What is Embedded Finance and How Does It Impact Banks?

Embedded finance is a rapidly emerging and evolving concept from the fintech space. This concept refers to the seamless integration of financial services into non-financial applications or platforms.

Embedded finance enables businesses to offer financial products directly to their customers through their existing digital interface, disrupting traditional banking models by dissolving the boundary between financial and customer-focused services.

The size of embedded finance remains limited in the overall scheme of things -- according to a paper by Allied Market Research, the global embedded finance market was valued at a mere $66.8 billion in 2022. It is growing rapidly, however -- the same report projected the embedded finance market to grow by almost 9.5 times by 2032 to $622.9 billion.

What are the benefits of embedded finance?

The primary advantage of embedded finance is its ability to provide personalized and convenient financial services at the point of need. With embedded finance, customers can transact, invest, borrow, or insure without navigating away from their favorite platforms.

In addition, embedded finance opens up opportunities for non-financial companies to monetize their customer base by offering tailored financial services. As technology continues to evolve, embedded finance is poised to redefine the landscape of financial services, making it more inclusive, consumer-centric, and technologically advanced.

What kind of businesses leverage embedded finance?

Companies from various sectors, including retail, travel, and technology, utilize embedded finance to create new revenue streams, enhance the customer experience, and foster customer loyalty.

One place where embedded finance is used that has likely been seen by everyone is e-commerce checkout screens. Many e-commerce brands and retailers now offer financing at checkout through a fintech provider such as Affirm to Klarna.

These partnerships benefit the ecommerce retailer by reducing payment-related cart abandonment, providing advertising for the fintech service provider, and allowing customers to take advantage of financing opportunities without going through a bank in advance.

How will embedded finance impact traditional financial institutions?

Embedded finance presents a significant challenge for traditional banks because it threatens their status as the primary providers of financial services. As non-financial companies increasingly offer embedded financial services, the need for customers to use financial services from banks will diminish, which naturally negatively impacts revenue. For example, someone using Affirm's "buy now, pay later" at checkout will pay interest to Affirm, not their credit card provider.

Are there opportunities for banks to take advantage of?

The embedded finance disruption presents opportunities for forward-thinking banks. By embracing the embedded finance model, banks can form strategic partnerships with non-financial companies, leveraging the latter's customer base and digital platforms to reach a wider audience. Banks would provide their compliance and risk management expertise while gaining access to innovative technology and customer insights. Banks with strong brands can also provide the marketing leverage that brings.

Additionally, regulatory requirements mean that it is cheaper and easier to partner with a bank that serves as the provider of regulated services. Banks can take advantage of this by developing relationships with fintechs that need banking services and their investors. This symbiotic relationship can potentially lead to diversified revenue streams, enhanced customer experiences, and a stronger competitive position in the evolving financial landscape.

Embedded finance is just one part of a larger transformation

It's important to remember that embedded finance is just one part of the ongoing digital transformation of financial services. Every part of the traditional financial services industry is undergoing rapid change.

Banks that want to grow and prosper in the coming years amid rapid digitization will need to embrace the pace of transformation and become agile enough to adjust rapidly to changing customer expectations.

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