It may seem natural now, but 10 years ago, paying for an online purchase with a couple of clicks or taps on your phone was something out of a sci-fi movie. Yet, here we are, using our phones to pay for our rides home, buying things while watching a TV show, and even splitting our bills with mobile apps. That’s all possible thanks to the huge tech revolution in the finance industry and the irruption of fintech.
Such a significant process wasn’t born out of the mere adoption of new technologies by finance companies. The rise of fintech also coincided with the increased customer demand for more accessible and straightforward financial services. In fact, a lot of the most interesting services in fintech come from outliers rather than from traditional financial businesses, which proves that the fintech revolution isn’t just a transformation of what we already know but also the creation of new financial services we hadn’t imagined.
In that context, many of us are already seeing the next wave in fintech, a trend that has many green sprouts around the world and that’s set to cement itself as the next big thing. I’m talking about embedded finance, a new approach to financial services that’s more customer-centric than anything you’ve seen before. Let’s see what it means and why so many are pointing at this trend as the future of fintech.
What is Embedded Finance?
The term “embedded finance” refers to non-financial companies using financial products and services to embed them in their own solutions to increase their value proposition. In other words, it’s the combination of traditional financial services (like payment processing) with another non-financial service (like an ecommerce app).
So, embedded finance is the integration of a financial service into a non-financial solution. There are three ways in which this integration can take place, including:
- Transfer of value in space: including services like payment processing as well as savings and checking accounts.
- Transfer of value in time: comprising investments, loans, and other financing forms.
- Risk Management: encompassing insurance and other risk-averting solutions.
You could use any of these categories to integrate it into your non-financial platform. There are countless examples of this, like when you pay your Uber through its app or you pay an outsourcing software development team through PayPal. Both platforms use your payment card information (issued by a financial institution) to operate within the services of a non-financial service.
The Three-Tiered Evolution of Financial Services
As I’ve said above, the evolution of the financial industry as a whole and of fintech in particular is more than just the integration of new digital technologies. New customer demands call for innovation which, ultimately, ends up impacting the entire industry. That’s how we ended up with embedded finance in the first place: after going through a three-tiered evolution.
When financial services started to get digitized, traditional financial institutions (mainly banks) adopted new digital technologies to modernize their services. Thus, for instance, the increasing digitalization allowed us to transfer money from bank to bank through digital channels. This first step was born out of convenience for traditional financial users but still had limited access, didn’t leverage user data, and needed the strong intervention of the financing institution.
Then came the fintech revolution. Pushed by the growth of digital solutions in the financial sector, some companies started to develop new fintech solutions to provide financial services on top of traditional banking processes and even outside of them. This allowed for fintech companies to offer a more accessible service with increased convenience but that still lacked customization.
Finally, we got to embedded finance, where specific financial services are served through non-fintech platforms. Since this is a fairly new phenomenon, the way in which these services are served varies a lot from company to company and from country to country. The next few years will show how the trend will develop and what will be the most popular expression of it.
As of today, there are 3 different expressions of embedded finance, all of which respond to different needs and requirements.
The Three Expressions of Embedded Finance
As it happens with any new trend, you can’t expect it to express itself homogeneously. There are different ways in which embedded finance is popping up around the world, each responding to the specific maturity of the financial ecosystem in which it operates. Thus, we can find embedded finance in 3 major expressions:
- Distribution of financial services through existing solutions. Integrating financial services in popular and extended platforms allows for greater democratization of those financial services while providing an added value to the platforms themselves. Payment processing in well-known ecommerce stores is a good example of this expression.
- Connectivity between fintech and non-fintech companies. Certain companies offer services that connect the financial services offered by expert businesses that know how to deal with the challenges that come with managing financial services. Thus, a non-fintech can offer a finance service (such as a credit line on a merchant platform) without having to worry about regulations that escape their expertise.
- Native Integration of financial services in an existing platform. While the first expression is about integrating a third-party solution to guarantee the financial services, this one implies adopting a customized financial solution into a digital ecosystem. This option makes sense for larger platforms that want their own financial stack (such as an ecommerce site that wants to venture into the financial world without depending on external processes). The native integration can be done with the help of a custom software company like BairesDev or by employing white-labeled processes from companies like Finix and DriveWealth under the infrastructure-as-a-service model.
Embedded Finance Benefits, Opportunities, and Future
Embedded finance found its space mainly because it brings benefits to all parties involved: traditional financial institutions, fintech companies, and users of financial services. For one, there’s the benefit of an improved overall experience that makes using and working with financial services more streamlined and with less friction.
Then there’s the huge flexibility that embedded finance offers to non-fintech companies when it comes to offering financial services. What’s more, embedded finance makes sense as it streamlines operations while providing enough customer data to spot new growth opportunities. Thus, companies using embedded finance solutions can find multiple revenue streams by locating underlying consumer needs.
The benefits, then, are present for everyone, which is why you can expect more financial institutions and fintech companies to adopt embedded finance. That’s especially true in the near future, as there are certain indicators that now is the best moment to jump on this trend’s bandwagon, including:
- Changing consumer behavior with a strong inclination towards digital interactions.
- Proliferation of banking disruptors: online-only banks and platforms have become very common and are as trusted as traditional institutions.
- Increasing trust in digital platforms: people are more willing to share their details digitally and aren’t so reluctant to digitize sensitive information (even when there are security concerns to consider).
All of those indicators combined provide a fertile ground for embedded finance to thrive. In fact, there are opportunities in multiple sectors that could benefit from adopting this new trend, including the agricultural sector, the health industry, and even the real estate business.
Embedded finance isn’t without its challenges, though. Though traditional finance institutions have become increasingly digital, a lot of them are still rooted in old practices. Given the huge influence they play on regulatory policies, it remains to be seen how those institutions would move when faced with an increase in the embedded finance adoption.
Regardless of that, it’s safe to assume that this is more than just a passing fad. Given how huge tech companies like Google and Facebook have already ventured into the financial world, it feels like it’s only a matter of time before embedded finance becomes a norm that will reshape the fintech sector for good.