By Kirill Iaroshenko, Senior Management Consultant at a leading global management consulting firm
Embedded finance is transforming the way financial services are integrated into everyday life, offering seamless, personalized experiences that traditional banks struggle to match. As financial services become increasingly woven into digital platforms, banks face both an opportunity and a threat. The challenge is clear: adapt to this new platform economy or risk losing relevance. This article delves into the rise of embedded finance, real-world examples that showcase its impact, and strategies banks can employ to stay competitive.
Table of Contents
Understanding Embedded Finance
Embedded finance refers to the integration of financial services—such as payments, lending, and insurance—directly into non-financial platforms, allowing consumers to access these services at the point of need. This approach removes friction and provides a seamless user experience, turning financial services into a “background” function of everyday activities.
The market potential of embedded finance is significant. According to McKinsey, embedded finance could generate up to $7 trillion in annual revenue by 2030, capturing 20-25% of the global banking market. In Europe, where regulations like PSD2 have opened up financial data, embedded finance is expected to grow rapidly, driven by consumer demand for convenience and better digital experiences(McKinsey & Company).
Key Drivers of Embedded Finance
- Changing Consumer Expectations
Modern consumers demand instant, integrated solutions that fit into their digital lives. Embedded finance meets this demand by providing financial services exactly when and where they are needed. In Europe, this trend is particularly strong among younger consumers who expect financial services to be as accessible as social media or online shopping. - Technological Advancements
The development of APIs, advanced analytics, and machine learning has made it easier for banks to integrate their services into third-party platforms. Open banking regulations, such as PSD2 in Europe, have further accelerated this by enabling secure data sharing between financial institutions and tech companies. This technological ecosystem allows embedded finance to flourish by facilitating quick and seamless integration. - Platform Powerhouses
Tech giants like Apple, Google, and Amazon have leveraged their extensive user bases and deep data insights to offer embedded financial services directly to consumers. Apple’s embedded finance strategy, which includes the Apple Card, Apple Pay, and Apple Pay Later, illustrates how a well-integrated ecosystem can provide financial services that feel natural and intuitive for the consumer. Apple’s move into BNPL (Buy Now, Pay Later) is a clear indication of how platforms can disrupt traditional banking models by embedding financial products within everyday transactions.
Real-World Examples
1. Apple: A Leader in Embedded Finance
Apple has revolutionized the embedded finance space by turning its ecosystem into a powerful distribution channel for financial products. The Apple Card, developed in partnership with Goldman Sachs, offers users a fully integrated experience within the Apple Wallet. Beyond traditional credit card features, it provides daily cashback, real-time transaction tracking, and a seamless user interface that encourages responsible spending.
The success of Apple Pay and Apple Pay Later further underscores the power of embedding finance into consumer technology. Apple Pay Later, a BNPL solution, allows users to split payments directly at checkout, offering a frictionless payment experience that has seen rapid adoption among European consumers. This is a prime example of how embedded finance can capture market share from traditional banks by offering a superior user experience.
2. Klarna: Disrupting Payments in Europe
Klarna, a Swedish fintech, has become a dominant player in the European embedded finance market with its BNPL services. Klarna’s partnership with major retailers allows consumers to split payments into manageable installments at the point of sale, directly within the retailer’s checkout process. This embedded model has reshaped consumer spending habits across Europe, making BNPL one of the fastest-growing payment methods in the region.
Klarna’s growth has not only been driven by consumer demand but also by strategic partnerships with brands like H&M, ASOS, and IKEA, which embed Klarna’s payment options directly into their platforms. This level of integration has helped Klarna become a household name, synonymous with flexible payments and a prime example of embedded finance success.
3. Shopify: Empowering Small Businesses with Embedded Finance
Shopify’s embedded finance offerings, including Shopify Capital, provide small businesses with access to financing directly through their e-commerce platform. By analyzing sales data, Shopify can offer personalized financing options like merchant cash advances, helping businesses manage cash flow without the hassle of traditional banking processes. This embedded approach not only simplifies access to capital but also strengthens the relationship between Shopify and its merchants.
Strategies for Banks to Stay Competitive
To navigate the evolving landscape of embedded finance and remain competitive, banks need to implement strategic approaches that leverage their strengths while adapting to new market demands. The following strategies outline how banks can maintain a strong position in the market and successfully integrate embedded finance into their business models:
1. Embrace Strategic Partnerships with Technology Firms
Partnering with technology companies, fintechs, and platforms is one of the most effective ways for banks to enter the embedded finance space. By leveraging the technological expertise and customer reach of these platforms, banks can provide financial services directly within the ecosystems that customers already use daily.
