The banking and financial services for many Indians have shifted to digital post-pandemic. As per the leading company Forrester, even before the pandemic, 59% of the Indians were open to accepting a digital-only bank. This trend has become more widespread after Covid and financial services are now moving towards a digital platform.
What is embedded finance?
It is a financial solution, like payments or funds embedded into a non-financial company to offer a seamless and customised customer experience.
With an increase in non-banking services around the world, embedded finance has emerged as a popular option. It is estimated the size of the global embedded finance market will reach approx. $7 trillion by 2030.
The dynamics of the global economy have also changed post-COVID-19. The crisis surrounding the pandemic has made many investors and businesses shift their focus towards people. The significance of human impact has surpassed economic impact.
The top agenda for businesses is people’s access to health infrastructure, human equality, and societal welfare. Businesses are understanding that these social and environmental issues have a direct influence on economic stability. This is why embedded finance has become a focus for everyone.
Understanding Embedded Finance
Many non-banking providers have started integrating financial services into marketplaces and other services. Technology companies have started playing a crucial role in the financial decisions of businesses and consumers and this phenomenon is called embedded finance.
Below we list some embedded finance examples:
- Consumer Lending Businesses: In India, the penetration of Credit cards remains only 59 million. This is a small number considering that in India, 800 million have a bank account. Many credit providers that have their base in Point of Sale (POS) include companies that work on Buy Now Pay Later principal. These companies help to ensure credit flow to the consumers and this helps to increase the Average Order Value for the merchants.
- Payment Companies: The payments landscape in India has been transformed with UPI. It has made it simple for technology companies to turn into payment providers. The technology platforms like Amazon, Ola, Google, and WhatsApp are now providing payment-related services.
- Insurance: Availability of various nano insurance products has now been embedded into the technology platforms. This has helped to increase the awareness of these products among Indians.
- SME Lending Businesses: Small businesses pave the future for the economic growth engine. But these businesses currently have a credit gap of $330 billion. The opportunity for embedded finance has grown exponentially with the rise in B2B e-commerce platforms. The digitization of trade and availability of alternative data for underwriting has also boosted this trend.
Companies that have embraced Embedded Finance
Below are the examples of embedded financial services that are becoming part of technology companies’ stacks.
Below are the examples:
- Vertical software, e-commerce, and Point-of-sale vendors – These platforms offer lending services and integrated payment processing services to sub-merchants. Examples are Shopify and Lightspeed.
- Ridesharing companies – Many of these companies provide various financial products like digital wallets, debit cards, and instant pay-outs to both drivers and customers. The examples include Ola and Uber.
- Consumer-focused FinTech – Many companies are expanding their functionality and including more financial instruments in their existing service portfolio through debit cards, instalment loans, and instant lending. The examples include Square SQ and Klarna.
- Large consumer technology companies – The companies that offer P2P payments, digital wallets, debit cards, lending, and credit to their users. The examples include Apple, Google, Facebook, and Amazon.
- Telco Companies – These companies offer a myriad of digital wallets, digital banking products, and payment cards. Examples include Orange Money and T-Mobile.
All the above companies have to form better and richer value proposition for their end users along with a revenue opportunity for their business. For example, Square converted its Cash App into business produced a $325m gross profit in Q2 2020. Shopify had received $14bn gross payments through the Shopify Payments services in their Q3 2020. Uber handles about 70% of their driver pay-outs with Instant Pay. The service is free if driver deposits their funds to Uber Visa Debit Card.
Who have benefitted from Embedded Finance?
Many stakeholders are now becoming the beneficiaries of embedded finance. These financial services have become an integral part of technology companies’ stack of all shapes and sizes.
Below are some of the examples of beneficiaries of embedded finance:
- Consumers: Many customers are benefiting from embedded finance. Technology platforms provide attractive rewards to consumers for payments. Buy now pay later providers to give their consumers access to credit and No Cost EMI. Most significantly the trend has shifted from financial product’s push-driven sales to embedding the right product at right time for the purchase journey of the customer.
- SMEs: The small lenders and businesses are unleashing the power of embedded finance using the data from e-commerce platforms. This, combined with the innovations in open banking are helping small and medium enterprises
- Government: The vision of the government is to support cashless India and in this embedded finance is playing a huge role. It is helping the government in bridging the gap between the wide credit that exists in the market and the insurance services.
- Enablers: The account aggregator and OCEN framework are expected to deliver technology for lending. API is helping upcoming entrepreneurs to build lending, payments, or insurance facilities
- Tech-driven finance companies: Increasing tech adoption by Indians, availability of alternative data, and the falling distribution costs were posing challenges for financial companies and traditional banks. But the customers that were previously difficult to serve are now being served through embedded finance which has started opening up these markets.
- Platforms: Many platforms have started monetizing through fintech services along with the core product. The rise in the ecosystem of embedded finance enablers and agile lenders has made it quicker and simpler for platforms to monetize.
Outsourcing Embedded Finance to Professionals
Many of these companies do not have the infrastructure to execute these services. Thus, they outsource the finance-related services to specialists and they concentrate on their core business. The third-party specialists who have the infrastructure to run financial services at a large scale help these companies in creating better products.
The third-party providers help to provide the financial fabric which is the financial infrastructure with an API-rich layer. This is embedded into many applications, from platforms to marketplaces to fintech apps. This financial fabric is woven into the business proposition and this can be augmented into the core business. The financial fabric is deployed for various use cases like pay-outs, payment processing, card issuing, and lending.
Key risks related to Embedded Finance
Below are the key risks that are associated with the use of embedded finance:
- Most companies do not have the necessary financial education that they need to match the ever-evolving digital world.
- Although embedded finance is giving opportunities to businesses, but with competition, their transparency could decrease especially if the technology platforms become stronger.
- With the increase in the risks associated with Cybersecurity, hackers are now targeting businesses in India. Our finance companies, platforms, and enablers have to get ahead of cyber threats to maintain customer trust.
Although the Indian companies have just started exploring this enormous opportunity, we are moving towards a better future. The growth in the embedded finance ecosystem will help companies to achieve full potential and give a boost to the economy.