Decoding 'Embedded Finance'- Is every business becoming a fintech?

Overview

Financial services are often seen as the spine of a nation’s economy, a system that has the capacity to define the future of a nation and its people’s prosperity. The last decade has been synonymous with change and disruption in the financial space. Innovators and entrepreneurs have repeatedly identified unmet needs of the customer and used them to address pain points in the customer journey thus creating products and services that have enabled them to create successful businesses. The lean nature of these companies has allowed them to pivot and provide products and services that traditional financial and banking institutions have not been able to match. Fast-forward to 2020 with the advent of the novel Covid-19 pandemic and the rapid adoption of digital services by retail consumers and businesses alike with a focus on enabling a smoother consumer experience, increase user traffic, upsurge monetization opportunities, and improve customer retention have significantly transformed global commerce. This trend is often referred to as embedded finance. 

Simply defined embedded finance refers to non-financial companies that have value propositions that are significantly enhanced or even transformed through the associated financial products and services embedded within. Thus, placing banking and financial services in the day-to-day experience of the customer engagement with the digital world. It relies on the use of APIs (a type of code) to essentially integrate systems. Embedded finance has become synonymous with thus providing Banking or Financial Services – as – a- service (BAAS) with which companies can ‘plug into’ specific banking and payments services and processes, building the solutions that they need without the difficulty of maintaining the technology themselves or applying for a banking license. Embedded finance enables any merchant or brand to offer innovative financial services to customers rapidly and at a relatively low cost  this increased flexibility results in better conversion rates and an enhanced customer experience overall, in most cases leading to higher average order value (AOV) and repeat customers. For example, customers can make cashless payments within a ride-hailing or food delivery app and book insurance while completing the purchase of a laptop on an e-commerce site. From the business point of view, embedded finance enables businesses in the MSME, B2C, and B2B segments to monetize their customer base for additional revenue streams, increase the customer Lifetime Value (LTV), and vertically scale their product offering. For the consumer, embedded finance offers unheard of levels of choice as to when and how to pay for goods and services, incorporating solutions such as in-app payments and short-term loans into the purchasing process, without the need to consult a bank or financial institution. 

The convergence of banking and financial services into digital apps at a rapid pace has prompted the global fintech behemoth Stripe and private equity firm Finch Capital to estimate that it could become a massive market with a current valuation of $240 billion and $7 trillion by 2030 in value  growing at a CAGR of 29 per cent. VC investments in the embedded finance companies have more than doubled from 2020 to 2021 in Europe and North America to reach a total of $6.7 billion. Indian companies in 2021 raised just over $1.2 billion in venture capital led by VCs such as Matrix Partners, Flourish Ventures, and QED Investors and is expected to grow at CAGR of 30.4 per cent from 2022 to 2030, currently valuing the market at $4.2 billion, making India the 4th largest market globally for embedded finance just behind the USA, UK, and Sweden. Capital Float was the leading company by funding in 2021 having raised $204 million. Other notable companies include Cashfree Payments, M2P Fintech, Niro, Fundfina, Buildd, Rupifi and Simpl .

How Does Embedded Finance Work?

The financial services ecosystem is underpinned by three core services of which any firm must be able to be provide at last one off to be considered a financial services firm which includes payments or transactions, financing or investments and risk management. In essence, the entity must be able to control and manipulate the flow of capital whilst integrating it seamlessly into the overall customer experience in a way that it achieves a seamless transition between the core business operated by the company under the limitation of the prevailing jurisdictional regulatory limitations . For example, Uber has payments embedded into into the user experience of getting a ride and, for the driver, into their experience of getting paid the right amount at the right time. Now with debit card and checking accounts embedded for the drivers, Uber drivers are getting an integrated and easy experience. They need not look outside of Uber to open accounts. Many unbanked drivers are getting into the financial mainstream. Uber became the third largest acquirer of small business bank accounts in the United States, and it is not a bank.

Embedded Finance as a ‘one-stop-shop’ financial ecosystem 

A myriad of publications and research have often cited the colossal issue of providing SME’s access to financial services through conventional means. Fixed costs of providing SMEs with financial services via traditional means are high. With the advent of open banking APIs and India stack, companies leveraging embedded finance can proliferate SME banking services using their platforms. This expansion will be due to SMEs’ willingness to pay more for value-added banking services, greater inclusion of the underbanked SME population, and the delivery of new product offerings. 