For example, Goldman Sachs has partnered with Apple to launch the Apple Card and Apple Pay Later, which seamlessly integrate financial services into Apple’s vast ecosystem of devices. This partnership allows Goldman Sachs to tap into Apple’s extensive customer base while reinforcing its own brand as a tech-savvy, innovative financial institution.
Similarly, BBVA collaborated with Uber in Mexico to provide embedded financial services such as digital bank accounts and card payments directly through the Uber app. This partnership allowed BBVA to expand its customer base significantly and provide innovative, convenient financial solutions for gig economy workers who rely on Uber for income.
2. Develop White-Label Solutions
Creating white-label financial products allows banks to offer their services through other companies’ platforms while maintaining control over the underlying financial infrastructure. This approach helps banks extend their reach without needing to invest heavily in new customer acquisition channels.
For instance, Solarisbank, a Berlin-based tech company with a banking license, offers a fully integrated BaaS (Banking-as-a-Service) platform that other companies can use to provide financial services under their own brand. Companies like Samsung, Vivid Money, and Penta use Solarisbank’s infrastructure to offer banking products without having to deal with the complexities of obtaining a banking license themselves.
White-labeling has proven to be a highly effective strategy for banks that want to scale their operations quickly and cost-effectively while minimizing regulatory risk. By enabling third parties to offer financial services, banks can access new customer segments and diversify their revenue streams.
3. Invest in API-Driven Architecture and Open Banking
Adopting API-driven architecture is critical for banks that wish to remain agile and integrate easily with external platforms. APIs (Application Programming Interfaces) allow banks to offer modular financial services that third parties can plug into their own products and platforms. Open banking regulations, such as the PSD2 directive in Europe, have accelerated this trend by requiring banks to share customer data with licensed third-party providers, creating a more competitive and customer-focused financial ecosystem.
For example, the UK’s open banking initiative has led to the rapid growth of new financial services and products by enabling third-party providers to access bank data securely. This has driven innovation in areas like personal finance management and payment solutions, putting pressure on traditional banks to adapt or risk losing market share.
4. Prioritize Customer Experience and Personalization
Embedded finance thrives on the ability to deliver highly personalized and seamless customer experiences. Banks need to prioritize the use of data analytics and AI to tailor their services to individual needs, creating unique value propositions that set them apart from competitors.
Revolut, a UK-based neobank, exemplifies this approach by using data analytics to offer personalized financial products such as tailored credit lines, budgeting tools, and custom spending insights directly within their app. By focusing on a user-centric approach, Revolut has successfully grown its customer base across Europe and beyond, becoming one of the leading players in the digital banking space.
5. Expand Beyond Traditional Banking Services
To stay relevant in a platform economy, banks must look beyond traditional banking products and explore opportunities to offer adjacent services that meet broader customer needs. This can include areas such as insurance, wealth management, and loyalty programs, all of which can be embedded seamlessly within third-party platforms.
For example, BNP Paribas has expanded its service offering by integrating insurance products directly into retail and e-commerce platforms, allowing customers to purchase coverage at the point of sale. This approach not only drives additional revenue but also enhances the customer journey by providing financial protection precisely when it’s most relevant.
6. Enhance Digital Transformation and Innovation Capabilities
Investing in digital transformation is crucial for banks aiming to keep up with the rapid pace of change in embedded finance. This includes modernizing legacy systems, adopting cloud-based solutions, and building in-house innovation labs to develop new financial technologies.
For instance, JPMorgan Chase has heavily invested in digital transformation through its innovation hub, Onyx, which focuses on exploring new financial technologies such as blockchain and digital currency. This commitment to innovation positions JPMorgan as a leader in embedding finance within a broader digital strategy, enhancing its ability to offer cutting-edge solutions to both retail and institutional clients.
Challenges and Considerations
Embedded finance offers significant opportunities, but it also presents several challenges that banks and financial institutions must navigate to succeed. Understanding these challenges is crucial for banks looking to remain competitive in the rapidly evolving financial landscape.
1. Regulatory Complexity and Compliance Risks
One of the most significant challenges in embedded finance is navigating the complex regulatory environment. Different jurisdictions have varying rules on data privacy, consumer protection, and financial compliance. In Europe, the General Data Protection Regulation (GDPR) imposes strict requirements on how customer data is collected, processed, and stored, adding complexity to embedded finance solutions. Banks must ensure that their embedded offerings comply with these regulations while maintaining a seamless customer experience.
