Why has Embedded Finance reached a tipping point?

Lars Markull
Lars Markull

After a week of vacation, I'm back with a new Embedded Finance Guide post, and this week I'd like to discuss timing. As they say, timing is everything. Especially when it comes to a new idea or concept. Too soon is just as bad as too late. However, with the right timing, magical things can happen.

I believe we have reached a tipping point in terms of Embedded Finance. You may wonder why now. Fintech has clearly been happening for at ten years, so why is it now? Why wasn't this done five years ago?

I see three reasons why the timing for Embedded Finance might be ideal:

Customer readiness

Simply put, customers are now willing to buy financial products from non-financial companies. What does this imply? Embedded Finance, as we know it today, does not involve the creation of entirely new financial products, but rather the distribution of existing financial products (such as cards or loans) through new channels. These new channels are companies that have never offered financial products to their customers before and they must persuade them that they are the right party to do so.

Customers have been exposed to a variety of new financial offerings over the last ten years, allowing them to learn, test, and trust such new providers. Almost everyone that Embedded Finance solutions are targeting has probably signed up for a neobank (e.g. Revolut, N26, Monzo), a mobile trading service (e.g. Trade Republic, FreeTrade), or a Personal Finance Management solution (Emma, Finanzguru). Although not everyone shifted all of their financial activities to such providers, they did learn about the advantages and disadvantages of such services and educated themselves on who they could trust.

Customers can experience a similar digital offering with Embedded Finance, but from a brand they already know and use for non-financial activities. Perhaps some customers would have been open to Embedded Finance solutions prior to the rise of Fintech, but I believe many more customers are now open to it thanks to Fintech.

Acquisition channels

The past ten years' of FinTech development not only educated customers about new financial offerings (see previous point), but it also allowed non-financial companies to follow the various trends the industry was experiencing and wait for the right time to enter the game.

Let me walk you through how I personally see the development in Fintech in the last years and describe how this is all leading to Embedded Finance:

a) First Fintech Wave started around 2012

In this wave, startups focused on specific financial products and provided a digital solution for them (bank account, trading etc). Some of them were successful in some ways, but many were not, and the main challenge was usually convincing customers to sign up for their new service. Yes, the offering of the new Fintech companies was often superior to previous solutions, but a (bit) better product is often not enough to win more customers. Especially, when the targeted customer has a solution in place already. This solution might not work perfectly but if it does the job somehow, then the customer might stick with it because switching costs are too high (not just financially). In an interview, Shreyas Doshi describes this quite well (source; jump to 0:52min for the specific part).

b) Second Fintech Wave started around 2016

The second wave describes the period when startups and banks began collaborating in various ways. For both sides, this was the logical next step: startups were struggling to gain traction for their service, and banks were struggling to build great digital products. Brining both parties together and focusing on what each side does best appeared to be a winning strategy: the startup is building digital customer experiences or using new technology to provide better customer benefits, and the bank is offering this product to their existing customer base. And while there were some projects that benefited both parties (e.g. Scalable Capital and ING in Germany), the overall impact of Fintech and bank collaborations was rather limited. Collaborations between startups and banks frequently fail because startups wanted to move "too fast" and banks took "too long" (typically banks were not sure how working with startups will impact their overall business activities and what it will mean when they "give up" certain areas that would like to own themselves). The third wave is the logical next step.

c) Third Fintech Wave started around 2019

This is the Embedded Finance wave, which builds on the previous two. An Embedded Finance solution typically involves two types of players: the non-financial company that provides the service (which was the bank in the second wave) and the B2B company that provides the financial infrastructure and licences required for the relevant service. Each party can focus on their strengths in this setup (similar to the second wave), but the relationship is different. It is not a partnership or a joint venture, but rather a supplier-customer relationship with distinct goals and incentives for each party. Furthermore, each side knows exactly what they are good at and is focusing on it. The strategic issue that banks faced during the second wave is no longer present. This lays the groundwork for future successful Embedded Finance products.

While each wave had its successes, we are now in the Embedded Finance wave because the previous two did not have the massive impact that they could have.

Infrastructure providers

Because we have providers in place who can meet the needs of non-financial companies, embedded finance is a reality today. Traditional Banking-as-a-Service (BaaS) providers have laid a lot of the groundwork for Embedded Finance and power a variety of Embedded Finance solutions. However, when you look at the various areas where Embedded Finance is currently evolving (and understand how traditional BaaS works), you will notice that traditional BaaS will be unable to meet all of the needs of the new players entering the market. The majority of BaaS providers were founded at a time when there was only one type of company to which they could sell their services: Fintech startups.As a result, their product offering is very well tailored to this customer segment and may not be suitable for everyone.

Around 2018/19, the first infrastructure providers who wanted to exclusively focus on the needs of non-financial companies offering financial products were founded, and they cr eated an extremely relevant offering for their target customers. In a separate blog post, I will discuss traditional BaaS vs. new infrastructure providers, but the most significant difference between the two providers is the financial investment required to build an Embedded Finance solution. With the new infrastructure providers in place, Embedded Finance is now accessible to almost any company, which is one of the reasons I am so optimistic about the space.

With all three elements coming together, I believe that these are the final days for Embedded Finance. Many new Embedded Finance solutions are being launched around the world, and I am curious to see how quickly each of them can gain market share.

Obviously, I am long Embedded Finance and see a market shift. However, I am aware that Embedded Finance may not be a simple, quick, and easy win in every industry. As a result, in the next week, I'll take a closer look at the factors that could harm Embedded Finance. Subscribe to my updates to receive each post in your inbox.


Lars Markull Twitter

Lars launched Embedded Finance Review in December 2022. He is an independent Embedded Finance advisor and Fintech investor.