Embedded financing is on the rise, and businesses are looking for new and innovative ways to work within the changing financial regulatory landscape. Embedded finance has grown in recent years because it has allowed merchants and companies that traditionally are not part of the financial sector to offer their customers more flexible financing options outside of their offering.
As technology has helped embedded finance gain traction, the regulatory landscape has changed too. The ubiquity of smartphones and the convenience of non-banking apps to increase access to financial services for consumers, helped pave the way. Because policy making moves at a far slower speed compared to the exponential growth of technology, regulators face an uphill battle heading into a new era. Governments have been challenged to level the playing field for nonbank companies to provide financial services. For example, the CFPB has advanced vehicles in place to give fintech startups room to test new products without the threat of enforcement action.
With these laws still being developed, embedded finance players have the unique opportunity to help develop industry best practices that can help define future policies, specifically on customer data and privacy.
Embedded financing has grown because of how it has been able to address current regulatory requirements:
- Enforcement of competition
- Partnerships
- Ensuring compliance with existing regulations
Enforcement of competition
With the rise in technology, embedded finance has never been easier for newer companies to enter the space. This has led to increased competition, as financial brands battle for market share. Competition can be seen as a good thing, as it drives down the cost of embedded finance both for merchants and consumers.
Regulatory bodies, however, must continue to enforce antitrust laws, to prevent any single embedded financial brand from gaining too much market share. The increase in competition has also led to a rise in innovation, as embedded finance companies compete to offer the best terms and products to their customers. These diversified products include partnering with other digital platforms such as e-commerce sites, social media, insurance, and the automotive industry.
Partnerships
Not all companies involved in embedded finance need to be licensed money services businesses. An embedded finance relationship simply requires one of the partners to be a regulated institution known as a "sponsor." Sponsors provide the infrastructure and due diligence for the embedded finance product, while the partner company provides the customer interface and products.
Consumers want to be able to have seamless digital experiences without leaving their favorite apps. If they can use an application that already has their primary bank account information linked to being used on other apps, they are more likely to continue using that app. This has led to a proliferation of partnerships between embedded finance brands and businesses in other sectors.
Getting involved in the embedded financial sector by partnering with a trusted partnerallows more companies to go to market quickly without investing as much time and money into compliance.
Ensuring compliance with existing regulations
By partnering with experienced institutions already governed within the industry, embedded financiers can ensure compliance with existing regulations. This mitigates a lot of the risk for both parties, as well as allows embedded financiers to focus on their core competencies.
Embedded finance companies have become a critical part of the banking system and, as such, need to comply with all relevant regulations. As embedded finance evolves and new products are created, regulators must keep up with the rapidly changing industry. This will help embedded finance brands operate in a compliant manner and limit any potential risks to both the embedded finance sector and consumers. Some new entities are even able to take on intermediary roles within the embedded finance space which are currently outside the regulatory perimeter.