Embedded Finance

Feb 2, 2023

A Beginner’s Guide to EmFi: Part 2 Navigating the Challenges

Learn more about the different categories of EmFi used across industries and which are the main barriers to implementing this new model.

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In the wake of digital transformation, data availability and the trend towards a cashless economy, users increasingly demand effortless digital experiences. Embedded finance (EmFi) came to the fore offering "all-in-one" solutions to improve the user experience, build user loyalty and generate new business opportunities. As these platforms become more integrated, seamless, and easier to use, consumers can access insurance, banking, lending, investment or easier payments on one platform.

With this model, both customers and businesses benefit. On the one hand, customers receive faster service, greater accessibility, and a more seamless experience. On the other hand, businesses gain more revenue opportunities, create stickier relationships, expand to new market segments, understand their customers better, and adapt their services accordingly.

In A Beginner’s Guide to EmFi: Part 1 Introduction to EmFi, we deep-dived into the world of EmFi, how it is mutually beneficial for both businesses and customers, why it is trending, and its place within the finance value chain. In this article, A Beginner’s Guide to EmFi: Part 2 Navigating the Challenges, we will further explain the different categories of EmFi used across industries and address the main barriers to implementing this new model. 

EmFi categories

There are many types of EmFi use cases, which vary according to the industry. The main categories, as outlined below, include embedded banking, lending, insurance and payments and investments. However, this article will focus on the first four:

Embedded Banking

In embedded banking, traditional banking services, like checking accounts and debit cards, are integrated with non-financial businesses like retailers. An example of this type of EmFi is the Ride-Sharing app Lyft, which offers drivers a current account and a debit card. By using this service, drivers can receive payment immediately after each ride, instead of waiting weeks for a payment, and they can also spend those funds on their debit cards and earn cash back and rewards. In parallel, by integrating their financial services into non-financial platforms, banks generate fees simultaneously.

Since the beginning of digital banking, Banking as a Service (BaaS) has been gradually evolving. BaaS providers offer financial and non-financial services, unlike a digital version of a bank. With the advent of new technology, banks can now offer their lending or banking licenses to other clients and their tech stack. Capital One, which recently launched Capital One Software, is an example of this. What started as a bank transformed itself over time, expanding its own use of data and cloud computing and creating a business to sell its software to third parties.

BaaS opens the door to new revenue streams and other types of clients, such as challenger banks. These have struggled to compete with traditional banks and stay afloat. However, through EmFi, they can now immerse their financial services elsewhere or even gain a commission by integrating financial services from other fintechs into their systems. These banks are established enough to form these alliances and, more importantly, cross-sell useful products to be as profitable as mainstream banks.

Embedded Lending

EmFi has enabled businesses to offer more favourable loan options so that customers do not have to rely on using their credit cards or taking out a traditional loan when in need of money. Embedded lending, therefore, combines loan and instalment payments with non-financial products and services.

Buy Now, Pay Later (BNPL) is a perfect example of how borrowing money has been greatly simplified. Businesses such as Klarna offer interest-free deferred payments over an agreed period. This type of lending is growing increasingly, especially in populations where large numbers are unbanked or young, need access to traditional credit cards, or simply prefer not to use credit cards. The beauty of embedded lending is that it opens up the doors to new customers by offering more favourable lending options than credit cards and ultimately improves a customer's risk assessment, even if they have no credit history. For example, half of Indonesia’s population has no access to the services of a bank or similar financial organisation. In situations such as these, BNPL can aid financial inclusion. As revealed in a recent survey, 42% of customers have used or proposed to use BNPL services, enabling a more effective monthly finance organisation. 

Earned Wage Access (EWA) is another type of instalment payment that enables the workforce to access wages that have been earned though still needs to be received. It can be termed ‘on-demand pay’ or ‘instant pay’. Employees that use EWA will constantly be able to access the money they have earned, which is especially advantageous for hourly wage workers who require access to their accrued salary before the end of their pay period. Thus, such employees can avoid late credit card fees and bank overdrafts. EWA can be extremely beneficial in helping employees’ journey towards a better credit history and, therefore, financial independence.

Embedded Insurance

Through embedded insurance, customers are given the opportunity to buy insurance while making a purchase. It aims to offer more affordable and personalised insurance efficiently. One example is how Airbnb offers Host Protection and Host Guarantee insurance, or how protection against theft is included in the selected package of a new mobile phone. These are all examples of natively embedded insurance or “Insurance as a Service” (IaaS).

With the integration of insurance on consumer platforms like Airbnb, consumers can enjoy customised coverage without purchasing it through a third party. Insurers and businesses can benefit from this solution, which offers opportunities for branding, revenue growth, and long-term customer loyalty. Customers can also benefit as it offers contracting flexibility at a reduced cost. For example, Carro, a Singapore car marketplace, adopted the EmFi approach to creating a comprehensive brand, offering various services, including contactless online purchases, usage-based insurance and car rental subscriptions to provide a richer customer experience. 

Embedded Payments

Embedded payments enable individuals to save a preferred payment method for future online purchases at the click of a button. The process of finding a credit card and submitting its details is a friction point that can result in customers disregarding a digital purchase if they do not have their card with them. As no card is required, embedded payments facilitate this process.

Furthermore, businesses are discovering how embedding these processes and controlling the whole value chain can improve customer engagement and revenue streams. Embedded payments are recognised for facilitating the checkout process, optimising time, improving customer experiences and reducing cart abandonment risk. A large number of apps, especially delivery and transport apps, already have quick embedded payment. In some cases, embedded payments include a rewards system to build customer loyalty and encourage repeat purchases. For example, the Starbucks app stores debit and credit card information so customers can make single-click payments and gain points for app usage.

