Embedded finance: navigating the challenges
Ushered in by open banking and encouraged by evolving customer behaviours amid the pandemic, embedded finance is a burgeoning trend in the fintech world.
As embedded finance progresses, it’s likely to prompt new regulations
Embedded finance, the integration of financial services into the apps, websites or business processes of non-bank brands, has introduced a new model of financial services distribution and new opportunities for ambitious companies to influence and enhance the financial lives of customers.
Creating a financial product is a serious undertaking that requires a significant investment in time and resources. This is particularly true for brands that don’t have much prior experience in the fintech arena. They must first get to grips with developing and launching a new product that has limited overlap with their core business before finding a way to navigate a complex legal and regulatory landscape.
When it comes to handling someone’s finances and data, compliance and regulation must be strictly followed at every level, both to bolster consumer trust and avoid penalties.
The responsibility for this compliance ultimately lies with the providers, though there should be collaboration and transparency between financial institutions and regulators to help providers to meet regulatory standards.
In addition to meeting regulatory requirements, there are some other challenges to be aware of before entering the world of embedded finance.
Reluctant incumbents are holding back the tide
Open banking and payment APIs are the key enablers for embedded finance. While these have progressed and matured to allow embedded finance to become viable, this is not yet the case for all markets – meaning embedded finance’s prospects are not yet universally strong.
It’s often said banks and other financial institutions are some of the slowest to adopt new technology. And this has certainly been the case with open banking and APIs, with many still using outdated technological structures to underpin e-commerce and international payments.
There’s also a question mark regarding their mindset. Embedded finance requires a different way of thinking, and for banks it means partnering with a wider range of companies, diluting their services and ultimately playing a less important role for the end user.
This is difficult for them to accept – especially when they’re already seeing the successes of neobanks like Starling and Monzo in the international payments space. The continued inertia by the large incumbents when it comes to fully opening up their technical capabilities in the spirit of open banking presents a challenge to the growth of embedded finance.
Nimble fintechs, meanwhile, are more willing and able to build out APIs at speed, allowing embedded offerings to sit underneath front-end interfaces. Brands wishing to harness embedded finance services can instead look to partner with these specialist providers to ensure they receive the required education and support that allows the product to serve both their business and their customers well.
Data quality, privacy and protecting against fraud
When considering the functional challenges around embedded finance, optimised APIs alone aren’t enough – they need data of sufficient quality and scope. For example, pre-filling a lengthy application form for a financial product can greatly enhance the user journey, but not if the data available is insufficient for the provider to make an accurate assessment of creditworthiness. As the incumbent banks still hold a wealth of data, it’s hoped they will further buy in to the concept of embedded finance.
A major factor in the success and acceptance of applications of embedded finance will be data privacy provisions and measures to mitigate the risk of fraud. As cybercriminals seek new opportunities, Juniper Research has predicted that online payment fraud will reach a cumulative $206 billion by 2025, which is ten times the net income of Amazon.
Consumers need to be sure their financial data is fully protected and secure. Given the power of APIs to transfer high volumes of complex data, new services and methods of customer acquisition must be balanced with a focus on the user experience, putting the consumer in control of their data usage.
By adhering to proper risk mitigation protocols and certifications, such as ISO 27001, providers can offer consumers a level of comfort with the knowledge their personal information is protected to the same standard as it is at banks. This is why it’s essential that embedded finance providers seek out partnerships with trusted and regulated embedded finance hosts.
As embedded finance progresses, it’s likely to prompt new regulations and the expansion of existing ones, such as anti-money laundering regulations like the Bank Secrecy Act (BSA). In addition, future fraud prevention solutions will be based on large-scale machine learning. A recent Economist Intelligence Unit report has highlighted this shift towards an AI-enabled fraud prevention solution landscape, stating that banks and insurance companies will see an 86% increase in AI-related technology by 2025.
