What is embedded finance?

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Embedded finance refers to the process of a non-financial company offering financial services or products. This is usually through a third-party integration or application programming interface (API). But as an emerging technology, new issues are being raised all the time, leading to calls for regulations around embedded finance. 

How does embedded finance work?

It uses financial technology systems in companies that are not licenced. Banking-as-a-Service (or BaaS) allows non-finance companies to integrate payments and lending APIs into their websites and applications. This means that they can offer the same services as a bank, for example. 

Embedded finance systems vary in their purpose and capabilities. For example, embedded payments allow companies to offer payments in-app without bank certification on every transaction. Embedded banking allows providers to create separate bank accounts without being regulated as a bank. And embedded financing offers funding and loans to consumers without having to fill out a loan application. 

Key examples

Uber and Grab are two examples of services which offer embedded payments. By allowing customers to connect their cards just once, each ride can be paid for within the app (hence the embedded payment) without the need for extra verification.  

Starbucks is the classic example of embedded banking, with depositing and withdrawal financial service facilities available on its app. Users can simply add funds with embedded bank accounts powered by the financial institution, JPMorgan Chase. Moreover, their loyalty rewards programme allows customers to increase the cash stored in the Starbucks app. 

Klarna is an example of embedded financing. Its ‘Buy now, pay later’ product encourages consumers to defer their payments for online shopping purchases. Traditionally, shoppers would have to fill out lengthy loan applications and be subjected to credit cheques before having access to capital. But the Buy now, pay later service removes both of these requirements, making it easier for all types of e-commerce with Klarna. 

Pros and Cons of EdFi

The term embedded finance was only coined in 2019, which means that it is an incredibly new sector to the fintech markets. However, we can already see some of the benefits that it offers (as well as potential concerns) of embedded finance adoption. 

Benefits of embedded finance

If there’s one thing for sure, it’s that the embedded finance solution offers a whole lot more convenience, both for customers and the vendors supplying them. This makes for a better customer experience with reduced friction all-round. 

Moreover, the partnerships created between vendors and their embedded finance companies usually form a seamless open banking experience between the primary company and financial services. With the ability to partner with a regulated fintech brand to offer banking services, compliance is covered. 

And, partnerships allow for a fast uptake of the product. This means that if you’re a non-financial company, there’s no need to spend resources on research and development for a digital platform in an area where you have no previous expertise. The financial product is covered. 

Concerns with embedded finance

One of the most prominent concerns with EmFi is data-sharing. Of course, laws like GDPR and the California Consumer Privacy Act exist to prevent the misuse of data. However, integrations tend to place regulatory compliance in between jurisdictions. With no one taking responsibility for data privacy and treatment, it’s likely to fall through the cracks.  

Secondly, the growing concern over embedded financing is that consumers have found it too easy to access funding and were not well-informed about the risks (namely, getting into debt). Therefore, recent questions around the misselling of embedded finance accounts to those who would be better off without them have triggered new changes to Buy now pay later regulations. 

The future of regulation for embedded finance

Currently, there are a few recent regulatory changes that touch on embedded finance technology. 

For example, the updated payment services directive (PSD2) is a European regulation which specifies that fintech integration providers require approval and licencing to operate.

Moreover, increased security (through strong customer authentication and the know your customer frameworks) aims to protect against data leakage. 

The recent updates to BNPL regulations in the UK will now require providers to perform credit cheques and create transparent advertising campaigns so that potential customers are informed of the risks. 

However, as an emerging technology, there is no overarching regulatory framework for embedded finance. We are likely to see sporadic updates in the next few years, with an abundance of manual changes. Small and medium-sized businesses can benefit from RegAssure, our highly intuitive AI system that does all the heavy lifting.