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.