Embedded FinTech
How use of APIs drives the innovation in payments, banking, and insurance
Introduction
Traditionally, when non-financial services businesses want to provide additional financial services to their customers, they adopt a reselling model in which they refer customers to a third party and charge a small amount as a referral fee.
Now, these non-financial service businesses are able to integrate financial services into their business model through application programming interfaces (APIs). This integration, hereby defined as embedded fintech, allows businesses to open up revenue streams and reinvent the services they offer to their customers.
Resell Model
- Example: Mindbody, a wellness class on-line scheduling platform, offered lending by referring customers to Lending Club
- Characteristics: less complexity, easier to launch, lower risks
- Target customers: non-tech savvy small and medium businesses with relatively low transaction volume
Embedded Model
- Example: Shopify, a platform that helps retailers launch their online storefronts, embedded payment processing to allow merchants manage checkout on the platform
- Characteristics: seamless customer experience, better economics, proprietary data
- Target customers: software companies with medium to large transaction volume
Embedded fintech attracts digital brands and merchants as it creates new revenue opportunities at very low marginal costs (given that the brand already has a customer base). It enables new customer experiences that drive loyalty and repeat purchase and allows merchants to capture more of the economics of the relationship.
Market Opportunity
The analysis above conducted by Matt Harris and summarized by Simon Torrance suggests that the embedded fintech market for insurance, lending and payments will grow to $3.6 trillion in 2030 in the US alone.
Embedded Payments
The rapid growing e-commerce and the rise of card-based and other digital ways of payment methods prompt digital brands and merchants to adopt new technologies to offer seamless financial services for their customers.
There are two common models for businesses in handling payment processing: outsource to payment facilitators (PayFacs) and integrate APIs to become PayFacs.
Businesses can either have PayFacs such as Stripe to handle payments on their behalf, at a higher cost — ~3% of transaction volume, or they can outsource to payment infrastructure providers such as Finix, who can build out the payment products for them, and allow businesses to bring businesses in-house. Some larger companies also have their own team building and improving their payments product.
Use Cases
Lightspeed POS is a point-of-sale e-commerce software provider. Before launching its own payments product in January 2019, it referred its merchants to third-party payment processors and received a referral fee of ~0.25% of the transaction volume. With Lightspeed Payments, it now captures ~0.65% of the transaction volume, 2.6 times the original take it made through a referral model.
Lightspeed POS partnered with Finix to build out its payment product. Finix has also provided payment infrastructure to enable other businesses to bring payments in-house. Its customer base also includes mobility management platform, Passport Labs, small businesses cash-flow platform, Kabbage, and private club management software platform, Clubessential.
Embedded Banking
Traditional banks are built on legacy systems and are not as nimble to incorporate APIs and innovate their product offerings. That gives rise to digital banks whose modern underlying technologies help them tailor towards unserved and underserved demographics.
Although these digital-first neobanks are nibbling the market share of the traditional banks, traditional banks still play an essential role as the backbone of the economy and are irreplaceable when it comes to providing the banking infrastructure for the former.
The diagram above illustrates the value chain of the current banking system. Traditional banks are license holders, and in order to provide financial services including lending and card issuing, they go through rigorous procedure to meet regulatory compliance. BaaS providers, on the other hand, partner with these license holders and offer APIs to neobanks (or non-bank merchants who are looking to provide banking services to their customers), helping them enable banking offerings on a speed dial.
More traditional banks will create or adopt BaaS strategy to increase their competitiveness in the digital economy. The old banking model is to grow the balance sheet via more deposits and lend the money to make profits. This model has been weakened by the better customer expectations shaped digital brands. BaaS strategy creates an ecosystem for both traditional banks and digital brands to reach scale and profitability, where traditional banks rely on digital brands as new distribution channels while digital brands can improve their customer experience and open up new revenue streams.
BaaS providers will create a marketplace to connect digital brands with a network of license holders. Instead of partnering with a few license holders at the backend, BaaS providers will allow digital brands to partner with a large network of banks. This gives customers more power in pricing and access to aggregated services. In this model, banks will become part of the competition, seeking out meaningful ways to improve their product offerings and acquire more customers.
