In the rapidly evolving world of finance, two concepts are making a significant impact: open banking and embedded finance. Open banking, a system that allows third-party developers access to financial data, has been transforming how consumers manage their finances. Embedded finance, a model that integrates financial services directly into non-financial platforms, is also redefining the very concept of banking and making purchases easier for customers.
What is embedded finance?
Embedded finance is the integration of financial products and services into non-financial platforms, such as ecommerce sites, social media platforms, or even ride-sharing apps.
Instead of visiting a traditional bank branch or using a standalone banking app to access financial services, users can now do so seamlessly through the platforms they already use on a daily basis.
This model eliminates the need for customers to switch between different apps or websites when conducting financial transactions, making it more convenient and user-friendly.
What is open banking?
Open banking, on the other hand, involves sharing financial data between banks and third-party providers through open APIs (Application Programming Interfaces). This allows users to securely share their financial information with authorized third parties, enabling them to access a wider range of services and products.
Open banking aims to increase competition in the financial industry by promoting collaboration between different players and providing consumers with more choices and better services.
Embedded finance vs. open banking
While both open banking and embedded financial solutions leverage APIs for integrating financial services, their applications differ.
Open banking primarily facilitates the sharing of user data between banks and third-party providers, thus broadening the range of financial services and products accessible to the consumer.
Embedded finance, however, integrates financial services directly into non-financial platforms, allowing users to conduct financial transactions within the platforms they are already using, thereby enhancing user experience and convenience.
Banking as a Service (BaaS) is also growing in popularity. BaaS is a model where banks provide their banking capabilities like payments, checking and savings accounts, cards, etc., as services to other businesses through APIs. BaaS can be seen as a facilitator or backbone for both open banking and embedded finance, providing the necessary infrastructure and regulatory compliance.
Some differences between embedded financial services and open banking include:
- Scope: Embedded finance goes beyond just sharing data; it involves the integration of full financial services into non-financial platforms. On the other hand, open banking mainly focuses on sharing financial data through APIs.
- Customer experience: With embedded finance, customers can access financial services without needing to switch between different platforms or apps. However, open banking still requires users to use separate apps or websites for different financial services.
- Market potential: While both embedded finance and open banking have the potential to transform the financial industry, embedded finance has a wider market potential due to its ability to reach customers through non-financial platforms. This makes it more accessible and convenient for customers who are not traditional banking users.
- User interaction: In open banking, users may need to interact with multiple platforms and applications to access various financial services, whereas in embedded finance, users access all financial services within one platform they are already using.
- Integration depth: Open banking shares financial data between entities and provides a gateway for third-party services, whereas embedded finance integrates financial services into the core functionality of non-financial platforms.
- Access and reach: Open banking largely depends on users who already have a banking relationship, while embedded finance can cater to a broader audience, reaching users on platforms where they already spend time, even if they are not traditional banking customers.
- Customer experience: The customer experience in embedded finance is seamless and does not require switching between platforms, making it more convenient and user-friendly. In contrast, open banking can still involve switching between different apps and websites for different financial services.
- Regulatory compliance: Open banking is heavily regulated, requiring strict adherence to data privacy laws, while embedded finance is not as heavily regulated, primarily because it does not involve sharing sensitive banking data.
- Business model: Open banking is collaborative, wherein banks and third-party providers work together to offer services. Embedded finance, on the other hand, is more about non-financial platforms offering financial services in addition to their core offerings.
Challenges and opportunities for embedded finance
While embedded finance presents exciting opportunities for financial institutions, it also poses several challenges.
One of the main concerns is data privacy and security, as financial information will be shared through non-banking platforms. There may also be regulatory barriers and technological complexities to overcome in order to fully implement embedded finance.
However, the potential benefits of embedded finance, such as increased customer reach and engagement, make it a highly attractive model for financial institutions to explore.
Factors for banks to consider when choosing
While open banking and embedded finance may seem similar on the surface, they have distinct differences in their approach and impact on the industry. Embedded finance has the potential to revolutionize how consumers access financial services. Before choosing which is right for your financial institution, consider the following:
- Customer preferences and behavior: Banks need to understand their customer's preferences and behavior. Are they more comfortable using their existing banking apps or are they open to accessing financial services through non-banking platforms?
- Regulatory compliance: Depending on the region, compliance with regulatory requirements can be a significant factor. Banks need to understand the regulatory landscape for both open banking and embedded finance.
- Data security and privacy: Both models involve sharing sensitive financial data. Banks need to consider the potential risks and ensure that they have robust security measures in place.
- Technological readiness: The implementation of either model requires a significant technological investment. Banks need to assess their current tech stack and determine whether they are capable of supporting the required integrations.
- Strategic objectives: Lastly, banks need to consider their strategic objectives. Are they looking to expand their customer base, improve customer experience, or perhaps diversify their range of services? The choice between open banking and embedded finance should align with these objectives.
Future trends and predictions
Embedded finance is a relatively new concept, and its full potential is yet to be realized. However, experts predict that it will continue to gain traction and have a significant impact on the financial industry in the coming years.
Some of the future trends and predictions for embedded finance include:
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Increased collaboration:
As embedded finance becomes more prevalent, we can expect to see increased collaborations between traditional banks and non-financial platforms. This will not only benefit customers by providing a wider range of services but also allow financial institutions to tap into new customer segments.
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Expansion into new industries:
Embedded finance has the potential to expand beyond traditional banking services and enter new industries, such as healthcare, retail, and transportation. This could open up new revenue streams for financial institutions and traditional banks by offering more B2B solutions.
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Personalization and customization:
With embedded finance, banks can leverage data from non-banking platforms to provide personalized and tailored financial services for their customers. This will not only improve customer experience but also increase customer retention.
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The rise of API-based banking:
As embedded finance relies heavily on APIs for integration, we can expect to see a rise in the popularity and adoption of API-based banking in the future. This will enable financial institutions to offer more seamless and efficient services.
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Increased competition:
With embedded finance, traditional banks are no longer the sole providers of financial services. This will lead to increased competition as non-banking platforms enter the market, driving innovation and improving service offerings for customers.
Modernize your payments technology with Episode Six
At E6, we utilize a progressive modernization approach, allowing banks and financial institutions to improve their systems incrementally, rather than overhauling the entire system at once. This method is particularly beneficial for embedding finance, as it reduces the risks associated with drastic changes and allows for ongoing improvements based on customer feedback and evolving market needs. Banks can start by modernizing key areas where customer interactions are most frequent, such as payments or lending. Contact us today to expand your offerings.