Lending Briefing: Embedded lending in a platform economy and Square dominating SMB financing

For fintech lenders, embedding enables effective low-cost distribution and ability to quickly reach scale, plus access to valuable predictive data from the banking partner.

And the market has claimed new territory in recent years – from point of sale financing and BNPL for consumers, to merchant cash advances and revenue-based financing for businesses.

Embedded lending seems to be the next evolutionary step of embedded finance, and the ‘platformization’ of finance in general. 

Traditionally, the existing system required customers to go and seek out a loan themselves, while banks competed on the actual credit products. But embedded lending can bring the product in front of the customer without the need of a deliberate search — reframing the legacy business model by placing customer experience at the center.

“The ideal experience for customers isn’t a more convenient account opening process. It’s not having to apply for the loan at all. It’s embedding lending within the context of the activity that the customer is attempting to complete,” writes Alex Johnson, director of fintech research at Cornerstone Advisors. 

Therefore, the goal of embedded lending is to unobtrusively provide financial services within the products and services that customers already use to complete non-financial services activities, according to Johnson.

Source: Alex Johnson

Another interesting aspect is that this new embedded finance market has mostly been propelled forward by fintechs offering white-labeled services that non-banks can use to serve their customers. 

And sometimes, those fintechs are founded by people with decades of experience in the traditional industry. 

For example, SMB lending platform QuickFi was founded by top officers from First American Commercial Bancorp. They found that the existing business model for financing commercial equipment, which was their specialty, took too long and was too costly for everyone involved. 

The disruption of online services in other industries, such as e-commerce, was an indicator of what their market might experience in a future that’s more digitally connected. And having been in the business, they knew how hard it was going to be for them to be able to compete with other platforms from within an existing company. 

“Why is it always an outsider that comes in and disrupts a market? Why is it that even Walmart, who had all the merchandising experience, the market dominance, isn't able to compete with Amazon easily? Because changing your business model is a very hard thing to do,” QuickFi’s founder and CEO Bill Verhelle told Tearsheet. 

One of the things they anticipated was the end-user self-service model, noticing that customer preferences were changing in that direction. Instead of a small business having to talk to a loan officer, or some sort of a finance salesperson, they could just do it themselves. 

The transition away from a business that relies on loan officers and sales people to a mobile and engaging digital customer experience appears to be unfeasible. There’s not really a path to turn loan officers into mobile developers – it’s just a completely different business model that requires different resources. 

“That's what led us to the idea of building an Amazon-like platform that we could make available to all of our former competitors in the industry. For a very low cost they could use the platform, and they wouldn't have to build it themselves,” Verhelle said. 

Therefore, banks might have to depart from the initial idea of building these capabilities internally, resigning to the fact that it makes more sense to build a partnership with those that already have the technology. 

So what role would incumbents play in this new ecosystem? It might just become a matter of choosing the right partner…

Chart of the week

Square Loans, Block’s small business lending division, ended the year 2021 with $2.5 billion in loans originated – a new annual record – placing it ahead of rivals PayPal and OnDeck for the first time ever in the digital small lending space. 

The fintech’s record numbers compared to $1.8 billion of loans at both PayPal and OnDeck. Square was also the only one to have exceeded pre-pandemic loan origination volumes.

As shown in the chart above, Square historically trailed below PayPal and OnDeck’s SMB lending divisions, but gradually started to inch ahead in the first quarter of last year.

And considering that earlier this year PayPal self proclaimed to be one of the nation’s top five small business lenders, that would make Square Loans and OnDeck market leaders as well.

So it seems that in 2022, three of the country’s top five SMB lenders are digital-only. 

What we’re reading 

Fintech launched first ever Filipino American neobank (Business Mirror)

Robinhood Readies Feature That Lets Users Lend Out Stocks (Bloomberg)

Banks invest in multi-lender BNPL platform ChargeAfter (Finextra)

Rising debt will shift fintechs to commercial debt sales (Lend Academy)

Corporate card and accounting platform Ramp gets an $8.1 billion valuation (TechCrunch)

The coming boom in metaverse lending for banks (Forbes)

What we’re writing

• Banking Briefing: What Biden’s executive order means for crypto growth
• Unlocking the value in consumer data: Klover CEO Brian Mandelbaum on making banking free
• This week in lending: 2021 BNPL results, credit markets poised for growth this year
• Incumbents are changing their overdraft policies – what does it mean for the industry?
• ​​Fast approval fertile for stolen and synthetic identities: BNPL’s fraud problem
• Decentraland: The financial activities happening in the Ethereum-based metaverse
• Fraud is becoming the biggest headache in financial services
• Quick take: How the pandemic changed commercial banking