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 – accelerated by the wave of digitisation following COVID-19 – 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.
According to
McKinsey, by 2030, 10-15% of banks’ revenues and 20-25% of retail and small to medium-sized enterprises (SME) lending revenues, may originate in embedded finance, with total European embedded finance revenues estimated to hit €100 billion. With this potential
in mind, here are some considerations for banks that are still looking to establish an embedded finance strategy.
Partnerships and frameworks in embedded finance
There are three foundational roles within the chain. These are:
1. The sponsor bank
The sponsor bank – also referred to as the partner bank – essentially supplies the licensing that makes embedded finance possible. The sponsor bank could be a regional or enterprise bank, a credit union, or an electronic money institution. Ultimately it
shoulders the regulatory liabilities associated with embedded finance – handing down to end-brands frameworks like Know-Your-Customer (KYC) and anti-money-laundering (AML).
In the wake of the second payments services directive (PSD2), when the concept of embedded finance was still fresh, the lines between each party in the chain were blurred, meaning that certain decisions around client onboarding or KYC were not as well enforced
by the sponsor bank. As we approach PSD3, the larger incumbents are more concerted in their roles and are working to effectively prop up the ecosystem.
2. The banking-as-a-service (BaaS) provider
Providers of BaaS are fintechs which link sponsor banks and end-brands in the embedded finance chain, by meeting infrastructural needs, such as card issuance, payment processing, or deposits solutions.
Until recently, one of the key roles of embedded finance providers was to make it easier for the end-brand to seamlessly inject financial services into its existing journeys, while also enabling the sponsor bank to distribute via additional channels. Today,
as the market has matured, providers must also be thinking about compliance, fraud and risk; extending the range of services a brand can offer, by orchestrating across numerous underlying providers; helping brands to operate across more national borders; and
finally, personalising for groups of customers, at scale.
3. The end-brand
The ‘hosts’ of embedded finance solutions are known as end-brands – and are often companies outside the financial services sector. These entities interface with customers (be they in the B2B or B2C spheres) and typically utilise behavioral data to create
differentiated products in non-banking environments.
Sponsor banks and embedded finance providers are advised to work with end-brands that have a large customer base, with online distribution. Strong customer engagement is a big bonus, since it generates a larger surface area and more data, from which other
relevant products can be sold.
Within this three-part embedded finance chain, the bank’s role is to be the legal backbone, contribute guidance on regulatory compliance, enforce risk-mitigation policies, and empower BaaS providers and end-brand partners. The core challenge comes from helping
to bridge the knowledge gap within end-brands, which know their customers well and are practiced in service delivery, but must be supported on pricing, bundling, and taking to the market financial services.
The delivery methods of embedded finance
There are many types of embedded finance, but the most common are embedded banking, payments, credit, insurance, and wealth. Here are some examples of the channels through which these solutions can be delivered:
In-app
As a result of evolving customer expectations, the increasing demand for digital and mobile optimisation, as well as the ubiquity of digital payments, online and mobile channels have become a focal point for embedded finance. Channels can include peer-to-peer
messaging platforms, social media sites, digital wallets, and branded apps.
Online
Embedded finance solutions can also be triggered by behavioral factors on a firm’s website. Many consumers will be familiar with this concept, having been offered
Buy-Now-Pay-Later (BNPL) services, by the likes of Afterpay or Klarna, when checking out online.
In-store
Not all embedded finance is totally digital. Brick-and-mortar shops often utilise in-person embedded finance to, among other metrics, boost repeat purchases. An example of this would be when a consumer goods retailer issues a branded credit card offer at
checkout.
When building an embedded finance strategy, partnerships, frameworks, and delivery channels are all essential factors for banks to consider.
Embedded finance: Strategy, execution, and activation
The establishment of embedded finance solutions involves three key stages: strategy and set-up, execution, and activation. Each can be broken down thusly:
1. Strategy and set-up
The very first step should be for project leaders to immerse themselves in the target industry. Who are the end-users and what are their needs? This should be part of a wider plan to drive knowledge of embedded finance across the institution.
Each business opportunity should be mapped out against the predicted impacts they will have on revenue, customer experience, and other prescient metrics. Which is the leading value proposition? How will it be executed?
Once an action plan is identified, the next step would be to create a shortlist of potential partners for each vertical – and screen them. After the request for proposal and due diligence processes are complete, negotiations should take place, covering pricing
and precise partnership models.
2. Execution
Next, all relevant digital infrastructures should be designed and refined. Orchestration platforms can serve to shrink the delivery timeline. Once the architecture is ready, the institution may wish to draft a launch plan and a list of well-defined business
goals.
In preparation for activation, the integration of all infrastructures, partner systems and front-end elements should be actioned. To validate the solution with core end-users, now is the time to test, tweak, and re-test.
3. Activation
Now it is time to take the solution to market – but the work is far from over. The bank must monitor users’ interactions, make the appropriate adjustments, and continue to drive adoption and revenue through a suite of marketing activities.
A 2024
McKinsey report on the subject summarises the key tenets of delivering value-positive embedded finance services, which are:
- Distinctive customer journeys;
- Joint vision and delivery – from the finance provider to the customer owner;
- Data sharing and collaboration – for improved decisioning and conversion rates;
- Win-win partnership economics – with an open-book, profit-sharing philosophy enables mutual value creation; and
- Enhanced unit economics – consider originate-to-distribute models to lower capital needs, and leverage data from the customer owner to reduce costs for data in credit decision-making.
The price worth paying
The challenges around establishing an embedded finance solution – including heightened regulatory scrutiny, increased potential for cyberattacks, as well as oversight or permission issues – are well known. But, if banks can holistically manage these challenges,
embedded finance promises to improve customer acquisition and retention, increase the lifetime value of customer relationships, create new revenue streams, enable data-driven insights, and create frictionless, integrated experiences.
Aside from the financials, embedded finance is also about perception. It flags to consumers that the institution is innovative, sensitive to global market shifts, and willing to ride the inexorable wave of modernisation.