What Is Embedded Finance? And How Identity Powers It

Embedded finance simplifies transactions for users by integrating financial services directly into non-financial platforms. When implemented in the right way, it creates a seamless path in a number of applications, including payments, lending, investments, insurance, and more.

With the right identity access management (IAM) solution in place, companies using embedded finance can mitigate risk and keep their customers' financial information secure while providing seamless and personalized services throughout the process.

Here's everything you need to know about using embedded finance and IAM to attract and retain customers.

Embedded finance maximizes convenience during the user experience while expanding reach beyond an FSI provider's traditional customer cohort. Instead of requiring a customer to manually connect accounts or upload documents, embedded finance can directly integrate their banking or credit information in non-banking platforms via secure, financial-grade APIs.

The demand for embedded finance is growing and is expected to reach $384.8 billion by 2029.  But financial-grade APIs must keep this process safe and secure by serving as the gatekeeper and ensuring IAM best practices across all types of devices. The bottom line is that consumers want simplified financial end-to-end experiences, whether it's applying for financing directly through a retailer or safely storing payment information in an online account. But it's up to the provider to make sure the process is secure and streamlined.

The Evolution of Embedded Finance

Embedded finance has been around for decades, but it's taken on different forms as technology and customer expectations have evolved.

Early integrations

The earliest forms of embedded finance include stored credit card information and online payment gateways. By storing their credit card information on a frequently-visited payment platform, users don't have to leave the site to complete the purchase, ultimately increasing conversion rates.

Rise of FinTech

The emergence of FinTech companies providing advanced embedded finance capabilities has made it easier for non-financial companies to collaborate with financial institutions at scale. Different FinTech platforms specialize in different services, such as card issuing, lending, or transferring money.

API Revolution

Financial APIs have been a cornerstone in today's embedded finance capabilities, particularly in monetization and financial-grade (FAPI) developments. They provide the actual data integration between a financial institution and third-party platforms. Instead of having to invest in one major software, APIs allow customization across multiple microservices that connect with each other.

In the future, blockchain technology and decentralized identity solutions will evolve embedded finance even further.

The growth in mobile and digital payments has been enabled by more complex and secure APIs and identity verification methods in these financial integrations. According to a McKinsey survey, banks use 20% of their APIs with external business partners and that number is expected to double by 2025. Partnerships are a key component of embedded finance, with APIs addressing the needs of businesses in a range of industries, including e-commerce platforms, mobile apps, and more. This is all part of the growing FSI and cross-industry ecosystems that allow new forms of embedded finance to emerge. These increasingly sophisticated capabilities provide the opportunity to seamlessly establish, verify, and even authorize a user's identity.

Regulatory compliance is also important and needs to be delineated when operating an embedded finance API. Regulated financial institutions are responsible for complying with any laws governing the financial service being provided. However, the third-party company using the integration must select their APIs with care to successfully manage their brand reputation.

The Role of Technology in Embedded Finance

Incorporating embedded finance capabilities increases digital transformation for both financial institutions and businesses. Here are some of the top takeaways when utilizing this type of technology:

Better user experience: Enhanced automation saves time for all parties involved – the customer, the platform, the financial institution, and third-party providers (TPPs). Creating a differentiated experience leads to better customer retention and helps decrease abandoned transactions.

Increased revenue: Businesses and financial institutions that incorporate embedded finance technology can gain market share ahead of their competitors. According to Deloitte, more digitally mature companies average 45% revenue growth, compared to just 15% for companies that are not as digitally mature.

Increased security and IAM: Protecting customer data is a priority in embedded finance, particularly as cyber attack tactics become increasingly sophisticated. Incorporating IAM is both proactive and reactive.

Wondering how embedded finance examples look in different industries? This roundup gives a quick overview.

Embedded Payments

Using embedded finance for payments makes it easy for customers to pay for services without having to handle cash or cards. Ridesharing apps like Uber, for instance, have removed the hassle of exchanging cash for a ride and requesting change from a driver.

