Embedded finance is destined to become one of the next new big players in fintech, with a market that “will exceed $138bn in 2026. The extraordinary growth of over 215% driven by increasing availability of APIs.” According to Juniper
That’s why our very own Hayden Smith representing Fuse Capital met with Martin Koderisch and Volker Schloenvoigt, from Edgar Dunn & Co. to talk embedded finance: what it is, where it’s headed, the major stakeholder, how it could benefit one’s company, the risks, who to partner with etc…
Edgar Dunn & Co. are big players in the Embedded Finance game, they’ve been around since the beginning, preaching the coming of embedded finance into mainstream fintech Valhalla.
- Embedded Finance provides financial services in non-traditional service environments
- It has great client engagement prospects
- The upside for SMEs and SaaS has been growing in parallel to technology advancements, particularly APIs
- Stakeholders are increasingly working together towards perfecting embedded finance solutions
- Risks are mitigated since the client is not responsible for the insurance itself
- Stepwise commitment makes partnerships lucrative for all parties
- Embedded finance rides the zeitgeist wave of seamless user experience and integrated payment solution
Here's a write-up of this very interview.
What is Embedded Finance: Beyond the Buzz-Word
Hayden: “Embedded finance is a bit of a buzzword, could you provide a definition?”
Martin:“The fundamental piece for people to grasp is that it's the shift away from banks and the standalone process of applying for a loan or applying for a credit card.”
Volker: “It's really leveraging new technologies, primarily APIs. It's all about the distribution of financial services products in a non-traditional financial services environment or context.”
“Everybody will know that Uber example: you take your ride, you walk off and you don't really think about you know the actual payment aspect and maybe to add to the definitional part and we might come to this. But I think in our experience embedded finance is almost the second step of this evolution.”
Fuse: “Are there any examples of client engagements you can take us through to bring that to life a bit more?”
Volker “It’s really going from SaaS 1.0 to SaaS 3.0: From traditional business model with a traditional invoice to 2.0 with embedded payments, to 3.0 with embedded finance products”
“Talking to SaaS platforms about their specific needs: they can be insurance products whether these are even the issuance of virtual cards for specific payments, and that’s especially relevant in the context of this gig economy concept where you don't have a fully permanent employee but you want to make a payment and then maybe the issuance of a virtual card in that context with expenses”
Volker “The one element in the research we conducted that probably stood out the most is around lending and working capital support: Especially so in the B to B context where you have a solution that is used by an SME for whatever purpose.
“You have a lot of transaction information from the embedded payments element and that SME is recognising "oh, I'm going to have some cash flow issues here." “I need to get quick access to a two-week loan or some working capital to loosen either a prepayment of expected funds or whatever it is and having that solution integrated into your platform is something that was that was of particular interest.”
Embedded Finance Potential and Key Trends
Hayden:“What are trends pointing towards embedded finance?”
Martin:“Shopify partnered with Stripe which was a huge success and has gotten a stronghold over SEA.”
Volker: “There is a real appetite of SMEs that are using SaaS platforms to try and get as many services and products out, on the one hand. There is a real concern about ease, are you always well served by traditional banks? You’re not always getting the customer support not always getting the best terms and conditions and really the opportunity for a SaaS platform to provide some of these services is something that resonates immensely with companies that we've been talking to.”
E.N: (What we can remark here is really pushes and pulls between those trends. On the one side, there’s a yearning to facilitate access to financial products within their client base, and at the same time, there’s a new possibility of supplying this financial solution through technological innovation. It’s best exemplified by Shopify, but will soon take over the B2B environment as well.)
Martin: “ The success of embedded finance, It's all about how technology enabled these solutions. You could talk about the supply side and you know it is innovation that's pushed from that perspective. But actually, if we take the customer-centric view, there is a tremendous and genuine demand and there's pulls from the consumer and the demand side. So I think there's classic product-market fit, we're observing that taking shape here in embedded finance.”
Hayden: “What are the key stakeholders in embedded finance in terms of platforms and financial institutions? What benefits does it provide to a platform to facilitate embedded finance solutions?”
Martin: “At the back end, you have the banks essentially the balance sheet providers which are regulated financial institutions. They still are massively important to this whole value chain. There’s the manufacturers of the product or the service, and then there is some kind of technology/fintech layer, which are providers that produces and develops the platforms, the APIs that enable the embeddedness to take place…and then finally you have the distributor or the platform that actually owns the customer relationship.”
Hayden: But you cannot talk about stakeholders without talking about revenues, can you? What are they, in that sense?
Martin: “There are revenue pools and profit pools along the way, right? So it depends what position you take and there's a bit of overlap between positions you can take. I suppose in the back end there’s the banking side, and they talk about the disintermediation risks and of course internally, the risk of banks not taking part in these operations anymore, and what impact that it might have on them long-term.
However, some banks are moving to actually enable and support this in a more productive way.”
