How Embedded Finance Actually Works
by Roger Vincent, Managing Director (UK&I) at Trade Ledger®
One of the major revelations the pandemic provoked was the sharp realization that our world is more deeply interconnected than it seemed. Over the last few months, we all saw the butterfly effect in action, its effects rippling in predictable and unexpected ways.
Zooming in on business lending, we can see how this emphasis on interdependence highlights the massive, untapped opportunity of embedded finance and collaboration in our financial & supply chain ecosystems.
In the fiercely competitive world of finance, the current transformation is particularly impactful. In the pre-pandemic paradigm, silos were a survival tactic, customers knocked on credit providers’ doors, and digital transformation was an elective, unhurried project.
Mirroring the medical situation, the current context in lending requires credit providers to work together to close the £1.2 trillion SME funding gap.
The only way to effectively move forward so everyone can benefit is through collaboration.
Flipping the iceberg
Rocked by 5 fundamental shifts, the current business lending landscape requires a reverse in logic.
Progress, survival, growth – they all hinge on financial actors’ ability to override their deep-seated tendency to keep their know-how, resources, and expertise solely to themselves.
To flip and reap the rewards intelligent lending ecosystems provide, they must be ready to incorporate new ways of doing business. Simply replicating winning formulas from the past just won’t do in the Open Finance era.
Business lending – the status-quo
Pre-pandemic, SME lending was mostly:
- Supply-driven, with financial product teams pushing lending products onto the customers
- Company-centric, with an overpowering focus on the company’s needs and revenue goals
- Standardized, to make the low value/high volume ratio economically viable
- Electronified, but not digitized, a world of PDFs, not APIs
- Slow, with an average application processing extending over 90 days.
Business financing could afford to be all those things before. However, a series of fundamentals have changed since that make this manner of operating a losing strategy for the future.
This was painfully obvious for lenders during lockdown, when loan origination & risk monitoring overload brought the industry to a halt. These are not growing pains. They’re cracks in the edifice.
Just as importantly, there’s more than one way SMEs can cover their funding needs.
New “kids” on the block
It’s not just traditional lenders that must become leaner by adopting technology that streamlines their process. New actors are joining the arena by integrating lending capabilities into their different, complementary products.
These new financial players don’t provide capital as their core business but they do hold valuable information about SMEs’ commercial posture – a key factor in loan decisions.
What’s more, they’re digitally native companies, so they can easily integrate new technology that enables them to diversify their offering – and tailor it to their customers.
For example, picture this and compare it to the sheer human effort required to tackle the deluge of SME loan applications over the past few months. This is a huge cost for incumbents but not for organizations looking to add lending-as-a-service to their offering.
In this context, we see key fintechs coming together and actually providing a strong offering that assembles their best capabilities. It’s even easier for them to do this when working off a shared platform, such as Trade Ledger®.
In this intelligent lending ecosystem, collaboration is a superpower.
It enables actors to:
- Share information securely for a global perception of the customer
- Develop lending capabilities as a new revenue stream
- Attract and capture an inflow of new customers
- Build the ability to cross-sell complementary financial products
- Engage with the audience straight away by leveraging existing relationships with ecosystem members.
Technology sits at the core of this new dynamic. Having an end-to-end, automated, fully configurable lending platform is the winners’ strategic lever.
What new financial service providers can achieve together far outweighs their individual growth opportunities. They don’t have to make business lending their core service to successfully sell it. They just need the right partners and tech.
In this ecosystem, tech supports them to achieve more stability while also delivering better outcomes for customers.
And here’s a reality that may surprise some credit providers: SMEs aren’t necessarily price sensitive. Since they just don’t have the resources to shop around (and get turned down over and over), borrowers may actually pay more for a faster decision with a higher approval potential.
Plus, SMEs shouldn’t need to have these in-house resources to deal with complex loan offerings. The best use of their resources is being out there, manufacturing, developing, selling.
Faster, better, more profitable loans – for everyone
Collaboration underpins other possibilities as well.
