Four factors powering an embedded finance renaissance

Why financial institutions are pouncing on new opportunities

 

Timing is everything, as the saying goes, and embedded finance is definitely having a moment. According to the 2023 Carat Insights report, 61% of consumers say it’s appealing to be offered a retailer’s credit card at checkout. Seventy percent of banking executives say that embedded finance is either core (24%) or complementary (46%) to their business strategy, according to IBM.

Merchants and businesses have been helping their customers finance purchases and maximize their buying power for decades. Embedded finance still revolves around mechanisms like layaway, loyalty rewards and private-label credit. The names might change – buy now, pay later (BNPL) is an evolution of layaway, for example – but the concepts are essentially the same.

And yet, when I’ve met with leaders of financial institutions over the last year or so, they’re more receptive than ever to discussing the new possibilities in embedded finance. In fact, they’re often the ones bringing up the topic.

What’s changed? Why do financial institutions have a renewed interest in embedded finance?

In this article, I’ll explore the timely convergence of four factors that are putting embedded finance in a new light and prompting action from all parties involved: financial institutions, brands and businesses, and fintechs.

 

1. Commerce is everywhere; financial services are following

The fundamentals of embedded finance haven’t changed, but it is being applied in new ways. That’s because commerce itself is changing. It’s following consumer desire to be digital first, and at the same time, commerce is becoming more and more ubiquitous. Financial services in general, and embedded finance in particular, are expanding to match new consumer experiences.

To get a sense of how commerce is changing, think about all the new ways that consumers are making purchases.

In the last ten years, new online marketplaces allow consumers to buy products and services sourced domestically and internationally. A growing number of merchants offer buy on app and pick up at the curb or home delivery for groceries to school supplies. Social commerce continues to evolve and gain momentum as anyone can now purchase anything their favorite influencer or athlete is wearing or promoting while online. Even basic web browsing surfaces commerce journeys, as consumers have gotten accustomed to clicking on just about anything they see (think clothing, housewares, recreational products and the like) and then being able to buy it.

Meanwhile, savvy businesses and brands are focusing on personalizing the consumer journey. Many are using next-generation technologies to create applications that engage customers; understand what's in their shopping carts; and offer access to payment options, including split-tender. These applications maximize customer purchasing power, improve cash flow and reward customers for their loyalty.

Businesses and brands increasingly understand that offering embedded finance – whether they are online or in a brick-and-mortar location – may improve conversion rates, increase basket size and raise wallet share.

 

2. The paradigm shifts: Financial institutions need deposits

Since the Federal Reserve began raising interest rates in March 2022, financial institutions have seen the cost of funds rise and, as a result, their need for deposits grow.

The cost of funds, however, isn’t the only challenge to bringing in new deposits.

A new breed of fintechs poses a new kind of threat to financial institutions. Vertical SaaS platforms, for example, already provide payment facilities to their small and medium business customers. Now, those kinds of fintechs are offering deposit accounts with their sponsor financial institutions. Big box merchants and online marketplaces are offering private label financial services, from installment loans to stored value products, to help their captive customers with purchasing power.

Fortunately for financial institutions, the current regulatory framework requires most financial services to be offered by chartered financial institutions. And extending those services to the new breed of fintechs and big box merchants is both easier and more profitable than trying to beat them at their own game.

Today, financial institutions are gravitating to fintechs that are technology platforms with existing customer bases. These customers are digitally native, their online experience is paramount for them, and they don’t care if the app they use belongs to a financial institution. In other words, banks have little chance of acquiring them as new customers through traditional channels.

When access to a fintech’s customers is part of a partnership with a fintech, however, financial institutions can attract new customers and deposits. By embedding banking services in these fintech experiences, we're starting to see much more growth for both fintechs as well as financial institutions.

 

3. Everybody wins: Value propositions align for all parties

As discussed in No. 2, above, financial institutions are gravitating to fintechs with existing customer bases. Likewise, banks are looking anew at businesses and brands that are focused on an improved customer journey (see No. 1, above).  

Today, banks, fintechs and brands are realizing their own specific value from these engagements:

• Financial institutions are positioning themselves to add customers and grow their deposits and fee revenues because they’re getting access to captive customer bases. Banks also stand to grow their loan portfolios.
  
• Many fintechs already know their customers’ payment proclivities and deposit cycles, but without a financial institution standing behind them, these fintechs can’t offer a full suite of embedded finance solutions. Working with a bank, fintechs can offer their customers timely lending solutions, enhanced purchasing power and (for SMBs) improved cash-flow efficiency.
• Whether we’re talking about a national retailer or a prominent regional brand, businesses and brands have realized that embedding different types of financial services into their user experience helps increase turnover and conversion rates for their stores while also increasing customer engagement and loyalty. As with the bank-fintech relationship, banks are a necessary ingredient for brands wishing to achieve these kinds of goals.

 

4. The API revolution comes to embedded finance

To deliver a full range of financing solutions into a commerce or SMB experience, there are multiple systems that must be engaged, including core banking, lending, rewards/points and merchant processing. Historically, a bank going to a fintech or financial services technology provider would have engaged with multiple divisions within the company in order to build a bespoke embedded finance solution.

Today, however, application programming interfaces (APIs) are bringing these systems together and making it much less labor- and investment-intensive for financial institutions to connect with fintechs and brands. API-based developer studios now serve as the connective tissue to bring all the pieces of the ecosystem together.

APIs are typically curated and served up from a fintech’s developer studio. This orchestration layer allows third parties to take those APIs and embed them in the brand’s experience. This way, fintechs and brands alike can create the exact customer journey they desire. 

 

Matchmakers bring the parties together

The API economy is making it possible to build buyer journeys of unprecedented power and richness. There’s still a need to bring all the parties together, however.

Fiserv occupies a unique space in the world of embedded finance in that we’re both a technology provider and, in a very real sense, a matchmaker between fintechs, financial institutions and those businesses wanting to enhance their customer journeys.

It’s important for financial institutions to align with fintechs and other technology providers that have the relationships across the embedded finance ecosystem: Not every financial institution matches up with every fintech, and not every fintech matches up with every business or brand. Embedded finance is no longer a bespoke product, but there’s still a lot of experience and knowledge that goes into facilitating the kinds of relationships that enable highly targeted, successful embedded finance projects.