Narendra Nandal is the CEO of Infintech Limited. In this article, he discusses embedded finance in financial inclusion.
In the Arab world, 69% of the population is unbanked. This includes advanced countries like the UAE, Saudi Arabia, and Qatar, as well as developing countries like Libya, Sudan, and Egypt. This part of the world has about 390 million people, of which 238 odd million people have penetration of phones. This means that people do not have access to financial services or a basic bank account. Primarily this is because there is a large unbanked migrant population that comes into this region in search of work. Once they are here, they do not get access to the banks. So ultimately, what happens is they have to rely on the local, fragmented banking systems or exchange houses with large transaction costs. This region has a huge number of remittances coming in as well as going out. Overall, there is a large demand for financial inclusion.
Looking at just the UAE, some of the financial inclusivity indicators are –
- 69% of people have access to banking
- 19% have access to credit
- 29% have access to savings
- 67% have access to digital payments.
A large section of blue-collar workers do not have access to a formal system or limited access to financial services but have access to smartphones.
This is attracting a lot of FinTechs, who are trying to set up their businesses providing services to this unbanked, underbanked population.
Embedded finance
There are customers, as well as small businesses, who are starting up today, but they never get to interact with a conventional bank. When they log in to e-commerce or accounting platforms, they are not directly talking to banks but interacting with a middle layer. These software companies normally partner with banks and technology providers to embed financial products into a seamless, convenient, and easy-to-use customer experience. This new form of partnership between banks, technology providers, and distributors of financial products via non-financial platforms is what embedded finance is all about.
Embedded finance places a financial product in a non-financial customer experience, journey, or platform. It is about providing financial services at non-financial places. Integrating financial products into digital interfaces that users interact with daily makes the next generation of embedded finance so powerful. These can be customer loyalty apps, digital wallets, accounting software, shopping cart platforms, etc. For consumers and businesses using these interfaces, acquiring Financial Services becomes a natural extension of a non-financial experience, such as shopping online, scheduling employees to work shifts or managing inventory.
The evolution of embedded finance has been enabled by fundamental changes in commerce, merchant and consumer behavior, and technology. The digitization of Commerce and Business Management has massively expanded opportunities to embed finance and non-financial customer experiences. As much as 50% of the global card spending now takes place online, with a large proportion of small and mid-sized companies relying totally on software solutions for managing their businesses. In addition, as digital natives come of age, they expand the pool of consumers and businesses to receive all the financial services via digital platforms.
Finally, open banking innovation has helped unlock latent demand by enabling third-party FinTech players to access consumers’ banking data and even conduct transactions on their behalf.
Embedded finance is likely to emerge in any environment, wherever there is a critical mass of end consumers who have frequent or digital interactions with the operator of the digital platforms, which we refer to as distributors. For a non-banking company acting as a distributor, embedded finance offers a way to enhance the customer experience and create a new source of revenue without incurring the overhead associated costs that come with operating a bank.
The types of businesses well placed to offer embedded finance include retailers, business software firms, online marketplaces, telecom companies, and OEMs. All these categories have seen very high levels of activity and innovation in embedded finance over the past year or two.
In addition to traditional financial products, some novel use cases are emerging. For example, Emperor finance distributors are offering prepaid cards to employees as part of a wage protection system around wage access programs. Some give merchants the option to use deposit accounts for instant payment settlements.
The embedded finance product portfolio will expand further as customer onboarding and product servicing processes are gradually digitized and real-time risk analytics and services grow more sophisticated. Risk is likely to remain a constant constraint on growth. However, products that require case-by-case assessment, in-person touchpoints, or regulatory waiting periods, such as commercial real estate finance, are less susceptible to end-to-end.
The distributors of embedded finance rely on two sets of providers to manufacture the embedded finance offering and grant access to it – technology providers (FinTechs or Banks) and balance-sheet providers (licensed or chartered financial providers).
Technology providers provide the platform through which distributors can access and customize embedded finance products. Some provide point solutions for specific categories of financial products, such as card issuing.
The balance sheet providers are responsible for manufacturing embedded finance products. They provide Risk and Compliance Services and offer access to funds for lending and deposit products. Balance sheet providers sometimes partner with technology providers to create an integrated embedded finance offering.
Some banks and FinTechs fulfill both of these functions. Having built their own technology layer on top of their own balance sheet, they provided embedded finance to distributors such as retailers, OEMs, etc. E.g., Stripe is partnering with Goldman Sachs.
All players do not benefit equally from the rise of embedded finance. As in banking in general, revenue primarily accrues to who takes the most risk and to the distributors that own the customer relationship. For example, most of the revenues from embedded finance lending products accrue to the balance sheet provider, which bears the risk of credit default. However, where payments and deposit products are concerned, the distributors who own the end-customer relationships benefit the most.
Market Trends
- Many embedded finance distributors begin by offering deposit and payment products before extending the product range to lending products such as credit cards and Merchant Financing. Deposit and payment products are attractive to distributors not only because they represent substantial revenue pools and promote stickiness but because they are also powerful tools for building customer relationships and capturing customer data that can be later used to inform underwriting decisions for further higher-margin lending products.
- Many technology providers seek to capture a larger share of embedded finance revenues by expanding the value chain. For example, in lending, they are looking to increase the share of revenues by finding ways to share the value chain when it comes to risk or by offering repurchase agreements for loans originating from the balance sheet.
Although there are emerging leaders, the embedded finance market still has ample whitespace for new entrants, and we expect it to rise or at least double in size over the next three years. The long-term winners will likely be those already building the table-stakes technology expertise and relationships needed for a future leadership position. Financial services firms and FinTechs looking to stake their claims in the embedded finance business would be well advised to commit themselves to implement broadly.
Embedded finance can be a game changer in the financial inclusion world by developing solutions that are very customer-centric propositions. Any solution that is very customer-centric, which takes care of the basic needs, is the first pillar.
Secondly, you must innovate or streamline the innovation in a very scalable manner because the target population is large and across jurisdictions and sectors.
The third pillar is embedded compliance, fostering trust among customers and partners.
Finally, once you have onboarded the customer and given them the basic services, how you offer multiple financial products is important.
So if you have to address the financial inclusion issue on a large scale, FinTechs have to unite, strike strategic partnerships and collaborate. That will help drive financial inclusion.
