Embedded finance: striking a balance between convenience and risk in the digital economy

DNB has published an analysis of the integration of financial products in non-financial apps and platforms by operators without a financial licence. This integration is also known as embedded finance. The analysis, which can be downloaded at the bottom of this news release, identifies the associated risks as well as the supervisory and other implications.

Growth through technology and complementary partnerships

It is not easy to gain a clear picture of the development phase that embedded finance has reached in Europe and the Netherlands. The impression of the authors of the analysis is that the scale of embedded finance is still relatively limited, both in absolute terms and compared to traditional financial services. They nevertheless see it as an important trend because of its significant growth potential, underpinned by structural trends such as digitalisation and the 'platformisation' of the economy.

Technological progress makes it possible to break financial services down into software components that are accessible to third parties. The growth of online shopping in consumers' daily lives, coupled with the platformisation of the economy, could lead to a future in which most products and services are obtained through digital platforms with integrated financial services. 

In addition, embedded finance offers growth opportunities due to the potential for fruitful collaboration between financial institutions and non-financial institutions. Financial institutions provide a robust foundation through their infrastructure, expertise, risk management and relationships with supervisory authorities, while non-financial partners offer complementary strengths such as customer relationships, data analytics and a user-friendly digital environment. This synergy can deliver a better response to customer preferences and help attract a wider customer base.

Risks due to complexity and conflicting interests

At the same time, embedded finance also creates risks, mainly due to the growing complexity of the financial value chain. The partnering financial institution bears ultimate responsibility and accountability for the risks, while the non-financial partner often manages the sales process and customer relationships. This can lead to risky behaviour, such as accepting high-risk customers. But there may also be other operational, integrity, financial, legal, reputational, revenue model and consumer protection risks.

These risks will increase as the use of embedded finance in financial services continues to grow, possibly resulting in a need for stricter supervisory measures. Our analysis indicates that such measures would be premature at present. However, in view of the cross-border nature of embedded finance, an international approach is desirable to ensure a level playing field and prevent institutions establishing themselves in locations with the least stringent supervision.