An increase in access and adoption of internet as well as recent events such as the Covid-19 pandemic that limited people’s movement have catalyzed a rapid transition into online banking across Africa. Today it is possible to get a loan from a bank without ever seeing the inside of its halls. Leveraging on this market-driven transition, traditional banks and fintechs have developing new revenue models to capitalize on the online banking wave. Institutions outside the financial services sector have also experienced an increased demand for convenience by their customers when it comes to making payments and other money transfer transactions. These organizations, which include online market places have “embedded” financial products onto their customer journey; in order to make it quicker for the customers to pay, as well as motivate them to spend more at their stores and build brand loyalty.
Embedded finance is a context whereby non-banking institutions include access to financial products such as insurance and credit onto their customer journey; in order to complement the purchase journey that the customer goes through. For example, an electronics online shop can offer insurance at the point of sale, and market place companies such as Amazon offer buy now pay later (BNPL) on certain products. These institutions introduce these financial products to their customers on a “if you need it” basis. Majority of airlines offer travel insurance at the point of paying for the flight ticket; as opposed to the traditional insurance distribution channel whereby insurance brokers would sell you travel insurance even when you are not travelling. The embedded finance sector is expected to grow to a market size worth USD 138 billion by the year 2026 according to Juniper research.
For the non-banking institutions, embedded finance offers a lot of benefits not only for the institution themselves, but also for their clients. On the customer side, embedded finance gives additional value to the customer on a “if you need it” basis. Buying insurance for an expensive electronic such as a television protects against financial loss. However, this is only valuable to a customer if they have purchased the device. Embedded finance gives access to financial products that are actually needed at that particular time when the target customer is transacting.
Businesses implementing embedded finance are able to build brand loyalty with their customer base, as they go beyond availing the core product or service to the customer; but also offer an additional value. For example, some online and retail market places offer access to credit to their customer at the point of sale. That is, their customers can access credit to purchase items and services they would not have been able to due to limited funds. These institutions are also able to increase the amount of money that their customers spend with them as their spending power is increased due to this available credit. Another benefit for the non-banking institutions is the access to customer data. In this digital finance era, data is the new gold. Being able to understand the spending behavior of your customer means you are able to offer products and services that are more inclined to their purchase frequency and spending amounts; and this could be a significant advantage to gaining and retaining additional market share.
Another key advantage that embedded finance offers businesses is the ability to build an all-inclusive ecosystem. Ecosystems allow for companies to maintain brand loyalty as they are seen to provide value to their customers through numerous channels. With this, companies are able to increase revenue derived per customer. On the demand side, consumers have increasingly demanded and appreciated integrated experiences. Non-bank companies have reacted to this by embedding financial offerings that are specific to their customers. For example Walmart’s announcement in 2021 that it plans to launch a Fintech that will provide financial experiences for its customers and associates.
Embedded finance poses a significant threat to traditional banks as the services that they would typically offer such as insurance or access to finance are being distributed through channels that they do not have control over. Credit is sought at the retail store as opposed to the banking hall. The opportunity for traditional banks is that these non-banking institutions that are looking to embed finance in their customer processes are not able to provide certain financial products such as credit; since they often lack the balance sheet and regulatory licenses or approvals to do so.
Traditional banks that have strong technological capabilities and resources, and are fully licensed to offer banking products and services will be best placed to take advantage of this market. Additionally, both the large and small banks can choose to work with technologically strong fintechs as opposed to focusing on building these capabilities in-house. Such as relationship would work well since banks are now being encouraged to share their customer’s data (with the consent of the customer); and these fintechs can tap into this data to offer financial experiences that best fit the needs of the customer. Regulators in Kenya have already begun to set regulations that will guide this. The Central Bank of Kenya in its 2021 – 2025 vision and strategy document, plans to work on standards for effective and appropriate development of API to ensure robust and secure data sharing in the banking industry. In Europe the PSD2 (Payment Service Directive) that entered into force between January 2018 and September2019 entails fundamental changes as it gives third parties access to the bank digital infrastructure.
With the increased sharing of data between all parties involved in embedded finance there is the increased risk of data abuse and misuse. All parties from the bank that is providing the financial services to the fintech that is the technology enabler to the non-bank institution that is providing the embedded finance products to its customers are exposed to data handling risks. One of the approaches that each of these institutions can adopt towards handling this data better is a GRC approach to management whereby governance, risk and compliance structures are looked at together for each functional unit in the company and embedded in the overall strategic plan for the company.
Author: David Kageenu