Why APIs are essential for the rise of Embedded Finance 🚀

API technology is revolutionising fintech and the finance sector in general. It has enabled ecommerce players, merchants, and brands to outstrip traditional banks, something the first fintechs struggled to achieve. It is an exciting time for the finance sector, but it is hard to stay up to date with financial API technology and to fully comprehend its implications. This article takes a closer look at a handful of the technologies and business models using the most popular APIs, such as Banking-as-a-Service and Embedded Finance, being used in the banking sector right now.

What is an API? 🔍

API stands for “Application Programming Interface”, a technology that isn't actually new at all. These types of programming interfaces have been around since the 1980s, becoming more widespread in the 2000s. API technology acts as an intermediary between two different applications, a connection that allows one software program to communicate with other programs. We use APIs every day without even knowing. APIs let us check the weather forecast on our smartphones. Any e-retailer with a website or app where customers can purchase their products uses them. It is API technology that makes the payment process possible once a customer has proceeded to payment, so an e-retailer can receive their money. In terms of transactions, APIs have greatly improved the customer experience by making it quicker, more secure and less expensive.

As required by the Payment Services Directive 2, European banks offer API products that allow businesses (ecommerce, merchants and brands), developers and even consumers to access their accounts and make payments via third-party providers without having to deal directly with their bank. By using API technology, customers can choose the services and products to which they want to enjoy secure and automated access. As a result, APIs have become an essential tool for banks and fintechs to reach and serve their customers and to gain competitive advantage.

Why APIs are so popular in the financial services sector

A difficult sector to enter historically, with traditional banks being so well-established and well-resourced, alongside regulatory hurdles that new entrants to the market found difficult to overcome.

In this environment of new regulations and technologies around APIs in particular, fintechs and non-financial brands have been able to enter the market by unbundling banking product portfolios and offering greater convenience through focusing their efforts on the creation of financial services with the customer firmly at their centre. Both consumer and business customers value convenience and availability on-demand when it comes to their finances, preferring to manage these digitally and have their payment information saved on non-banking applications, like e-retailers and third parties. For example, a growing number of non-financial businesses are seizing market share and accessing API technology to extend their financial service offerings. Shopify is a perfect example, built using API Stripe Treasury, offering merchants a unique, one-stop-shop to manage funds, pay bills and track expenses. Shopify already has a vast database of merchants open to adopting a financial product, all the more so as it is easily embedded into the Shopify system. This adds a further layer of convenience for the merchants in its ecosystem, thus enabling its adoption.

APIs are not viewed as technical interfaces but more as essential products with myriad uses: acquiring more data, improving customer satisfaction, creating new revenue streams and facilitating the diversification of service offerings. APIs are tools of differentiation that optimise the customer experience and highlight the identity of banks and fintechs.

APIs have released a new wave of innovation in financial services, particularly across the four main banking sectors: Open Banking, Banking-as-a-Service, Core Banking and Embedded Finance. We’re going to dive into how these four sections fit together and the value each offers:

#1 - Open Banking offers APIs to sell financial products 📱

The concept of Open Banking is not new; as already mentioned, the term was coined over a decade ago. It gathered pace because of a payment regulation called the Payment Services Directive 2 (DSP2). By granting access to data and third-party payment services, Open Banking has become a way of bringing new financial service providers on stage and has allowed the use of new technologies and innovation in banking services.

The principle of Open Banking is the innovative use of existing financial functions and financial products. This lets budgeting apps import the financial history of an individual for example and use it to create a personalised budget. It can allow a lender to analyse an individual’s or a business’s financial data to assess their financial situation. Open Banking has led to many advances in the financial sector because it has allowed financial technology companies to use existing financial products to improve or create new services and functionalities.

However, as the name suggests, Open Banking focuses just on banking services and, more precisely, on account and payment data. Other services like insurance, credit and investment products are not included. This scope is expected to widen in the next few years through greater use of banking data which will lead to the new concept of Open Finance.

#2 - Banking-as-a-Service (BaaS) platforms allow brands to embed financial services  💳

Banking-as-a-Service platforms break down financial services (accounts, payment cards, loans and payments) into consumable APIs that any business can use to create solutions, for example by combining e-commerce with banking in the case of Shopify Balance x Stripe Treasury.

However, this is where the Banking-as-a-Service market becomes more difficult to grasp, as some providers only offer the capacity to create new financial products but require the user to find a (banking) partner for the necessary licence, for example, to issue credit cards. If a business wants to develop its business activity and offer a new service that requires a banking licence, it may not be worth the trouble of obtaining a licence. Instead, they can partner with an existing bank to gain access to a commercial licence.

Traditional banks sitting at the cutting edge of technology view this as an opportunity to proactively embed themselves in the BaaS space. Players like BBVA and Goldman Sachs were among the first to enter this new market. BBVA joined forces with Uber, making available banking services for a new financial experience for Uber drivers and delivery partners (current accounts and payment cards). When it launched its credit card in the USA, Apple called on the services of Goldman Sachs (for the use of its licence and capacity to issue payment cards). 

Whether a bank or fintech builds its own platform or works with a partner, BaaS can offer strategic value in developing customer segments, speeding up successful market entry and even reducing operating and distribution costs when launching a new business activity.

#3 - Core Banking Platforms supply back-end systems and enable the orchestration of financial services 👨‍💻

A Core Banking Platform is a back-end system that manages all financial transactions on a daily basis. It processes payments and updates bank accounts and financial files. As per its name, a Core Banking Platform sits at the heart of a bank or financial institution, as well as of the Banking-as-a-Service platform providers who offer their bank licence and report as part of their service.

Considered next-generation Core Banking, these “process-centric” platforms have an orchestration layer and APIs to connect to the functionalities and functions that financial institutions need to offer financial services. This capacity to orchestrate facilitates the coordination and embedding of components while connecting them to Core Banking accounts. This “Lean Core” approach allows Core Banking Platform users to build, embed, change and develop more quickly.

#4 - Embedded Finance is the development of transparent user experiences that include a financial product or service 🙋‍♂️

There is an undeniable appetite for Embedded Finance. Prominent figures from the financial world are setting forth a vision that is both seductive and bold, like Angela Strange who declared that “Every company will be a fintech company” and Matt Harris who has predicted that the Embedded Finance market could be worth 3,600 billion dollars in the next decade in the US alone. Financial products have stayed largely the same; clients still use the same services, but they are now distributed digitally.

Embedded Finance reveals the transparent process of embedding a financial product at the point of interaction, tailored to the individual user’s needs and often improved by the use of contextual data. Embedded Finance can be characterised as the stage in the user journey where the customers of non-financial players expect to be offered financial services (payment facilities, insurance, loans, etc.).

An example of Embedded Finance is the Shopify Capital loan or Quickbooks credit which allows quicker access to loans for SMEs and at a reduced rate. This means SMEs can use their online Quickbooks data to apply for loans with a single click. The airline Lufthansa offers credit cards to its customers through its “Miles and More” loyalty programme, along with the chance to collect bonus points and even offers cancellation insurance, rental car insurance and international health insurance.

These banking functionalities are natively embedded and complement non-financial services for a transparent user experience. Embedded Finance is so important because of its fundamental use of APIs, and it will rewrite the financial landscape by allowing new products and unique processes to emerge over the next few years.