The emergence of embedded finance has been a standout development in financial services in 2023. Digital businesses in various industries, from employee benefit platforms to corporate credit providers, are already tapping into the concept, harnessing its potential to generate vital new revenue sources. Still, we’ve yet to see this innovation take practical hold in the banking sector, despite tremendous advantages it could bring.
Recent independent research on why this is may surprise you. Sure, considering the infancy of embedded finance, it’s plausible that some banks are still in the process of deciphering what this distribution channel truly entails and how it integrates into their existing business frameworks. Keeping pace with the latest technologies is never a cakewalk, especially in a rapidly evolving sector like financial services. This could be a contributing factor to the slow adoption. However, as banks continue to demonstrate awareness and even excitement about this innovation in financial services distribution, there is widespread uncertainty as to how it will be leveraged in the near future.
Understanding the term
We recently commissioned independent research to ask UK banking executives if it is a lack of awareness or understanding of the opportunity that is presented by embedded finance that was behind slow adoption across traditional financial institutions. We were given a resounding ‘no’ in response. In fact, the research highlighted that 80% of interviewees both recognised and shared a distinct meaning of embedded finance. Likewise, 58% of those we spoke to admitted it’s a term they’re now encountering frequently.
Therefore, it seems that banks do understand embedded finance, but are struggling on taking that next step and committing to it. This is hardly surprising. Traditional financial institutions like banks must always be cautious when adopting new channels, ensuring that they don’t fall foul of stringent regulations and compliance requirements, or end up leading to unintended consequences that adversely affect customers. Think about the pain involved in the transition from branch to telephone, telephone to web, web to mobile, and you get the idea of the scale of the challenges embedded finance raises for banks.
Knowing the risks
Having worked closely with banks throughout my career, I completely understand these apprehensions. Exciting opportunities always have to be weighed against the risks, and the banking industry has plenty of cautionary tales to reinforce this. Entities in the sector must exert every effort to safeguard and uphold their reputations, and arguably, the recent regulation of Consumer Duty in the UK makes it even harder for banks to work with third-party brands to sell and deliver their financial services.
Adopting embedded finance enthusiastically does not mean doing so uncritically. In contemplating partnerships with other non-financial brands, banks rightly fear disintermediation. Digital brands could potentially harness embedded finance to serve customers with financial services, replacing the bank-customer relationship that is one of the enduring strengths of traditional banks. This move could considerably diminish the role of banks in the financial ecosystem, making room for enterprises from outside the field to break in, snatching customers by providing superior customer experience, data-powered products and high convenience services. Smart banks will strike deals with embedders that give them exposure to segments where the bank has few customers.
Finding the right approach
Ultimately, as with the web and mobile channels, banks will want to be where their customers want them to be. Banks need to be where their customers want and expect them to be – applications like Uber and Airbnb for consumers and Shopify and others for B2B have been setting new expectations. Should they ignore this shift, they risk losing market share to fresher, more agile competitors and also make their brands less relevant and therefore less valuable.
While the threat of disintermediation is real, smart banks will choose to partner with digital brands that give them distribution within customer segments where their own penetration is poor and where the partner’s brand has achieved proven traction.
The real debate is not whether but how financial institutions should do embedded finance. Given the risks involved, many banks might initially feel at ease just ‘testing out the waters’ with this immense ocean of opportunity by setting up specialised, narrow-focus embedded finance partnerships, for instance with a major retailer or with an automotive brand.
Though this might seem a prudent approach, it signals short-term thinking and could result in a scenario where banks continually build and maintain small-scale, disparate embedded finance systems – a process both time-consuming and financially demanding and yet never quite delivering the returns they hope for especially as they end up having to maintain bespoke and isolated solutions, which are notoriously hard to scale.
Taking the next step
Some banks are rightly exploring a more holistic strategy that is required to effectively tap into leverage the potential of embedded finance. By regarding embedded finance as a powerful but idiosyncratic distribution channel, banks should focus on creating financial products that target specific use cases where digital brands are well placed to sell them and actually design these financial products to be embeddable from the get go. That will allow the bank to target a number of digital brands for each such ‘embeddable financial product’ rather than be constrained to a bespoke solution designed to support a specific partnership with a single digital brand.
This brings us to the need for the technology for assembling such embedded finance solutions.
Now more than ever, companies across the embedded finance landscape are turning to a technique of bringing together various discrete banking capabilities through an orchestration platform to deliver solutions to use-cases rather than discrete functions, coupled with a flexible compliance or regtech stack and a suite of developer tools such as a sandbox, simulators, and means of data visualisation.
When banks create embeddable financial products, they avoid the need for the digital businesses that serve as distribution partners having to manufacture the financial solutions themselves and to focus instead on deploying embedded finance much more easily to delight their customers and unlock new revenue streams.
What’s more, this approach to embedded finance allows banks to maintain oversight of the product’s front end, while ensuring full compliance on the back end. This created a ‘win-win’ scenario. Banks gain total visibility over the process without the need to juggle multiple embedded finance projects simultaneously – a task that could be both time-consuming and costly. This arrangement not only optimises resources but also opens up potential for improved customer experiences, pointing towards a promising future for banking and finance.
Time for change
The question for banks is not whether to adopt embedded finance, but how. Up until now, companies in this space have struggled to decipher how to support scale adoption to unlock massive value from this transformative distribution channel. Thankfully, technology platforms are finally emerging to give banks the chance to create fully embeddable financial solutions in a totally compliant and cost-effective manner.
Alex Mifsud is CEO, and co-founder of Weavr