Collaboration will be the key for financial institutions to leverage embedded solutions
an article written by Rajeeb Gurung
Embedded finance is one of the biggest trends set to impact the financial industry this decade. The implementation of the PSD2 directive, and the introduction of open banking services, were the prelude to embedded finance, which has integrated certain banking services into retailer and e-commerce platform experiences.
According to Joris Hensen, founder and co-lead of the API programme at Deutsche Bank, embedded finance takes “banking products into different platforms and products, and through APIs, have the possibility to bring your products into new areas of the life of a customer.”
While embedded finance has empowered vendors to provide seamless and cost-efficient services, banks have had to reposition themselves to maintain relationships with their customers.
But there is a silver lining: embedded finance could push banks to innovate and adapt to retain their market share.
“Embedded finance is a huge opportunity. We have started our API programme also with a view to engage with partners who could provide new products and services for our customers – in addition to our own products and services, helping us to retain existing clients and win new customer,” says Hensen.
“And the same is true for embedded finance, because it is offering us a new dimension of what is possible.”
What is the driver behind embedded finance?
Payment is one of the most widely available embedded services in app-based and online platforms, popularised by the likes of Uber.
According to ResearchAndMarkets.com, the global embedded payment industry is expected to reach $380.6 billion in revenues by 2029 from $124.7 billion in 2022, growing at a CAGR of 23.1% during the period.
The figure is underscored by the likes of Dutch payment group Adyen partnering with Portuguese IT company Nonius, and US hospitality software Agilysys‘ plans to tap into the duo’s client base in the hospitality industry.
Notable fintech payment platforms like Square and Stripe are also providing embedded payment features to their clients.
The expected growth is further backed by the growing demand for embedded payments.
Research commissioned by payments platform, Paysafe, found that 75% of respondents, comprising 11,000 consumers in Europe, North America and Latin America, were willing to use embedded payments going forward.
Customers desire embedded finance products because they offer a frictionless alternative to a time-consuming experience with banks.
John Hammond, chief commercial officer at Railsr, an embedded finance platform, explains, “We believe consumer behaviour is what drives everything, and consumers want frictionless, fun experiences.”
Read more: Banks need to adapt to a consumer drive for open finance, says Railsr CCO
Hammond’s sentiment is shared by Andrew Reeves, managing director for SaaS business office at Temenos, the global banking software platform.
“Customers are not looking to go to their bank every time they want to get a financial service. They want those services to be available in the channel that they are in at that time, whether that’s social media, merchant, or shopping on Amazon. This need is driving embedded finance,” Andrew states.
Rather than seeing embedded solutions as competition, however, traditional financial institutions largely support the growth of the sector and welcome the potential for innovation.
“Banks must now reconsider and redefine their role in day to day of their customers. Digital adoption by consumers will drive success for banks, as many can now increase the touchpoints with consumers to gain a greater understanding of the individual,” Ignacio Narvarte, deputy CEO of PagoNxt Merchant Solutions (Santander’s payment platform), tells bobsguide.
“As such, many have sought to reposition themselves as lifestyle partners’ and will strive to offer customer centric financial services and a comprehensive view on financial lives.”
Challenges to the financial institutions
The increasing adoption of embedded finance solutions has given prominence to non-financial institutions as a point of contact for customers. In turn, traditional financial service providers have been pushed into a background role.
For instance, consumers can tap into Apple’s buy now pay later (BNPL) offering via Apple Pay. The loan, however, is issued by Goldman Sachs, which works in collaboration with Apple to operate in the BNPL space.
Likewise, customers can also buy insurance products from Tesla when purchasing the company’s car. The electric vehicle maker’s in-house insurance product makes it a cheaper alternative to offers from the traditional insurance providers.
The acceleration of digitalisation in recent years has led to the increase in the number of digital savvy consumers. According to Mckinsey, Europe alone registered a net gain of some 100 million digital users since 2019, with industries like banking, grocery, and healthcare seeing the biggest gains.
Despite the increase, financial firms are not always agile to move from their legacy technologies to cater to the digital savvy consumers’ expectations. Speaking from the wealth management perspective, Matt Cockayne, CRO of Nucoro, a digital wealth management platform enabler, explains: “The traditional customer base is decreasing. The next generation of customers are now digital natives and want digital solutions.”
“A lot of these wealth managers do not have that capability. And they should, because if they do not that is a bad thing for their valuations and share price.”
In a survey of 300 C-suite executives conducted by Economist Impact, 54% noted their financial institutions have faced greater competition over the past five years from digital alternatives, such as banking-as-a-service (BaaS) or embedded finance.
Marca Wosoba, managing director of Europe at Modulr, the embedded payments platform, explains, “Software companies who want to embed payments into their tech stacks are increasingly struggling to do so via banks, because their [banks] legacy systems are not built to handle quick and easy API access. This enables fintech companies, like Modulr, to continue to take business away from legacy and incumbent players.”
Banks’ slow adoption of embedded finance also means they could lose a share of their market to fintech companies. According to a 2019 report by New York-listed IT consultant Accenture, banks risk losing $280 billion in payments revenue by 2025.
As companies launch e-wallets, self-issued cards and payment rails connected to each other, they have created their own payment ecosystem on a merchant level with a less prominent role for banks.
“A lot of banking services could get broken up, embedded into other experiences,” believes James Booth, head of partnerships EMEA at payments platform, PPRO. “That’s where banks need to keep on their toes and just make sure that they keep merchants and consumers embedded into their ecosystem”
McKinsey, in its 2021 global banking annual review, reported that fintech companies have already captured 3-5% of banking revenues in the US and the UK.
Opportunities for traditional FIs
Despite the challenges brought on by embedded finance, it has provided traditional FIs with a multi-trillion-dollar opportunity.
Deutsche Bank’s Hensen says, “[Embedded finance is] offering a new dimension of what is possible. It is not only the banking industry that has opened up other industries too. Take the energy sector, for example. They are starting to build their own API and they open up the same say. So, there are opportunities that will emerge.”
“It is the opportunity to develop completely new products where boundaries of the different sectors will disappear.”
Dutch FI Rabobank also sees opportunity in the embedded finance space and has focused on lending to SMEs.
“We believe that more loans will be distributed via non-banking channels in the future. We are focusing on partners with whom we can provide digitally distributed loans to SMEs,” says Olaf ten Duis, lead strategic partnership management at Rabobank.
In 2021, the bank partnered with online retailer bol.com to offer Dutch vendors on the e-commerce platform with borrowing options within 15 minutes.
The full article here