The banking and financial services industry is staring at a disruption, yet again.
As customers expect an end-to-end experience that seamlessly meets all their banking needs through a single platform, technology firms have started building digital platforms for small and large businesses that come with embedded options to meet a business’ financial needs. Amazon offering lending options to small businesses is one such example. In addition, these platforms help retail consumers by linking product discovery and purchase as well as offering financial assistance.
With traditional banks not present on these platforms, they are losing considerable business almost daily, and in the longer run, the impact on their books won’t be pretty. It has therefore become imperative for banks to embed their offerings into these customer journeys and industry platforms and offer financial assistance through point-of-sale financing and merchant finance. This will, in turn, help banks retain primacy in their customers’ financial lives and, in the long run, escape commoditization and/or disintermediation. We explore the strategic options available to banks in this space.
The new disruptor
Traditionally, banks have been the primary channel for the financing needs of consumers and businesses.
However, the supremacy that banks have enjoyed thus far is now under threat, thanks to the rising popularity of ecosystem-led business models. These days, we have digital ecosystems that cover the entire customer journey, right from the time a customer starts researching about a product to the final purchase.
The traditional boundaries between providers of goods and services and financial institutions have forced customers to demarcate the product purchase and financing journeys. This has occurred due to regulatory barriers, inflexible technology, and industry players trying to own and protect their own turfs. However, customer expectations have now changed and the increasing demand for seamless banking experiences have broken down these barriers, paving the way for embedding financing options into purchase journeys—the embedded finance market is expected grow to USD 51 billion by 2026.
Enter digital ecosystems
Incumbents are fast getting replaced by fintechs.
The delays due to legacy lending processes and outdated infrastructure of incumbent banks have resulted in customers approaching fintechs for their financing needs. Fintechs have therefore attained a significant market share, particularly in lending and payments. Albeit still evolving, embedded lending offers banks a way to regain centerstage in their customers’ financial lives.
Embedded finance is a set of technology-led interventions that seamlessly integrate financial services like payments and lending into the non-financial arena to more easily and efficiently facilitate the purchase of goods and services. It promises tighter integration with customer journeys than what card-based services or point-of-sale financing offer.
Big tech, fintech, and e-commerce companies are fueling the embedded lending trend by creating digital ecosystems where they partner with multiple banks to offer tailored financial services by leveraging advanced data-science capabilities. By offering financial assistance products, they are slowly but surely assuming the role of lenders – and this should be a cause of worry for the incumbents. For example, Shopify, an online commerce platform, provides business loans through WebBank, which is a specialty bank that only lends through partners. While customers get to seamlessly experience the entire lending journey through Shopify’s channels, the underlying financial transactions are executed by WebBank. Shopify thus gets unparalleled insights into the operational and financial performance of the business. Incumbent banks that get involved in the journey only at the point of financing have no visibility into the actual business and operational data and are therefore unable to tailor products to meet customers’ contextual needs.
To understand how embedding banking and financial services can generate value for banks, consider the case of a bank partnering with a business formation and registration agent. Small businesses work with such agents to help them through the business incorporation process, sharing information required for incorporation. Banks can seamlessly integrate into the business formation journey and eliminate several steps from the onboarding and account-opening process, thereby reducing the friction between business formation and account-opening journeys. This can help banks become the primary financial services provider for these new businesses. Banks can also gain visibility into their customers’ operational data to craft contextual financial assistance products, thereby gaining a competitive edge.
Many industries like retail, travel, healthcare, ecommerce, home ownership, vehicle ownership, agri-business, utilities, education, small business, and entertainment are ripe for integrating lending services into their platforms, setting the stage for banks to go beyond banking.
The next big opportunity
Entering the embedded lending space has become a business imperative for traditional banks.
This will require banks to be part of digital ecosystems where they can embed their products and services and distribute them through other ecosystem partners. Banks must also identify what role they would like to play in the embedded lending space—should they orchestrate their own ecosystem or participate in existing ones? Banks can choose one of two operating models (see Figure 1) to build a digital ecosystem and cash in on the embedded lending opportunity—they can either participate in an existing consumer ecosystem or build a bank-led ecosystem.
Figure 1: Types of ecosystem models to embrace embedded lending
Participating in an existing ecosystem
In this model, banks bring significant advantages to the platforms that own the end-customer relationship. The high cost of developing and offering lending products and services, coupled with regulatory issues, pose challenges to non-financial businesses offering such services. By partnering with a regulated financial institution, non-financial businesses can capitalize on banks’ expertise in risk assessment, pricing, and collections. Banks, too, benefit by expanding their lending books in sync with non-financial firms’ business and avoid excessive exposure to a specific product or customer segment.
For example, banks can partner with ecommerce platforms like Shopify, Inc., and Block, Inc. to source customers. Many small businesses partner exclusively with some of these entities to set up digital storefronts and retail point-of-sale systems and use their services to track orders and inventories, manage product catalogs, and so on. Banks can use the granular data generated to offer loans and proactively identify imminent cash-flow issues and extend timely financial assistance to tide over the situation.
Building a bank-led ecosystem
Banks can orchestrate their own business ecosystems in this model. A crucial advantage of this model is that the ecosystem revolves around the bank’s offerings rather than the non-financial player’s. This approach has been successfully adopted by challenger banks in the UK to create digital marketplaces through which they offer their own as well as partners’ services to customers.
For example, banks can partner with used-car portals to offer financing options. While product research, discovery, and purchase are managed by the used-car portal, banks can seamlessly integrate into this journey by embedding financing options, thus benefitting from low-cost customer sourcing through real-world transactions. Banks and partners can devise and agree on revenue-sharing models to govern the apportionment of income that each entity earns. Banks can also integrate offers, loan fulfillment, and disbursement options into the used-car purchase journey, link disbursement to the actual handover of the car, and leverage data on used-car dealers to offer financing options, such as dealer floorplan financing.
Re-architecting lending platforms
Embedding lending services into adjacent industries will help banks offer beyond-banking services.
For this, they must re-architect their core lending technology platforms to deliver lending through the as-a-service (lending-as-a-service) model (see Figure 2). The primary need is to transform their platforms to offer real-time services—this must be truly on-demand and not merely an application programming interface (API) layer built on top of a legacy application. These services can be made available to ecosystem partners through banks’ API marketplace, and partners can invoke them to provide their customers with financial services. Similarly, banks can use ecosystem partners’ APIs to embed their services in the end-user journeys. In this way, banks can offer financing journeys independent of the end point, whether it is within the banks’ own channels or the third-party ecosystem partners’ channels.
Figure 2: Re-architecting lending platforms to offer lending-as-a-service
With this architecture in place, banks can co-create customer journeys where lending is not a separate action but is tightly integrated into the overall process or experience. For example, take the case of a small business integrating its bank account into its enterprise resource planning (ERP) platform. As the bank’s systems are interconnected with the customer’s ERP platform, the bank is able to gather data on business operations in real-time and proactively offer financial assistance when required.
Banks that can successfully re-orient themselves to integrate embedded lending options into customer journeys will be in a strong position to counter the imminent onslaught by big technology and fintech companies. To capitalize on this opportunity, incumbents must transform their landscape and offer lending through the as-a-service model and build ecosystems to offer their products through both their own platforms as well as partner ecosystems.