Deciphering Embedded Finance
If you are part of the financial services industry or have been to a fintech conference recently, the term “Embedded Finance” will not have escaped you. But like many hot Fintech phrases, this is one that can get misused and confusing. Today we try to decode what Embedded Finance really means and understand some real-world use cases, implementations and challenges.
Embedded Finance is - simply put - the native integration of a financial product, within a non-financial customer journey.
The financial product could be a loan, insurance or wealth product, but offered via a more convenient and contextual user experience than usual, which should in theory - lead to greater comfort and delight to the customer.
Embedded Finance is not the same as “Open Banking" (although the terms do get used interchangeably). Open banking is the concept of Financial institutions creating open APIs to share financial data of customers with each other (or an intermediary). In India, account aggregator is a great example of Open Banking.
Most of us have probably used Embedded Finance without necessarily knowing it. For example: taking a consumer loan whilst shopping on e-commerce, bundling a small ticket travel insurance when doing an online flight ticket purchase. Or even when being offered a co-branded credit card within a food-ordering app. Over the years, it has seamlessly made its way into our lives - at least in most relatively developed financial markets.
India has been especially advanced in developing these products and we even see our own government embedding credit for SMEs on its e-marketplace GeM Sahay via OCEN. There are many powerful potential applications of Embedded Finance to MSME credit especially given the digital underwriting data now available such as GST (tax) returns.
Embedded Finance has been slowly reshaping traditional financial services for a while but the recent speculation about the Apple-Goldman Sachs partnership tapering off has put the spotlight back on this. More on this later!
What is driving the embedded trend?
Whilst consumers seem to be embracing Embedded Finance in many markets, for the trend to be sustainable, it must also offer significant advantages to both the embedder (eg a bank) and the “embedee” (eg a food ordering app).
For the builders of financial products, distribution is always one of the biggest costs and operational complexities in their business. The concept of embedding their products within customers existing day-to-day experiences meaningfully reduces this cost and headache by putting the onus on the partner to help design the user journey and context. The financial services provider can offer seamless digital experiences without having to invest in the expansive technology that would be needed to build these in-house.
This should ultimately lead to higher conversion rates and higher levels of customer delight.
For the bank; it also offers an opportunity to tap into an entirely new customer base that they may not easily have access to via their traditional channels and many have seen success in this by tapping into digital mobility and other “super apps” in markets around the world.
For the embedee - the primary attraction is very often monetisation of the customer. Distribution fees (paid by the bank) can be extremely healthy and often based on a revenue share model; incentivising growth. These can provide a significant boost to the P&L of a consumer tech company and a great “story” for them and their investors.
At the same time, it can be argued that the customer builds a deeper relationship with the brand, this can drive loyalty and repeat and the overall experience on their platform. IF the partnership goes to plan!
Great win-win-win for all parties, you may say. The catch is always in the execution.
Co brand credit card partnerships going strong
In India, we have a number of successful examples of co-branding of credit cards within digital retail experiences. Perhaps the best example is the ICICI-Amazon India partnership. The e-commerce giant partnered with ICICI Bank for a co-branded credit card which has more than 4 million users now. It apparently accounts for over 28% of the bank’s entire credit card user base. With a 100% digital on-boaring flow (co designed with Amazon) this would have had a major positive OPEX and ROE impact on the ICICI cards business.
The Apple-Goldman sachs partnership
Recently, many reports have emerged that the landmark partnership between Apple and Goldman Sachs for delivering Embedded Finance (credit and deposit) products within the ApplePay app has been called off.
The Apple credit card was launched amidst much fanfare in 2019 with consumer friendly features like no fees, cash back and an impressive seamless integration into Apple devices. Goldman Sachs was the card issuer responsible for everything backend from underwriting to customer service and compliance. The programme garnered 6.7 Mn card holders in the U.S. - one of the fastest-growing credit card programs in recent years. Both parties were excited until it became evident that this was not going to work.
Increased losses in credit card division reportedly led to the bank wanting to end the partnership highlighting the need to build more commercially sustainable partnerships in this space.
This breakdown may highlight one of the one of the biggest challenges in this space - the alignment of commercials between the two partners over time, especially when credit risk is involved.
Challenges with the model
In addition to the commercial alignment point highlighted above, there are a number of practical and technical reasons why Embedded Finance may not grow at the pace many experts are predicting.
Firstly, creating smooth Embedded experiences in the first place, is no small feat. The bank or financial institution needs to have extremely evolved middleware with sufficient APIs that can be easily exposed to the partner, to conduct every step of the journey in the smoothest manner. Anyone who has tried to build these products, will know this is a huge challenge that cannot simply be solved by a single software vendor or partner. Goldman would have invested Hundreds of millions of Dollars in making the consumer bank ready for such an integration.
Secondly, data and how exactly it is passed between the two entities and used within the product flow, can prove a significant challenge to these products. The key is to strike a balance between providing a personalized and low friction journey vs an intrusive or “creepy” experience.
Finally, it is expected that the non-financial partner will deeply control the UX in these products, but for many traditional financial institutions this can be deeply uncomfortable with a high number of concerns around compliance, fraud, risk and other controls. Banks spend an inordinate amount of time controlling for these risks in their own native apps and handing over journeys to third parties can make compliance and risk departments deeply uncomfortable.
For Embedded Finance to work for a financial institution, an entire culture and mindset change is needed (vs simply a tech solution).
According to KBV research, embedded financial services will produce $385 Bn in revenue by 2029 from less than $22.5 Bn generated in 2020.
What’s your experience with Embedded finance - as a consumer or builder? For which industry do you think it can change the status quo? Tell us in the comments!
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