Although these four EmFi categories differ in their goals, they are sometimes all integrated into a non-financial platform as an "all-in-one" to build user experience, user loyalty and new business opportunities. Credolab, for example, offers solutions for all these EmFi categories using Machine Learning (ML) algorithms to identify behavioural patterns for early fraud detection and risk assessment. Gathering insights from smartphone and web metadata, credolab collects unique user behavioural information once to perform checks for their fraud strategy, ensuring an effective user verification while detecting possible fraudulent behaviours.

Four categories of Emfi

While EmFi offers a new agile model for financial services and new opportunities for businesses and customers, it also has its challenges. However, fintechs can break down these barriers by building up APIs and working with accredited and fully complying businesses.

“To create API products that can be embedded across many different partners, they would need a decisioning platform that orchestrates the customer journeys, having the ability to segment their customer base, enabling access to external and internal data sources in real time to auto-optimise decisions—along with the impact of those decisions—across your entire customer lifecycle. This gives lenders the ability to target specific niches, which could be product-based, segment-based or service-based.”
By Bharath Kumar Vellore, General Manager of APAC at Provenir, an AI decision platform.

Furthermore, fraud detection can also be achieved by partnering with credible businesses that can effectively allocate scores through sophisticated fraud detection models that identify fraudulent actions and their intentions. 

The challenges of EmFi

Due to COVID-19 accelerating digital transformations, businesses expedited their own digitisation, and customers changed their habits and behaviours. Nowadays, people are turning to technology to manage their personal finances in a more accessible and easier way. Furthermore, fintechs are becoming a key tool for improving customers' financial well-being. 

As shown in Plaid’s Fintech Effect 2022 report, a 38% increase in fintech adoption from 2020 to 2022 was reported, with 93% of consumers witnessing the great benefits of using fintech apps. Eight in ten consumers currently use some form of digital financial tool. These tools empower customers, as they have found ways to manage both time and money effectively. Fintech's exponential growth over the past three years has resulted in a continuous need for technology-driven financial innovation.

These new trends have been positive overall. However, some challenges that must be addressed when dealing with changing consumer habits include data security, customer risk detection, access to capital and stakeholder resistance to change:

Data Security

Through enablers such as Open Banking, BaaS or APIs, businesses can integrate payments, have customer insight, and perform credit scoring. All of this is possible due to the availability of a wide range of high-quality and accessible data. However, with the shared use of EmFi data, system security breaches and data confidentiality have high risks that need to be controlled and improved. Therefore, to preserve the security of personal data, protocols must be adhered to, and regulations must be followed, such as ISO 27001. For financial institutions, an oversight can pose a huge risk. 

EmFi customers expect clear navigation of applications and the protection and security of their data as they are aware large amounts of data need to be processed.

Customer Risk Detection

With embedded lending, more people can access financial services even without a credit history, as the traditional system requires. However, this lack of data may lead to difficulty in discriminating against borrowers when assessing risks (including a high default rate), and this can have a negative impact. 

For example, countries in Africa and the Middle East with a large percentage of unbanked population must create strategic alliances and promote EmFi in an effort to achieve greater financial inclusion. The use cases in countries across Latin America and the Caribbean lean more towards supporting small and medium-sized enterprises that, with traditional lending, would have to wait a long time for the outcome of financial applications. At a global level, with a growing youth population, a driving force behind the increased adoption of EmFi solutions, the growth rate of embedded lending is expected to increase by 27.5% between 2022 and 2029

Stakeholders' Resistance to Change

While EmFi enablers are a key tool to achieve this model, they are only suitable for some markets since they require new ways of thinking. For example, financial institutions are slower to adopt new technologies as they struggle to integrate innovations into their existing legacy systems and, often times, are slowed down by lengthy InfoSecurity assessments, data governance, and data due diligence processes. Although digitalisation has brought about an evolution in the banking business model, some resistance still exists from banks “curious” to partner with non-fintech businesses in an effort to staying relevant and capture revenue along the value chain whilst recognising that they may play a less important role for the end user.

The need for Embedded Scoring

With the rapid shift to digitalised and customer-centric services, especially after the pandemic, financial service providers are under enormous pressure to meet their customers' needs. Digital lending has become one of those industries with the highest impact. As a result of an increase in online shopping and an overall interest in consumer financing, coupled with better BaaS technology, digital lending has gained popularity over the last few years. The global embedded lending market is forecasted to grow a CAGR of 27.5% during 2022-2029, reaching $199 million by 2029.  

Along with embedded lending and distinguishing between good, bad and negligent customers came embedded scoring. Businesses like credolab offer lenders and financial institutions an integrated scoring solution that uses permissioned consumer data and respects user security to secure their services against the risk of fraud or non-payment and improve businesses’ customer satisfaction.

Embedding a credit scoring technology into existing financial services allows for simpler and more frictionless user experiences and overall digital onboarding processes. Using Artificial Intelligence (AI), applications become more transparent and have a level of security designed to measure a borrower's creditworthiness quickly and automatically for all. Through alternative data, lenders can now fairly assess the eligibility of any applicant, even those without credit histories. We can achieve greater financial inclusion if more people can access financial services.

EmFi is here to stay, offering simplicity and practicality for all users. While there are still challenges to overcome, technologies continue to adapt to new customers' changing habits and needs. Partnering with trusted providers such as credolab is essential for success. With an API-based solution, credolab can offer various services for embedded lending, embedded banking, embedded payments and embedded insurance using ML algorithms to identify behavioural patterns for early fraud detection. With data processing and analysis using AI and ML, businesses can gain more insight into their customers, improve risk assessment, detect and reduce fraud, increase sale rates and offer a better overall customer experience. 

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