Similarly, retailers like Amazon and Starbucks offer saved payments so that customers can order online without having to search for a credit card every time they want to make a purchase.

Embedded Lending

Embedded lending simplifies the financing process by offering partnerships between financing companies and retailers. Buy-now-pay-later (BNPL) services like Klarna and AfterPay provide a built-in option to split up payments over time. Installment payments are conveniently advertised on both product and checkout pages.

Today, BNPL transactions are expected to total $334 billion in 2024 and rise to $687 billion by 2029. Embedded lending APIs allow financial institutions to expand their financing offerings to different customer segments while balancing credit-related risk with built-in controls.

Embedded Insurance

Insurance shopping has changed substantially in recent years. It's predicted that by 2030, up to 20% of U.S. auto insurance policies could be purchased through embedded finance — that would total $50 billion in premiums. All types of insurance policies are being integrated into other transactions, rather than being separate transactions. For instance, both auto and homeowners insurance can now be purchased during the loan application process instead of separately going through a traditional insurance agent.

In the travel insurance industry, policies are embedded into reservation platforms. Travelers can purchase relevant policies at the right time; for instance, they can add on customized insurance when booking a rental car or reserving a flight.

Embedded Investments

Embedded investments incorporate investment options into apps and platforms that may traditionally help with everyday financial management. Many banking institutions, for instance, incorporate a "round-up and invest" feature. Purchases are rounded up to the nearest dollar, with the change going into a pre-selected savings or investment account. Acorn is an example of a banking app that incorporates automated investments into its other services.

It's crucial for any financial institution embedding investing platforms to use identity management best practices to comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. A modernized IAM infrastructure provides identity verification across third-party provider ecosystems.

As with any emerging technology, there are both advantages and drawbacks. Understand both to learn how to mitigate the cons while maximizing the benefits.

Benefits of Embedded Finance

There are a number of benefits that come along with using embedded finance both for consumers and businesses themselves:

• Convenience: Customers can complete transactions at relevant stages throughout the purchasing journey.
• Improved user experience: Embedded finance features like stored payments or automated investments make it easy for customers to follow through on their transactions without encountering unnecessary friction in the process.
• Increased financial inclusion: Businesses and financial institutions can reach new audience segments, giving better access to financial services to individuals across income and credit categories.
• Profitability: Embedded finance features provide new revenue streams along with purchasing opportunities for consumers around the clock. It's also a cheaper form of customer acquisition.

Challenges and Risks of Embedded Finance

Successfully using embedded finance features requires substantial planning and effective IAM strategies to overcome challenges and mitigate risk. Here are some considerations:

• Regulatory challenges: The companies and brands utilizing embedded finance don't have experience with regulatory compliance. It's important to have a clear delineation of responsibility among all parties involved in whatever financial service is being provided.
• Data privacy concerns: Companies and financial institutions must have data-sharing agreements in place, while also addressing data handling issues (whether intentional or unintentional).
• Security issues: Similarly, financial data must be protected across multiple platforms to prevent identity theft and cyber-attacks. Not doing so can result in lawsuits and brand reputation issues for all parties involved.

There are many players within the embedded finance industry. Here's how each one plays a role:

Fintech Companies

Fintech companies create APIs and software-as-a-service (Saas) solutions that connect various platforms with financial institutions. These are the companies doing the actual embedding part of "embedded finance."

The major players who have contributed to the growth of embedded finance include:

• Stripe: Provides payment services such as processing credit cards online.
• Plaid: Connects consumer accounts with their bank accounts using a seamless login experience.
• Affirm: This early adopter of BNPL now has over 18 million users and was founded by one of the original PayPal founders.

Traditional Financial Institutions

Traditional banks and financial institutions that embrace embedded finance can create ecosystems consisting of multiple third-party partnerships.

A McKinsey report highlights several embedded finance examples of banks partnering with other brands, such as:

• WebBank and Toast: Merchant cash advances for restaurants based on their card receivables data
• Evolve Bank & Trust and Uber: Debit Mastercards for driver payments and fuel rewards.
• CBW Bank, Uplift, and airlines: BNPL services for flight purchases.

