How embedded finance is simplifying borrowing

When Jet’s Piz­za store own­er Nick Woods had fin­ished refur­bish­ing his new restau­rant in Hart­land in the US state of Michi­gan, he was strapped for cash. Wor­ried he wouldn’t be able to pay for any emer­gen­cies, such as an oven break­down, say, he noticed his cred­it card proces­sor World­pay was offer­ing him a work­ing cap­i­tal loan through its online por­tal. 

The loan was, in fact, being pro­vid­ed by small busi­ness lender Liberis. This was an exam­ple of embed­ded finance, a way for busi­ness­es to seam­less­ly inte­grate finan­cial ser­vices prod­ucts into their own plat­forms as if they were pro­vid­ing the prod­ucts them­selves.

“We bring busi­ness finance to our part­ners by inte­grat­ing into their ecosys­tems, so we do the onboard­ing of cus­tomers through their own plat­form, under their own brand, and we do the under­writ­ing and we do the lend­ing as well,” says Rob Straathof, chief exec­u­tive of Liberis. 

In the case of Jet’s Piz­za, the loan did cov­er an emer­gency, the coro­n­avirus pan­dem­ic, giv­ing Woods a finan­cial cush­ion to keep his busi­ness afloat until he received a COVID loan from the US gov­ern­ment.

Liberis pro­vides so-called rev­enue-based financ­ing for small busi­ness­es like Jet’s Piz­za, pre-approv­ing bor­row­ers for short-term loans based on their trans­ac­tion­al data and allow­ing that mon­ey to be repaid as a per­cent­age of future cash flows.

“Because you’re pre-approved, you don’t need to go through a whole under­writ­ing cycle because we’ve already done that based on all the data we get from our part­ners like World­pay and, in as lit­tle as ten min­utes, the mon­ey hits your bank account. So it’s ful­ly inte­grat­ed and com­plete­ly fric­tion­less,” says Straathof.

Buy-now, pay-later finance

Such embed­ded finance tools could poten­tial­ly reshape how small and medi­um-sized enter­pris­es (SMEs) access short-term finance, for instance by replac­ing the need for over­drafts.

“Over­drafts are a blunt instru­ment that lend mon­ey on a short-term basis at a fixed rate, but if you actu­al­ly know what some­body needs that mon­ey for – buy­ing machin­ery or com­put­ers or pay­ing salaries – they are all spe­cif­ic financ­ing needs with dif­fer­ent risk pro­files,” says Nigel Ver­don, co-founder and chief exec­u­tive of Rails­bank, which pro­vides the tech that enables com­pa­nies to embed finan­cial prod­ucts into their own plat­forms. 

“Buy­ing a com­put­er can be asset-backed lend­ing, so why use an over­draft that is priced at unse­cured lend­ing rates when it could be priced as secured lend­ing?”

By work­ing with mer­chants and embrac­ing embed­ded finance, lenders can get real-time data on those trans­ac­tions and offer cred­it that is priced accord­ing­ly at the point of pur­chase, enabling SMEs to bor­row at more flex­i­ble rates.

But it is not just SMEs that can ben­e­fit from embed­ded finance, oth­er plat­forms are also pro­vid­ing buy-now, pay-lat­er prod­ucts for con­sumers. Kuba Zmu­da, chief strat­e­gy offi­cer at Mod­ulr, says a good exam­ple is But­ter, an app that allows shop­pers to buy from major high street brands using a vir­tu­al card and then spread the cost of the pur­chase through an instal­ment plan.

“For con­sumers, it offers a new and con­ve­nient way to access cred­it, while for the lenders, this increas­es their under­stand­ing of their clients and their needs,” he says.

Miri­am Wohl­far­th, co-founder of Banxware, a Ger­man embed­ded finance plat­form that acts as a bridge between banks and ecom­merce and pay­ments plat­forms, says embed­ded finance could mean banks have a less cus­tomer-fac­ing role in the future, instead act­ing as an infra­struc­ture and finance provider behind the scenes. This could also change the tra­di­tion­al nar­ra­tive about fin­techs com­pet­ing with banks.

“A lot of press in the past has been about fin­techs ver­sus banks, but embed­ded finance is much more about banks and fin­techs work­ing togeth­er,” says Wohl­far­th.

Ensuring borrowers can afford to repay

This back­drop is cre­at­ing oppor­tu­ni­ties for banks that are will­ing to inno­vate. Sil­via Mens­dorff-Pouil­ly, head of bank­ing solu­tions for Europe at FIS, says banks could use embed­ded finance to devel­op smarter bud­get­ing tools that help cus­tomers make more informed cred­it deci­sions at the point of pur­chase.

“As a con­sumer or an SME, it’s not that use­ful just to see my cur­rent bal­ance; it could be that tomor­row I have a direct deb­it that will wipe out my bal­ance, but my bank knows that and they also know what’s com­ing in,” she says. “If you’re a for­ward-think­ing bank, you can pro­vide your cus­tomer with a bud­get­ing tool to help make a deci­sion on whether they can buy some­thing with avail­able funds and, if the answer is no, offer them an alter­na­tive way to buy.”

How­ev­er, devel­op­ing more fric­tion­less ways to bor­row mon­ey is mak­ing reg­u­la­tors uneasy. Cur­rent­ly if bor­rowed funds are repayable with­in 12 months, and they are free of inter­est and fees to the con­sumer, they cur­rent­ly fall out­side the Finan­cial Con­duct Authority’s reg­u­la­to­ry remit, says Nik­ki Wor­den, part­ner at law firm Osborne Clarke. 

“Because these prod­ucts are not reg­u­lat­ed these lenders have been able to embed them­selves and make these cus­tomer jour­neys real­ly fric­tion­less and smooth,” she says. 

As a result, such prod­ucts are like­ly to be reg­u­lat­ed in the future. “The Finan­cial Con­duct Author­i­ty is con­cerned that if you make cred­it too easy to apply for, then peo­ple will. So the FCA wants fric­tion to be intro­duced into these jour­neys,” says Wor­den.

Those con­cerns might have become more acute dur­ing the coro­n­avirus pan­dem­ic giv­en the pres­sure on con­sumer finances and the ease with which such plat­forms can pro­vide cred­it, but lenders, whether it is for con­sumers or SMEs, are still com­mit­ted to lend­ing respon­si­bly, Wohl­far­th adds. “We don’t offer loans where the busi­ness is going down; we only want good loans,” she says.