Embedded finance is the new norm in payments and banking. A new ecosystem-based innovation, embedded finance integrates financial services traditionally obtained via a bank directly into non-financial mobile applications, and business processes to offer fluid and superior experiences to customers. Think of an e-commerce marketplace store offering real-time, sachet-based credit products in the form of Buy Now Pay Later, aimed at breaking down bulk cash outflows into low-cost EMIs to shoppers at the point of purchase, or a ride-hailing service enabling customers to buy travel insurance products whilst booking a ride to the airport.
Much of the early excitement surrounding embedded finance has been around the extent to which its development will enable Techfins (e.g. Facebook, Apple, Amazon, and Google) to enter markets. Embedded finance has tremendous potential in the business-to-business payments space as much as consumer payments and banking space. It can streamline financial processes for mid-market businesses by lowering barriers to entry for various products and services. Many mid-market enterprises operate in an environment of irregular cash flows and limited cash liquidity. For many, navigating the financial landscape and finding the right financial support to address working capital gaps is difficult and time-consuming.
The challenges
Traditional financial institutions are oriented towards larger businesses, discounting the needs of mid-level enterprises for efficiently managing cash flows. For example, the 63 million small and medium businesses (SMBs) in India form the backbone of the country’s economy. But they face a significant credit gap, and a mere 16 per cent of MSMEs have access to formal credit. According to an IFC report, Indian SMEs’ share of credit is a minuscule 6-7 per cent and the total credit gap is close to US$1.1 trillion. Long processing times, lack of transparency in timelines, and insufficient loan sizes remain substantive pain points, compelling many MSMEs to continue to seek informal sources, often at significantly higher interest rates.
Why embedded finance?
Against the current backdrop, the rise of embedded finance can address and smoothen liquidity gaps. Previously, a business buyer may have spent hours on cumbersome paperwork to access trade credit. Embedded finance makes these services integral to day-to-day business activities. Companies are aiming to solve the biggest pain point for their target market, liquidity, and cash flow management, by incorporating payments and credit into their business payables automation platform. Let’s say a restaurant needs to purchase new kitchen equipment. Rather than waiting for weeks for the bank to process a loan, the restaurant can access embedded credit services to initiate and make payments toward the purchase.
Trends Influencing Growth
The convergence of several factors is influencing the growth of embedded finance in business supply chains. Beginning with an accelerated digitalisation momentum combined with several powerful government and regulatory policy initiatives and the rise of banking as a service.
Accelerated Digitalisation: In the post-Covid era, swift digital transformation for increasing operational and business agility is vital. Several industry studies indicate that the adoption of digital technologies by businesses has sped up by 3-7 years. Companies are making technology investments across the enterprise and embracing digitalisation across various dimensions – refocusing efforts from predominant customer-facing experiences to core business processes and workflows including supply-chain interactions.
Favourable Regulatory Environment: Policy initiatives by the government and the central regulator to reduce access barriers and grow the share of formalised credit has provided a strong innovation impetus. Compared to large corporations, a major obstacle that SMEs come across is the shortage of credit data, which prevents them from accessing traditional credit facilities through banks and other lenders. The Central banking regulator through initiatives such as Trade Receivables Discounting System (TREDS) ecosystem, is encouraging lenders to adopt cash-flow-based lending instead of balance sheet-based credit.
Over the last few years, many Fintechs have stepped up to make financial services more accessible to enterprises underserved by incumbent financial institutions. This current state of data inequality is gradually being negated via the identification of new ways to evaluate SMEs’ creditworthiness, which includes using alternative data. The digitisation of the economy, growing use of digital payments, and introduction of GST have made available new data sources including GST returns, bank statements, cash flow transactions, and invoicing information to determine the line of credit a business should receive. Other factors that are used to calculate the borrowers’ potential include data from social networks, cell phone records, and psychometrics.
Rise of Banking as a Service – The financial services market is inexorably moving towards a model which is more open, transparent, and interlinked. Growing global adoption of open banking initiatives and the emergence of banking as a service (BaaS) are major enablers for embedded finance services. Today, financial institutions are increasingly offering BaaS, enabling nonbank companies to access their services, typically using APIs. For financial institutions, BaaS offers a cost-efficient mechanism to enter new markets and capture new revenue growth.
Benefits of Embedded Finance
Embedded finance is a method of using APIs and BaaS to create financial services that are built into other non-financial products. With embedded finance, banking services have implanted digital platforms which SMEs use to run their day-to-day business. Embedding payments into native business flows such as payables is a time-and-cost saving measure that offers several benefits to high-velocity growth enterprises. Leveraging transactional and other data, enterprises can gain immediate access to secured or non-secured credit which helps proactively manage working capital needs, make timely payments, and maximise cooperation with suppliers.
With embedded commercial card offerings, businesses have the flexibility to reduce the cost of payments. Embedded card offerings, for instance, can be backed by a fixed deposit that enables enterprises to earn interest rates on deposits and avail of cashbacks and credit
Embedded finance is at an early stage but B2B enablement in the embedded finance sector will see significant growth area over the next 12-24 months, with the potential to revolutionise credit access for enterprises.
(The author is Mr. Avinash Ramesh Godkhindi, Managing Director and CEO, Zaggle and the views expressed in this article are his own)
