Embedded Finance – coming into its own

Embedded finance (EmFi) refers to seamless integration of financial services into a traditionally non-finance service.

In the last few years, more non-banks have started integrating financial services into their digital channels. Ride hailing services (think Ola money) to food delivery (Swiggy money etc.) to online retailers, telcos, utilities, travel aggregators/ airlines/ hotels and logistics firms have all started providing EmFi services in some form or another.

The most prevalent use cases for EmFi are:

-?????????Embedded payments – online payment options like credit/ debit card, other smart cards, UPI (in India), net banking. Many providers are also offering digital wallets that service not only their own platform but many others as well (e.g., Amazon Pay). Of course, these wallets utilize a back-end Banking-as-a-Service provider for the payment plumbing. Embedded payments are also showing increasing acceptance with wearables being used for making small ticket payments conveniently

-?????????Embedded Credit – in the non-digital world, one of the fastest growing consumer finance segments was consumer durable loans. This product is now offered as an EmFi product by several retailers online. The entire process is digitized and instantaneous. Credit is also offered in many areas beyond consumer durables including in HR tech platforms to facilitate employees and employers as well. A number of payments fintechs have diversified into providing credit to individuals and MSME entities (these of course are coming under the regulatory scanner to tackle instances of mis-selling and aggressive collection practices)

-?????????Embedded Insurance – the complex process of buying insurance has been simplified to a great extent and included as part of EmFi with several providers. The most common use cases are with the travel industry (travel insurance which booking a flight), equipment insurance when purchasing electronic goods etc. We are also seeing health insurance as embedded offering in HR tech platforms for corporate employee coverage

-?????????Embedded Investments - Wealth management advisors are starting to offer embedded investment solutions to enable clients invest and manage money across a range of asset classes without having to leave the base platform. Other providers are also offering up embedded investment services especially for customers with small ticket size capacity. This will ensure a wider coverage of customers giving them access to avenues of savings and investment that would not have been available otherwise

Why is embedded finance picking up so much traction?

-?????????Customers increasingly expect a more frictionless experience – e.g., its much easier to use the ride hailing app’s wallet to make the payment for the ride (happens in the background) than to pay cash at the end of the ride or even use a credit card. Stretching this further – the cab company now also offers an advance to top up your wallet so that the experience stays seamless, and you can take care of the repayment later (of course whether this will eventually lead to another asset bubble is still up in the air!)

-?????????Aspiration of the non-finance company that owns the customer and wants to provide her with tools to improve the experience as well as customized financial solutions to meet her specific needs

-?????????Alternative revenue source for the non-finance service provider (who will typically get a slice of revenue from the embedded financial service provided). Growth opportunity for the financial service provider at a relatively lower client acquisition cost (CAC)

-?????????Increased customer stickiness for the non-finance provider as well as potentially increased revenue from the base product being sold (e.g., a BNPL or credit offering to a customer may enable her to buy a consumer appliance like a TV or a refrigerator that she may not otherwise have been able to pay for upfront)

-?????????Regulatory opportunity – PSD2 in the EU and the Account Aggregator (AA) framework in India are the drivers of open banking in the respective jurisdictions. In India, the AA is a new class of NBFC which acts as an intermediary between Financial Information Providers and Financial Information Users along with a robust customer consent architecture. In such a scenario, non-bank providers can tie up with the AAs to match customers with financial service providers based on the customer’s behavior

-?????????With embedded finance offerings, the non-finance service provider gets extraordinary insights into customer behavior and habits and this in turn can help personalize offerings to the customer. Similarly, the financial service provider also gets deeper insight into the customers financial health and spending habits and use this insight to cross-sell relevant financial products

The importance of BaaS

-?????????Linked to the growth of embedded finance, several banks are offering Banking-as-a-service (BaaS) solutions that the non-banks can use to provide a single-window service to their clients

-?????????It’s also clear that with banking continuing to get commoditized, BaaS is the way for banks to continue to stay relevant in the financial services food chain and EmFi is one of the most important vehicles to achieve this

Challenges

-?????????Legacy systems (especially in banks) require significant upgrade to be able to handle the almost instantaneous decision making required when offering embedded finance solutions. Elastic infrastructure capacity (think cloud) becomes critical to keep running costs under control while managing scale

-?????????Managing partnerships between the non-finance provider, a bank and more often than not a fintech, coming together to provide a seamless experience to the customer is not always easy. Integration of systems, ensuring uniform compliance and infosec standards needs to happen

-?????????Increasing regulatory scrutiny – e.g., the recent RBI rules in India around fintech lending stipulates that only regulated entities can disburse/ collect funds. Clear understanding of data privacy regulations is needed to ensure there are no tripped wires

-?????????Customer service – is not a problem when things are going to plan, but in the event of an exception, unless there are very explicit paths defined, customer service can go badly wrong. The most important question – who owns the customer experience end-to-end and how much control do they have on this experience

-?????????Financial service providers need to deal with two clients – the partner who embeds the product and the end customer. Both have different needs, and this can create a complex operating environment

Not withstanding the challenges, Embedded Finance is here to stay and will thrive, if one goes by the various industry growth estimate ranging from USD 750 bio to over USD 1 trillion in the next ten years! This is largely fueled by Asian and Emerging markets which are also home to a large pool of younger customers who are the main drivers of this growth. Intelligent use of technology can provide access to digital financial services to a whole swathe of users who may otherwise have been deprived. This will achieve the goals of inclusion while also leading to a superior user experience. For the service providers who need to collaborate to provide these services, it’s a vast opportunity to be tapped.

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-Shrinath

Shrinath Bolloju is the Chief Strategy Officer of KGISL (KG Information Systems Private Limited, www.kgisl.com ), a BFSI centric multiproduct enterprise software company. KGISL has been partnering with some of the largest global organizations in their transformation journeys for over 25 years.?

Shrinath has spent over 30 years in the banking and securities services industry and has worked in technology, operations and run a business, in various geographies across Asia, Europe and the Americas.?