Embedded Finance in the US – an interview with EY payment experts

Patricia Partelow of EY showcases Embedded Finance vs. BaaS differences, US Embedded Finance status and the primary challenges it needs to overcome.

One of the primary distinctions between Embedded Finance and BaaS is the role each plays in the customer journey. Embedded Finance focuses on integrating financial solutions with other goods and services to provide a seamless and convenient customer experience. In contrast, BaaS is a back-end process that enables digital banks and non-banks to offer financial products and services quickly to their customers through APIs.

Another significant difference is how payments are processed. Embedded Finance payments are typically dynamic and contextual, happening during the checkout process or within the context of the product or service. For instance, an ecommerce platform may offer financing options during the checkout process. Whereas BaaS payments are typically pre-agreed and happen behind the scenes, because of a pre-established agreement between the fintech and the bank. Customers may not be aware of the bank's involvement in the transaction, as the front-end brand processes the payment on their behalf through the bank's APIs.

Embedded Finance is a rapidly growing trend in the US market, with the market size projected to reach USD 230 billion by 2025. This growth is attributed to increasing demand for digital financial services, the heightened expectation of users and the start of Open Banking in the US. Additionally, Embedded Finance is expanding across industries such as retail, healthcare, education, and mobility. Growth in Embedded Finance platforms has also increased, with many companies forming partnerships with providers to offer a wider range of services.

Consumers are looking for embedded financial services that provide tools to manage their personal finances and investments more effectively. This includes features such as portfolio management and investment tracking and recommendations. And, with increasing concern around identity theft and fraud, consumers are also looking for services that provide credit monitoring and identity theft protection. Segments that could benefit most include:

• Platforms that connect freelancers with clients can embed financial services such as invoice financing, expense management, and tax preparation to make it easier for the gig economy workforce to manage their finances.

• Business owners looking for embedded financial services that provide them with tools to manage their finances more efficiently and are integrated with their business management software. This includes features such as invoicing, receivables, payment processing, and expense tracking.

One of the main barriers to Embedded Finance is regulatory compliance. Financial services are heavily regulated, and integrating financial products into non-financial platforms can create regulatory challenges. Providers of Embedded Finance must comply with a range of regulations, including those related to data privacy, consumer protection, and anti-money laundering.

To address regulatory compliance in the US, providers of Embedded Finance are taking several approaches: 1) to partner with existing financial institutions that are already compliant with the necessary regulations and 2) to obtain the necessary licences and regulatory approvals to operate as a financial institution. These can be a time-consuming and costly process, but it allows Embedded Finance providers to have more control over the products and services they offer.

One of the risks I am most concerned about is the exposure to third-party risks as the safety and soundness of this integrated transaction rely on all parties involved. To curtail third-party/counterparty risk, there are different types of licencing with new controls and processes as regulators adapt quickly to address factors like data privacy and KYC requirements. Firms may need to become a payments and/or electronic money institution and obtain the requisite licencing by the state.

Over time, embedded payments will become the standard.  Now is the time for providers to invest the time to understand the customer journey and partner with the most relevant stakeholders to create the integrated customer experience while keeping compliance due diligence front of mind along the way.

This interview was first published in The Paypers' Embedded Finance and Banking-as-a-Service Report 2023, which is the latest comprehensive market overview and analysis focusing on the key products and players within the Embedded Finance and BaaS ecosystem.   

About Patricia Partelow

Pati is an EY Managing Director in the Payments practice, where she works with clients on assessing the market, developing strategies, implementing processes and platforms to deliver growth. She helps clients optimize the use of different payment types, implement the supporting systems to grow revenue and improve customer satisfaction.

About EY

EY is a global professional services organization that exists to build a better working world, helping create long-term value for clients, people and society and build trust in the capital markets. Working across assurance, consulting, law, strategy, tax and transactions, EY teams ask better questions to find new answers for the complex issues facing our world today.