Embedded Finance: Benefits and Challenges

August 2021

Fintech & Payments

Nick Maynard

VP of Research

Since the announcement of PSD2 (Second Payment Service Directive) in the EU, the financial services market has inexorably been moving towards a model which is more open, transparent and interlinked. Open Banking and APIs are major enablers to changing the financial services market in this fundamental way. 

Creating an ecosystem where financial tasks are present in non-financial activities creates a profoundly different market – new opportunities for partnerships and additional revenue streams will come to the fore, while traditional financial institutions will struggle with the threat to their once distinct role in financial services.
User experiences in this sense will commonly mean eCommerce checkouts, for example where payment options are embedded to avoid having to re-enter details, or where options like insurance are embedded within the checkout process.

Embedded finance is a broad definition, made up of several different areas where APIs are enabling the integration of different functions in new areas.

For a significant period, much of the excitement surrounding embedded finance has been around the extent to which its development will allow big tech companies (eg Facebook and Amazon) to enter markets, such as financial services, which are new for them. This interest from big techs is a major driver for embedded finance development for several reasons. Firstly, big techs continue to diversify.

However, it is not all about additional revenue streams. Big tech companies have definite value to add in the financial services area. What these technology companies are good at is user experience, which is something that has traditionally been more challenging for financial services. By combining their expertise in user experience with third-party capabilities, big tech can add value and significantly broaden their appeal in a constantly evolving market.

Under embedded finance, the brands leveraging the ability to create new financial services are not the only beneficiaries. Embedded finance is an important way for B2B vendors to generate revenue, and is increasingly seen as an additional stream for financial services vendors.

However, there are challenges that can threaten the future growth of embedded finance. Indeed, embedded finance has key enablers in the form of Open Banking, BaaS and payment APIs. While these have all developed to a degree to which embedded finance becomes viable, this is not the case for all markets, meaning that embedded finance’s prospects are not universally strong.

Furthermore, it has often been said that banks and financial institutions are among the slowest to adopt new technology, and this has certainly been the case, with many banks still using outmoded technological infrastructures. Outside of the technological question, there is a broader question of mindsets. Embedded finance requires a different way of thinking – for banks, it means partnering with non-fintechs, and playing a less important role for the end user, which will be very difficult for them to accept.