Moreover, the rise of embedded finance has prompted regulators to scrutinize the roles of banks and non-bank entities more closely. For example, embedded lending and BNPL (Buy Now, Pay Later) services offered by tech platforms like Klarna and PayPal have raised concerns about consumer credit risk and transparency. Regulators are increasingly focused on ensuring that these services do not exploit consumers or bypass traditional financial oversight, placing additional compliance burdens on both banks and their tech partners.
2. Data Privacy and Security Concerns
Embedded finance relies heavily on the exchange of data between banks, platforms, and consumers. This data flow is crucial for personalizing financial products, but it also raises significant privacy and security concerns. Banks must ensure that they have robust cybersecurity measures in place to protect customer data from breaches and misuse. For example, data-sharing agreements between banks and platforms must clearly define how data is used, stored, and protected.
In Europe, where data protection laws are stringent, banks must navigate not only GDPR but also country-specific regulations that may impose additional requirements. For instance, recent scrutiny over third-party data usage has led to calls for more transparency and accountability in how embedded finance platforms handle sensitive customer information. Banks need to implement data governance frameworks that align with regulatory expectations and reassure customers about their data privacy.
3. The Risk of Disintermediation
As tech companies increasingly offer embedded financial services, traditional banks face the risk of being disintermediated from the customer relationship. When customers use financial services through third-party platforms like Amazon, Google, or Shopify, the bank’s brand often takes a backseat. This disintermediation weakens the bank’s direct connection with its customers, making it difficult to build loyalty and differentiate its offerings.
To combat this, banks need to rethink their approach to branding and customer engagement. One strategy is to develop white-label solutions that allow banks to maintain a presence within embedded finance ecosystems. However, this approach comes with its own set of challenges, such as managing brand perception and ensuring consistency in service quality across different platforms.
4. Technological Integration and Legacy Systems
The integration of embedded finance requires banks to modernize their technology infrastructure, which can be costly and complex. Many traditional banks still rely on legacy systems that are not designed for the flexible, API-driven environment that embedded finance demands. Upgrading these systems to support seamless integration with third-party platforms can be both time-consuming and resource-intensive.
Furthermore, banks must ensure that their technology stack can handle the high volume of real-time data transactions that embedded finance entails. This requires investing in cloud computing, data analytics, and API management platforms. Failure to modernize can result in operational inefficiencies, slower response times, and a diminished ability to compete with more agile fintech players.
5. Balancing Innovation with Risk Management
While embedded finance offers new revenue opportunities, it also introduces new risks, particularly in areas like credit underwriting and fraud prevention. For example, embedded lending through platforms may expose banks to higher credit risk due to a lack of direct control over the customer relationship and limited access to comprehensive customer data.
Banks must develop robust risk management frameworks that can assess and mitigate these risks effectively. This includes leveraging advanced analytics to improve credit decision-making, implementing real-time fraud detection systems, and maintaining oversight of the financial products offered through third-party platforms. Additionally, banks need to work closely with their partners to establish clear risk-sharing agreements that outline each party’s responsibilities in managing these new risks.
6. Strategic Alignment and Cultural Challenges
The shift toward embedded finance requires banks to adopt a more collaborative mindset, working closely with non-financial companies to co-create value. This cultural shift can be difficult for traditional banks, which are often accustomed to operating independently. Building effective partnerships with tech platforms requires banks to be agile, adaptable, and willing to share control over the customer experience.
To succeed, banks must foster a culture of innovation that supports cross-industry collaboration and encourages experimentation. This may involve restructuring teams, redefining roles, and investing in talent with skills in technology, data science, and partnership management. By aligning their organizational culture with the demands of embedded finance, banks can position themselves as proactive players in the evolving financial ecosystem.
Conclusion
Embedded finance is not just a trend; it represents a fundamental shift in how financial services are delivered and consumed. For banks, this new landscape offers both opportunities and challenges. By embracing embedded finance, banks can reach new customers, enhance user experiences, and unlock new revenue streams. However, success will require a strategic approach, a willingness to innovate, and a commitment to building the partnerships and technologies needed to thrive in a platform economy.
The embedded finance revolution is here, and banks that adapt will not only survive but lead the next wave of financial innovation.
