The Road to Leadership in Embedded Finance

Over the past 20 years, banking transactions, half of which used to occur in-branch, have migrated predominantly to digital self-service channels. However, the bigger trend is that as we march further in this decade, many of these transactions will originate outside the bank network altogether. This is because, thanks to trends like open banking and banking as a service, bank transactions will be embedded within customers’ primary journeys for other products and services. In our view, this migration will be much faster than the first, because being more contextual and seamless, embedded finance experiences are likely to enjoy rapid adoption. As a proof point, look at India’s UPI-based open payment transactions, which are running at nearly 6 billion per month. Over 80 percent of these payments originate in two non-bank apps, PhonePe and Google Pay. This, despite there being more than 60 similar apps from incumbents, challengers and neobanks.

What’s more, embedded finance creates wins for all stakeholders: frictionless banking for customers; new business for merchants and brands who can attract customers with Buy Now Pay Later and other digital financing and payment options; and business expansion at affordable costs for banks, thanks to maturing digital infrastructures.

Thus, it’s not surprising that embedded finance is among the hottest opportunities in banking today, promising great returns to institutions that can embed their offerings across a variety of customer contexts. Also, it is not a zero-sum game by any means. There is enough room in the embedded finance ecosystem for all types of providers – incumbent, challenger, and neobanks – to coexist. This is particularly true for growing economies and underserved markets. For instance, household debt in India is less than 15 percent of GDP, compared to nearly 75 percent in the US and 55 percent in China.

That being said, banks looking to lead this opportunity should move quickly with their plans. The following three goals should be high on their agenda:

Scale Initiatives to Embed APIs Where Possible Throughout the Ecosystem

The starting point is to build a robust API infrastructure for exposing bank services and data to a variety of ecosystem partners. It is recommended to build APIs in standards-based formats, such as those published by BIAN, for widespread integration. An API management platform, assuring secure access to approved partners for approved purposes, is essential. Also, there needs to be a sandbox and accompanying documentation to ease the developer experience. A mature digital stack is imperative for supporting massive embedded finance transactions, at very high performance levels, and very low incidence of technical failure.

Progressive organisations are seen to approach API banking with a product management mindset, viewing APIs as a class of products for taking their services to third parties. Hence there is a dedicated product management team responsible for prioritising, developing, deploying, upgrading, and even retiring APIs; there are also teams to develop and test use cases with partners, especially for non-standard, industry-specific applications, and to support developers, partners and customers with their needs.

Embedded finance is a separate revenue stream that should be developed like any other line of business. Banks should therefore put together teams for promoting API banking and for building alliances with corporates, small businesses, large digital infrastructure providers, fintech firms, e-commerce players, and other entities. A key goal should be to evangelise APIs through the influential developer network.

Develop Unique Capabilities That Can Be Embedded Faster, Cheaper, Better

Stepping up digital transformation after the Covid-19 breakout, the majority of banks put basic APIs in place for their checking accounts, unsecured loans, payments, etc. As competition grows, APIs are commoditising further. Therefore, the question is how can one bank differentiate its API banking service from that of another.

Innovating with unique, or better, propositions is one way. Another is targeting specific niches, which may be product-based (for example, student loan APIs), segment-based (ICICI Bank has nearly 200 partners just for co-creating embedded experiences for SMEs), or service-based (for example, China’s PingAn One Connect for Identity Management as a Service ). Since many brands prefer to source embedded offerings from a one-stop-shop provider, it makes sense for banks to offer bundles that may even include others’ products, such as insurance with loans, virtual accounts with retail checking accounts and so on.

Take a Marketplace/ Ecosystem Approach to Expand the Business

When the above foundation is in place, the next step is to grow the business. A considered marketplace approach can help banks consolidate their lead in embedded finance. Apart from offering their own APIs/services, they can feature both complementary and competing third-party services to become a singular destination for banking APIs. From that position of power, they may be able to influence standards driving growth and information security in embedded finance, beyond the narrow regulatory prescriptions for open banking existing at present.

A marketplace expands a bank’s ecosystem on both the supply and demand side in a natural, self-sustaining way. When a marketplace features a number of brands, it becomes a magnet for supply-side partners, and vice-versa, thereby unlocking significant network benefits for its bank. As the ecosystem expands so does the data flowing through the marketplace platform, providing rich insights that the bank can use to enhance its embedded finance proposition.

Another benefit is the ability to dictate pricing. When a bank offers many API-based services, it can price the basic (undifferentiated) capabilities very competitively to lower the entry barrier and charge a premium on unique or high-value services. Last and by no means least, a marketplace is the go-to destination of large embedders who prefer to fulfil all their requirements in one place.

For all these reasons, it is believed that the quality of a bank’s financial health will be determined by the strength of its ecosystem/marketplace.

What could be a better argument in favour of embedded finance?

This article was previously published in The Banker.