Until just a few years ago, only banks could lend money to consumers–but that has all changed. Increased connectivity now underpins easier access to credit, with various lending options and numerous vendors available to users. 

The following statistics highlight the shift in consumer borrowing habits:

1. The average digital lending deal rose by 63% in 2021.

2. The global embedded lending industry will grow at a compound annual growth rate of 27.5% from 2022 to 2029.
   
   
3. By 2030, the entire embedded finance industry (including embedded lending, insurance, and payments) will be worth $7.2TN. 

The growing market share of these non-financial companies presents a challenge for traditional lenders to modernise and deliver services with heightened efficiency and ease. But the change in consumer borrowing trends towards easy-to-access credit presents a range of lending issues for industry disruptors–particularly in a volatile economic environment. 

Find out why embedded finance has become increasingly popular, the challenges payment fintechs need to overcome, and the importance of collections management software.

What is embedded finance?

Embedded finance is an umbrella term for the integration of financial solutions within the services of non-financial entities, and it’s becoming increasingly popular across a range of industries. A growing number of retailers, for example, have Buy Now, Pay Later (BNPL) payment providers such as Afterpay and Klarna built into their online checkout systems, giving customers quick and easy access to funds without the need to utilise external finance systems. 

The idea of built-in lending is inherently linked to open banking–a system in which users permit third-party financial services access to their personal financial data. The process is facilitated through application program interfaces (APIs), software tools that enable apps to safely and securely communicate with each other to streamline access to financial data. UK and EU legislation mandate that, once consent is granted, banks and financial institutions must share customer data with other financial bodies, affording smaller firms means to provide near-instant lending.

One of the key strengths of embedded finance is its ability to remove buying pain points. Physically accessing and parting with cash to complete a transaction can be enough to discourage a purchase altogether. But embedded payments are a way to remove barriers and soften the blow of committing to buying goods. 

The commercial applications of embedded finance

In-app payments

In the case of ride-sharing apps like Uber and Gett, the removal of cash is a key point of difference when compared to traditional taxi services. Instead of scrambling to find the correct change, customers are automatically billed once their ride is completed.  

Card transactions

Offering connectivity with traditional banking systems, platforms like PayPal and Google Wallet act as intermediaries between users and their banks. These tools link to users’ bank accounts and cards and let the consumers choose the account from which funds are pulled when it’s time to pay. All transactions are then processed through the intermediary platforms.

Branded checking accounts

More and more, non-finance companies are moving into the finance space by offering banking products. 

Grover, Europe’s largest consumer tech subscription company, recently announced the launch of the Grover Card. The Visa Debit card, issued by Solaris, is accessible through the Grover app and allows customers in Germany to claim a 3% return on everyday purchases, which is then tracked and redeemed against tech subscriptions within the app. This gamified tracking and rewards experience highlights the increased personalisation available through embedded finance tools.

Purchase add-ons

In much the same way that point-of-sale finance products make ad-hoc borrowing fast and efficient, purchasing ancillary goods and services is also becoming a seamless experience.

Valued at $700 billion in 2020, the embedded insurance market allows consumers to access the cover they need directly at the time of purchase. This empowers brands to improve their value proposition and fosters heightened customer retention in the long term.

The benefits of embedded lending systems

Quick access to funds

Traditional lending processes are time-consuming, with completion taking anywhere from one to three months. This lengthy turnaround is often unviable for consumers needing credit quickly, underscoring the value of fintechs that offer on-demand access to loans. 

An emphasis on personalisation

The majority of conventional lenders provide broad, generalised borrowing operations, servicing customers with uniform processes. But non-financial companies often have access to rich data that banks lack, such as buying history and purchase frequency. This allows neobanks and other lending firms to provide highly tailored experiences, accounting for customer preferences and improving the user purchase journey.

Expediency of service 

Prior to the advent of embedded finance, consumers were required to take out loans or use credit cards in order to borrow money, taking on the financial burden of high interest rates. Embedded lending provides far more favourable terms, though–offering weekly or monthly interest-free repayments–increasing buying flexibility during the checkout process. 

Lending challenges for fintechs

1. Data security 

While system integrations enable streamlined service and seamless customer journeys, the use of APIs can lead to numerous operational challenges–such as breaches of system security and user data confidentiality. To mitigate these issues, strict risk management controls and security frameworks are necessary. Oversights on this front can entail huge reputational risks for financial entities. 

2. Customer risk detection 

While conventional banks may lack insight into consumer behaviour and user purchase preferences, their use of financial data enables them to accurately identify high-risk and low-risk borrowers. This tracking of repayments and overdraft statuses is a safeguard against potential non-payment. But businesses with embedded lending services cannot readily identify at-risk borrowers. This results in a system of uniformly offering customers the same repayment terms, irrespective of their financial status. 

A consequence of this open borrowing is an increase in rates of non-payment across fintech loans compared to traditional lending. In fact, fintech loans are twice as likely as conventional bank loans to be delinquent after 15 months.

3. Access to capital 

The flexibility and efficiency of embedded lending is driving a surge in adoption rates, with the BNPL market growing at 39% per year. But an open-door lending policy increases the potential of widespread adoption from high-risk consumers, further negatively impacting non-repayment rates.

To compound matters, fintechs invariably lack the capital reserves of traditional banks, which, when combined with higher average loan values than those offered by their non-disruptor counterparts, creates cash flow challenges as delinquency rates increase. 

Tackling the issues of embedded lending

Embedded finance has shifted the consumer focus away from lending processes and onto products and services. The streamlining of transactions removes roadblocks to access and redefines the financial product as an incidental step within the larger purchasing journey.  Nevertheless, the clear and present risks of almost barrier-free lending pose a range of challenges and issues in the debt recovery process. 

Fortunately, the tailored, data-driven approach of embedded lending is now readily available in debt management systems, offering essential consumer insights and providing personalised collections processes. 

Steps to recovery success

As borrowing becomes increasingly digitalised, a growing number of companies are switching from legacy systems to AI-powered debt recovery solutions, implementing robust collections management tools to manage recovery. 

Businesses are transforming their approach to debt management by leveraging the insights offered by cloud-based, data-driven platforms to craft tailored dunning strategies. This is empowering collections teams to iterate on their approaches with increased agility and efficiency - without the need for IT professionals. 

For companies operating at scale, A/B testing is an invaluable tool for measuring process success, segmenting customer groups and boosting recovery rates. And to enhance the customer experience, self-service payment functionalities let consumers manage their debt autonomously.

Ultimately, an emphasis on personalisation–both in messaging and payment method choice–creates a consistent, familiar user experience, from initial purchase to debt repayment. This allows businesses to better allocate resources and yield improved repayment rates over time.