For example, SMEs can ultimately access short-term funding more easily. These borrowers can finally stop shouldering the opportunity costs of business opportunities they frequently lose because of insufficient capital.
These new customer-centric competitors increase SMEs expectations and enable them to stop being price-takers. For the first time, SMEs can get personalized loan offers that match their present needs (not those they’ll have in 3 months), at a price tailored to their capacity.
That’s why, for this borrower segment, faster decisions are more important than loan prices. What they want is not chiefly cheaper loans, but more transparent loan pricing and a quicker, more accurate decision.
Our platform facilitates all this – at scale.
It also enables lenders to do automated, risk-reducing loan monitoring. Automatically triggered alerts give the lender the ability to proactively intervene when a borrower’s situation deteriorates. It gives them the chance to guide the borrower out of their predicament, reducing the risk of them defaulting on the loan.
Data-driven lending is a catalyst for positive change in finance and well beyond.
Examples of Embedded Finance
Needless to say, the best examples of embedded finance are already thriving in the retail banking sector through ‘buy now, pay later’ schemes aimed at financing consumer goods at digital point of sale.
In the commercial & corporate banking sector where our platform technology is gradually being adopted by mainstream banks and lenders, things are a little slower, but the speed of innovation is accelerating.
Overall we see two distinct models emerging:
White-Label model: – For banks & lenders who prefer to partner with fintechs
The corollary of this is the companies that are open to expanding their sourcing model by offering third-party products and services to their customers. Essentially, these firms are alive to the possibility of using their customer base as the pull to aggregate the best and most value-added third-party products, to give customers more choice and more convenience and in turn boost profitability by increasing customer loyalty and lifetime value.
Most incumbent banking organizations with large customer numbers are well placed to become aggregators. Notable examples in this space include MarketFinance’s partnerships with Barclays and Ebury for invoice finance.
Another example is TradePlus24’s partnership with Post Finance. As we know, high operating costs stemming from rigid, manual processing make it uneconomical for many banks to lend to certain segments. Even though many banks are beginning to address this, many may take a different route and choose to lend their balance sheets via new intermediaries like TradePlus24, a fintech startup based in Switzerland.
TP24 uses digital channels for originating and servicing receivables financing and state-of-the-art technology for credit-decisioning and ongoing monitoring of its loans, which collectively mean that it can lend at extremely competitive rates, 4-6% (compared to 6-15% for factoring), even against small amounts. As a result, they are democratizing invoice finance at the same time as giving its bank partners a healthy return on their assets.
Integrated model: – For banks & lenders who prefer to drive their own product innovation
Once lenders move into the world of tech enabled data-driven products it becomes possible to embed these services into other services to create meta-services. These could be akin to ‘buy now pay later’ solutions for the corporate sector like point of sale loans for SMEs operating on digital marketplaces, but the possibilities go much further such as embedding lending into accounting systems and supply chains.
Leveraging the power of exceptional customer experiences, this category ultimately aims to connect the most well-known brands to the most commonly trusted financial services creating embedded, highly personalised and convenient bundles of services and experiences.
A great example of this in commercial banking is Marcus from Goldman Sachs. With good technology and low cost-to-serve they have managed to gain distribution faster by embedding their end-to-end lending service in wider ecosystems. It allows these lending-as-service platforms to achieve greater economies of scale, while their partners can either add a service offering or add an alternative, lower cost alternative to their own-labelled lending services. Most notably Marcus has partnered with both Google and Apple to turn our devices into a digital wallet and credit card respectively.
The world of lending is changing – and faster now in light of the pandemic.
The new world will be one based on Open Finance and collaboration will be its fuel.
For incumbent organizations, there are many steps to fully capitalize on ecosystem-based models. Arguably, the most important and hardest has nothing to do with technology and involves cultural change. But, where technology change is needed, it will require organizations to invest in new orchestration platforms, as well as to adopt a comprehensive strategy for data.
For those that embrace this opportunity, the returns will be exponential.