Trawl the internet for an explanation of embedded finance and it’s easy to see why the uninitiated might be confused. It’s arguable that there isn’t a universally agreed definition for this fast-growing area of financial innovation. That was until management consulting specialists Bain & Company took a look at the subject. In a standout report providing insight for anyone in banking, fintech and commerce more broadly, Bain’s experts explore the trends, the players and characteristics of embedded finance.
Marqeta spoke to Adam Davis, a co-author of the report, titled Embedded Finance: What It Takes to Prosper in the New Value Chain. Here’s what he told us about:
The overarching trends in embedded finance.
The foundation for this is based on customer preference. What we’ve seen in the market and through our research is that customers have an inherent trust in their preferred software provider to offer them financial services. And why? Because the software provider fundamentally changes the way financial services are offered, by using their position in the end customers workflow to capitalise on new, richer and better data streams to provide access to finance at the exact point of need.
These software providers, especially for businesses, are ones that tend to underpin key operational processes. The digital servicing of this journey is what has seen volumes grow substantially over the past few years and led to the term embedded finance, facilitated through a growing vendor eco-system of BaaS players. And this works two ways.
Firstly, it works for companies if they’re using a software platform to manage their key business processes, for instance a restaurant booking system, or a CRM system through to end consumers using buy now, pay later or a retailer that offers that kind of solution at the front end.
Secondly, and from the consumer perspective, the less complicated the better. Using a service which is natively branded and seamlessly integrated to the software provider, we believe is a key component of embedding financial services generally. The proliferation of this kind of branded financial infrastructure within a retailer or within a platform is still very nascent. But there are a growing number of examples, especially in the UK and the US. Companies offer these services to enhance their overall relationship with the customer, increase engagement rates and drive new revenue streams via diversified business models.
How mature is embedded finance technology today.
When it comes to the integration of embedded finance in everyday commerce, more and more industries are adopting the model to serve their customers’ pain points. We’ve seen strong growth in ecommerce, food and delivery models, as well as mobility providers. We’ve also seen embedded finance touch gaming, construction, shipping, sports, transportation – from the delivery of financial products and the use of underlying capabilities. The rocketing adoption is because fully digital journeys have been enabled through better tech and integration development. In fact, our definition is very much that it’s a digital end-to-end seamless process.
As a result, when it comes to adoption by sector, we believe manual, process laden transactions will be the last to be disrupted, as they tend to be the most complex.
For instance purchasing a house, principally because the model of buying is a multi step, multi actor process that is easier to dissect and disrupt vs embedding end to end. The ability to digitise that journey all the way through is very, very difficult. That’s why currently, there’s a natural tendency for embedded finance to be targeted to and adopted by those platforms and businesses with the potential for a fully end-to-end digital journey. And that’s not really a trend; it’s a part of the DNA of what the definition is.
The capabilities needed to build embedded financial solutions.
To both supply and consume banking as a service successfully you need to have the requisite technical and operational capabilities to manage not just a suite of integrations and partners, but also complex financial products. Within that, a good way of thinking about it, is delivering two sets of services. One is the product side and one the capability side. So, on the product side, there is the provision of payments, lending and cards amongst others. Then there’s a set of services that that any platform needs to use to make these work for their end customers. For example, if you’re looking at lending, that means loan origination, underwriting servicing etc. Then there’s a whole suite of capabilities which sit underneath that – things like AML, KYC, Reporting & Accounting etc. These are each huge markets, with a number of fintechs attacking each one.
As well as the decision on what to offer, is the question of how. In parallel, software providers are looking at their own operational, partnership and procurement efficiencies to see what the best models are to partner into this ecosystem.
Where banking-as-a-service fits.
As we point out in the paper, we foresee significant growth in banking-as-a-service, as an increasing number of larger software providers and platforms use this to scale their distribution, create better, more contextual services for their customers and grow their exposure to new value streams.
We’ve seen that already with organisations like Shopify and Uber whose provision of financial services is central to their core product structures. The opportunity for BaaS is to change structural norms and there are some fascinating use cases being unlocked.
Take, for example, gig workers across the U.S. who don’t currently have access to virtual cards. Virtual, single-use cards could make a huge difference to speeding up payments and reducing the cost of payroll , weaning off a reliance on checks. Accepting that there are infrastructure constraints currently, the long-term potential is absolutely enormous.
The future direction of the embedded finance industry.
Our report suggests a revenue growth rate of 2.5x over the next five years and a 3x growth in embedded value transacted over financed pipes. This is just for the U.S. So, you can probably multiply that two or three times globally.
We also know from some of the conversations we’re having with retailers and software providers, that there is a lack of understanding of risk and a lack of many proven delivery models for certain use cases, especially in lending. As we overcome this, we will learn and unlock much more.
There will also be a change in the way products are potentially manufactured, not just distributed which goes hand in hand with the role that banks play and where incumbents sit in the value chain going forward. This will be influenced in the future by Web 3, as growing institutional blockchain adoption will continue to put more financial assets on ‘chain’ unlocking decentralised protocols that could play a huge part of banking as a service stacks in the future.
