Over the past 5 years, there has been a proliferation of embedded FinTech startup companies. Many of these companies make claims suggesting that traditional finance, banking services, and mortgage lenders are on their way out. Instead, embedded FinTech promises more transparency and shorter processing times. Is the promise up to the hype?
Let’s start with an example to better understand the promise of embedded FinTech. In the near future, a job applicant starts a new job and goes through the company orientation process. The employee will be informed that access to emergency cash loans will become available after a probationary period of 90 days. These loans will be originated and deposited right from the workplace to a personal bank account, but the employer will not actually issue them; the process will be seamlessly completed by a bank through embedded Fintech.
Seamless, and fully transparent. A business model that’s too good to be true, or is this the future of financial services?
Financial Technology (FinTech) has been part of our lives for far longer than Information Technology (IT) has been in our homes. Some IT historians believe FinTech started when credit cards were equipped with the magnetic stripe interface provided by the IBM 360 system in the 1970s. Other historians believe that the electronic automation of the Nasdaq stock exchange in 1971 is the true origin of FinTech.
What historians can agree on is that both the credit card industry and the Nasdaq greatly contributed to the creation of solid data networks many years before Americans were able to go online from their homes.
Embedded FinTech is a logical progression of financial technology. In essence, embedded FinTech refers to providing value-added financial services to institutions such as banks. In the near-future scenario described at the beginning of this article, we mentioned emergency cash loans made to workers through HR, but the actual funding would be taken care of through traditional banking services. The embedded FinTech aspect of this example consists of a series of application programming interfaces (APIs) that connect the HR department with the bank.
The complexity and feasibility of embedded FinTech can greatly vary from one application to another. You can have something as simple as a kiosk that prints vouchers for payments of utility bills at point-of-sale (POS) terminals, but you can also have embedded FinTech that lets individuals make retail purchases with cryptocurrency tokens stored in their smartphones.
Let's briefly return to our HR loan example. We have already established that the APIs that connect HR databases with banks are a classic example of embedded FinTech. We also mentioned that the employer is not the one making the loan; there is an outside bank involved in lending and servicing. More than likely, the borrower will agree to repay the loan through payroll deductions, thus making the entire process seem as if the employer is in fact providing a banking service, which is exactly what embedded finance is.
A few examples of embedded finance
Perhaps a better example of embedded finance would be the 2010 partnership between PayNearMe, a major embedded FinTech provider, and convenience store chain 7-Eleven. We know 7-Eleven stores as places where we can get coffee, snacks, beer, groceries, and household goods. But we can also go there to pay for services such as water, electricity, smartphone, and others.
Here’s another take on the subject. If you are interested in a Ford SUV, for example, you can visit a licensed Ford dealership in your town and complete an application for financing through the Ford Motor Credit Company. The convenience is undeniable: Instead of having to go to various places for the car loan, the embedded finance process will allow you to take care of everything right at the dealership. The connected APIs that handle the credit check and other steps of the application are embedded FinTech solutions that let you drive your new SUV right off the lot without leaving the lot.
The takeaway
This is what embedded finance entails: The ability of a non-financial business to provide financial services traditionally associated with banks. In other words, embedded FinTech is what makes embedded finance possible. Embedded finance has not been around as long as embedded FinTech, but there is no question that it has expanded significantly over the last few years.
APIs are at the heart of both embedded FinTech and embedded finance, and will play a major role in the creation of future financial service ecosystems. These are intertwined technologies that will define the future of financial products and banking in general. APIs allow developers and businesses to create new solutions that can be embedded into other systems. For example, the PayNearMe application described above was built to work with specific platforms and systems, but there are endless applications of this technology in other areas of finance.
The concept of credit cards will never disappear, but embedded finance is not limited to just credit cards. Other forms of financing such as car loans, mortgage loans, and loans for higher education, are also becoming embedded FinTech services. Other types of products may include insurance, retirement accounts, and payment gateways.
An API essentially consists of interfaces with which to communicate and the protocols that connect the interfaces to the client. The embedded FinTech world uses APIs to interact with banks and other financial institutions and to manage services and processes, while embedded finance uses APIs to provide value-added services that in turn enhance the customer experience. It is important to point out that many financial services have moved into the digital space through the use of APIs: Banking services, financial investment, financial planning, and more.
Useful and convenient APIs can certainly get the attention of customers. Let's say you open a PayPal account in the U.S. and want to link two of your personal bank accounts; you see one of your banks listed as an option on the PayPal interface, which means that an API has been established to make linking easy and convenient with just a few mouse clicks or taps on the touchscreen. Your other bank lacks this API, and it makes you jump through hoops to complete the linking process. You will be reminded of this the next time you conduct a PayPal transaction.
