Embedded finance has all the hallmarks of a trend that will become an inevitable component of business software. Here’s why.

Customers – their experience and expectations – are ultimately the biggest driver of this directional change. Similar customer-driven shifts have moved markets before with an uncanny sense of inevitability. Think the move away from landlines to the rise of practically universal mobile phone usage: people like to communicate, and people are ever more on the move. Seen in this light, the shift to mobile was inevitable once the technology and business models made it possible.

Back to embedded finance. Consumers increasingly rely on digital apps to live their life: from planning their day, to deciding how to get to work, to picking a cafe to meet a friend for lunch, researching destinations for a holiday, and planning for retirement. Similarly, most businesses today, at least in developed economies, run on B2B SaaS: their data is on these digital platforms, and they implement their processes and workflows on them. It turns out that these jobs-to-be-done – whether those of consumers or of businesses – often have critical financial components to them: making a payment, receiving a payment, sending money, changing money, borrowing money, investing money, and so on. It is only natural for them to expect the financial activities associated with a broader purpose to be integrated into the applications that help them achieve that purpose. That natural expectation drives the inevitability.

Who, how, when … may not be determined yet, but the what and the why are already clear. Who will be the first to make it mainstream? How might it come into the mainstream? And when might adoption become the norm? It’s those innovators spanning the financial and software industries who will deliver the answers, setting the movements that will push embedded finance on its onward trajectory and identify the lessons we can learn from the industry’s past. Eventually, these lessons will teach us how to overcome real obstacles and open up a future where embedded finance is utterly commonplace.

Looking back to move forward

Previous approaches to embedded finance have been with us for some time now – Banking-as-a- Service (BaaS) and open banking have played a significant part in delivering the examples that we are familiar with today, for businesses and consumers.

Open banking – a financial model which allows third parties to access their financial data sitting in their existing bank accounts through APIs – has had its successes. Beyond empowering consumers with more autonomy over their financial data, open banking paved the way for fintech startups to provide valuable real-time insights to consumers on their financial profile. But open banking is just a first, and somewhat limited, step in terms of the potential for delivering on the promise of embedded finance.

Perhaps more compellingly, BaaS promised: build the financial products that you like, without being a bank. Unfortunately, the BaaS approach neglected a critical component of building and running financial products: catering effectively for the management of risk and compliance.

Failures such as those of Synapse in the US – whose collapse effectively froze close to $160 million of customer funds – are ushering changes to a new era we can call post-BaaS, new BaaS or something else entirely. Less dramatic but also disruptive failures have happened elsewhere, notably in Europe with BaaS players losing their licence or suffering restrictions imposed by the regulator.  

All this makes one wonder – and there are certainly many investors who were formerly hot on the BaaS space who do wonder – whether embedded finance is simply too hard to happen at scale. It may not happen on the BaaS model as we know it, but the odds are that embedded finance will continue to grow, simply because customers demand it.

What applies to Uber – the poster child for embedded finance – applies to many other complex human activities that software and data is increasingly supporting. Beyond making payments easier and faster for customers, Uber provides drivers not just with the means to receive payments, but also to have access to credit so they can improve their service offering on the Uber platform. There is an obvious business parallel to this in Shopify’s merchant solutions which, in addition to its original business of providing a means for businesses to develop an online presence, now not only provides online businesses the means to get paid online but also offers working capital to help them grow. So compelling is the proposition that the vast majority of Shopify’s revenues today comes from financial services, and this is only possible because its customers simply love the embedded finance that’s on offer.

A reasonable question at this stage is to ask why, given how compelling the embedded finance proposition is to the customer, and as Shopify shows, how attractive it is also to software businesses of all kinds: why haven’t we arrived already? Why hasn’t every relevant software business done embedded finance? The answer lies in the junkyard of failures we looked at earlier – embedded finance, however compelling it may be, is still very hard to get right. How can we make it easier to unlock the value? To understand how, it’s worth revisiting the reasons for these failures.

Compliance, embeddability, and simplicity as foundations

From the exciting successes and many failures that I have seen over the past few years, I’ve come to think of three barriers that the industry must overcome to achieve widespread and mainstream adoption of embedded finance.

First, and somewhat obviously in retrospect, is compliance. Financial services providers and digital application businesses make for uncomfortable bedfellows – ‘move fast and break things’, Zuckerberg’s famous rally cry for Facebook, does not go down well with financial regulators. The premise, and promise, of BaaS was that digital brands were better placed to understand not just their customer needs but also the domain or market in which they are operating, and so would be better equipped to understand and manage the specific risks that may lurk there. Therefore the brands are best trusted to manage risk and compliance in the context of their offering. Maybe so, but there is also a glaring misalignment of interests in this model: a brand will invest the next dollar in acquiring, pleasing, and retaining customers and not in bullet-proofing its risk and compliance systems. Banks learnt this lesson at their own cost, and many are either navigating serious regulator sanctions or exiting the market.

A less obvious one is embeddability. It is hard to mash-up highly-secure financial processes with non-financial application software that is optimised for usability over failsafe security. The result can be cumbersome journeys where the customer is constantly moving from one screen or even website to another, constantly having to authenticate themselves for part of the user journey, and even being required to download separate helper apps to do so. Achieving elegance does not happen by default in embedded finance. Often the financial institution can only offer the problem – of maintaining security, or ensuring customers provide the relevant consents, of ensuring that unusual behaviour is detected – but cannot provide the tools to achieve these things in an embedded context. It is up to the embedder to source the solutions to the standards set by the financial partner. That makes it all the harder to achieve an optimal balance between compliance and seamless experience.

The third barrier I wish to highlight is the complexity involved in getting embedded finance right, for the reasons explained above. To do so is a complex endeavour, which many get wrong and either deliver usable solutions that are vulnerable to risk or robust solutions that are unusable. For embedded finance to become mainstream, specific tools and specialist supporting services are needed so that embedders, whose core business by definition is not financial services, can deliver seamless experiences that are built and operated on a robust and compliant infrastructure.

An essential component of the digital era

By addressing the desire of customers for automation and convenience, embedded finance is unlikely to be a passing fad, but rather an inevitable development in the digital transformation of the world we live in. To do so, it has to overcome the challenges illustrated by the first generation of successes and failures. How, when and who will bring it into the mainstream is still yet to be determined.