Use Cases
Asia-focused UK bank Standard Chartered forged a partnership with Indonesian beauty and personal care e-commerce Sociolla, through its BaaS solution nexus. The partnership will enable Sociolla to offer financial products, like savings accounts, loans and credit cards that are powered by nexus in late 2021. It will also give Standard Chartered the opportunity to reach the unbanked and expand its customer base in the world’s 4th most populous country, where the e-commerce adoption rate is the highest in the world.
Digital neobank Varo Money announced in July 2020 that it has been granted bank charter, after going through 3 years of waiting and tons of paperwork. However, since its launch, the challenger bank has been able to provide customers financial products without the charter (as many fintech companies do) through its partner bank, Delaware-based Bancorp Bank, empowered by Temenos’ core banking platform. In other words, Varo maintains the front end — providing a clean user interface, Temenos supplies the middleware — enabling the end-to-end banking functionality, and Bancorp lays the infrastructure — owning underlying checking, savings, and credit accounts.
Embedded Insurance
Our society faces a widening protection gap between the amount of insurance needed to socially and economically benefit individuals and businesses and the amount of insurance that has actually been purchased. Reasons such as affordability and awareness on the demand side and transaction costs and limits to insurability on the supply side contribute to a complex business model operating on a thin profit margin with low value outcomes.
While insurers have access to large amounts of aggregated data, they may miss what would be the most relevant information at the individual level. For example, an auto insurer underwrites your policy based on your age, location and driving records, the input of which would yield a premium through their model. However, what would be more relevant but missing here might be what speed you drive on freeways, what distance you keep from the cars ahead, and how many seconds you fully stop at the stop signs, all of which more accurately illustrate your driving behavior.
Embedded insurance provides digital brands an opportunity to solve this problem by integrating insurance into their already data-rich model. With real-time knowledge of the financial or health status of their customers, digital brands are in a perfect position to add personalized insurance solutions to complement their existing product offerings.
Just like BBVA and Goldman Sachs (Marcus) offering BaaS, traditional insurers are transforming themselves to an “open insurer”, offering Insurance as a Service (“IaaS”). Ultimately, insurers will shift from building full end-to-end insurance solutions to assembling best-of-breed insurance services tailored to meet the customer needs. Many companies are providing APIs to be integrated with insurers and help them with digital transformation.
Use Cases
Qover helped Deliveroo build the insurance product to insure the food delivery platform’s riders. Qover connected the proposed insurance solution with the Deliveroo rider app, handling everything from partnering with insurance carriers to IT integration to customer care.
In 2018, Muang Thai Life Insurance developed Baowan BetterCare, a health insurance product for diabetics, with dynamic pricing, which rewards customers who improve their health behavior with premium discounts. Policyholders receive a blood glucose monitor that is connected to a healthcare smart app, which tracks their glucose score and daily behaviors from diets to exercise, and based on the data collected, policy makers adjust the premium respectively, to encourage a healthier lifestyle that would reverse diabetes. The key driver for the interconnectedness between the devices and insurers are APIs.
Conclusion
Use of APIs has been widely popularized in many industries in the last decade to achieve different outcomes. It has enabled digitization of operations, increased efficiency in business processes, better connected partners in the ecosystem, and allowed companies to offer new services. As applications in payments, banking and insurance are becoming more mature and delivering tangible results benefiting end users, we will also expect to see the growth of other industries following the similar trends as follows:
- Increasing customer demand for personalized options with more touchpoints (e.g., tailored banking products and individualized insurance coverage)
- Enterprise incumbents will establish open APIs, exposing their data and products to, and integrating with, third-party providers to open its distribution channels and introduce new revenue streams
- Tech-savvy start-ups will build out new products on innovative business models (e.g., usage-based premium, P2P insurance and microinsurance in the space of InsurTech)
- Continuous adoption of new technologies from IoT devices to AI, allowing new ways to collect data, process data, and provide better insights to optimize business operations
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