What is Embedded Finance and How Does it Work?

If you've been keeping an eye on the latest developments in the fintech space, chances are you've come across the term embedded finance. With an estimated market value of over $138 billion by 2026 and a projected global value of $7 trillion in the next decade, it's clear that this isn’t just some short-lived trend; it's the real deal.

Forbes has spotlighted some compelling examples that vividly illustrate the impact of embedded finance. A standout case is Uber, which relies on Instant Pay for 70% of its driver paychecks. Then there’s Shopify, which managed a whopping $14 billion in gross payments through its Shopify Payments Service during Q3 2020.

With such success stories, it's clear that embedded finance is reshaping the landscape of financial services, empowering businesses to offer enhanced customer experiences while bolstering their own financial bottom line. And this trend is still accelerating.

In this article, we'll delve deeper into embedded finance. We’ll uncover what makes it such a game-changer and explore its significance and role in reshaping financial services and the financial landscape in general.

What is embedded finance, and how does it work? 

Embedded finance has seen a surge in popularity in recent years, driven by businesses' pursuit of a more streamlined user experience. As consumers demand faster and more convenient services and companies seek quicker payments, embedded finance has emerged as a game-changer. So what exactly is embedded finance?

Put simply, embedded finance refers to the seamless integration of financial services like payment processing, lending, or insurance into non-financial businesses, including online marketplaces, e-commerce platforms, and mobile apps.

In other words, it's making financial products and services readily available to a broader audience by incorporating them into the non-financial products and services they use every day.

For instance, a travel booking website could partner with a financial institution to offer travel insurance directly within their platform, or a ride-sharing app could offer users the ability to pay for their rides directly within the app without having to switch to a separate payment processing platform. It’s really just about making financial services seamlessly available where you need them most.

This seamless integration eliminates the need to redirect customers from the platform to traditional financial institutions, providing a more accessible, efficient, and seamless user experience for consumers and businesses alike.

By embedding financial products and services, businesses can now offer their customers a convenient one-stop solution for all their needs. But how exactly do businesses achieve this? By leveraging Application Programming Interfaces (APIs), businesses can embed various financial products and services, such as payments, lending, or insurance, directly into their platforms.

For example, Cafe Delight, a leading coffee shop chain, recently expanded their payment options through a partnership with a prominent payment facilitator (Payfac). Their user-friendly mobile app now lets customers order and pay for their coffee seamlessly using various digital payment methods.

Key features of this system include:

- Efficient ordering and payments: Customers can order ahead and pay directly through the app, significantly reducing wait times and improving service speed.

- Integrated loyalty program: The app tracks purchases, offering personalized rewards and discounts, encouraging repeat business.

- Data-driven personalization: Utilizing customer data, Cafe Delight tailors offers and recommendations, enhancing customer satisfaction.

The result of this implementation was a notable increase in efficiency and customer retention. The streamlined payment process, coupled with tailored customer engagement, not only simplified Cafe Delight's operations but also offered valuable insights for future business strategies. Platforms like this are a huge step in digital integration for customer-centric service in the food and beverage industry..

Key components of embedded finance

Several key components make embedded finance so effective, including:

Integration

At the core of embedded finance is the integration of financial services into non-financial businesses. This integration can vary in complexity, ranging from simple payment processing to offering more intricate financial products like loans and insurance, all within the same platform.

APIs (Application programming interfaces)

APIs play a vital role in enabling non-financial businesses to access financial services easily. In the context of embedded finance, financial institutions provide APIs that allow businesses to access their financial products and services. 

For instance, in the early days, businesses often partnered with banks to offer basic payment processing services for e-commerce transactions. With the introduction and adoption of APIs, that’s no longer necessary. These interfaces act as bridges, making it super easy for businesses to offer a wide range of financial solutions without needing to build and maintain their own banking infrastructure from scratch.

Seamless experience

The ultimate goal of embedded finance is to provide a seamless user experience. Users should be able to access financial services effortlessly without leaving the platform they’re using (a major convenience for users, and a powerful way for companies to keep users on the platform longer). Whether it's making a payment, securing working capital, or purchasing insurance, the process should be smooth and hassle-free, eliminating unnecessary steps and enhancing user satisfaction.

Personalization

One of the standout features of embedded finance is its ability to offer personalized financial solutions to users. By tapping into user data and behavior, businesses can tailor financial services to match individual customers' unique needs.

For instance, a retail app might offer customized financing options for specific products based on a customer's past shopping history, creating a more personalized and relevant experience.

Real-time transactions

Embedded finance often enables real-time or near-real-time transactions, making financial services more efficient and responsive.

Whether it's instant payments, quick credit approvals, or speedy insurance claims processing, embedded finance ensures that transactions occur promptly, providing users with a seamless and responsive experience. The ability to conduct financial activities in real-time significantly enhances overall user satisfaction and convenience.

Benefits of embedded finance

Businesses are turning to embedded finance for several key benefits that give them a competitive edge in the market and drive growth and profitability. Here are some key benefits:

Enhanced customer experience

One of the biggest advantages of embedded finance is the seamless user experience it provides. By integrating financial services into their platforms, businesses can offer their users more convenience and better outcomes.

