Beginning of the Embedded Finance Era?

The Fintech space is constantly evolving with new concepts and ideas creating a flurry especially as its starts getting funding. Though ‘Embedded Finance’ is getting a lot of mind share today it is not a new concept. Though financial institutions have adopted technology and digitization, the legacy business models in financial services have become stagnant and not evolved with the change in technology and consumer preferences.  While most financial institutions had already embarked on a journey to transform their business models in response to threats from new age FinTech, the Covid 19 pandemic has only accelerated the need.

There is a huge opportunity to un-bundle, re-imagine and rebuild the entire value chain of delivery of financial services from the current vertical structure to a more ubiquitous horizontal platform structure where it becomes an inherent part of the base product and services instead of an add-on allowing consumers to think of it as a single offering. Hence instead of financial services becoming technology enabled or digitized, businesses become finance enabled.

So simply put, embedded finance is a means by which non-financial businesses are able to integrate financial products and services into their offerings in an imperceptible manner resulting in new or better value propositions.

Leveraging consumers trust in the base offering, embedded finance is expected to go mainstream with the market size being estimated to be $7 trillion by 2030.

In the past several years we have seen financial services being embedded into a variety of software and is becoming a disruptive trend that is reshaping the distribution model of financial services while creating a new role for technology companies and enterprises alike.  I am sure most of the examples I list below would sound familiar

• An e-commerce platform offering ‘buy now pay later’ that automatically converts a purchase into a loan in seconds without going to a third partly lender and following a tedious process
• App based taxi services offering journey based micro insurance against accidents
• B2B e-commerce platforms offering financial services to its sellers
• Finding and purchasing a parking slot directly through an map app
• Consumer technology companies offering wallets, P2P payment, lending, cards etc
• Vertical software vendors offering integrated payment processing or lending services
• Telcos offering wallets and digital banking products

Every decade there is a change in the software business models. 2020s saw a increasing movement towards vertical markets (i.e. software around a specific industry) which is leading this wave on embedded finance.

Source: A16Z

At its nascence it started off as a distribution model which enhances the customer lifetime value and stickiness of the base product by creating a more seamless customer experience. 

The below cross tab shows a quick snapshot of all the opportunities available. 

Source: Saison Capital

There is however a subtle difference between a reseller model vs true embedded finance.

From a maturity perspective it starts with distribution of financial services through the existing platform in a reseller model where there is a hand off. As these lines scale, some of these build their own financial services verticals. Once the realization of the difficulty of managing a financial services business sinks in (regulations, access to capital, knowledge etc) comes the stage where there is connectivity and partnerships between financial institutions, fintechs and non fintechs. This leads to more native integration of financial services via APIs and micro-services. As the transaction volumes scale, the difficulty of managing and building these platforms stops making economic sense resulting in an opportunity for startups and fintechs to pick up the load and offer white labeled platforms and processes.  This embrace of banking like services by new incumbents and non banks or neo banks are increasingly further pushing traditional banks to move towards API banking or banking as a service.

The question then to ask then is, whether this is a zero-sum game or un-bundling of services in a manner in which each player in the ecosystem focuses on the core strength resulting in a re-imagining of the financial fabric.  

If you want to start a financial company, instead of spending two years and millions of dollars in forming tons of partnerships, you can get all of that as a service and get going.

— Andreessen Horowitz

It is about finding opportunities to combine data, process and capital in ways that accomplish the same ‘jobs to be done’

—    Saison Capital

So what is the impact to the players in the ecosystem?

Consumers:  Integrated experience, eliminates pain, instant gratification, seamless experience, easier access to services

Non-Financial companies : Increased stickiness and stronger value proposition,  new revenue scheme and means of monetization of their customer base, resulting in lower or fixed cost of acquisition and higher customer lifetime value. Proprietary data sets for multiple use cases.

Neo-Banks, FinTech, Platform providers : Enablers of the ecosystem, monetize the platforms capabilities with limited financial risk. In India specifically, a quick look at OCEN and Account Aggregator framework will give a sense of the crucial role played here

Financial Institutions: Access to big data, focus on core competencies, risk sharing (in FLDG or co-lending use cases), opportunity to transform from a legacy business model and tech stack to a API banking or Banking-as-a-service model focusing on their core strengths like access to capital, regulatory compliance etc. Better cost structures and ability to recoup technology investments, new business models and lines of revenue.  

Governments : Financial inclusion and bridging the gap in credit and insurance for the wider segment of society.

As the ecosystem evolves and the subtle differences in approach taken by a variety of participants plays out, and challenges around acceptance by conventional banks, pace of change are surmounted; whether financial companies retain their edge as they find ways to reduce friction and embed technology, the traditional business model of financial services are surely undergoing a change as customer preferences for a more seamless experience and their trust in big tech increases, embedded finance is here to stay.

Sanket J Dantara

The views expressed are purely the author's opinions basis available data

References

Saison Capital

Mckinsey Insights

Forbes

Business Insider

Anthemis

A16Z

Business World

Industry Wired

Economic Times