Volker: “What's probably important to highlight is that when we talk about these embedded finance opportunities we're not saying that it's the SAS platform that is the actual provider of that product.”
“So coming back to my earlier example around the lending and then maybe the working capital support, we're not looking at a scenario where SaaS platform X is providing the loan and is therefore liable for it. That is not the scenario that we're thinking about. We're thinking more about you know providing the connectivity to one or a multitude of financial service providers that provide the loan or compete for that loan and who ultimately take that liability and the risk.”
“So in a B2B environment, it's really a form of partnership, though you can almost look at it in the way SAS platform might become a sales channel you know to some extent for the banks.”
Volker then proceeds to give us an example:
Volker: “Lloyds Banking Group have hired someone that looks after embedded finance, there's an embedded finance division that has just recently made an investment into an app that deals with all the payments that we as motorists would have to make whether these are road tolls, insurance payments, congestion charges and so on. It's all integrated and I think the opportunity here for Lloyds investing into that and then maybe providing other financial products onto that platform."
“It's something that Lloyds can proactively sell to their own customer base. So I think in the B2C environment I would not be that surprised if we would see a lot of investments from banks into some of these technology providers to learn from their technology and how to benefit from the agility that a lot of these new start-ups and fintech’s have. Ultimately maybe even fully acquiring those businesses."
“I think the relationship between the platform and the financial services provider will be different and how the financial service provider operating in that embedded finance scenario is going to be different by channel,”
Martin: “Yes, essentially, in embedded finance it's about collaboration and not a one-stop solution from a bank or what have you. It's the creation of an ecosystem. Someone recently said it's possibly even the kind of the “App Store” for financial services that are emerging. It becomes fairly plug-and-play."
Hayden: So, to what extent are you really tied to a partner?
Martin: “Well, the idea is that you're not obviously so. You can plug and play and you can almost…orchestrate. You have concepts of service orchestration between different providers, and you as the distributor can choose who you want to activate at a certain time in a certain channel depending on certain situations. And this kind of ecosystem, or “App store” idea is starting to play out and I think that's how we can probably expect the embedded finance trend to develop.”
Dynamics Between Partnership Models and Risk Management
Volker: “Again because of the partnership model, I think that has an impact on the risk. Because SaaS platforms are inherently worried about provisional financial services, what's the risk for me because you're partnering with someone else? I think in our view the risk is more than manageable.
Monetising embedded finance
Martin: “You can get involved in embedded finance as a distributor with zero risk and this is typically what we see: the partners will enable you to do that. There's an entry-level arrangement where there's no risk from a disputed point of view. The embedded finance provider will take on that risk as the regulator of that activity.”
“There is a trade-off in terms of monetisation, right? Whoever takes the risk will take more of the margin, right? That's fine and everybody's completely aware of that.”
“If you want to expand your margins as a distributor, you can kind of start stepping into that risk-taking activity and it's not necessarily all or nothing. There are gradual steps you can take. you can work with your partner to develop that road map.”
“This is again a similar trend we're starting to see now with these kinds of stepwise commitments. Furthering into better finances is typically how the partners are approaching and engaging or going to market within finance.”
Hayden: Is there a war on progress, of sorts, with banks for this monetisation?
Martin: "Where we are now, as opposed to early-days of Fintech where there was this sort of clear kind of war between fintech and banks. It's far more of a collaborative situation now. I think it's fair to say there's more partnership um from both sides, a desire to partner.
Predictions & Key Trends
Hayden: Do you have trends and predictions for this year and beyond in terms of embedded finance, where do you see that going?
Martin: “OK, crystal ball time, right? *chuckles*”
Volker: “My viewpoint of the industry is that that we are at the beginning of really seeing, not mass rollout, a significant number of embedded finance implementations, or deployments, however you like to call it.”
“We are about to move up on that curve, if I’d have to put my money on now, it’s really based on these customer researches we’ve made that there’s a real demand."
“I don't think that insurance products in an embedded finance contract are going to be, you know, the next big thing. I think that might be a little bit off, but I'm really excited about the opportunities around lending and working capital support.”
“Leveraging that data, leveraging those insights, we've seen it in the payment acceptance space and I'm fairly certain that we will see something of a similar sort, in that in the entire digital world and SaaS platforms, working capital lending products will be the next thing.”
Martin: “I personally draw parallels with the “.com” bubble, and to the extent that a lot of the Internet companies, not all of them but many of the Internet companies that we know now really emerged in that Web 2.0 era after the.com bubble burst, from 2002 onwards. It's not a direct comparison but to an extent, it's the story of the last decade and then some. The current fintech winter is going to come to an end and there will be a massive rebound.”
“There’s embedded finance which goes in the same direction, along with Blockchain, Crypto, A.I, this is all going to contribute to deeper integration and less friction in the user experiences: an entirely digital end-to-end flow like we haven't seen so far. That’s kind of what we expect to take place over the next five years and embedded finance is definitely part of that.”