Views on… embedded finance: “Moving fast and breaking things simply does not work in financial services”

We are gathering Views on… embedded finance, which is widely regarded as having enormous potential for financial services and wider industry sectors. So far we have sat down with John Salter, chief customer officer at ClearBank.

In our second instalment, Alex Mifsud, co-founder and CEO of software provider Weavr, looks at how banking-as-a-service (BaaS) and open banking are ways to achieve embedded finance. 

Tune in next week when we meet Andrea Ramoino, MD, Electric Money Business, UK & EEA Solaris

Q: What are the key differences between BaaS and embedded finance?

A: Embedded finance is a form of distribution and delivery where financial services are offered and accessed through non-financial applications. Shopify is a great example. Merchants who build their website using it can also access payment acceptance and working-capital loans through Shopify and, indeed, Shopify’s revenues from financial services now exceed that of their software revenues. BaaS, which delivers payments and banking services via APIs [application programming interfaces], is just one way of achieving embedded finance. Open banking is another means to achieve embedded finance, although it is arguably less powerful than BaaS.

Q: Which holds more potential for banks?

A: Many banks are discovering that BaaS involves a high degree of risk and exposure since the bank behind it is often dependent on the embedder to take care of risk and compliance management. Another option for banks that is only just starting to emerge is the creation of embeddable financial products that already have complex controls and sophisticated risk and compliance processes built in. Because they are financial products (albeit without a user interface) rather than raw capabilities (such as opening an account or issuing a card) they are far easier for banks to oversee and control when they are embedded into a third-party application.

By way of example, an accounting platform can bring a fully formed solution into their software that includes the financial capabilities, risk, and compliance and more, all targeted to the needs of their use case. That's a very different proposition from adding a card and having to figure out how they handle the rest. And 'the rest' is necessary of course.

Q: Have fintech companies suffered from poor BaaS?

A: Many fintech companies have been built over BaaS. In fact, the best fintechs are great customers for BaaS because they tend to have the competence and appetite for doing risk and compliance to high standards, therefore keeping the bank out of trouble. In the best pairings, the fintech can operate without having to get their own financial licence, and the BaaS provider gets the transaction volumes without the cost of customer acquisition and servicing.

Q: What type of financial services are consumers and businesses looking for?

A: In the context of embedded finance, there are compelling propositions based around embedding payments (for both B2B – see Shopify, as well as B2C – think Uber and Airbnb), insurance within e-commerce (for both consumers and businesses), as well as lending, as evident from the buy now, pay later trend for both B2C and more recently B2B.

Q: The Covid-19 pandemic fuelled a lot of growth – will we see demand grow backwards as the global economy recovers?

A: The pandemic has driven digital transformation and adoption as never before. The surging demand for digital during the pandemic has eased but the structural change in digital adoption remains. What is needed now is for marketers to build on that confidence with digital to provide experiences and propositions that generate demand post-pandemic. In this respect, embedded finance is a powerful tool to provide the next generation of B2C and B2B applications that delight customers and move into the mainstream, much as Uber and others did well before the pandemic.

Q: What have been the barriers to embedded finance so far?

A: Financial services are a highly regulated industry, whereas software is largely permissionless. The approach of moving fast and breaking things, as epitomised by Silicon Valley, simply does not work in financial services – regulators will simply stop it. This means that new tools are needed to bring software and financial services together. The present tools – BaaS and open banking – fall short: BaaS is complex to use and requires taking on responsibilities that many software companies are ill-equipped to do, while open banking provides only meagre capabilities for fully embedded digital experiences.

Q: What is the growth potential of this market?

A: Matt Harris of Bain Capital made a rough estimate for the market cap potential of embedded finance firms as in excess of $3tn in the US, a figure later extrapolated by Simon Torrance to above $7tn globally. Lightyear Capital have made nearer-term estimates for revenue to grow to $230bn by 2025. No one can know with any accuracy at this stage, but it is worth noting that embedded finance is at the intersection of two huge industries: software and financial services.

Its potential is vast and can touch almost every area of human activity across sectors like health, education, real estate, employment, transportation and many others. These are trillion-dollar industries, and embedded finance has the potential to change their customer value proposition and their economics. 

Read other Views on... embedded finance:

• “Should a good brand put its customers in debt?”