The COVID-19 pandemic accelerated the shift to digital payments and brought about a permanent change in digital consumption patterns
Consumers today prefer digital interfaces they use daily to avail of basic financial services. And that too, in a single digital journey instead of using disparate services from multiple service providers. Embedded finance, and specifically payments, which has emerged as the next digital evolution, is the integration of financial services into non-financial digital journeys.
Fintechs and big techs are shaping customer expectations by offering payments and lending features on their apps and online platforms. Customers now expect a similar experience from all their interactions across sectors such as retail, hospitality, and travel. Businesses across industries are therefore increasingly looking to embed financial services in their products and services. Consequently, embedded finance is growing rapidly, with payments accounting for a large piece of the pie—consumer payments through embedded platforms are expected to touch $3.5 trillion by 2026 while embedded B2B payments are predicted to reach $2.6 trillion.*
We discuss the innovations in the embedded payments space and the opportunities for financial institutions, while outlining an approach for implementation.
Digital ecosystems are key to leveraging the embedded payments potential.
An ecosystem that offers day-to-day products and services that consumers use and meets their lifestyle needs is crucial to making embedded payments ubiquitous and creating multiple avenues for customer engagement. Enabling embedded payments at scale will require payment providers to build application programming interfaces (APIs) or software development kits (SDKs) with the capability to process payments initiated through multiple modes and channels, especially mobile.
We see three foundational layers (see Figure 1) as imperative to operationalizing embedded payments:
The good news is that these foundational layers already exist in a certain form or the other. Ecosystem players, which could be banks or technology players or other entities with a vantage position in the industry, must take the lead and collaborate with partners to offer embedded payment services.
That said, the embedded payments space is still evolving and different countries are at different levels of maturity, which means that there is no one-size-fit-all approach. Individual firms will need to identify the collaboration approach that best suits them. This could either mean verticalization of payments wherein financial institutions focus on mastering the payment workflow of a particular sector or building capabilities for multiple industries (such as healthcare, travel, and hospitality) where they have a strong presence.
Putting theory to work
Bundling services is critical to a seamless embedded payments journey.
However, what is even more critical is the customer experience. Three key parameters—look and feel, ease of use, and the ability to meet lifestyle needs—contribute to superior experience. Successfully meeting customers’ needs drives repeat usage and creates regular engagement opportunities.
Payments are getting embedded across industries for different purposes or outcomes (see Figure 2). While multiple payment methods will be available, the context, customer’s preference and history determine where, how, and what payment options are displayed. Payment providers assure seamless experience regardless of the service used. The service can be from within the industry or from adjacent ecosystems and the bundling is determined by the individual customer’s needs.
Both financial institutions and businesses (merchants) must gear up for this evolution and acquire the capabilities required to seamlessly execute different payment methods. This will require more scalable, secure, and standardized front- and back-end infrastructure.
As customers go to the merchant site or app to pay, the end application is hosted by the merchant which means that the backend systems of the merchant have to be able to drive the embedded payment journey. However, merchants face challenges with legacy systems, limited digital capabilities, and tie-ups with multiple payment processors and banks with varying API formats and standards. These challenges also hinder merchants in their efforts to build a single app that offers a uniform checkout experience, which ultimately affects the customer experience. Most merchants may not have the technical expertise to address these challenges.
In our view, incumbents must step in here—if they don’t, fintechs will enter the space and create a niche for themselves either relegating financial institutions to mere backend payment processing or disintermediating them altogether from crucial aspects of the payment process. And in fact, traditional banks have a lot to gain by entering this space, such as a larger customer base, opportunities to partner with adjacent industry players, and access to new sales and distribution channels.
Another point to note is that merchants are exploring new payment options for their customers as cards are proving costly. They are likely to switch if their financial institution does not offer new-age embedded payment facilities such as account-to-account (A2A), request-to-pay, QR codes, and so on. Given that emerging transaction methods are set to cannibalize card revenues, financial institutions would do well to offer such cannibalizing products themselves rather than conceding ground to fintech or big tech rivals.
To avoid disintermediation, financial institutions will need to:
Digital ecosystems for embedded payments
There are two ways for financial institutions to participate in embedded payment ecosystems.
One way is where they orchestrate the ecosystem by aggregating products and services of ecosystem partners. In this case, customer experience and the payment aspect are controlled by the financial institution. The other route is where financial institutions embed their services in ecosystem partners’ consumer journeys across different channels (see Figure 3).
For the ecosystem to function seamlessly, both ecosystem players as well as financial institutions need to build APIs or SDKs. They must also develop the requisite software applications to enable customers to consume embedded payment services through varied modes and channels, which will play an important role in making embedded journeys scalable and ubiquitous.
In the first option, the financial institution is an enabler. For example, we helped a leading Indian bank convert its mobile banking application to a mobile payment application. This allowed customers of any bank to link their account and use the app to make online and physical purchases, renew insurance policies, transfer funds, buy tickets, pay bills as well as pay for parking recharges, subscriptions, and toll fees, and much more. The bank orchestrated the ecosystem where partners from various sectors such as travel, ecommerce, hospitality, insurance and more offered their products and services. With this approach, the bank was able to:
In the second option, the financial institution is an embedded participant. Many firms are going the second way, where they are embedding their products and services in vertical specific apps. For example, a leading global card network has tied up with a premium car manufacturer to enable embedded payments through the car’s dashboard.
Given that an efficient real-time payments system is a foundational layer for enabling embedded payments, the Indian experience can offer valuable lessons, especially as globally, nations are at different stages of their digital payments journey. India’s Unified Payments Interface (UPI) platform is ranked as the top real-time payments system in the world based on its standards, APIs, and participation.
UPI enables multiple payment modes through bank accounts, e-wallets, and now, even cards by using a proxy or an alias. Merchants enable an app-switch mode in their app, which permits the UPI payment authentication interface to open within the merchant app and allows payments to go through securely. Mandates can be set on the UPI platform to automatically debit customers’ bank accounts, making the payment journey completely invisible. Request-to-pay is another mode where the payment request is sent through a link to customers’ mobile device or the app. Customers just click on the link, verify the details, and approve the transaction. UPI has been hugely successful in India, and for countries interested in launching similar initiatives, it offers significant learnings across technical principles and considerations, digital infrastructure, and business model.