What embedded finance is: financial services inside a non-financial business

What embedded finance is

Embedded finance is the offer of a financial service, whether a payment, a loan, insurance or savings, inside the product, platform or purchase journey of a company whose main business is not finance. The customer meets the financial service at the moment of need, in an interface they already use.

In a 2024 Focus Note on finance for micro-retailers, CGAP, a partnership hosted at the World Bank, describes embedded finance as creating opportunities to provide financial and non-financial services through a single interface.

Two ways to deliver it

CGAP distinguishes two delivery models:

• In-house embedded finance: real sector firms provide both the non-financial and the financial services themselves.
• Partnership-based embedded finance: a real sector firm provides the non-financial service and works with one or more financial institutions, such as banks, payments operators or fintechs, that provide the financial service.

Within the partnership model, CGAP mentions enablers such as banking-as-a-service and API providers that offer a more plug-and-play environment. The Bank for International Settlements describes how a partnership can divide the work in credit: the technology company provides the customer interface and quick loan approval, while the bank raises the funds and manages the loan.

CGAP notes that providing finance directly removes the complications of sharing and protecting data with a partner. In that case the company provides the financial service itself, under whatever licence its market requires; the comparison of lending rules shows how markets differ.

Why non-financial companies take it up

In its 2019 Annual Economic Report, the BIS describes the business models of large technology firms by three features it calls DNA: data analytics, network externalities and interwoven activities. The three reinforce one another: more users generate more data and a wider range of activities, which feed back into the loop. Financial services, the BIS notes, both benefit from and fuel this loop.

CGAP's study points to similar advantages for distributors and business-to-business e-commerce platforms that serve small shops. The cost of acquiring and servicing a borrowing customer is reduced dramatically, because the customers have already been onboarded onto the platform, and credit can be aligned with the retailer's ordering cycle of between seven and thirty days.

What can be embedded

The BIS observes that payments were the first financial service large technology firms offered; that some then ventured into lending, mainly to small firms and consumers; and that they also offer insurance and money market funds, often as a distribution channel for third-party providers. It adds that they have typically entered financial services once they had secured an established customer base.

• Payments and wallets: paying, collecting and storing money inside the company's app or checkout.
• Credit: paying later at checkout, working capital for merchants on a platform, or stock on credit for retailers supplied by a distributor.
• Insurance: cover sold with a purchase, a trip or a delivery.
• Savings and investment: balances or funds offered to the company's customers.

A worked example: CGAP describes a programme in which micro-retailers can receive up to 150 percent of their previous purchase on credit. With illustrative numbers, a shop whose last order of stock was worth 2,000 could receive up to 2,000 times 150 percent, or 3,000, of stock on credit in its next order. The limit rests on the shop's own purchase record.

Where it has grown: Southeast Asia and other regions

The BIS reported in 2019 that the expansion of large technology firms into finance had been most extensive in China, with growth notably in Southeast Asia, East Africa and Latin America, and that these firms accounted for most fintech credit in Argentina and Korea. It also put the scale in perspective: even in China, the total flow of fintech credit in 2017 was less than 3 percent of total credit outstanding to the non-bank sector. These are dated figures and cover large technology firms rather than all non-financial companies.

First risks and the questions to settle

The same sources name the risks. CGAP lists the risk of defaults when repayment incentives are eroded through increasing competition, and cybersecurity and data protection risks. The BIS warns that dominant platforms can consolidate their position by raising entry barriers, that privacy sets limits on the use of personal data, and that in some settings, such as the payment system, large technology firms could quickly become systemically relevant financial institutions.

• Who provides the financial service, and under which licence?
• Who holds the customer data, and on what consent is it shared?
• Who carries the loss if a loan is not repaid?
• How will the customer know who is responsible, and where to complain?
• Will the loans be reported to the credit bureau, so that other lenders see the borrower's total debt?