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What is embedded finance?

The next phase of fintech innovation is to re-bundle finance, but not back into banks or some other dedicated financial entity, writes Currencycloud's Richard Arundel.

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Embedded finance is the buzzword of the day in fintech. 

Some predict the global embedded finance market will be worth a stunning $7trn by 2030. The reality, though, is that embedded finance has been around for a while, only now it has been labelled as you start to see examples of it across different financial services.

If you’ve made in-app payments when taking an Uber or buying food through Deliveroo then you’re already familiar with the concept. Put simply, it’s when a financial service, like payments, is embedded into a non-financial brand to create a far more seamless and customised customer experience.

Use cases like the two I’ve mentioned above have dominated our use of embedded so far. But the ‘movement’ is taking off and embedded is starting to go beyond merely creating more convenient checkout experiences for consumers, transforming lending, investments, insurance and other financial services.

Companies are reshaping their business models and big investors are piling in. Fintechs, banks, Big Tech and other non-financial brands are now all scrambling for a share of this emerging, uncharted, and lucrative embedded world.

A movement comes of age

Finance used to be simple. Businesses and consumers went to banks for financial services and these institutions were the only real game in town. But this meant payments, lending and other services always had to be done separately through a bank, adding a lot of friction.

Then came the fintech revolution following the financial crisis, which saw the rise of start-ups with a mission to do financial services better than the established banks. This led to a proliferation of fintech apps all highly optimised for specific functions and the challenger banks like Starling,N26 and Tide. Indeed, today, there really is an app for nearly every type of financial service as the unbundling of banking develops apace.

The next phase of innovation is to re-bundle finance, but not back into banks or some other dedicated financial entity. Until recently, however, this was nearly impossible. Finance simply hadn’t digitalised to the point that it could successfully integrate with non-financial companies.

Yet, over the past decade developers have been working to standardise APIs, which has been accelerated by the Open Banking movement and will expand its remit through its evolution into Open Finance. This is a key piece in the puzzle, as open APIs create a common language that allows businesses with different software systems to talk to each other.

Think of it like a waiter in a foreign restaurant who can translate the menu and order your food for the chef to cook the way you would like it. The waiter is the API translating your order into something the chef can cook for you and deliver it from the kitchen to your table.

Shifting customer expectations

Customer expectations are driving this shift, too. Whether it’s for music streaming, cloud-based working or e-commerce, consumers are used to moving seamlessly between different apps and ecosystems that are all able to talk to each other. These behaviour shifts have only heightened during the pandemic as more aspects of our lives have moved online.

Businesses also want their payment processes to be as sophisticated and seamless as they experience as consumers. This is not just for convenience, but they recognised the operational efficiencies and cost savings that can be achieved by integrating financial services into their workflows, helping build resilience in their business models.

Across the board, there is a mindset shift where people want to have a financial service at their fingertips, when and where they want to use it. This is pushing finance more and more into the background, though its value in many ways is only increasing.

Innovation ventures into uncharted territory

While the trajectory of fintech innovation has always been towards an embedded world, how this manifests itself in different markets and sectors remains to be seen. Indeed, it is already taking hold in fundamentally different ways around the world.

Geographically, embedded finance is developing in different ways:

  • In Europe, innovation will continue to be shaped by the challenger banks and Fintechs that, as digital natives, are now at a stage where they can start partnering with third parties to offer, for example, mortgages or cheaper gas and electricity. This is being helped along by Open Banking and PDS2.

  • In the US, Big Tech is likely to continue making big strides into e-money services, partnering with the big retail banks to more quickly comply with state-by-state regulation. Apple’s partnership with Marcus by Goldman Sachs to launch its card is just one example.

  • In Asia, some countries arguably have the most developed embedded markets in the world. The superapps like WeChat, Grab and AliPay already play a fundamental part in people’s daily financial lives. They have nearly entirely circumvented the banking system to allow consumers to order a taxi and many other things without having to leave their messaging apps.

While the frontier of innovation is uncharted, it will not be a competitive free-for-all. Fintechs will not just try to do things on their own but work with non-financial brands, recognising the opportunity to open up their addressable market.

Fintechs will also look to form strategic partnerships with other Fintechs, and indeed Banks, to add other financial components they may not be specialised in to add further value. The next wave of innovation will still be highly competitive but also collaborative – with Fintechs competing in certain areas and working together in others.

These battle lines and alliances will form without much fanfare or awareness by the general public. But this is the very point of the embedded finance movement. People don’t care what’s happening under the surface, they just want a more connected and open financial world.

Richard Arundel is co-founder of Currencycloud.The views and opinions expressed are not necessarily those of AltFi.

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