Whether it's instant financing options during checkout on an e-commerce platform or personalized financial products tailored to each customer's needs, the focus on customer experience boosts satisfaction, experience, and loyalty.

Streamlined financial services

Embedded finance streamlines financial services by integrating them into other platforms. This reduces the friction associated with accessing financial products, leading to higher adoption rates and improved customer retention. Additionally, partnering with various financial institutions allows businesses to offer a diverse range of financial products to their customers.

Increased revenue opportunities

By offering financial services, businesses can generate additional revenue streams. For instance, an e-commerce platform partnering with an embedded capital company can earn a revenue share on each financing transaction.

Moreover, embedded finance can boost customer lifetime value by deepening the relationship with customers, leading to increased repeat purchases and referrals and ultimately driving revenue growth.

Improved data insights

Embedded finance also provides valuable data insights for businesses. By analyzing user behavior and financial data, businesses gain a deeper understanding of their customers, enabling them to make informed decisions about product development and targeted marketing strategies. 

For instance, businesses can use financial data to identify spending patterns, offer targeted promotions, or develop new financial products tailored to their audience's needs.

Financial inclusion and accessibility

Embedded finance plays a crucial role in promoting financial inclusion and accessibility. Embedding financial services into non-financial platforms opens up opportunities for underrepresented and underserved individuals to access essential financial products.

For example, individuals who may have limited access to traditional banking services can now easily access financing, insurance, and other financial tools through platforms they already use, fostering greater financial empowerment and inclusion.

Innovation and agility

Embracing embedded finance encourages innovation and agility within businesses. The ability to quickly adapt and integrate to new financial solutions through APIs enables businesses to stay ahead of the competition and respond to changing market demands more efficiently.

This flexibility allows businesses to experiment with novel financial products and services, driving continuous improvements and pushing the boundaries of the financial industry.

The different types of embedded finance

Embedded financial services can take several forms - including payments, lending, insurance, and wealth management. The beauty of these services is that they can be integrated into any business model, irrespective of the industry. Here are some prime examples of how embedded finance is transforming the financial landscape:

Embedded payments

Embedded payments are at the forefront of embedded finance offerings. Many big players like IKEA, Uber, Walmart, and Amazon have implemented embedded payment solutions–allowing customers to order and pay seamlessly within their applications.

Currently, about 33% of card spending worldwide and 50% in the US happens online. Notably, many small and midsize businesses in the US now rely on software solutions to manage their operations effectively.

Embedded payments aren't just limited to large companies; small businesses can also leverage these solutions. For instance, a local roof repair company can use a payment solutions platform like Xplor Pay to collect payments on-site, reducing the need for invoicing, accelerating cash flow, and simplifying the reconciliation process.

On-demand food truck marketplace Goodfynd also uses embedded payments–customers can simply pay using their cards.

“The benefit for the customer is you don’t have to re-put in your credit card number. You don’t have to trust a third party that you don’t know with your personal information, but you’re able to check out seamlessly,” said Sofiat Abdulrazaaq, CEO and co-founder of Goodfynd.

Embedded lending

The focus on embedded finance is now expanding into capital and embedded lending, with a growing number of fintech startups offering financing solutions that businesses can integrate into their processes.

Businesses no longer need to go to a bank to get a loan; embedded lending and capital solutions allow businesses to access financing offers right inside the platforms they use to run their businesses. With technology and live data, these alternative financing options can be much faster and more efficient than traditional financing, while also bypassing all the friction of going off-platform to seek capital. 

Embedded buy now, pay later/ credit

Similarly, embedded finance has transformed the buy now, pay later concept. Previously, layaway options required customers to make a deposit and wait for the product. Now, with embedded finance, customers can get the product right away and pay for it over time.

Online retailers increasingly offer "Buy Now Pay Later", allowing customers to purchase products and pay for them in installments. This embedded financing option simplifies the buying process and makes it more accessible for consumers.

Millennials and Gen Z are increasingly drawn to the convenience and user-friendly nature of mobile app-based financing. With this approach, customers can easily apply for financing using a mobile app and subsequently make repayments through the same platform.

This streamlined process appeals to younger generations, making it a popular choice for accessing credit in today's digital age. AfterPay, Affirm, and Klarna are examples of businesses that offer this.

Embedded insurance

People no longer need to go through the traditional process of meeting with an insurance agent in person or going through a separate application process. Tesla, for instance, provides car insurance as part of online and in-store transactions.

With embedded insurance, non-financial businesses can now offer insurance options integrated into their checkout or purchase experiences. Through collaborations with insurance providers, companies can seamlessly present insurance options to customers at relevant points of interaction.

For example, an online travel agency might provide travelers with travel insurance options during the booking process. By collaborating with insurance providers, the travel company can present insurance coverage as an additional add-on, making it easy for travelers to protect their trips with just a few clicks.

