Maximizing value and minimizing risk in the embedded finance value chain

Nebo Djurdjevic Categories: Business Insights Date 06-Apr-2023 6 minutes to read

Embedded finance has opened up the revenues from the lucrative financial services market to other non-financial players such as software developers, retailers and professional service providers.

Maximizing Value And Minimizing Risk

Table of contents

    A mere couple of decades ago, financial services were firmly tied to the brick and mortar of the financial institutions offering said services. A small business owner would walk over to their bank to make cash deposits on a regular basis, meet with their insurance provider when the time came to renew, and walk around the corner again to the bank to obtain a loan. Today, a small business owner is much more likely to log into their payment processing app, and be able to achieve all of the above from the same application, even though the service is provided by a different institution entirely. Similarly, a consumer may log into an app to check their credit score, and obtain a credit card, a loan, and or/a mortgage.

    The inclusion of traditional financial products in a nonfinancial customer experience journey or platform is called embedded finance, and if you’re looking for the next field for your fintech or financial services company to play in, it warrants a very close look. However, not all embedded finance opportunities are the same. Understanding the distribution of value and risk in the embedded finance value chain is essential to maximizing your chances of success – and your share of the overall revenue. 

    Understanding your opportunity – the opportunity categories of embedded finance

    There are numerous creative routes to take in developing an embedded finance offering. To determine where you should play, you should develop an understanding of their variety.

    The categories of embedded finance

    The vast majority of embedded finance offerings can be categorized under the following categories:

    • An embedded payments offering provides customers with seamless ways to pay for their goods and services as part of their digital experience. Most common examples include digital wallets and instant payments so that users can pay for a company’s services, reimburse their loyalty points, or find applicable coupons without leaving the company’s website. 
    • Embedded insurance enables customers to purchase insurance as an add-on to their desired product or service. Whether a customer is renting a car or purchasing a fancy new controller for theirr racing simulator, the seller will now offer to insure their rental or purchase at the click of a button.
    • Embedded lending is most commonly embodied in “buy now, pay later” offerings. It lets customers make purchases and pay for them later in the future - All on the same page, and within a few seconds.
    • Embedded investing and wealth management is commonly experienced on health benefit providers’ websites and apps. In addition to checking their benefit balances, users are offered the opportunity to buy into various investments, along with financial and wealth management advice.

    Clearly, there are many opportunities for creative plays across the embedded finance landscape, as one of the three main types of players:

    • Digital platforms and marketplaces are the apps, websites and businesses in general that are embedding the financial service into the overall customer experience or offering.
    • Infrastructure providers are the organizations providing APIs to connect the user experience to the financial service provider, supporting aspects such as credit scoping, security, connectivity and insights.
    • Financial services providers offer the financial services being embedded and take on most of the financial risk; this includes banks, small financial institutions, insurance providers, etc.

    Main types of players in embedded finance

    While there are many opportunities and roles to play in the value chain, the truly successful entrepreneurs will develop an understanding of the associated risks.

    Mapping and mitigating risks is key to success in embedded finance

    Business has always been a game of risk and reward. Evolving technology offers many opportunities, but inevitably also implies an evolving risk landscape.

    Key risks in embedded finance include:

    • The regulatory landscape is a fundamental consideration in any finance-related endeavor – finance being a heavily regulated industry. As offerings evolve, it is sometimes difficult to anticipate the societal consequences, and the regulators’ actions to address such consequences.
    • Security, privacy and data risks are associated with any tech enterprise. Any breach in this space concerns sensitive customer data, and sometimes their hard-earned money. Liability in such cases often far exceeds the opportunity, and such risks must be carefully managed.
    • The right partnerships are key to success. Partnering with the wrong player in the value chain can literally suck all of the value out of said chain with just a single catastrophic event.

    With all of this understood – how do you capitalize on the opportunity while minimizing risk?

    High risk, high reward - who is capturing the value?

    Which player profits the most from the overall value is largely determined by the risk such a player takes on in the value chain.

    One obvious trend is that, per McKinsey, more than 55% of the $14 billion overall embedded finance revenues in the US are captured by the lenders/financial services providers who take on the risk of credit default – rather than the marketplaces who distribute them or the tech companies who enable such distribution as infrastructure providers.

    If you are a financial services provider, this is great news. However, if you are a marketplace or an infrastructure provider, you may want to look at other types of offerings. Out of the remaining $6 billion in the US market, $4 billion (or 30%+ of the overall market) is captured by the platforms/marketplaces who drive the primary value in the relationship by promoting the ‘stickiness’ and quality of the overall customer experience.

    Another trend to be aware of is the opportunity for the platforms/marketplaces to take on higher risk – and therefore reward – in the lending aspect of embedded finance. One way to do so is to offer repurchase agreements for loans originated by financial services providers.

    No matter how technology evolves – ‘no risk, no reward’ is an adage as true as ever in the world of finance.

    Forging the right partnerships - navigate and reduce your risk universe

    The use of embedded finance is often dependent on partnerships and collaborations between different parties (e.g., banks, retailers, API or platform providers). This makes identifying the right partner(s)—with compatible technologies and capabilities—critical to the successful development and delivery of embedded finance solutions.

    Working with partners that may have different technologies or processes in place lead to operational complexities and risks if not considered in advance. On the flipside, an experienced partner can help you minimize the risks across your risk universe.

    My software development company, Vega IT, employs domain experts who understand the value chain and can help reduce such risks. Vega IT can help with integration of different technologies ensuring successful development and delivery of embedded finance solutions. Most fundamentally, this means developing your technology up to the stringent standards required by the financial services industry, based on proven experience. Equally importantly, our domain expertise means we can share best practices related to technology, but also business lessons learned from working on other similar endeavors – so that you don’t have to learn the hard way, and have a much shorter learning curve.

    Enabling innovative business endeavors through technology, always employing the right domain expertise, is what our professionals do - day-in and day-out. Let’s discuss how we can support your own embedded finance success story!

    Nebojsa Djurdjevic Author
    Nebo Djurdjevic Partner & Chief Strategy and Innovation Officer

    Entrepreneur and executive leader with over 25 years of global fintech experience and passion for partnerships that unlock growth and create value.