The Covid-19 pandemic was one of the key drivers (open banking the enabler) of global embedded finance adoption. According to
Global Market Insights, the
embedded finance market shot to $58 billion by 2022, and is estimated to clock-in a 29% compound annual growth rate (CAGR) until 2032 – by which point it could exceed $730 billion.
A new ecosystem
So, what about embedded finance makes it so alluring?
Embedded finance is the digital provision of financial products within a non-financial context – such as the purchase of an Uber journey, within the Uber application. This relatively recent innovation enables the entities that deploy it – in both the digital
business-to-business (B2B) and business-to-customer (B2C) spheres – to improve their product offering, increase customer lifetime value and drive sales. For the end-user, embedded finance is the gift of convenience.
Enabled by application programming interfaces, or
APIs (the digital ‘engines’ that transport data between system A and system B), this technological phenomenon is serving to create a new ecosystem of businesses and financial institutions that can deliver a fresh wave of services to consumers and B2B clients.
Real-world examples
In point of animating the construct, let us focus on one specific kind of embedded finance: embedded lending, or
Buy-Now-Pay-Later (BNPL).
As the cost-of-living crisis unraveled, many consumers were increasingly keen to stretch their ever-narrowing reserve of disposable cash (or delay outgoings) as far as possible. Providers of BNPL schemes, such as Afterpay, Klarna, Zip, Zilch, ClearPay and
Affirm, were placed to meet such demand – providing online consumers the opportunity to defer the payment of products.
Picture for a moment the journey of buying an item of clothing from a retailer, online. Once at checkout, the retailer may offer a BNPL option, which enables the customer to spread her payment across several installments, with zero interest. The BNPL provider
makes its money by charging the retailer a fee; with boosted sales provided as justification.
According to Bloomberg Quicktake, the value of the global BNPL payments market was $120 billion in 2021. By 2026, it is expected to hit $576 billion – no doubt fueled by consumers’ increasing use
of BNPL to afford essentials, such as weekly food shops, in the shadow of the cost-of-living crisis.
But at the point of sale, embedded lending is not the only kind of embedded finance available to consumers. There is embedded payments (such as the purchase of a coffee within the Starbucks app); embedded investing; embedded insurance; and embedded
banking – whereby banking accounts are provided by fintechs, for example. The inverse of this is available too: embedded fintech, which sees banks offer customers added services via their website or app (such as the review of subscription services, or
crypto investment options).
The kinds of firms that may offer embedded financial services include merchants, software firms, marketplaces or platforms, telecom companies, and equipment manufacturers.
Chief commercial officer of NatWest Boxed, George Toumbev, identifies the
key components of a successful embedded finance strategy as: a deep understanding of end-users, the utilisation of their data, as well as an evolution from the “transactional” to the “relational” partnership of entities in the aforementioned ecosystem.
The to-be-tamed Wild West
Notwithstanding embedded finance’s economic advantages, user experience improvement, and leg-up for financial inclusion, there are some areas – particularly embedded lending – with unaddressed issues.
When UK interest rates hit a
14-year high by 2023, BNPL firms’ margins contracted, while at the same time their customers began struggling to make good on loan commitments. This salad of misfortune sent the firms back to their financiers, cap-in-hand - in turn driving them deeper into
the red. Only adding to the instability was the visitation of regulatory scrutiny, drawn by an all-too-generous credit cap dangled in front of UK consumers.
At the time of writing, BNPL schemes are
yet to be comprehensively regulated in the UK, beyond the Financial Conduct Authority (FCA)’s umbrella consumer protection directives. Embedded lending providers are being called upon to ensure their loans are affordable and their advertising transparent.
Evidently, as is the case with any bourgeoning industry, embedded finance is yet to overcome its inaugural flush.
Three nascent spheres
Whatever the regulatory hurdles, embedded finance is far too transformative to go away now. Instead, it is poised to irrevocably mold the future of online shopping, investing and business operations.
But that's not the least of it. The hottest areas, set to drive embedded finance’s CAGR in the run-up to 2032, include the wide-open market of SME B2B lending, where there is opportunity to plug the working capital gaps left by incumbent banks; proptech,
which promises to rationalise the antiquated process of making payments and accessing mortgages; and embedded wealth – the home of thrilling innovations like investment-as-a-service and crypto-as-a-service.
These are only a few examples. In the energy-rich sunlight of the
PSD3 planet,
thousands of possibilities are likely to germinate underfoot. Expect the embedded finance sphere – its data sources and contexts – to evolve considerably in the next 5 years.