Embedded finance
Embedded finance

Embedded finance definition: everything you need to know

A simple and comprehensive embedded finance definition to help non-financial institutions start exploring this new area of opportunity.

People in the fintech industry find it hard to align on a single definition of embedded finance, perhaps because it has been so transformative to their industry in the last few years. A variety of embedded finance products and solutions are making waves across all sectors by challenging the status quo. It's a powerful force reshaping the distribution model of financial services - opening up a world of convenience and new possibilities for both consumers and SME companies. But what sits behind the trends, and how can you harness it for your own organisation?

There are many things that you need to know about embedded finance to stay on top of it, but let’s start with this one fact: The embedded finance market is forecasted to exceed over $138 billion by 2026. It’s not an opportunity that any enterprise would want to miss.

A simple embedded finance definition to start

Put simply, embedded finance enables businesses to ‘embed’ financial services into their business models at various points along their customers’ journey by leveraging their own proprietary data on top of external financial information. This allows any company - not just financial institutions - to become more competitive by offering financial services and products to their customers.

One of the primary aims of embedded finance is to streamline and open up access to funding - making it a much smoother, quicker, and easier process.

Whereas before, a consumer or business would need to go through a financial institution to apply for credit, with embedded finance, credit can be accessed in the same place they shop or do business.

Examples include eBay’s business solutions for eBay merchants, or Klarna for consumers. Companies like YouLend, for example, make it simple for any company -including banks - to take advantage of the embedded finance opportunity by white labelling embedded lending or financing solutions..

Now that we know what embedded finance is, let’s look at the most important features and capabilities it can offer.

What does embedded finance do?

What makes them unique and popular is that embedded finance solutions offer financial products at the exact moment they are needed, in a distribution format that makes more sense for the customer. When a customer notices that they have sold more inventory than planned but won’t be paid in time to replenish their stock, they don’t need to leave their Point of Sales (POS) system to raise funds for restocking - they can just use the POS’s embedded lending solution.

Similarly, with revenue-based financing (which is a type of embedded finance) the loan paid back is based on a percentage of revenue, not on a fixed rate. This gives businesses the flexibility to pay back when they can and scale up or down on repayments to follow demand.

Moreover, like with eBay’s business solution, embedded finance allows companies that wouldn’t usually provide finance with an opportunity to offer an additional service. For example, Uber has recently announced a bank account offering designed for its drivers.

Who is embedded finance for?

Both businesses and consumers can benefit from embedded finance.

🛠SMEs

One of the greatest pain points for SMEs is navigating the complexity of finance solutions available to them. Consumers are now able to find financial services exactly where and when they need them. It needs to be the same for businesses.

A payment service provider, an online marketplace, a retail bank, or any other organisation that deals with SMEs can take a step in that direction as well, by incorporating financial solutions in their user journeys to make them accessible in the right format, at the time when the merchant needs them. That way, they provide small businesses with much-needed funding to overcome their cash flow challenges. That’s why companies like eBay, Shopify, Dojo or and many others have launched these solutions for their SME business clients.

👨‍👨‍👧‍👦Consumers

The most typical form of embedded finance that you’ve probably come across is for consumers, such as retailers offering buy-now-pay-later solutions on their online checkouts. By removing the typical challenges of applying for credit, consumers can instantly purchase an item and are more inclined to buy again from a retailer that offers this instant access. In fact, BNPL options have a 36% higher purchase frequency than regular shoppers.

Why embedded finance is hot right now

During the pandemic, businesses across most industries were forced to digitally adapt in order to continue offering services. Projects that were planned for future years were brought forward and implemented within months.

Now, permanent changes to consumer behaviour mean digital adoption is here to stay. And with it, the opportunities for embedded finance continue to grow.

In particular, embedded financial products such as cash advances on invoices or revenue-based financing are crucial for attracting and retaining SMEs and digital part-time entrepreneurs.

💡 It’s key to provide flexible solutions for SMEs. They are an underserved market, which is surprising when they make up 99.9% of the business population - accounting for three-fifths of the employment and around half of the turnover in the UK private sector alone.

The different types of embedded finance

There are multiple forms of embedded finance. Here are some of the most popular use cases:

  • BNPL - Buy now pay later (BNPL) is a popular new form of credit for consumers. Its popularity has taken over credit card usage and is often seen on retail sites.
  • Insurtech - When purchasing a new product, customers can opt to insure their goods at the same time through the automated processing power of this tech.
  • Cash advance - This is when a business receives a lump sum in advance and the repayment fee is established upfront - rather than having running interest.
  • Revenue-based lending / Advances on receivables - These terms are often interchanged. Here, the loan paid back is related to a percentage of revenue, or dependent on a receivable being collected at a later date. The amount therefore fluctuates with income.
  • Embedded card payment - Like with Paypal, users can link their Paypal accounts to their bank accounts to streamline transactions.
📕Further reading: Embedded finance products: Risks and rewards

Keys to success for an embedded finance solution

While there’s an abundance of opportunity, there are risks associated with implementing embedded finance solutions. To make sure your embedded finance project is a success, watch out for the following key considerations:

  1. Sensitive data requirements - A significant amount of confidential business data is needed to offer this solution. Whether it's deployed in-house or through a partner, companies need to assess the risk and ensure they comply with the different regulations, depending on the type of businesses they serve, whether they build the solution themselves or go through a white-labelled partner.
  2. A spotless reputation - Financial service providers need to be trustworthy and have up-to-date certifications. This can be a risk especially if partnering with an external provider to offer lending solutions under your own brand, for instance. For that reason, it’s crucial to make sure your chosen partner not only has all the required data security and privacy certifications, but also handles financial processes in a fair and ethical way. Some questions to ask a potential provider: how do you work to remove bias from lending decisions? How inclusive are your products? What industries do you work with and what sustainability priorities do you have in place?
  3. Challenges building embedded finance in-house - Successfully launching this sort of solution in-house takes time and specialist skills, as most of the power of modern embedded finance solutions comes from.
  • the sophistication of their data modelling,
  • the partnerships they have with various capital providers,
  • and their understanding of how to work within regulatory constraints while still offering their products to as many merchants as possible, and especially those who are not served by existing solutions.

These drivers are usually out of the core competencies of non-financial institutions, and even of some established financial ones.

So if they want to go to market quickly with an inclusive risk model that satisfies compliance and regulation, many lenders use a third party embedded finance provider.

📕Further reading: Embedded finance: Buy or Build

Wrap up

Embedded finance solutions allow all sorts of organisations to meet the nuanced needs of their small business customers, from payment service providers to online shopping platforms to food delivery hubs.

By augmenting their core offerings with these flexible and competitive financing options, they give themselves an advantage over the competition, and keep their customers happy and thriving. Ultimately, embedded finance is about creating delightful experiences around financial products, and that is probably the biggest reason for its success so far.

💡

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