The APIs provided by PayNearMe to 7-Eleven and other retail giants such as Walgreens and Walmart add a layer of convenience for customers that translates into increased foot traffic at brick-and-mortar store locations. This kind of convenience will continue to expand in the near future, but we are also seeing other APIs being developed to benefit gig economy platforms such as Uber, which connects with Hertz Car Rental to provide vehicle leasing deals to drivers. Furthermore, embedded FinTech also provides BaaS to drivers so that they can efficiently manage their personal finances right from their smartphones.
Web3 is an upcoming stage of IT innovation that will be as transformative as the Web 2.0 paradigm that brought us web applications, social networks, and cloud computing. Some internet scholars believe that Web 2.0 has become too centralized; this is a trend that can be observed with the rise of internet giants such as Google and Facebook, which thrive thanks to the monetization of user data.
Decentralization is at the heart of Web3; to accomplish this, we will see greater use of cryptographic blockchain technology. Web3 will also feature the metaverse, which can be described as a collection of connected virtual worlds that may one day replace websites. A digital economy will fuel the metaverses, and we are not talking about a virtual economy. The advent of digital currencies that run on modern blockchains will play a major role in the development of Web3 and this is where embedded FinTech comes into play.
When Bitcoin became legal tender in El Salvador, the Central American nation went through a major embedded FinTech revolution. In a matter of days, financial regulators in El Salvador rolled out solutions such as digital wallets and mobile POS apps that enabled street vendors to easily accept Bitcoin. We can safely say that embedded FinTech will set the stage for the future of the digital economy within Web3.
Let's look at three current embedded FinTech applications that hint at what we should be seeing more of in the near future:
The catchphrase for this financial trend is "Buy Now, Pay Later." In essence, FinTech solutions allow retailers to offer credit financing during the checkout process, and this can take place on e-commerce shops as well as brick-and-mortar POS terminals.
Electric vehicle giant Tesla Motors allow prospective buyers to purchase new models online along with the convenience of car insurance policies that go into effect the moment they take delivery of their EVs.
Each time you see an option to complete purchase transactions with digital wallets, this is a sign that we are headed towards an embedded FinTech future. E-commerce industry analysts believe that more than 50% of purchases will be settled with digital wallets by the year 2025.
* OpenLending: This Texas-based fintech company specializes in automating the lending process so that banks can easily connect with prospective borrowers.
* Uncapped: Easy access to business capital for e-commerce operations is at the heart of this Polish tech startup. One of the biggest Uncapped clients is TransferWise, which has become one of the biggest names in international money transfers.
* PayNearMe: As previously mentioned, this provider of bill payment solutions has managed to land partnerships with major players such as Walmart and 7-Eleven.
*Fundmore: A new player in the embedded FinTech industry, Fundmore uses AI and smart document management to drastically cut down on mortgage processing times.
* Falcon: One of the most lucrative markets for microlending and small personal loans is India, and this is where Falcon aims to become a dominant FinTech provider. Facebook and Silicon Valley Bank are among the early funding sources for this company.
* Intergiro: The value proposition offered by this Swedish startup is very enticing. In essence, an e-commerce business that wishes to provide BaaS to customers and clients can simply make an online request for Intergiro to develop the relevant APIs with full compliance.
* Plaid: More than 5,000 apps that provide financial services at the personal and business levels are built on this embedded FinTech platform, which some technology analysts believe could become as influential as PayPal.
Each new development in the world of embedded FinTech is celebrated with excitement, but not everyone is convinced that the open banking trend will be so disruptive.
Something to keep in mind is that a significant aspect of FinTech is centered on providing services to individuals who are disenfranchised from the banking system. To this effect, there is a divergence of opinion among conservative bankers who see FinTech as an adversary. However, many of these bankers will admit that embedded finance presents a great potential in terms of driving new business.
If you feel that embedded FinTech is just a fancy term to describe white label financial services, you are not alone. You are probably thinking about branded credit cards, particularly those marketed by airlines that offer rewards. A more updated example would be wireless service providers that offer some level of bill payment and money transfer solutions.
The thing about embedded FinTech is that we are still trying to define it, and perhaps it is better for everyone to exclude branded credit cards and other white label examples. We should be thinking about FinTech giants such as Green Dot, which has been a major Walmart partner since 2014, and which provides the entire technology stack that the Apple Pay digital wallet runs on.
In the end, we should accept that our business and personal financial futures will be closely linked to embedded FinTech. We will know this to be the case when we don VR headsets to navigate the metaverse to make purchases with Bitcoin wallets.