International Finance
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The game changer called embedded finance

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Studies show that economists and scholars have ignored the development and benefits of embedded finance

When, where, and how individuals interact with financial services are significantly changing thanks to embedded finance, which also offers significant opportunities for financial and non-financial businesses to reach a larger market. Around 88% of businesses using embedded finance report more customer involvement and 85% claim it aids customer growth.

Although embedded finance is not a new idaea, it has not received much attention until recently. Payments are the foundation of embedded finance since they allow a client to purchase goods or services through a straightforward application without switching to another app.

With the ability to connect banks and FinTech to their platforms through APIs, non-finance companies can embed or incorporate financial products and services, providing customers with financial products and services. It is a significant departure from the idealised FinTech model, and that of traditional banking and embedded finance has the potential to disrupt both.

However, studies show that economists and scholars have ignored the development and benefits of embedded finance. Many contend that the ability of embedded finance to assist their consumers was made possible by open banking. Researchers are now pointing out the success of the programme through integrating APIs for banking data, financial services, and goods into non-financial enterprises’ apps and goods in collaboration with embedded finance partners.

Defining embedded finance

The incorporation of financial services into non-financial businesses is known as embedded finance. An online retailer that sells insurance, a coffee shop software that allows one-click payments, or a credit card that bears the name of a department store are a few examples of integrated finance.

Whether it’s a loan, payment programme, insurance plan, or simple means to make a payment, effective integrated finance solutions meet the consumers where they are and provide them with the financial alternative they require.

Some embedded financial services, such as credit cards for airlines, insurance for auto rentals, and payment plans for expensive goods, have been available for some time. Now that e-commerce businesses are providing financial services directly on their websites rather than sending clients to a bank, embedded finance is gaining traction online. This phenomenon is made possible by third-party ‘banking-as-a-service’ providers that integrate financial services into non-financial enterprises’ user interfaces through the use of APIs.

By 2029, embedded financial services are predicted to earn $384.8 billion in revenue, a roughly 17x increase from the $22.5 billion they did in 2020.

Some potential use cases

The term “embedded finance” is closely associated with terms like “embedded banking” or “banking as a service.” That’s because banks traditionally provide most embedded financial solutions, such as loans and payments. In this instance, we’ll define “embedded banking” to refer to bank accounts and the debit cards that go along with them, leaving other aspects of embedded finance, such as payments and loans, to stand on their own.

Non-financial businesses can provide their customers with a branded checking account to hold money and make payments with embedded banking. For sellers or service providers who use a company’s platform to do business, embedded banking often makes the most sense. It probably provides quicker access to money and benefits only available to platform members.

For instance, the ride-hailing app Lyft offers its drivers an individual checking account with a corresponding debit card. Instead of waiting weeks for a lump-sum payment, drivers can use this account to receive payment right away after each ride. Then, they can use those dollars from their Lyft debit card to make purchases and receive cashback and perks not available elsewhere.

Another illustration is Shopify Balance, which enables store owners to “skip the bank” by receiving payments more quickly and avoiding the requirement to register a separate company bank account. Additionally, it provides a debit card with special benefits for expenditures made to expand a Shopify firm.

Through a convenient user experience and unique rewards, embedded banking is intended to increase platform loyalty in both cases. It’s less probable that a Lyft driver will simultaneously drive for Uber if they have a Lyft checking account that expedites payment.

Another use is in integrated payments. The difficulty in pulling out a credit card and entering the information can make customers decide not to make a digital purchase. By linking and preserving a payment method for later usage at the touch of a button, embedded payments simplify this process. For instance, the Starbucks app keeps card details for one-click payments, and users get points for doing so.

Credit cards are just one type of embedded payment. While saving retailers money on fees, embedded payments can also provide customers with the opportunity to pay directly from their bank accounts.

Customers can receive discounts and prises by using the embedded bank account payments capability in the mobile app SmartPay Prises, which is designed for petrol stations and convenience stores. Because ACH fees are sometimes lower than credit card fees, using ACH for payments saves merchants money. Discounts and prises foster brand loyalty and encourage repeat business.

