Embedded Finance - 101
This blog articulates the meaning, mechanisms and business motives behind offering embedded finance solutions.
Imagine you are a farmer from Ratnagiri who harvests and sells mangoes. Every year you visit the local shop named “Sabka Retail” to buy manure, fertilizer, pesticide, and agriculture equipment. The seller also has a website from where you can purchase all the products. The cost of these items is approximately Rs. 21,0001. In addition to these items, there are many more additional costs (labour, pumphouse, fencing etc) that amount to Rs. 2 Lakh. Given the seasonality of cashflows for most farmers, it is difficult for you to pay a lump sum amount of Rs. 2 Lakh at once. In this case, what if a bank would offer to integrate with the seller’s (Sabka retail) website and offer you an EMI for these purchases as well as crop insurance for the farmer? Sounds like a less burdensome payment, right?
By offering multiple products at the checkout point, Sabka Retail is integrating a payment infrastructure (to fulfill online payment) and a digital credit and insurance product (to offer EMI and crop insurance), which may not even be from the same company. This type of solution is called embedded finance.
When a financial services company seamlessly integrates its products into a traditional non-financial platform (the shopkeeper’s website), the process is known as embedded finance. To elaborate, embedded finance solutions and infrastructure enables customer-facing digital platforms to embed financial solutions into them. The solutions could be embedded in the customer’s digital experience, journey, or platform.
Let’s be aware of the fact that embedded finance has existed for a long time. For instance, sales finance at appliance retailers or car loans at dealerships are some of the hands-on examples of embedded finance. The differentiator as well as the reason for its popularity lies in integrating financial products into digital interfaces that customers use frequently. This is built on the layer of trust and familiarity of the host app.
The business that wants to offer financial services will no longer have to build a fintech arm, which reduces the cost borne by the company to build. Similarly, technology service provider partners with banks to offer the product in a single, seamless, and easy-to-use customer experience. What this means is that in almost any digital platform – from e-commerce to gig work platforms, these apps/websites can integrate financial products within them.
Embedded finance products are at the intersection of commerce, banking, and business services. One of the first use cases of EF has been payment and multiple innovative product ideas have branched from thereon.
So, what kind of embedded finance product can be embedded into digital platforms?
The innovations under embedded finance are booming globally. From payments, EMI, buy now pay later, investments, credit, insurance, to even credit scoring algorithms – the range of offerings that can be integrated seamlessly is quite a few.
For a financial service provider, embedded finance solutions enable them to increase their reach, reduce the cost of acquiring new customers and capture a newer customer base. For the customer, these financial solutions help with easing out cash flow without straining their resources. It makes high-value purchases to be affordable. Some of such embedded finance examples are
A ride-hailing app is able to provide flight cancellation insurance to their passengers
An agriculture e-commerce platform can offer crop insurance
Availability of credit products on business WhatsApp
But how will the banks know on which platform to offer embedded finance products?
Typically, embedded finance solutions are a good fit for any business platform that has a large number of daily/frequent users. Here the platform plays the role of a distributor of the product. Businesses in India that are well-placed to offer EF products are e-commerce websites, ride-hailing apps, tourism websites, etc. Embedded finance enables businesses in MSME, B2B, and B2C to create a new source of revenue without incurring the overheads associated with operating a bank.
From a technology POV, what’s at the backend of offering an embedded finance product?
Yeah, we know you are wondering about this. Fair enough. So here’s how the flow occurs when a user clicks on an embedded finance product on a digital platform. Let’s say you are a passenger in an Uber and your flight is at 4 pm but you are pulling into the airport at 3.20 pm (brave of you!). By now you are confident of missing the flight and suddenly notice the flight cancellation insurance on your Uber app and click on it. Here’s a journey map of what happens in the back end :
For any embedded finance product that you see on an app, there are three parties involved in the backend – The financial institution, the digital platform, and the fintech/embedded finance infrastructure company that provides the software to integrate the product on the platform.
To give an example closer to home, IIFL Bank acquires customers and offers an entirely digitized loan experience to its customers through WhatsApp. The fintech company that provides the backend infrastructure (APIs) to integrate IIFL Bank with WhatsApp is Setu. In this use case the financial institution is IIFL Bank, WhatsApp is the platform and Setu is the fintech infrastructure company.
Another example could be in the case of travel insurance provided in the same workflow as booking a ticket on your go-to travel booking website. Let’s say you visit a travel website to book a ticket and in the same journey that you are booking the ticket, you also want options for travel insurance for that journey. In the embedded finance design – the insurance will be available on the same portal and does not require us to come out of the journey and buy the ticket separately, remember the ticket details and feed that into a separate website and buy the insurance.
One of the original examples of embedded finance is a payment gateway because it enables a merchant to collect payments from their customers through multiple payment methods, it could be savings could be credit and so on and so forth – Nikhil Kumar, Global Fintech Fest
Embedded finance provides a ‘plug-and-play’ functionality using API stacks and sometimes even no-code/low-code stacks for individual merchants.
How does the business benefit from offering embedded finance products?
Embedded finance products increase the competitiveness of the product. For instance, the travel portal that offers insurance on their portal also provides a refund in case the travel gets canceled. Such an offering drives people to that website and improves the stickiness, conversion rate, and revenue from the product.
Moreover, the company providing embedded finance products also gets access to a database of customer details. In the travel insurance example, the platform company (travel website) will get access to the insurance nominee, phone number, and resident’s detail – this allows to harness more analytics and insights about the consumer which creates business opportunities and stickiness for the company.
From a bank’s perspective, embedded finance reduces customer acquisition and serving costs.
The fascinating part of the Indian financial landscape is that if we take a closer look at the India Stack model, all the individual blocks enable partnerships between fintech and banks that make embedded finance a reality. This is particularly important for India because despite being ahead of the curve in terms of fintech innovations, the availability and access to affordable insurance and credit products are low. To reach the population at scale, it is necessary for financial services to ride over tech products with large distribution networks. There lies the scope and opportunity.
All artworks are designed by Himanshi Parmar.
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