Embedded economy: navigating the challenges

Ushered in by open banking and encouraged by evolving customer behavior amid the pandemic, embedded finance is a burgeoning trend in the fintech world.

As embedded finance evolves, it will likely lead to 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 for the distribution of financial services and new opportunities for ambitious companies to influence and improve the financial lives of their customers.

Creating a financial product is a serious task that requires a significant investment of time and resources. This is especially true for brands that do not have much previous experience in the fintech arena. They must first tackle 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 all levels, both to strengthen consumer confidence and avoid penalties.

Responsibility for this compliance ultimately rests with the providers, although there should be cooperation and transparency between financial institutions and regulators to help providers 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 key to embedded finance. While these have evolved and matured to allow embedded finance to become viable, this is not yet the case for all markets – meaning that embedded finance’s outlook is not yet universally strong.

It is often said that 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 And this has certainly been the case with open banking and APIs, with many still using outdated technology structures to underpin e-commerce and international payments.

There is also a question mark regarding their thinking. Embedded finance requires a different way of thinking, and for banks that 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 already see the successes of neobanks such as Starling and Monzo in the international payments space. The continued reluctance of the major incumbents to fully open up their technical capabilities in the spirit of open banking poses a challenge to the growth of embedded finance.

Nimble fintechs, meanwhile, are more willing and able to build out APIs at rapid speed, allowing embedded offerings to sit beneath front-end interfaces. Brands looking to leverage embedded financial services can instead look to partner with these specialist providers to ensure they receive the necessary training and support to enable the product to serve both their business and their customers well.

Data quality, privacy and fraud protection

When considering the functional challenges of embedded economics, optimized APIs alone are not enough – they need data of sufficient quality and scope. For example, filling in a long application form for a financial product in advance can increase the user journey considerably, but not if the available data is insufficient for the provider to make an accurate assessment of creditworthiness. As the incumbent banks still have a wealth of data, it is hoped that they will further buy into the concept of embedded finance.

An important factor in the success and acceptance of applications for embedded finance will be data protection provisions and measures to reduce the risk of fraud. As cybercriminals seek new opportunities, Juniper Research has predicted that online payment fraud will reach $206 billion by 2025, which is ten times the net income of Amazon.

Consumers need to be confident that their financial data is fully protected and secure. Given the power of APIs to transmit large amounts of complex data, new services and methods of customer acquisition must be balanced with a focus on user experience, giving the consumer control over data usage.

By following proper risk mitigation protocols and certifications, such as ISO 27001, providers can offer consumers a level of comfort in the knowledge that their personal information is protected to the same standard as in banks. This is why it is important that embedded finance providers seek partnerships with trusted and regulated embedded finance hosts.

As embedded finance develops, it is likely to lead to new regulations and the expansion of existing ones, such as anti-money laundering regulations such as the Bank Secrecy Act (BSA). In addition, future fraud prevention solutions will be based on machine learning on a large scale. A recent report from the Economist Intelligence Unit has highlighted this shift towards an AI-enabled fraud prevention landscape, saying that banks and insurance companies will see an 86% increase in AI-related technology by 2025.