments, lending, banking services) into non-financial offerings, typically in B2B and B2C applications, that creates better user experiences for consumers and small businesses, and faster sales cycles and additional revenue streams for platforms. Embedded financial products are a natural fit with newer, innovative technologies like API-first, cloud-based solutions, streamlining financial flows and user experiences to a degree not seen before.

Though the value proposition for embedded finance is very strong, there’s a lot of complexity in designing functional embedded systems that “plug-and-play” into software platforms. Thus, looking backwards from the simple and frictionless user experience, there’s a challenge with successfully integrating the underlying core banking, payments, accounting, tax, contract execution, KYB, KYC and back-office reconciliation mechanisms that makes embedded finance work. The proper implementation of these core functions with non-financial software can be time consuming, costly, and kludgy if not thoughtfully architected and implemented. This is why the embedded finance/ fintech industry finds itself prone to cooperative commercial partnerships between specialty fintechs, banks, payment processors, compliance services, card and banking schemes, and SaaS platforms who, only through collaboration, can create the efficiencies and experiences that undergird and deliver on the promise of embedded finance.

Regardless of the fundamental challenges to build functional embedded financial systems, there’s no disputing the directionality and momentum of the trend – a parabolic curve with a positive leading coefficient. Market demand for embedded products is exceedingly high.

Sub-Categories of Embedded Finance

Embedded Banking:

Embedded banking is the integration of banking services such as checking accounts, debit cards and loans, directly within non-banking platforms. This creates a more accessible and streamlined banking service experience for customers. Embedded banking opens new revenue streams for merchants and accordingly, increases revenue per customer. 

An example of embedded banking is Lyft, who offers an in-app checking account and debit card to their drivers. Drivers are able to use the account to receive their earnings instantly, manage their funds, and access cash advances without a separate bank account.

Embedded Lending:

Embedded lending allows users to access loan options at the point of sale, which helps companies increase their sales because they are able to offer more payment options. Before embedded finance, a consumer would have to use their credit card, be pointed to a detached workflow to apply for a credit card, or take out a traditional loan from a financial institution leading to more friction in the purchasing process, potential cart abandonment, and in many cases, higher interest rates.  

The most visible form of embedded lending is ‘buy now, pay later’ (BNPL). This process occurs at checkout and allows the consumer to split the payment into installments, typically providing for monthly or weekly payments over a predetermined period of time, and in very short periods,  no interest. The largest BNPL companies are Klarna, Affirm and Afterpay.

Embedded Investing:

Embedded investing is integrating investment options for non-investment service companies, which allows users to invest without needing to open a separate account with a traditional financial institution. This makes investing accessible through seamless integration with services the consumer already uses, such as a shopping app or a banking platform. Three big benefits are increased customer engagement through readily available investing options, a new revenue stream for businesses, and financial inclusion by opening up investment opportunities to a wide audience who may not have previously had access to investment platforms.

An example of embedded investing is Greenlight, a debit card designed for kids and teens, and allows the card holder to save their money in an interest-bearing account or invest those funds. Another example is Venmo and Paypal which offer consumers options to purchase cryptocurrency directly from their platform.

Embedded Insurance:

Embedded insurance allows users to purchase insurance online at the point of sale. An example is when purchasing a laptop, you may be offered insurance options with no need for a separate engagement with an insurance company or agent, and sometimes with multiple competitive options. 

Companies who embed digital insurance options into their platforms often partner with fintechs who can build the options into the checkout flow. This allows customers to choose insurance options as an ‘add-on’ to their purchase.

Three common types of embedded insurance:

• Singular policy: Companies underwrite insurance policies themselves and then integrate them into the purchase flow. Examples include: Boost and Bsurance.
• Multiple policies: This is more of an ‘agency’ approach, companies integrate multiple insurance options into their checkout flow. Examples include: Matic and Branch.
• Extended warranties: This is offered at the point of sale when the customers are most concerned about protecting their purchase, and covers repairs or replacements for the purchase. Examples include: Clyde and Extend.  

Embedded Finance – The Takeaway

Better end-user experiences and more, monetizable revenue streams for merchants and platforms, along with embedded finance’s characteristic simplicity and seamlessness of information and transactional flows, are powerful drivers for faster innovation and better products. This ensures an extremely active market for capital raising and strategic acquisitions with a lot of runway, affecting all species of ecosystem participants in the embedded finance universe.