As digitization is further expanding, traditional lending models and cumbersome lending processes are becoming intolerable for the millennial and Gen Z customer. Embedded finance is proliferating the creation of a one stop shop digital solution that would enable the user to access finance from one platform that they regularly use than switch to another just to access financial solutions.

The far improved customer experience has opened the financial services market to a whole new demographic actively ready to participate in the industry enabling these new age digital companies to leverage data to create new products and services customized to meet their customer’s needs and democratize banking services to those previously underbanked. 

Embedded Finance in India 

BlackBuck is the largest online trucking platform in India, currently servicing 22 per cent of all truckers in the country. It has a vertically integrated approach to building a trucking marketplace by digitising fleet operations for truckers (providing predominantly payments solutions around tolls and fuel) and operating a marketplace matching trucks with relevant loads. The platform has close to 700,000 truckers and over 1.2 million trucks on its platform, with over 15 million monthly transactions. India’s economy relies on a very fragmented and disorganised trucking industry for the transportation of goods across the country. There are 1.5 million truckers (fleet owners) who own 3.5 million trucks. 80 per cent of truck supply is owned and operated by small owners (owning on an average 2–3 trucks). They are typically truck drivers who have over time invested in their own fleet and now employ their own truck drivers.

There are two core pain points for truckers and drivers:  Managing and paying for expenses of the trucks including electronic toll payments, fuel, and other consumables (e.g., tyres and lubricants). The trucking industry is estimated to spend $100 billion annually on these expenses related to operating a truck. At reasonable take rates this represents a significant revenue opportunity. Securing suitable and well-paying jobs for the truckers. It’s estimated that trucks can be idle for 25–30 per cent of the time because of inefficient demand supply matching. Today the trucking industry GMV for transporting goods stands at $150 billion in India. A very fragmented industry of unorganised, offline brokers sits between the demand (shippers) and supply (truckers). These brokers charge 10–15 per cent, representing another $15 billion revenue opportunity to disrupt, by organising and bringing online transactions between shippers and truckers that would otherwise occur offline.

Following the government efforts to digitise toll payments with electronic tags, special road lanes were dedicated to all drivers that had a tag installed for automatic toll payment. BlackBuck issues and installs toll tags onto trucks. These tags can only be topped up within the BlackBuck app which also makes it easy for a fleet owner to track expenses. BlackBuck is an embedded payments company, whereby it forms the issuer side of a closed-loop payment network with National Payments Corporation India (NPCI) acting as the clearing house and banks as the acquirers. It charges a take rate per transaction, and on top of this charges subscription fees for additional value-added services. It also issues virtual fuel payment and loyalty cards for its drivers . Toll tags are topped up within the app through India’s Unified Payments Interface (UPI). This can be done through bank accounts/wallets/cards, etc. The Indian government has been the primary agent of change in modernising India’s payments infrastructure, with strong growth in digital payments, growing at 60 per cent CAGR over the last five years, led by UPI, where the total value of UPI transactions in 2021 was at $560 billion (up from $510 billion in 2020), far outpacing in both volume and value terms credit and debit card transactions. India’s public digital infrastructure led by policies such as India Stack consisting of Aadhar, UPI, Open Banking API enabled under the Data  Empowerment and Protection Architecture (DEPA), the ‘data’ layer combined with initiative such as Pradhan Mantri Jhan Dhan Yojana and Ayushman Bharat  have opened significant opportunities for embedded finance in health, agriculture, and mobility to name a few. 

Conclusion

Banking and finance have historically been limited to a select few yet critical infrastructure for trade, business, and overall prosperity of the masses. Traditional financial services businesses have often not been able to address the underbanked market and in the 21st century is being complimented by corporation and brands that are able to understand the winds of change in the consumer sentiment and understanding of the enormous opportunity to deepen consumer relationship by entrenching them into an ecosystem of services and products in a single digital solution. India’s Fintech ecosystem is poised to welcome a sleuth of innovations based on tenets of enhanced customer experience, customer-centric products and services and collaboration between traditional service providers and new age digital disruptors. India’s unique fintech story is an example of astute direction of policy makers and regulators. The future of embedded finance is intertwined with the creation of a policy infrastructure which encompass regulatory guidelines as part of the processes. This will further integrate customers into the financial services ecosystem and promote innovation.
 

This article is authored by Sarvashreshth Kalash.