Borrowed banking: How lenders can use embedded finance

Our thinking on embedded finance

Posted on 19th April 2022

Embedded finance is solving age-old pain points for the lending industry. And that’s just the start…

Embedded finance for lenders

Lending is as old as money itself. Actually, it’s older. In Ancient Mesopotamia around 3,000 BC, when food was a form of payment, farmers would borrow seeds and then share their produce when the harvest came in to pay off their debt. 

Sadly, the logistics of lending haven’t improved much since then. Ok that’s an exaggeration, but there’s still a lot of room for improvement. Despite lending predating most of The Bronze Age, we’re still running into common problems and pitfalls. 

However, this may finally be about to change. Embedded finance offers an improved way to offer and manage lending, providing solutions to commonplace issues and elevating what lending can do. But first, what are those pain points lenders are still grappling with? 

The challenges of lending

All lending has one common challenge: how do you get your money back? This central question impacts who is able to get a loan, the size of the loan, the interest they pay and the method of repayment.  

It’s a question that can never be fully answered. There is always inherent risk with giving an individual or a business money that they are not guaranteed to be able to return. So how do lending services decide? They’ll use a variety of methods - for small-scale personal lending that will involve a credit score check and perhaps asking for bank statements for a certain time period. For larger loans they will also require collateral which you will lose if you can’t make your payments (your house, car etc). 

These approaches all have flaws. The level of accuracy that can be obtained from a few bank statements is limited, and what if certain documents are forgotten? Or worse, falsified? Credit scoring is still a blunt tool that only captures one view of an individual’s financial situation. Many people may have no credit history or a poor credit score, despite having a good job and being otherwise credit-worthy - a problem for anyone who has recently moved to another country, for example. Inaccurate, incomplete data is therefore a major handbrake on efforts to make finance and lending more inclusive.

Then there is the repayment of the loan itself. It goes without saying that a lending service is constantly receiving payments. But unlike, lets say, a retail site, those payments then need to alter each individual customer’s loan balance so their outstanding debt is tracked accurately. Incorrect payments create a lot of manual reconciliation pain for operations teams, and mistakes can happen. As a result, many lenders are wasting a lot of time chasing payments and correcting errors. 

For a lot of lending services, these are simply accepted as a cost of doing business. They shouldn’t be. Situations like these are precisely what embedded finance can solve. 

Lending, the embedded finance way

Embedded finance allows businesses to access financial services without building any further infrastructure or apply for additional licences. While lending services are of course no strangers to finance, this allows them to benefit from features like embedded banking and payments which may operate under a different regulatory regime to their core lending business. 

One example is Open Banking. Open Banking permits Account Information Services (AIS) to give direct access to an individual’s personal bank account data, providing the individual has consented. Instead of asking potential customers to send over bank statements or running multiple credit checks with third parties, an AIS can give your business all the financial data an individual has with a few clicks. 

This drastically reduces the time it takes for a loan to be issued, with certain decisions even able to be automated based on the data received, improving customer experience. But it benefits the lending service as well as the customer. More information leads to better decisions regarding who is given a loan, how much they are offered etc. With embedded finance, a lending service can plug directly into an AIS provider and use that service within their own product ecosystem. 

Virtual IBANs are another feature which can benefit lending services. By assigning every single customer a virtual IBAN, incoming payments can be reconciled automatically. For the customer, their experience doesn’t have to change at all. But for the lending service, reconciliation becomes a frictionless, automated event. Customers are, in effect, paying money into their ‘own account’ with a lender, so keeping track of where the debt stands couldn’t be simpler. 

Looking ahead 

The points made above are far from the only ways embedded finance can be used to enhance lending, they are just two of the clearest. Lending firms may want to issue debit cards to make it easier for customers to use their loan in specific circumstances. If customers urgently need to send money abroad, they may want to embed an FX feature, keeping the entire journey within their platform. 

Embedded finance gives them that two-pronged approach: capable of removing existing pain points while enhancing their entire customer experience, making it smarter, slicker and more comprehensive. 

The question now for lenders is: do you think about how embedded finance can improve your offering, or do you stick with the Ancient Mesopotamian farmers?


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