The Role of Embedded Finance in Creating a Frictionless Experience

Businesses who choose to embed financial products into their platforms, get to discover better ways to improve value for their customers. Embedded finance is based on building relationships with all stakeholders – banks, non-financial companies, and fintech - that are symbiotic. Brands trust fintech companies or 3rd party service providers to provide financial services within the brand’s app. Fintechs and financial service providers trust that banks will provide accurate and swift responses when API calls are made to their databases and banks trust that the fintech will not abuse or pose a risk to their secure models by granting access to their database.

What is Embedded Finance?

In Bright Talks 18th podcast edition on Embedded Finance, Steven Bajic describes the concept of embedded finance in simple terms as

“Experiencing financial services when consumers need it, how they need it, and where they need it”

Embedded finance is the flawless and seamless interaction between a financial and digital product. It helps businesses build an experience powered by financial products. The key objective of companies who choose to incorporate embedded finance is to grow customer engagement and value. The great advocates of embedded finance Andreessen Horowitz and  Matt Harris have repeatedly canvassed the undeniable rewards of embedded finance in both developed and developing markets. In essence, the notion being propagated is every company can become a fintech company if they choose to.

Embedded Finance gives companies more control over users’ experience and helps them attend to every need of the user, be it financial or not. Another noteworthy plus of embedded finance is the shortened turnaround times for product launches, which empower startups to launch and scale products quickly and economically.

Embedded FInance vs. BaaS

Banking as a Service (BaaS) is oftentimes used interchangeably with Embedded Finance. While Baas is profoundly similar to embedded finance, there’s a subtle and simple difference. BaaS is the framework around which Embedded Finance is built, just like you can’t have a sundae without ice cream. Other differences between embedded finance and BaaS can be classified in terms of the order, uses, and functionality.

BaaS is a model that allows banks to give Third Party Service Providers like Fintechs or Non-financial companies access to customers’ accounts warehoused by financial institutions using APIs and webhooks.  Every time a customer within the app or website of a non-financial company requires a banking service, these on-demand financial services are readily made available in the most frictionless and seamless way. In essence, the concept of embedded finance exists because it rides on the framework of BaaS.

Let’s dissect embedded finance players and outline the roles and contributions of each player, shall we?

The Customer’s Mounting desire for Convivence

C-Stores are designed to keep you in store for as long as possible with an end goal of enticing shoppers to spend more, a review of consumer behavior shopping habits has revealed. Promotional offers, music playing in the background, mirrors and bright lights to enhance the store’s environment, ever ready to help staff (if you are lucky) who lure you to add that last item to your cart for the 7th time, the beautiful and elaborate display of products on the accessible shelves that are difficult to ignore and the temptation list go on.

According to a report by McKinsey, the ecosystem model gives better insights into consumer niches, bridges the gaps along the value chain, and increases the lifetime value of consumers. Consumers are increasingly inclined to prefer simple, embedded systems that truly give a holistic user experience. Once a customer has to worry, even for a second about how to access a product or service being offered, there’s a high chance they’ll drop off and move on to something else.

The Rise and Rise of FinTechs

Many embedded finance innovations rely on financial institutions that offer BaaS services to their partners who use their services. Essentially, fintech’s who establish partnerships with banks can go ahead to offer these services to non-financial companies, who all ride on the infrastructure the banks have created. The less-regulated structures of Fintech make them easily accessible to smaller businesses and a broader range of retail consumers in dire need of financial services. The explosion of fintech gives a fair idea of how accommodating the government and public are to this party cluster in the financial cycle.

Globally, venture capital-backed fintech funding reached $210.1 Billion in 2021. In Nigeria, Fintechs tend to have a deeper understanding of the business and risks of the market cohorts banks have been unable to reach. Similar to their international counterparts, they rely heavily on automated workflows, APIs, and agile technology tools to develop and scale faster than archetypical financial organizations.

