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Breaking Down Embedded Finance: A Look at the Possibilities
Embedded Finance Series, Part 2
By Michael Bradley, Senior Vice President of Growth, Infinicept
In our last post, we called out the trends supporting the emergence of embedded finance. We covered why it is not only a natural fit within the world of embedded payments, but also fast becoming a strategic imperative.
In this, the second post in our series on embedded finance, we further break down the concept. Embedded finance, like “fintech,” is a very broad term, So, what exactly does it comprise?
If embedded payments are the foundation to all of this, let’s first be sure we’re in agreement about what that term means.
At Infinicept, we characterize it as payments that are integrated into a software platform, marketplace or other “contextual” offering – not delivered as a standalone service. Payments are literally “embedded” into the software experience.
More often than not, the main embedded payments players adopt the payment facilitator or merchant of record (MOR) model, but other approaches are fast emerging.
Let’s further ground ourselves with the idea that payment acceptance is the foundation for embedded payments. Embedded payments includes processing payments through the networks built by the traditional card brands (Visa, Mastercard, AMEX). But they also encompass other payment types (think: ACH, real-time payments and various localized services, networks, and digital wallets).
Many have used the term “alternative” to describe these other kinds of payments. But in many markets around the world (like China and Germany), card brand-based payments would be considered alternative. So, let’s be more expansive and say we have card brand-based payments and adjacent payments (payments that are processed next to the card network rails).
These adjacent payments can be important, depending on the user context. For example, in the U.S. in some verticals, such as field and home services, paper checks are being replaced by eCheck as the principal form of payment. The rise of adjacent payment platforms like Venmo and BNPL (buy now pay later) solutions highlights the importance of taking a broader view of payment acceptance than just card networks.
The Big Three of Embedded Finance
Any company can now harness #fintech to embed innovative and compelling financial service components or solutions (of any kind – payments, credit, savings, insurance, investments) into their propositions and customer experiences, as native components or add-ons – quickly, cheaply; testing and iterating fast. – Simon Torrance
Let’s move into embedded finance, which can be broken down into three broad categories:
- Money movement
- Insurance, tax management, accounting and payroll (ITAP)
This category refers to all things related to moving money. Examples could include P2P transactions, disbursement of funds to submerchants in the payment facilitator model, or accounts payable capabilities embedded in an accounting software or ERP platform.
Let’s look a little more closely at some common subcategories:
Disbursement is the commonly used term for moving funds to specified bank accounts, usually done by a merchant services provider. A typical use case is a merchant services acquirer or payment facilitator moving funds to a merchant’s demand deposit account. You accept payments on behalf of your submerchants and then you move money to them – as well as various third parties – after you subtract your fees for your services.
Virtual Accounts are a form of disbursement, specifically one that involves using moving funds to virtual accounts, across a card or wallet network. Virtual accounts are used for a variety of use cases, including accounts payable, tips, and contractor payments.
FBO-as-a-Service is a hugely important concept that sits at the intersection of embedded payments and embedded finance. FBO stands for “for benefit of.” It’s a bank construct that enables an account to be opened on behalf of a beneficiary for disbursement purposes.
Basically, an FBO account is an account where one party holds money that is due to another party. In payments, FBO accounts are used for money collected from transactions that are due to the merchants. Software platforms (often that act as payment facilitators) sometimes use this type of account for settlement.
However, this is where it gets interesting. In the U.S., there are 48 states that require a money transmitter license (MTL) for moving money in this way. The very largest platforms have acquired these licenses, but it can take millions of dollars of legal and consulting fees and years of effort.
So, most platforms don’t take this approach. Instead, they contract with a bank (or a money transmitter licensee) to own the money due for settlement, thus relieving the platform from the MTL requirement. Using this best practice, the bank is the owner of the money in the FBO account, and it’s the bank’s tax ID number. (For the banking geeks out there, the title of the account is “[Bank Name] For Benefit of [Platform Name]’s Submerchants.”)
FBO-as-a-service extends this concept a bit further. An FBOaaS offering, as provided by a few banks and tech platforms, allows multiple sources of funds (think of card acceptance proceeds from multiple processors, ACH or check transactions, alternative payments and more) to be held for settlement at a single bank to be paid out to the submerchant. This allows single settlement to a submerchant.
The “as-a-service” part of this concept is critical because solution providers with this capability give embedded payments organizations the ability to serve unique use cases that traditional banks often are unable or unwilling to do.
Think of an embedded payments organization such as a property management software company. In the FBOaaS approach, the platform can receive funds into an FBO account designed to disburse co-mingled funds to the individual downstream accounts – property owners, in this instance. But FBOaaS providers are set up to service money movement to other parties.
For example, the property management company can also pay out a convenience fee to a rental management company. Similarly, a content publisher can receive funds from multiple sources and then disburse to content originators while also paying fees to advertising affiliates.
The payables (paying invoices or paying for services rendered/goods delivered) subcategory is moving money, in the most general sense. But there are some significant differences from the previous money movement topics.
Consider the context in which payables roam: moving larger sums of money less frequently, and tied to invoicing and ERP systems, which means that specific data elements must be present when the money is moved.
Often subject to various tax laws, payables are arguably the most expansive definition of moving money. These types of transactions generally use different rails than our previous examples and are often international. In fact, there is so much to payables, this category likely merits an article of its own.
When you think of banking, what comes to mind? Stodgy gals and guys deciding whether to give you a loan, maybe, or ludicrous commercials about opening a bank account while someone serves you an espresso?
Getting past the stereotypes and noise, here are the banking services that are especially relevant to embedded finance:
Bank accounts, treasury and cash management: yep, as boring as these sound, they engender all sorts of downstream financial services. A plethora of specialized service providers deliver not only the boring stuff but exotic interest-bearing accounts, accounts linked to crypto or other alternative assets, and so much more.
Issuing / card services refers to virtual accounts, commercial cards, or other card-based products tied into the flows of funds the embedded payments company is offering its merchants. The combination of account-linked offerings and visibility into business risk through underwriting and transactional monitoring could enable embedded payments companies to penetrate a very saturated market more effectively.
Cash apps or wallets. It is possible to launch a wallet for your customers and move money into it (see the FBOaaS section, above). Embedded payments companies need to be ambitious, with scale and the right dynamics in their market ecosystem to pull this one off.
Lending and financing is another subcategory of embedded finance that deservedly warrants its own deep dive. Within lending and financing, the principal idea is that the software-led embedded payments company has visibility into the customer’s business and risk profile. This creates a unique position from which to offer or facilitate highly tailored financing products.
Encompassing everything from short-term credit card receivable financing to trade financing, the joining of embedded payments companies that intimately know their customers with banking-as-a-service partners will revolutionize the commercial finance industry for working capital, equipment or project loans and receivables financing.
If somebody has a better label for this category, please let us know. This group of services moves the line from “embedded finance” to “embedded business operations (EBO).”
However, to keep our bearings, we just need to revisit our foundational premise that services like insurance, tax management, accounting and payroll can all be delivered, with the help of purpose-built specialist providers, through a software platform to a universe of small and medium-sized businesses. Embedded insurance alone is a $3 trillion opportunity.
Phew, that’s a big download. In our next post in this series, we’ll discuss approaches to prioritizing all of these embedded finance capabilities and determining how any of them may (or may not) fit into your world.