Embedded Finance: Enabling New Customer Facing Intelligence

In recent years digital technologies have disrupted shopping experiences and electronic transactions between enterprises and their retail customers. Specifically, customers can nowadays purchase virtually every good and service on-line. At the same time, merchants and other on-line service providers offer personalized shopping experiences through their web sites and fulfill customer requests regardless of time and location. Contracts, payments, and other financial transactions are integral elements of such shopping experiences, which leads many services providers in integrating financial transactions in their offerings. This integration is commonly known as embedded finance or embedded banking. Likewise, the companies that enable this integration are usually characterized as embedded finance companies.

Embedded finance enhances non-finance services with  full-fledged digital finance functionalities. Most incarnations of embedded finance services are integrated within customer-facing services i.e., services involving interactions with the end-consumer. As a prominent example, embedded payment services enable consumers to make payments whenever they make a purchase. In recent years, the interest on embedded finance is skyrocketing, which has led to a proliferation of companies that integrate banking and payment functionalities into electronic products and services. For instance, the popular Buy Now, Pay Later (BNPL) service enables on-line enterprises to integrate short-term financing functionalities with their products. Leveraging these functionalities companies can pay for goods and services at a future date.

Drivers of Embedded Finance

The interest in embedded finance is due to various factors, including recent technological and regulatory developments. In particular, service providers and product vendors are increasingly embedding finance functionalities in their products for one or more of the following reasons:

• The need for integrated customer experience: To complete their on-line purchases customers are usually transferred from the merchant’s web site to the application of some financial institution. This makes the customer experience fragmented and sometimes cumbersome. Nowadays, customers ask for more integrated and user-friendly experiences. Embedded finance functionalities are a key ingredient of simple, holistic, integrated, and pleasant experiences, which are more appealing to consumers. Such experiences are demanded by millennials and Gen Z consumers, who are used to integrated on-demand purchasing experiences.
• Digital finance technology and innovation: The rise of the internet and of the on-demand economy has given rise to the emergence of many financial technology (fintech) firms. Embedded finance is one of the focal areas of many fintech enterprises, which have gradually evolved into embedded finance companies. This has shifted payments and other embedded finance functionalities from the banks to the on-line digital products and services.
• Open banking and related regulations: The implementation of embedded finance functionalities hinges on flexible access to back-end banking services such as customer accounts, credit cards and payment clearance services. The advent of Open banking has greatly facilitated fintech enterprises to access such services through easy-to-use banking APIs (Application Programming Interfaces). Furthermore, recent regulatory developments (e.g., the 2^nd Payment Services Directive in Europe (PSD2)) have opened up access to data from a variety of financial institutions, which has helped embedded finance companies to implement novel data intensive services. Hence, open banking and related regulations are acting as catalysts for the proliferation of embedded finance implementations. As such they are also key ingredients of modern embedded finance infrastructures.
• Quest for trust in financial services: Traditional financial institutions are no longer trusted by some of the end customers. This is the case for millennials and Gen Z individuals, who prefer using fintech services over the services of incumbent financial institutions. Hence, there is a shift of trust from banks to fintechs and other stakeholders of the embedded finance ecosystem. In many cases this has also lowered the trusted barriers for switching from traditional finance services to embedded finance.
• The COVID19 pandemic outbreak: During the last two years, the COVID19 pandemic has increased the number, density and intelligence of on-line transactions. Customers have got used to expect more from their commerce transactions, including integrated experiences and seamless access to financial services. Moreover, it has led companies to consider an accelerated pace of digital transformation, which has boosted the adoption of embedded finance services.

Embedded Finance and Embedded Banking Use Cases

Embedded finance enhances on-line products and services in different ways. A list of popular use cases follows:

• BNPL Services: As already outlined, embedded finance enables consumers to purchase a product and pay for it later. In essence, this creates a new credit line for shoppers, which facilitates upselling and reselling practices. BNPL facilitates the purchase of higher value products and services since payment can be done later.
• Lending at the Point of Sales: BNPL is a great option when it comes to purchasing low to moderate price goods. However, there are cases where consumers purchase high price items that exceed the limits of BNPL. To this end, they can benefit from embedded lending services. The latter use customers’ information (e.g., credit history) to offer them with appealing loans that enable them to purchase expensive items that go beyond BNPL credit.
• Loyalty Payments: Thanks to embedded finance, on-line products and services can be directly integrated with loyalty management features such as points collection and redemption, coupon discounts, and financial rewards. Embedded finance facilitates the implementation of complex loyalty programs through integrated access to the back-end services of loyalty management marketplaces.
• Embedded Product Insurance: Embedded finance enables the implementation of novel forms of product-level insurance services. For instance, they facilitate the practical implementation of “money back guarantees” should the purchased product turns out to be faulty. In this way, insurance services can be instantly delivered to consumers, which enhances customers’ confidence on the on-line purchasing process.
• Personalized Investments and Asset Management: Embedded finance can be used to enhance conventional finance services with investing, trading and asset management options. For instance, savings accounts can be enhanced with personalized wealth management services in capital markets. In this direction, conventional finance services providers leverage the services of on-line investing and trading firms. Overall, personalized investment services can make existing financial products and services more appealing to customers.

The above-listed use cases provide a glimpse on the disruptive potential of embedded finance projects. They also explain why research firms anticipate a significant growth of the embedded finance movement, which is likely to exceed $100 billion by 2026. These are good reasons for on-line service providers to keep a close eye on embedded financial tools and to gradually develop their own embedded finance strategy.