Embedded finance has increasingly become a fixture in the commerce landscape, and consumers now expect payment options like buy now, pay later at the point of sale. While these payment options might drive more sales for merchants, they represent just a small fraction of what embedded finance can offer business owners.
In his new report, Embedded Finance: What Do Merchants Want?, Don Apgar, Director of Merchant Payments Practice at Javelin Strategy & Research, examines embedded finance trends and explores their impact on merchants.
The Promise of Embedded Finance
Most merchants rely on software to run their business, often paying a monthly software-as-a-service fee for tools that helps them manage inventory, rentals, and time and attendance. This software typically includes built-in support for credit and debit card payments.
In addition to this, small businesses need a business checking account to deposit earnings and pay bills. They also require the ability to receive and pay invoices from suppliers and manage employee payroll, including health and retirement benefits.
Business owners receive statements from their payment processors detailing the amounts processed, as well as from their banks listing the amounts received. They might also get statements from their payroll companies outlining employee payments.
Most small businesses invest substantial time and money into accounting services to reconcile these various data sources. Even though all the information is available online, it’s not currently connected.
“As a business owner, what if you could access your checking account at your shop directly through your point-of-sale system?” Apgar said. “As you’re processing payments, you could pull a report that says you have $1,000 in credit card sales. Wouldn’t it be great if the point-of-sale system could log into your banking portal and verify that the $1,000 was received? The business owner can immediately check that box, it’s reconciled.”
With many time and attendance systems, employees log in and out through their phones, and their hours are automatically tallied. The payroll application then processes payments accordingly. With an integrated system, businesses wouldn’t require a separate payroll application.
The real potential of embedded finance, from a merchant’s perspective, lies in serving as a central connection point. Embedded finance software could centralize and utilize data from a single hub, giving small businesses the power to share and manage data across various functions.
“It’s a huge time suck, having to do all the accounting,” Apgar said. “Even if you have a CPA doing it, the CPA is going to need guidance on certain aspects, because they don’t know your business. The scarcest resource the small business owner has today is time. If all the sources of data and all the uses of data are connected, it eliminates a ton of manual work.”
BaaS Integration
Embedded finance is intertwined with banking-as-a-service to the point where one topic can’t be discussed without the other. This model has created an opportunity for banks to use software companies as distribution partners, just as in the payment space. Banks who want to attract more customers could embed their services directly into a merchant’s point-of-sale application.
“This is basically what is happening with payments,” Apgar said. “More software companies bundle payment processing with the software services business owners use. It was a function many banks previously served, but they have been largely disintermediated out of the payment processing loop by software companies. BaaS trends indicate that will happen again with other financial services, like basic banking services.”
If software companies are already handling payments processing, it makes sense for banks to partner with these providers. This way, business owners could open a checking account directly through the software at the same time they open a payments account.
The issue is that many banks have been content for software companies to handle those duties. As embedded finance gains traction, banks should look to software partners to distribute their financial products. However, financial institutions must ensure they have strong controls in the relationship, because they will still have to retain compliance responsibilities.
While embedded finance is still in its nascent days, banks should consider the role they will play and their strategy for scaling up. Whatever that role will be, it’s critical to start planning now.
“If your bank doesn’t want to play in that sandbox, you should have another plan,” Apgar said. “We’re still early in the process and banks won’t be cut out tomorrow. However, over the next couple of years we will approach a tipping point. The banks with a plan will start to grab market share from the banks without an embedded finance market plan.”