In 2025, embedded finance will unlock new opportunities and transform the financial sector to increase accessibility to financial products and streamline the consumer experience. But a misstep by financial institutions—like a failure to provide adequate security or comply with federal regulations—can lead to significant consequences. As a result, skillful management and strategic planning is needed for financial institutions considering embedded finance.
What is Embedded Finance?
Embedded finance integrates financial services within non-financial platforms or businesses. It can be used for small and medium-sized business lending, to facilitate insurance or investment transactions, or to restructure payments into smaller, more manageable remittances.
While everyday consumers have widely adopted embedded finance, companies are ready to leverage the trend to grow their businesses. According to a Pathward report, 77% of senior executives say they’re embracing embedded finance, 44% already offer it, and 33% plan to add it to their portfolios. Meanwhile, 53% of companies surveyed report that embedded finance has been a revenue driver for their businesses.
While embedded finance solutions can offer a competitive advantage, it’s also essential to understand the risks before implementing them.
Embedded Financing Risks
While the potential rewards of embedded finance are significant, there are risks. In addition to the obvious fraud and credit risks, reputational damage, regulatory compliance challenges, and liquidity issues pose additional threats.
Partner-Associated Risks
One of the most significant considerations of embedded financing is the potential for reputational damage caused by an unethical or negligent partner. If a partner site experiences operational difficulties or failures, negative changes in its business model, or an otherwise compromised reputation, it can negatively impact a lender’s standing. Some actions can breach consumer trust or cause financial losses to multiple stakeholders.
Financial institutions can mitigate these partner risks by exercising due diligence when evaluating potential partners. Opting to utilize only financially stable platforms and monitoring their fiscal performance, public reputation, and operational practices is warranted.
Stakeholders should also have strong contractual agreements for embedded finance partnerships, with risk allocation clauses detailing each partner’s responsibilities. Additionally, an exit strategy should be developed early in the partnership just in case it becomes necessary to disassociate from a partner.
Finally, establishing a foundation of compliance, monitoring, and crisis management is crucial for protecting against potential reputational and financial damage from partner infringements and other issues. Transparency should also be a priority to build customer trust and educate consumers about lender and partner roles. Contingency plans can also help mitigate customer attrition.
Compliance Risks
As embedded finance is still evolving, it sometimes lacks clear-cut guidelines in the regulatory and compliance landscape. Unfortunately, this means financial institutions face higher compliance risks.
In addition to the complexity surrounding lending regulations in embedded finance, lenders have the added challenge of staying current with data privacy and consumer protection laws. Financial institutions that fail to comply with new regulations may face fines or even be stripped of their ability to operate. For example, in 2024 TD Bank was hit with more than $3 billion in penalties for failing to guard against money laundering and for violating the Bank Secrecy Act.
To mitigate regulatory risks, lenders should invest in robust regulatory compliance programs to address the challenges of evolving regulatory laws. Hiring a compliance team to collaborate with legal professionals specializing in financial services regulation is essential to staying apprised of new compliance requirements.
Lenders should also regularly audit internal controls to ensure compliance. Utilizing innovative technologies, including advanced encryption software and automated frameworks, can add a layer of protection against consumer data while maintaining privacy standards and preventing breaches.
Liquidity Risks
As embedded finance integrates financial services like loans or credit issuance into platforms, it can potentially result in liquidity shortfalls. This is especially true if a significant number of borrowers default on the loans or get behind on repayments.
To mitigate these risks, proactive diversified portfolio management across several borrower segments and sectors is recommended to provide a hedge against economic disruptions. Lenders can also reduce defaults by leveraging advanced data analytics to improve risk prediction forecasting and enhance the credit assessment process. Having reserve funds can also help cover shortfalls during times of payment delays.
Finally, offering flexible repayments or shorter loan terms can limit illiquidity during weak economic periods and free up capital. Lenders can also sell off part of their loan portfolios to quickly access liquidity if it becomes essential to maintaining financial stability.
The Future of Embedded Finance
The U.S. embedded finance market is projected to grow to $468 billion by 2034 as Application Programming Interfaces (APIs) make it easier to circumvent conventional banking procedures and provide financial services directly within apps and platforms.
As the embedded finance ecosystem continues to transform and offer unparalleled opportunities for financial institutions and platforms, both stakeholders must tread carefully while adapting innovative risk management strategies to harness its power and thrive in 2025 and beyond. Automated, scalable compliance systems must be implemented to meet regulations, optimize the auditing process, and mitigate risks.
Biz2X is at the forefront of financial services integration, revolutionizing embedded lending solutions that empower small businesses and platform partners to render an optimized lending experience that unlocks new revenue opportunities while delivering customized financial solutions. We partner with world-class providers to facilitate transformative growth and experiences for small and medium-sized businesses (SMBs).