Then there are personalised credit cards. Branded credit cards are older than fintech because consumers may still buy them at their preferred department stores. Fintech, on the other hand, has boosted the use cases where it makes sense and enhanced businesses’ capacity to issue branded credit cards.

The B2B market is one place where branded payment cards have an influence. Companies have long allowed their employees to use their credit cards for work-related spending, or they’ve given them a company credit card from their bank. Both approaches have several drawbacks, such as having employees pay for business expenses out of their accounts or providing them with a corporate card that they may easily use to buy non-business products.

Nowadays, firms can more easily obtain their business credit cards and provide them to all employees thanks to platforms like Ramp and Divvy. Compared to traditional banks, these platforms often speed up and simplify the sign-up process, provide more access to company credit, and let businesses produce as many branded business credit cards as they want, with both virtual and physical cards being offered.

Any company that provides embedded banking should also be able to provide branded debit cards to customers, staff, vendors, and even independent contractors. A prime example is the Lyft debit card, which was stated in section one and is connected to the integrated bank accounts that Lyft only provides to its drivers.
Finally, there is embedded lending and investing. A sort of embedded finance called embedded lending gives customers access to better loan options at the point of sale. Before embedded finance, consumers had to borrow money from a financial institution or use their credit card, which might have exorbitant interest rates. Embedded lending improves consumer access to credit and aids in business growth.

One of the most prominent types of embedded financing encountered by internet customers is “Buy Now, Pay Later” (BNPL). The offer to spread the payment out over time arises throughout the online checkout process when customers are thinking about their available cash. These products often offer interest-free monthly or weekly payment instalments over a defined period. In addition to Klarna, Affirm, and Afterpay are well-known businesses that provide buy now, pay later options.
Any size of business may easily give their consumers new payment options thanks to embedded lending. Customers who frequently choose to spread out payments over time would benefit greatly from this, as will businesses looking to boost sales and customer engagement.

Embedded investing enables non-investment service providers to provide investment solutions that improve customer satisfaction and open up new revenue streams for businesses. Consumers had to open a new account with a traditional company like Fidelity or Goldman Sachs to invest in the past.

Consumers may now purchase cryptocurrencies from other services they currently use, including Venmo and Paypal, thanks to the growth of embedded investment.
Although this is a more recent application of integrated financial services, it has great potential as users learn to anticipate more services from the websites they visit. In the future, this might involve letting users purchase shares of stock through their checking account app or enabling them to discuss equities in a chat room before doing so.

The difficulties ahead

Embedding financial services can make it unclear who is ultimately accountable for regulatory violations, which is a significant barrier for embedded finance. Regulators must decide who is ultimately responsible for customer data privacy violations.

Second, the use of embedded financial services contributes to the complexity of business interactions. For instance, problems arise when a loan defaults because the bank is unaware of the borrower when a non-finance company extends credit through its platform. The recovery of the [bad] debt requires the redeployment of valuable resources, particularly when the loan is integrated into the platform of a non-financial organisation and does not have [direct] contact with the end user.

Customers’ complicated economic interactions with goods or services from two different organisations present another difficulty. Customers become confused as a result since they do not know which company is in charge of each component of the buying process.

Who does the customer complain to if they need to? It results in regulatory issues with data security.

Furthermore, a traditional bank might not want to support a third party’s API in the financial ecosystem, which could result in embedded finance costing banks market share. This problem is made worse by a lack of collaboration, which slows the development of embedded finance. Even though embedded finance requires collaborations with API providers, financial institutions, end users, and regulators, financial institutions may have good reason to reject relationships with non-finance enterprises and API providers.

Additionally, utilising embedded financial services can necessitate relaxing anti-money laundering and know-your-customer (KYC) rules, opening up companies to payment fraud.

The excitement surrounding embedded finance is expanding and displacing the accepted thinking about institutions. The advantages are significant and include increased customer satisfaction, better customer experience, more revenue streams, a deeper understanding of consumer behaviour, and increased competitiveness.
Regulatory compliance, integration difficulties, data privacy and security concerns, building customer trust, and managing heightened business complexity are some of the difficulties to be overcome.

Despite these obstacles, companies that adopt integrated finance will benefit greatly from the changing fintech market. Embedded finance will be essential in determining how financial services are developed in the future as the trend develops.

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