Is Embedded Finance the Next Evolution in FinTech?

As one would expect, there has been a myriad of predictions for 2020. The outbreak of coronavirus, however, deeply affected financial markets with governments placing restrictions on the way people work, travel, and shop—something that nobody had considered. Despite these circumstances, something known as embedded finance is quickly gaining popularity, with many recognizing it as the next stage in the evolution of FinTech. Financial institutions and FinTech are collaborating to drive the next wave of innovation with the intention to make unique and necessary products and services available more cost-effectively and swiftly.

In this article, we provide insights regarding the four main questions related to embedded finance and FinTech:

• What is embedded finance?
• What are the different stages that make up the embedded finance hierarchy?
• How and why is the macro-trend embedded so crucial in the FinTech ecosystem?
• What are the potential opportunities in embedded finance?

Let's get to it!

Introduction to the concept of embedded finance

Today, nearly all aspects of customer lives are “embedded” with finance. This has also brought forward more cooperation in the FinTech world. Embedded finance refers to non-financial companies that offer significantly enhanced or transformed value propositions through associated financial products and services embedded within them.

It seeks to create a mutually beneficial relationship as well—while users save time, businesses, too, can avoid time and resource expenses. Moreover, embedded finance allows users to return power into the user’s hands, giving them the opportunity to make their payments when they want—not when it’s convenient for their bank. The time factor, in particular, is a significant aspect. Business owners, who know better than to take the concept of money literally, understand that they can make more money if they work on maximizing their time.

We would also like to add that modern Banking-as-a-service (BaaS) providers are working on delivering a developer-friendly experience. This includes extensive documentation and support, modular services, modern RESTful (representational state transfer) APIs, and of course, customer-friendly pay as you go pricing models. In short, BaaS is hands down a key enabler of embedded banking.

Payments, wallets, and banking-like services have all become an indispensable component of internet-led companies on the global front, irrespective of their industry. This intelligent product and solution positioning will give an intimate level of insight to businesses to help them provide a more customized and seamless experience for B2B as well as B2C customers.

Big shots like Google, Apple, and Uber have already launched money services in 2019. So it’s safe to say that the embedded finance trend is here to stay.

Understanding the chief elements of the embedded finance hierarchy

Despite massive damage, COVID-19 has spurred a rally in growth stocks in certain industries. As a result of this, more and more financial companies recognize the need for making changes to an otherwise traditional finance system, irrespective of whether you want to trade and maintain securities or digital currencies. The adoption of embedded finance is just another example.

If you observe embedded finance companies, you‘ll find how most of them take advantage of the different stages that comprise the financial value-chain. This hierarchy can be divided into three main stages, which interestingly correlate with the financial ecosystem of the specific region.

Stage One: The Ecosystem Builders—Distribution-as-a-service

The first stage prioritizes the distribution of financial services via an existing platform. It’s a practice commonly prevalent in Asia where distribution and education arenas are often troublesome.

Under this stage, FinTech companies like Grab and Shopify focus on building an ecosystem of services that aim to incorporate intensely across the value chain within their respective verticals.

Stage Two: The Pipe Builders—Connectivity-as-a-service

The second stage revolves around establishing connections between FinTech and non-FinTech companies. Lacking institutional knowledge and huge capital, companies recognize that managing financial services is a difficult task.

You see, connectivity can help FinTech companies to streamline the proliferation of financial services—and sometimes even add a social element into traditionally corporate-dominated industries. Instacred, Flexmoney, Plaid, and so on are some of the popular companies in this stage.

Generally, regulators insist on keeping products and services under the purview of banks, while banks look forward to participating in the forefront of FinTech. Both situations acted as catalysts that gave rise to the second stage of the embedded finance hierarchy.

Stage Three: The Infrastructure Embedders—Infrastructure-as-a-service

The third stage's primary focus is on the native integration of financial processes through an existing platform.

It’s natural for platform ecosystems to grow with the increasing transactions, which can increase the dependency on external financial processes. As it isn’t an economically viable option to build and maintain such large platforms in-house, startups have started to empower B2B companies to adopt white-labeled financial processes into the digital ecosystems. Companies like Finix, Matchmove, and DriveWealth permit existing ecosystem players (Shopify, for example) to offer their exclusive white-labeled financial stack.

Think of this as infrastructure-as-a-service, which facilitates stronger proprietary financial ecosystems. Besides, we should encourage cloud-based integrations as they can provide more convenient and on-the-go solutions to customers. These can be incredibly time-saving as well!

Embracing the embedded future is the need of the hour

At the moment, Big Tech companies are dominating and leading the embedded finance space. Many experts suggest that we desperately need more entrants to prevent the establishment of monopolies, even though there’s a respectable amount of people who disagree with this kind of logic.

Regardless, we would like to point out that tech companies making up this space have different ideologies and operating styles. While a few end-user-focused brands might choose to build their own money services, others can be deterred by the intimidating burden of financial regulation, operations, and infrastructure.

Keeping this in mind, partnerships are the only way—or at least the most effective way—for banks and FinTechs to survive and emerge as winners in this new embedded world. This can develop a mutually beneficial partnership where people will have more chances to learn about their offerings.

In addition to this, financial services can make for excellent addition through APIs throughout the customer journey. In turn, this can be used by banks as a means to add value across the customer journey by adding specific services, such as currency exchange, escrow, and lending.

It's crucial for finance companies to change their attitudes. Instead of viewing themselves as monolithic structures, they need to develop a more open form of financial services. A great way to ensure this is by set-up other services like payments amidst the traditional financial background.

Wrapping up

New phases should always be a welcomed change in the financial technology market, especially considering how the industry has constantly been expanding through acquisitions, investments, buyout, and partnerships. After all, doing this will give rise to fresh ideas, new companies, and new use-cases.

The entry of Big Tech into financial services doesn’t have to arouse fear. Instead, banks and FinTechs should view it as an excellent opportunity to collaborate and embed themselves in other ecosystems and sectors, which, in turn, can establish them on the global market.

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