This extract from an overview of the Fintech landscape in Nigeria shows the Nigerian Fintechs industry has a long way to go to harness the opportunities that abound

“There are still other opportunities for Nigeria to further foster its ecosystem in fintech and it has begun to do so. The country is just large enough (the largest country in MEA by population and one of the largest in the world) that fintech has huge potential to cater both to its professional class and the majority of the population – the working class and poor”

The Central Bank of Nigeria (CBN) as part of its financial inclusion strategy actively supported companies that contributed to the reduction of unbanked adults in the country which has fallen by 17% between 2008 and 2020. In the wake of the global pandemic crises, the Fintech space grew by a staggering 800% in 2020. The CBN has pledged it will continue to give priority to organizations, especially Fintechs who actively contribute to growing the number of financially included adults. It’s no doubt that Fintechs have become the enablers of digital financial services in our modern world and we cannot ignore their overwhelming contribution to the world of finance.

The Bank’s Paranoia

Several embedded finance ambassadors claim there’s absolutely nothing to be worried about. The universe will “sort out” itself and resources (revenue in this case) will be redistributed and not completely lost.  “Owning” customers will no longer be of importance as the focus will shift to growing the landscape to include more consumers. The wide margins previously enjoyed by banks will be eroded but when the volumes grow, it will make up for any perceived losses and the “cycle of life” will ultimately be preserved.

Banks by nature have strict regulatory requirements that make them ideal gatekeepers of compliance, risk, and data security. Embedded finance has birthed the need for innovation in the way banks operate, and for banks who have braced themselves for the impact, there is a $25 billion market opportunity waiting to be taken with Banking As a Service (BaaS).

The general use case of embedded finance is payments, where customers can easily and readily make payments for a company’s goods and services but beyond that embedded finance is more than just payments. If there’s a financial arm to any process, product use, or experience, then there’s a place for embedded finance. There are cogent facts showing that embedded finance has been the main driver of BaaS in the wake of digital financial transformation and this is based on the large contributions of embedded finance to the e-commerce and payments domain.

Non-financial Companies and Frictionless Experience

One of the exciting things about embedded finance is that it can be applied to companies of all sizes and at any maturity level. It’s not for the first movers or the latecomers. It’s for companies who genuinely care about providing the best holistic solutions for their customers. Ready companies should seek to emancipate themselves from old ways of doing things and take that plunge.

There’s never been a better time to get cracking on building your non-financial business empire than with all the financial services your customers need.

A Means to an End

As with all trends and hypes, companies must ensure they are not just following the crowd blindly. If you must jump on the bandwagon, at the very least do it with eyes wide open to avoid situations that might do more harm than good to the business. Embedded Finance is still a means to an end. The means – financial services; the end – delighted customers and increased revenue.

In understanding the trends in embedded finance or banking as a service, Mckinsey advises players within this industry to consider :

• The practicality and bottom line of adding financial services to your current user journeys? Will it make the user experience simpler, faster, and better than what you currently have?
• Will you considerably grow your volumes and increase revenue to justify project expenses eventually?

For banks, some tough decisions also need to be made on how they intend to interact with BaaS providers and the extent of the interaction such they don’t lose out. Some are:

• How do banks ensure the advantage they have over retailers who provide integrated experiences to consumers is retained and strengthened?
• To what extent should banks be willing to partner with Fintechs? What will be the terms of engagement?

Common Use cases of Embedded Finance

Some of the best-known use cases of embedded finance are centered around Lending, Insurance, Investments, and Fintech-as-a-Service. Here’s a visual snapshot of some fintech companies in Nigeria and the different industries they cater to:

The Future of Embedded Finance

Embedded Finance has evolved beyond payments for singular transactions. Investment, Payments, Insurance, and Loans can be applied to a plethora of industries such as Retail, Healthcare, Real Estate, Education, Logistics, and across different models such as B2B, B2C, and C2C. There are no bounds to what can be achieved with embedded finance, and several companies are taking advantage of this revolution.

They also need to design scalable models to support programs with different risk exposures; one size cannot fit all.  Companies should be able to measure their readiness for agility and digital transformation if they decide to embed finance into their business solutions.

Customers are still big on frictionless experiences and because consumers are insatiable in their quest to improve life’s meaningfulness, the job is never done. Embedded Financing is an evolving concept that seeks to address the insatiability of consumers, where the last state for one cycle becomes the starting point for a new one.