Fintech & Software Firms

Fintech and software firms can help banks and financial institutions increase their technology capabilities more quickly than if a bank had to develop software on its own. From creating white-label mobile banking apps to integrating additional online product offerings and freebies, these tech providers support embedded finance on all levels.

Embedded finance can be facilitated in several ways. Marketplaces and aggregators are becoming more popular, as are non-financial platforms that can now offer financial services.

Marketplaces and Aggregators

Marketplaces and aggregators for financial products like loans and insurance provide multiple purchasing options for consumers to compare. Both business models offer touchpoints for multiple financial services that are embedded into the customer journey.

Non-Financial Platforms

Non-financial platforms like e-commerce sites, retail and travel marketplaces, and social media networks, utilize embedded finance in several ways. Common examples include:

• Stored payments on frequently used retailers
• Rewards programs that offer customers points or cash back
• Onsite financing opportunities, like BNPL options
• Product integrations on social media platforms like Pinterest

Identity Access Management (IAM) is an integral component of embedded finance. There are a number of benefits that come with using IAM in any digital ecosystem.

Identity Verification and Authentication

Robust identity verification and authentication processes are a must when incorporating or launching an embedded finance feature. ExtensibleIAM solutions leverage third-party biometrics, identity verification, and risk management technologies to enable secure and seamless identity proofing as well as continuous risk-based authentication.

Authorization

Having a converged IAM Solution in place helps increase customer confidence to authorize third-party providers to access their credit or financial information. For instance, they may feel uncomfortable logging into their bank account through a non-financial website if they don't trust that the right IAM protocols are in place.

To illustrate the importance of proper authorization, here are three common use cases

1. Financial service providers (FSIs) can grant authorization to trusted third-party providers (TPPs) to access customer data via secure APIs. This is particularly relevant in Open Banking scenarios, where regulatory compliance is essential.
2. Customers can authorize their FSI to share specific data with a TPP. In scenarios involving decentralized identity, users have the flexibility to permit only particular identity attributes to be shared, enhancing privacy and control over their personal information.
3. Customers can also authorize their FSI to share their financial data with general third-party providers. This enables them to receive personalized offers and services, tailored to their financial profile and preferences.

The Importance of IAM in Embedded Finance

Incorporating embedded finance into any business model requires many providers and applications working together. There are three specific use cases for the identity management lifecycle:

• Customers can consent to their data being shared with a TPP to receive embedded finance offers.
• Customers can view and revoke their consent when appropriate.
• Customers can self-service and specify what information is shared with whom and when.

Regulatory Compliance

It's important to keep user data secure and private, especially when collecting and storing financial data. Organizations must have plans in place to prevent data breaches. IAM solutions can help with this by providing consistent authentication experiences across multiple apps and consent and privacy management to stay in line with the latest regulatory requirements. In Europe, the proposed Financial Data Access framework (FIDA), payment services regulation (PSR1), and new payment services directive (PSR3) will be critical in driving growth in embedded finance services.

Enhancing User Experience

To maximize the benefits of CIAM, users need to have a smooth experience. The goal is to improve experience, increase loyalty, and maximize upsell as well as customer lifetime value. For new customer segments, it's about capturing new customers at a sustainable price in a scalable fashion.

Users should experience a seamless journey without feeling like they are navigating multiple platforms or APIs. Personalization is crucial, with providers closely understanding and catering to user needs. CIAM creates a frictionless process for both registering and signing onto different accounts.

Plus, CIAM provides personalized services that focus on the right questions for authentication, rather than overburdening them with too many steps. Ultimately, a positive user experience increases the chances of a user returning to the website.

IAM is a foundational component of embedded finance and enables functionality for streamlining an entire ecosystem of multiple APIs and TPPs. A comprehensive IAM solution is a must-have to gain and retain customer trust while staying compliant with the latest regulations.