A logo of Australia’s AfterPay in a store window in Sydney, pictured in July 2020: embedded finance is changing the structure of traditional retail finance. © Reuters
Tilman Ehrbeck is managing partner at Flourish, a global venture investment company. He is based in Washington, D.C.
When COVID-19 first struck a year ago, startup entrepreneurs and early-stage investors paused briefly to assess what the pandemic might mean for the burgeoning theme of fintech innovation. Rather than threatening new financial business models, though, the pandemic has brought the future forward, dramatically accelerating changes to customer behaviors and industry structure in Asia and beyond.
What had previously been expected to play out over years has been accomplished in months. And with new data showing that financing volumes for fintech companies reached record highs in the first quarter of 2021, I believe we are entering an accelerated phase for innovation in finance.
This has the potential to deliver better outcomes for consumers and small businesses around the world — and I expect it to be shaped by three related themes that have demonstrated their importance over the past year: platforms, plug-ins and plumbing.
These themes should be front and center in an increasingly robust financing environment for fintech. Investment in the sector slowed during the initial uncertainty around the pandemic but picked up toward the end of last year and roared back in the first three months of 2021. According to CB Insights, fintech companies globally raised nearly $23 billion of financing in the first quarter of 2021 — more than half the total funding they attracted in 2020. Asian fintechs attracted $3.7 billion in the first quarter, up from $1.9 billion in the last three months of 2020.
Embedded finance, or the integration of traditional retail financial services into platforms that millions use on a daily basis, has gathered momentum during the pandemic. Startup entrepreneurs and early-stage investors have redoubled their efforts in this area and — judging by the slew of recent news — later-stage investors and public stock markets have taken notice.
There are three key components to embedded finance. The first involves platforms that are relevant and helpful to people’s daily lives during the pandemic: the gig worker platform that creates earnings opportunities, the e-commerce platform that delivers goods to neighborhood stores, the agri supply chain networks that link farm gate to food plate and the social media platforms that help people stay connected.
Platforms like these naturally integrate digital payments. They have rapidly growing user numbers, often commanding strong trust and engagement. Importantly, they also generate proprietary data and insights into user needs and behaviors, allowing them to expand into financial services other than payments.
When Grab announced its plans to go public via a merger with Altimeter Growth, a Nasdaq-listed special purpose acquisition company, it highlighted its embedded finance plans as one of three priorities and upside opportunities. The proposed merger, worth close to $40 billion, is the largest SPAC deal so far and would be the largest ever equity offering by a Southeast Asian company.
Grab’s apps on a mobile phone screen: Grab highlighted its embedded finance plans as one of three priorities and upside opportunities. © Sipa/AP
The deal has attracted more than $4 billion of parallel new funding from marquee investors such as BlackRock and T. Rowe Price as well as sovereign investors like Singapore’s Temasek, Mubadala from the United Arab Emirates and Permodalan Nasional Berhad of Malaysia.
The second component of embedded finance is the plug-in products that leverage these popular platforms’ high engagement, payment transaction data and other customer insights. With these plug-ins, platforms can deliver a broader, more tailored and often cheaper set of financial services than were previously feasible for, or available from, traditional providers — especially new forms of credit or insurance.
The most visible example at present is buy-now-pay-later credit in e-commerce, which is often subsidized by online merchants who want to stimulate consumer demand. On the back of strong volume growth in the past 12 months, the CEO of Australia’s AfterPay has publicly contemplated a U.S. stock market listing following a similar move by U.S. competitor Affirm in January. While it has been less prominent so far, strong momentum is also building behind embedded working capital credit for rapidly digitizing small businesses and corner stores via supply and distribution logistics platforms.
The third component of embedded finance is the new breed of application programming interface based infrastructure. This plumbing is required to connect the new generation of customer interfaces and product providers with the regulated balance sheets or capital markets that finance, aggregate and manage risks at the back end. Across emerging markets, startups such as Brick in Indonesia or M2P Solutions in India are rushing to provide the type of connectivity that Plaid has created for financial data exchange in the U.S. — while Plaid itself raised $425 million of funding at a $13.4 billion valuation earlier in April.
Supercharged by the pandemic and lockdowns, embedded finance is changing the structure of traditional retail finance. Because of their large user bases, strong customer engagement and new data sources, platforms, product plug-ins and new plumbing together have the potential to bring financial services to far more customers, offering better services at lower costs than the traditional bricks-and-mortar banking system.
This is particularly true for Southeast Asia, which has higher per capita income and mobile internet penetration than other emerging markets, but where traditional banking penetration is still around 50%. By leveraging these three elements of embedded finance, entrepreneurs, investors, incumbent banking partners and regulators in Asia have the opportunity to create a fairer and more inclusive financial system as the region begins to recover from the pandemic.