Embedded Finance provides an alternative infrastructure for capital to flow from those wishing to deploy it for a risk-adjusted return (the capital markets) to consumers and small businesses accessing it in the form of financial services products within the digital economy.
Here we explore the evolution of embedded finance, the benefits thereof across the value chain and detail how technology is helping both financial services companies and digital applications to capitalise on this shift.
Financial services today
The enterprise value of financial services today surpasses $22.5 trillion. Despite the colossal size and scale, the industry is hamstrung by low profitability, manifested in an average Return on Equity (ROE) of 0.28%. This low ROE can be attributed to friction in the system underpinning the sector, resulting from:
- Inefficient legacy technology and disjoint systems
- A slow move away from traditional analogue distribution channels
- Archaic, outdated products and propositions
The digital economy
Meanwhile the digital economy is growing exponentially and is expected to reach $23 trillion – the same size as the entire financial system today – by 2025, at which point it will represent 25% of the overall global economy.
This growing digital ecosystem presents an opportunity to fundamentally change the underlying financial services business model for the better with:
- No dependencies on legacy technology and infrastructure
- Access to huge numbers of self-serving digital users
- An abundance of open data to power needs based propositions
As the economy transitions, huge numbers of consumers and small businesses – collectively referred to here as end users – are digitising their operations and in the process, depositing vast quantities of data with every interaction. A typical digitally enlightened end user will divide their usage between fintech, horizontal and vertical SaaS platforms – collectively digital applications – depending on the nature of their lifestyle or business.
For example, a boutique hotel might have a business bank account with Revolut Business (Fintech), manage their financial accounts using Sage (Horizontal SaaS) and manage their day to day hotel operations using Cloudbeds (Vertical SaaS).
Image 1 - Example hotel operational tech stack
Scaling challenges for digital businesses
While digital applications represent some of today’s most notable businesses – think Shopify, Meta, Stripe to name a few – the digital business model presents common scale challenges for growth and ultimately profitability for many:
- Customer acquisition is expensive, competitive and capital intensive
- Propositions consolidate and converge at scale resulting in limited differentiation
- Growth in revenues and margins is not fast enough to sustain heady enterprise valuations
We are seeing these scale challenges appear now in stock prices which have fallen significantly with the onset of high inflation resulting from overly loose monetary policy, exaggerated by negative externalities and supply chain woes.
Despite growing pains for scale digital businesses, the digital economy provides an immense opportunity to solve long standing market failures synonymous with financial services today.
Payments for example, are now in app and instantaneous and have already transformed digital marketplace profitability, where subscription business models which have been constrained by user growth are being bolstered with additional revenue streams.
Shopify, the digital ecommerce platform with a subscription based business model for example, successfully diversified it’s revenue by embedding payments services which have become a significant value driver. Payments however, are just the beginning.
Embedded finance – The next frontier
Embedded Finance, referring to the practice of non-financial digital companies embedding financial services products such as credit or insurance in order to enhance or transform their core value proposition is the next frontier. This is not simply distribution through embedded delivery but fundamentally enhancing the financial services product experience for the the end user.
Companies embracing Embedded Finance are leading a step change in in the evolution of financial services for the digital economy. The advent of which has seen financial services products be made available seamlessly to integrate within digital applications, marketplaces and other channels.
New value creation in monetary terms alone has been estimated at over $3.5 trillion, while the consequential benefits are threefold across the value chain with increased utility for capital providers, digital distribution platforms and most importantly for the end user (see Table 1).
Table 1 - The value chain benefits of Embedded Finance
Unlike Fintech 1.0 – which saw the digitisation of incumbent financial services products – Embedded Finance is fundamentally changing the way that financial services products are designed, built, bought and sold.
Example - The boutique hotel
Consider the example of the boutique hotel, they could (and should) be able to access working capital finance in all areas of their existing digital ecosystem:
Via their business bank account (Revolut):
- A neo-bank data asset, including KYC/AML/ID verification and transaction record should provide a detailed foundation for automated risk assessment.
- Given unlevered balance sheet, digital data asset and the nature of the banking product, there should exist a seamless opportunity to provide an overdraft and/or a business loan offering.
Via their accounting package (Sage):
- An accounting package data asset, including historical management accounts and invoice repayment behaviour, again should provide a solid foundation for automated risk assessment and ongoing monitoring.
- Invoice management functionality provides a seamless entry point for the provision of an invoice finance product as well as a trade credit insurance to insure receivables.
Via their hotel management platform (Cloudbeds):
- A hotel management platform data asset, including historical booking information, occupancy ratios and other industry wide benchmarks provide an alternative data asset for innovative risk assessment approaches and again, automation.
- Payment terminal provision and online payment gateway services provide a seamless entry point for a merchant cash advance product.
- The hotel management dashboard and supporting data could be used to power an adaptive hotel insurance proposition including flexible public liability, employers liability and buildings products to name a few.
Simultaneously, capital providers will benefit from open access to alternative digital distribution channels, increased profitability through improved risk assessment (given differentiated data assets and real time monitoring) and a low cost, scalable operational infrastructure.
Despite the above, the boutique hotel in today’s market is forced to leave this digital ecosystem — taking with them their data in a non-standardised, low security format — and apply for a traditional product, either from a bank or an alternative capital provider.
Certua – The Embedded Finance platform
Certua are the Embedded Finance platform connecting the capital markets to the digital economy, helping all stakeholders to realise the benefits of Embedded Finance and in the process, resolve some of financial services longstanding market failures.
We have a history of innovation and are the UK’s first embedded finance platform to power both insurance and credit propositions having invested heavily in R&D, working with established design partners to develop our platform.
We are helping to power transformative propositions addressing systemic issues in the most inefficient markets in Financial Services, partnering with both traditional financial services institutions and digital applications to build the next generation of embedded financial services propositions using our infrastructure.
Image 2 - The Certua Embedded Finance Platform
 Financial Services Global Market Report 2021: link
 Return on Equity by sector (US): link
 Digital Spill over: Measuring the true impact of the digital economy, Huawei, Oxford Economics: link
 Shopify full year 2021 results: link
 Matt Harris, Bain Capital Ventures: link