Today, there is virtually no part of the finance ecosystem—and no part of customers' everyday financial interactions—that hasn't been impacted by embedded finance. Perhaps without even realizing it, customers across the world make use of innovations in embedded finance on a daily basis. From buying delivery through Grubhub to requesting a ride from Uber, routine experiences have been made far more convenient thanks to embedded finance.
The opportunity around Banking as a Service ("BaaS") and embedded finance is huge. In a recent report, Finastra predicts the total market opportunity will exceed $7 trillion by the end of the decade and it will fundamentally change the way financial services are sold and consumed.
So, what exactly is embedded finance and how can banks participate in this evolution? In this article, I will explain the continuum of open banking, Banking as a Service, and embedded finance and how all three phenomena create the seamless financial experience consumers have grown accustomed to today.
Open banking: Put simply, open banking is a mandate for banks to make their products and services open and accessible. Part of the public consciousness since 2018, open banking connects banks and fintechs with APIs—the building blocks of innovation—and unlocks new capabilities that significantly enhance the value both entities can deliver.
BaaS: Banking as a Service is the natural progression of an open financial ecosystem. Supercharged with tech and data advancements, BaaS enables banks and fintechs to take what's open and connect it to enabling platforms and new indirect channels. BaaS is the provision of retail or wholesale banking products and services, in context, as a service using an existing licensed institution's secure, regulated infrastructure with modern API-driven platforms.
Embedded finance: This is the next phase in the evolution of open banking and BaaS. While BaaS makes it possible to connect banking services to non-banking platforms, it doesn't mean it's embedded to a point where a customer actually wants to consume it. Embedded finance refers to the integration of relevant, valuable financial services for retail, business and corporate customers, in context at their preferred point of consumption.
One way to think about embedded finance is as a transformation from "conscious banking" to "unconscious banking." Examples of embedded finance consumers encounter everyday include:
- Flexible finance at point of sale
- Payments embedded into a taxi app
- On-demand car insurance when hiring a car
- Purchasing street parking through apps like Google Maps
- Travel insurance when booking flights
- Health insurance or deductible financing when visiting a doctor
- Mortgages offered inside a home buying app
As customers that normally access financial services through banks' proprietary channels start to consume those same services (and more) through convenient and more contextual third-party interfaces, banks must adapt to remain relevant. They need to follow their customers to where they want to engage.
Collaboration amongst industry players will be key to bring together providers (those with licenses to supply banking services), distributors (e.g. retailers, who engage with customers and manage contextual experiences) and enablers (orchestrators, like Finastra, which enable the connection between supply and demand). This will require a deep understanding of customer context, financial services and an open API platform-based approach to drive consumption at scale.
Data, data, data
The combination of open banking and embedded finance will expand the number of workable use cases. In the past, those individuals who had a patchy or weak credit history were often excluded from borrowing. However, the advent of open banking gives lenders a far more comprehensive picture of potential customers' financial background and makes creating an inclusive ecosystem a reality.
Focus must also be given to data analytics throughout the customer journey, rather than just at the point of context. Data collected as customers engage in different contexts will be extremely powerful and pave the way for additional value-added services.
As more and more use cases are developed for embedded finance, it's not an exaggeration to say that at some point in the future almost every company could become a fintech. It's no surprise that customers are more than willing to switch from traditional financial service providers to innovative fintech start-ups that offer more personalized and frictionless services.
More than simply replicating the existing relationship between the bank and customer in a new channel, BaaS and embedded finance will create a very powerful contextual brand experience that includes financial services. In addition to being able to provide products to people at captive points of context, BaaS and embedded finance have the power to enable whole ecosystems of IoT machine-to-machine connectivity and payments.
2022 will see BaaS pioneers extending their leadership position and beginning to monetize the significant value of embedded finance.
The rise of embedded finance is one of Finastra's 100 fintech predictions. Read the full predictions report for more, including an outlook on Decentralized Finance.
Angus Ross is Chief Revenue Officer, BaaS, at Finastra. He leads Finastra's Banking as a Service (BaaS) go-to-market capabilities and the industry partnerships required to deliver them, driving the company's BaaS strategy and co-innovation with customers, technology alliances and digital brands.