As COVID-19 continues to transform our daily lives in significant ways, traditional banking models have come under intense pressure. Technology is facilitating a rapidly evolving landscape for financial services, with the execution of financial transactions no longer solely under the stewardship of conventional financial institutions. Instead, nonfinancial companies have managed to make inroads into this space and position themselves as providers of an array of financial products and services for their customers. In doing so, they are now significantly promoting the democratisation of finance.
Thanks to embedded finance, moreover, this process looks set to evolve further such that these companies will be able to provide a full suite of financial offerings. At its core, embedded finance involves integrating one or more financial services into nonfinancial-provider solutions, meaning that companies from a diverse range of industries now have the opportunity to layer in banking capabilities and thus significantly broaden their overall customer propositions. As for the customer, it means being able to access a financial service at his or her point of need.
The progress of fintech (financial technology) to date has been mainly about using digital services and apps to improve traditional banking, wealth management and savings, according to Todd Latham, chief growth officer at API-based global payments platform Currencycloud. But while these financial services have evolved, Latham noted, they still existed in isolation and were not integrated into other services and sectors. “Embedded finance will be the next stage in the evolution of fintech,” he predicted back in January. “Payments, wallets and banking-like services will become an integral part of internet-led companies spanning all aspects of the global economy.”
And, indeed, we are now seeing the popularity of embedded-finance solutions in the real world. Apple’s collaboration with Goldman Sachs to produce Apple Card gave the tech giant an important financial tool embedded within the Apple ecosystem. Shopify, meanwhile, was among the first e-commerce companies to enable merchants to accept card network payments directly through the platform rather than through a third-party payment gateway. More recently, it has partnered with consumer-financing fintech company Affirm to embed buy-now-pay-later (BNPL) functionality into its merchant offerings. And banking as a service (BaaS) is also helping to expedite the proliferation of embedded finance. Such platforms are enabling digital merchants to plug into financial systems through APIs (application programming interfaces), allowing them to integrate financial services into their user experiences efficiently.
As such, embedded finance is laying the foundation for customers to perform a variety of financial tasks from just one app without having to access other services separately. Perhaps, soon, we will see a real-estate agent providing customers with mortgage offerings upon purchase of specific properties without them having to liaise separately with lending institutions. Or maybe a fitness app will allow its users to access health-insurance deals from within the app. Of course, it does not necessarily mean that every nonfinancial company will suddenly become a full-fledged bank, but it will enable those who seek to expand and reinvent their offerings within the platform to do so, meaning that embedded finance has the potential to equip every business with at least some fintech capabilities.
So, who are the main players in the embedded-finance space at present? According to private-equity firm Lightyear Capital, there are three interconnected categories of tech companies driving the bulk of the growth:
- Providers: service providers plugging financial offerings into platforms to increase distribution and improve customer retention, such as Lemonade, Wealthsimple and Raisin.
- Enablers: companies providing data infrastructure and connectivity through APIs and banking-as-a-service platforms, such as Green Dot, Railsbank and Marqeta.
- Containers: firms offering platforms that aggregate financial services across providers, thus allowing customers to access a range of solutions in a frictionless manner. Examples include Amazon, Gusto and Shopify.
Can banks still compete with this new, sophisticated model of financial-service provision? Challenger consultancy 11:FS sees the traditional banking model as being fundamentally broken. “The business model of using deposits as a cheap way to fund lending offers diminishing returns,” it observed in its recently published report “Better Banking Business Models: Embedded Finance and the Path to Growth”. The report cites a handful of key reasons for the model’s deterioration, including net-interest margins being squeezed by rising competition and low interest rates, internet-driven transparency and competition forcing banks to lower their once highly profitable margins for various products and services. The shift from the physical world to the digital world is also leaving banks with increasingly obsolete infrastructure that is generating diminishing returns.
With ultra-low interest rates persisting and a massive global shift towards digital banking, moreover, the coronavirus seems to have only further exacerbated the global banking industry’s systemic problems. At the same time, however, the fintech sector is largely achieving greater success in meeting customer expectations. And with the increased reliance on APIs, financial services can simply be added to the existing suite of tech-company offerings.
There are also specific client segments, such as small businesses, that may well be more suited to the convenience and transparency of embedded finance vis-à-vis banks. “Traditional banking isn’t built to serve small businesses, and financial technology is quickly filling that gap,” Greg Ott, the chief executive officer of Nav (a financing firm for small-to-medium businesses [SMBs]), asserted. Nav recently launched a new embedded-finance solution that allows users to more efficiently match their personalised funding needs as well as access financing expertise and support through a team of funding managers at no extra cost. And according to Ott, embedded finance has reached “an inflection point” amidst extremely uncertain times. “SMB owners need simpler, transparent access to capital. And on the flipside, lenders and service providers need data to innovate faster and deliver better offerings. Embedded finance solves this on both sides.”
That said, the banking industry can still be of considerable value to certain clients, but it will almost certainly be required to adapt and be more flexible to identify those areas along the customer journey where it can add the most value. “This requires a shift in attitude, no longer viewing themselves as monolithic structures that must always own the client relationship, but providers of a more open form of financial services,” Todd Latham stated. “They also have to realise their customers have a life outside their finances, and they may be able to best serve their needs by putting services such as payments in the background.”
Some banks are already taking up the challenge. In late November, for instance, Goldman Sachs announced that it had released software to allow clients to embed banking services into their own products. “We are trying to create a new industry by integrating our services into their businesses so they can cater to their clients as if we had them,” Goldman’s head of transactional banking, Hari Moorthy, told CNBC. “Imagine a technology company that can use these APIs to create a solution for payments or deposits in concert with whatever else they currently provide to that client.” The move is seen as part of Goldman’s broad strategy to shift away from traditional businesses such as investment banking and trading and into corporate and consumer banking.
Nonetheless, embedded finance is now being projected to grow astronomically during the coming decade. According to “Fintech 2030: The Industry View”—a report by Tribe Payments that asked 125 fintech executives and industry leaders from such noted firms as 11:FS, Bain Capital, Currencycloud, eToro, iwoca, Locke Lord, Moneyfarm, N26, Onfido, Plaid, Plum, Qadre, Thought Machine, Wirex and Zego for their opinions on how fintech will change over the next decade—embedded finance is expected to dominate the industry by 2030. “Embedded finance will see software companies—many of them big tech firms—embed financial services within their offerings to attract and retain customers,” Tribe observed. “As fintech continues to be embedded into financial and increasingly non-financial products, we will no longer categorise fintech as its own distinct sector, just as no one today talks about the Internet as a discrete market.”
A recent report by Lightyear Capital, meanwhile, estimates that embedded finance will grow from $22.5 billion in 2020 to $230 billion in 2025, during which period the sector will create more than $1 trillion in value before rising further to $3.6 trillion by 2030. The report highlights four key areas in which embedded finance is set to have a particularly profound impact during this time: (i) wealth management, (ii) consumer lending, (iii) insurance and (iv) payments. These segments will be responsible for $2.6 billion in revenue (up from $0 in 2020), $15.7 billion (from $1.7 billion at a CAGR [compound annual growth rate] of 62 percent), $70.7 billion (from $5 billion at a CAGR of 62 percent) and a whopping $140.8 billion (from $16.1 billion at a CAGR of 54 percent) respectively.
According to Mark Vassallo, managing partner at Lightyear Capital, “We believe businesses that pursue embedded strategies can deliver more tailored solutions, manage risk better, and increase customer retention.”