Embedded investing

If you’ve ever used an app like Acorns or Robinhood, then you’ve seen embedded investing playing out. Thanks to embedded finance, investment opportunities can now be embedded into non-financial platforms or applications.

This integration allows users to access investment options and manage their portfolios directly within the platforms they are already using for other purposes without needing to visit a dedicated investment platform or brokerage.

Banking as a Service Vs. Embedded finance

If you've come across embedded finance, chances are you've also encountered Banking as a Service (BaaS). BaaS and embedded finance are two important buzzwords currently reshaping the fintech landscape. So let’s break down their differences:

In BaaS, banks and financial institutions open up their core banking infrastructure and functionalities to third-party businesses through APIs. This allows these businesses, often startups, to integrate banking features into their own platforms and offer banking solutions to their customers without building their own infrastructure. BaaS serves as a backend support system for these companies, enabling them to provide banking products and services.

Embedded finance takes this idea a step further. It allows non-financial companies to directly integrate financial services into their platforms. This integration goes beyond just basic banking services and includes various financial products like payments, lending, insurance, and investing. 

The focus is on creating a smooth and user-friendly experience for customers by seamlessly incorporating financial services into their existing interactions with non-financial products or services.

The key difference lies in user experience and integration level. BaaS primarily focuses on giving banking services to other businesses, while embedded finance makes financial services a seamless part of the customer's experience. BaaS deals with backend infrastructure needs, whereas embedded finance takes a customer-centric approach.

What is driving embedded finance?

Several factors are behind the growth of embedded finance, including:

• Emergence of fintech: Fintech companies play a vital role in driving embedded finance. Their innovative technologies and solutions enable easier access to financial services, breaking down traditional barriers and empowering individuals and businesses alike.

• Popularity of digital platforms: The widespread adoption of digital platforms has transformed how we interact with services. These platforms offer convenience, ease of use, and a plethora of services, making them ideal for seamlessly embedding financial functionalities.

• Growth of mobile commerce: Mobile commerce has surged, allowing users to conduct transactions through their mobile devices, which are constantly connected to the internet. Embedded finance capitalizes on this trend by offering financial services that cater to mobile users' preferences.

• Rise of the sharing economy: The sharing economy relies on peer-to-peer transactions, necessitating efficient and quick money transfers between individuals. Embedded finance enables these transactions by providing integrated financial services within sharing economy platforms.

The disruptive power of embedded finance: transforming industries and unlocking opportunities

Embedded finance has brought significant changes to various industries. Here are some of the industries that have experienced notable impacts:

Retail and e-commerce

Embedded finance has revolutionized the retail and e-commerce sectors. With the growth of online shopping, businesses can now access financing and other financial products more easily. This accessibility has allowed them to expand and scale their operations, resulting in overall industry growth.

Travel and hospitality

The travel and hospitality industry has also reaped the benefits of embedded finance. Travel companies are now offering financing options to hosts and hotels, enabling them to access capital for business expansion, marketing efforts, and other essential needs. Moreover, travelers can now conveniently access financial products like travel insurance, foreign exchange services, and credit facilities, making travel more affordable and accessible to a broader audience.

Healthcare

Embedded finance is making its mark in the healthcare sector as well. Healthcare companies are providing financial services to healthcare providers, simplifying the payment process for patients seeking medical services. Additionally, this approach allows healthcare providers to access capital for investments in technology, equipment, and infrastructure, ultimately improving the quality and accessibility of healthcare services for patients.

Real estate

Companies like Roofstock and LendingHome are offering financing options to real estate investors, enabling them to invest in properties and generate returns. Platforms like Zillow are also offering mortgages and other financial products to prospective homebuyers, making homeownership more achievable, especially for first-time buyers.

As embedded finance continues to evolve, we can expect even more industries to be positively transformed in the future.

Why embedded finance is the next evolution in fintech: the future of seamless financial integration

With the incredible advancements in APIs and technology, we’re witnessing a remarkable surge in businesses–both startups and established enterprises–embracing embedded finance to enrich their offerings. Embedded finance is tearing down traditional barriers, extending the reach of financial services and making them more accessible and user-friendly.

When financial services become an organic part of the customer experience by integrating into existing products and services, we achieve a game-changing shift. This transition from standalone entities to integrated solutions significantly enhances customer engagement, fosters loyalty, and ultimately drives revenue growth.

But the beauty of embedded finance doesn't stop there. It also opens up exciting opportunities for non-financial companies to diversify their revenue streams and offers the potential to create tailored and targeted financial products.

The growth of embedded finance is exciting, and has the potential to dramatically revolutionize how we access and use financial products and services. As technology continues to advance, we can look forward to even more groundbreaking developments.

Bottom Line

Embedded finance seamlessly integrates financial products into everyday products and platforms, offering enhanced financial access and user-friendliness. 

As embedded finance gains momentum, it will stimulate increased competition in the financial services market, sparking innovation and driving the development of more convenient and efficient financial solutions.

This shift towards embedded finance is the future of fintech, promising exciting possibilities and advancements in how we manage and interact with our finances.