The increasing prevalence of embedded finance is leading to greater consumer expectations for convenient and customised services, not least as we move into 2024, in having access to credit natively in checkout, in invoices and in other touch points when transacting with businesses.
Across 2023, the embedded finance industry has gained momentum, with the market expected to reach $1.91 trillion by 2029. Embedded finance enables businesses to provide tailored financial services to customers, creating better experiences, increased revenue, and greater loyalty. Credit is a growing component of that story.
Rob Fernandes, Chief Product Officer at Deko, said: “Where lending plays a role in the embedded finance landscape, we have seen some significant shifts over the last 18 months, with rapid adoption of finance distribution at checkout, tempered by the economic environment, making for a challenging credit market”.
Consolidation
Little over a year ago, global brands Zip and Openpay left the UK Buy Now Pay Later (BNPL) market, after being unable to keep up with industry demands, with OpenPay recently falling into administration. As 2023 reaches its end, finance providers are being increasingly squeezed and their business models tested.
Stuttering regulation
2023 was expected to be the big year of regulatory change in credit, particularly for the Buy Now Pay Later (BNPL) sector, yet new laws have been pushed back with there yet to be any significant change. The launch of Consumer Duty has at least introduced a need to assess the affordability of credit for borrowers during an application, creating at least one necessary investment in the experience of BNPL and other embedded finance providers.
A range of BNPL players have opted to exit the market before the full regulation arrives, while smaller providers continue trading in a pre-regulation grey area. Market leaders such as Klarna, have seen a decrease in valuation, and are amending their business model, for example charging fees for customers who default on payments, and tightening credit appetite.
While BNPL remains unregulated, other embeddable finance products such as monthly instalment loans and digital credit accounts are governed by the UK regulator, although consumers rarely differentiate between the two, often lumping them all into the BNPL bucket. With delayed regulation extending negative press coverage of BNPL and its consumer risks, a wider explosion in embedded finance use cases may face some reputational headwinds where credit is involved, despite often delivering regulated products.
Interest rates
Continuing to rise throughout 2023, interest rates hit their highest levels in almost 15 years. This has resulted in a host of issues for consumers and merchants who are having to pay more to access credit. For example, lenders have hiked up their pricing to reflect the cost of borrowing, increasing subsidies (the fees merchants pay to offer credit) and decreasing acceptance rates as they adjust for a higher risk of loan default.
As a result merchants are now more selective about offering promotional or interest-free finance where they are picking up the ever increasing cost of the subsidy, which in turn leaves more consumers facing less attractive finance options, adding to a recent cost-of-living based reluctance to use credit. While this has led to overall access to finance products decreasing, it has made smarter and more tailored embedded finance propositions crucial to achieving customer and business objectives.
Fernandes added: “Despite the turbulence, the race to innovate and differentiate in how credit is surfaced in transaction experiences will result in 2024 becoming a prominent year for embedded finance and in particular for embedded lending.”
Further consolidation in 2024
Large banks are aware of the locked opportunity that sits within embedded finance, and recognise that despite recent pressures, checkout finance remains comfortably the fastest growing form of payment in the UK, representing a generational shift away from their traditional credit cards business.
The entry of major banks into the UK embedded lending market, along with the aforementioned shakeout of existing BNPLs exiting the market, will drive a new level of consolidation around the very biggest players.
Apple, which launched its own finance product, Apple Pay Later, in the US 18 months ago, could even roll out a UK equivalent in 2024 based on their prior timelines for extending Apple Pay features to their British users. This will restore some competition in the market among remaining incumbents such as Klarna, with an increase in trusted and responsible brands from both the big banks to multinational technology brands.
Blurring of the lines of embedded finance.
The growth in embedded finance has led to financial services appearing more frequently within retailer ecommerce platforms (such as Shopify, working with Affirm) and other sector-specific business software platforms, making credit embeddable for businesses across use cases of all kinds, blurring the lines between traditional finance and other fast growing industries.
Fernandes concluded: “The embedded finance and embedded lending market will continue to establish itself in 2024, with greater emphasis on technology fit into software platforms, as well as optimisation and tailoring of credit options to counteract the limitations of a high interest market. Advantages such as multi-lender connectivity and product flexibility will help platforms, their merchants and consumers, get access to competitive pricing and enable better acceptance. In tandem, major UK banks will seize on the consolidation opportunity and ramp up efforts to establish their own embedded finance offerings, either through new market entry or working with experienced fintech partners”.
