An increasingly bright future for embedded finance banks will depend on a growing number of consumers completely ignoring the banks themselves and concentrating on doing business with their favorite brands.
Those institutions that partner with non-bank brands to become the financial engine behind their websites and mobile sales — and even at the physical point of sale — will enjoy increasing success, albeit anonymously.
The number of traditional institutions and fintechs that will step in and win with this strategy will increase, but it will still be a small part of the industry – probably around 300 companies, all together, sharing $25 billion in annual revenue. Financial players and the brands they partner with could enjoy a “flywheel effect” — ie. the momentum of their arrangements will increase business for both. This is to remove the friction of mixing purchases and payments. Consumers will focus on what they buy and use, not how to pay for it or finance it.
These conclusions come from the Embedded Finance Flywheel study Cornerstone Advisors completed for Bond, “The Embedded Finance Flywheel”. The consulting firm’s Ron Shevlin, principal investigator, notes in the report that in some ways the basic idea of embedded finance is not a new concept at all. Indirect auto financing relied on a structure where the dealer was in the foreground for both sales and finance, and the bank was in the background.
Built-in finance builds on such long-standing practice. The report defines the term as follows: “Integrating financial services into non-financial companies’ websites, mobile applications and business processes.”
The goal of the study was to survey consumers to determine the degree of acceptance of embedded finance versus the preference to keep things separate.
To some extent, the use of mobile apps by retailers, most notably Starbucks, shows that many consumers are willing to cross the line between banking and commerce.
Embedded financing has the potential to expand to many more brands as larger retailers and other sellers try it out, says Roy Ng, co-founder and CEO of Bond. Indeed, research by Accenture found that nearly half of the companies surveyed planned to launch embedded financial offerings. A key element, Ng continues in an interview with A financial brandis trust in the non-banking retailer’s brand, since the embedded financial brand is essentially invisible.
What sets the future of embedded finance apart from the past is that creating a meaningful business out of it depends on moving past fundamentals that have become table stakes, says Ng.
Embedded finance requires expansion:
You can squeeze so much from exchange fees alone. Switching to embedded loans is one way that income can be increased.
Consumers’ favorite brands and their potential for embedded partnerships
“The potential value of embedded finance rests on a very important assumption – that consumers will get financial products from their favorite brands if the brands offer them,” the report said. “Interestingly, despite all the fuss about embedded finance, this assumption has gone largely unexamined.”
The first part of the research looked at how deep consumers go with their premium brands.
Cornerstone researched people’s favorite brands by company, finding that Amazon is the top retailer for 44% of consumers, with Walmart second at 21% and Target third at 12%. The study also asked questions about pharmacy preferences. CVS led the way with 25%, followed by Walgreens with 23%, Walmart with 12% and Amazon with 10%.
The study also asked about favorite spending categories and the brands that dominate them:
- Technology/Electronics: 58%, Samsung, Amazon
- Home decoration: 42%, Lowes, Home Depot, Ace Hardware
- Gaming/Consoles: 39%, PlayStation, Nintendo, Xbox
- Fashion/Luxury Goods: 34%, Coach, Chanel, Gucci
- Home Fitness: 25%, Fitbit, Peloton
- car industry: 19%, Ford, Chevy
Going beyond the data, the potential for embedded relationships clearly exists for a handful of competitors in each space in some cases. Ng points out that different lenders have different risk appetites and different focuses on consumer loan layers. Over time, more financial institutions could fit into the retail sales funnel, he suggests, with the retailer seamlessly routing the customer to the appropriate lender. All of this would happen in the background of the purchase.
A striking part of the study looked at how often consumers interact with brands in the six product areas listed earlier.
As this table shows, in the three categories more than half of the people surveyed communicate daily with companies in the gaming/console, home fitness and technology/electronics industries. This suggests a potentially huge flow of credit and payment volume for banks and fintechs that can gain the coveted position of being an embedded brand finance provider.
How often consumers interact with companies in their favorite categories
Source: Cornerstone Advisors
Why consumers will — and won’t — accept non-bank financial products
The use of embedded financing is already in motion, so there is some experience to explore. 35% of consumers have already used embedded financial services from technology/electronics retailers, for example, most often in the form of a credit card or extended warranty.
Given that the embedded relationship must pay off for both the non-banking brand and the financial provider, Cornerstone also asked consumers what impact embedded financing has on their relationship with non-banking brands. This produced a nuanced image. While nearly a third of those surveyed said they were spending more money at dealers that offered built-in financing, for example, a nearly identical number of people said nothing had changed.
Although spending more money at retailers is only listed a third of the time, focusing on that alone ignores other important results seen in the chart. Choosing a reseller over the competition also means more sales (and volume for the embedded provider) and increased loyalty, and referrals can also go a long way.
The study then looked at willingness and unwillingness to use financial services provided through non-bank vendors.
The strongest argument seen among those who would use financial products comes down to price – four out of five assumed that getting a financial product from a retailer would be cheaper. This may be influenced by consumer perception of the way most buy now and pay-later programs have worked in the past — the seller is seen as making a BNPL offer on behalf of the provider and there is no interest.
However, there are obstacles in moving forward with an embedded financial model. As seen below, 77% of consumers said they would not trust financial products obtained from non-banks. It may be that the invisibility of a bank or fintech in the mix may be a handicap in some segments.
Incentives and innovation can help move those needles. The study provides a long list of variations on product themes. Among those that caught people’s interest, with the percentage indicating attraction:
- Credit card that rewarded players for game purchases and in-game purchases: 75%
- In-game deposit account (real money) used to buy and sell in-game items and to store real game progress rewards: 74%
- Health insurance with rates tied to personal fitness habits: 68%
- Investment account integrated into apps for fashion and luxury brands to invest in stocks, cryptocurrencies and other brand assets: 65%
- A savings account that sets aside extra money for a future car purchase, other than current car payments: 52%
- Home equity line of credit built into home improvement stores’ own apps to handle payments for large projects: 49%
Adjustments that financial providers must make
Ng points out that embedded finance efforts rely on a balancing act between the seller and the finance company. The non-bank controls the user experience in this case, not the financial player, but the latter, as a financial service provider, controls what that service will be and how flexible it will be. Perceptions are also important. If a person thinks they are using a home loan from their favorite home center, for example, suddenly a bank or fintech logo appears will be a negative, unpleasant experience.
The move to embedded finance also requires some changes in mindset for the bank or fintech to fade into the background. The question of “who owns the customer” is a factor when the provider is used to a direct relationship. Ng says it’s helpful for banks and credit unions to view embedded financing as an additional channel for getting products to potential customers, something that’s separate from their traditional channels rather than a parallel path.
In addition, technology must be adapted from a direct relationship to an arm’s length approach. A large investment is required to ensure that data is exchanged accurately and in a compliant manner, explains Ng.