How Banks Can Monetize Embedded Lending

Embedded Finance and Banking as a Service Explained

Embedded finance is rapidly gaining traction in the financial services industry. Global Market Insights, for example, estimates that the market for embedded finance will grow from $105.8 billion in 2024 to $834.1 billion in 2034.

Embedded finance delivers financial services through a non-financial platform. Embedded financial solutions have several use cases, including:

• embedded lending
• digital banking
• embedded payments
• buy now, pay later (BNPL)
• insurance
• credit cards

Banking as a Service (BaaS) providers power these embedded financial services through the use of Application Programming Interfaces, or APIs.

Everyday consumers have become quite familiar with embedded finance solutions. For example, companies like Klarna offer BNPL solutions that are now commonplace during checkout at many major retailers. Other companies like Amazon and Shopify have also implemented solutions like Stripe for payment processing.

However, it’s embedded lending that’s garnering attention these days. In the near term, the embedded lending market is expected to exceed $30 billion in annual revenue.

BaaS platforms allow lenders using embedded financing to retain control of credit, compliance, and risk management, while fintech companies and software as service (SaaS) platforms influence customer acquisition and the user experience.

Embedded lending provides financial institutions with an opportunity to modernize their business models and "plug in” to platforms their customers already trust without needing to design tools from scratch or spend money on marketing for leads. Your bank can also benefit by expanding its lending capabilities, decreasing acquisition costs, and building a scalable, recurring revenue stream.

Core Architecture of Lending APIs

APIs make embedded lending work behind the scenes. APIs are simply channels that connect your bank’s software system to a partner’s platform.

These channels allow small business users to apply for and access loans from the apps they’re working in, like point-of-sale or accounting platforms. They don’t even have to visit your bank’s website at that point unless they choose to.

This “plug-and-play” approach enables your bank to retain control of the loan process while offering services to more customers through trusted third-party Fintech platforms.

The following are the key elements of a standard embedded lending API system:

• Application Intake: The platform collects loan application data from the small business user, and then the data is transmitted through the API to your bank's system in real time.
• Pre-Qualification: The API confirms basic eligibility by rules you specify (e.g., business age, revenue, credit rating). The system then determines whether the user will be approved before it sends a full application.
• Credit Decisioning: Your financial institution factors in applicant data during the underwriting process. Then, an approval or rejection is returned via the API in real-time or within a defined period.
• Loan Disbursement: Money is sent to the borrower’s account once approved. This can take place quickly, at times on the same day.
• Servicing and Repayment Tracking: The API keeps the platform (and your staff) updated with repayment status, balance, and due dates. Borrowers can directly check loan details from the platform.

At various touchpoints, your bank’s system will connect to the API platform. These touchpoints include the Know Your Customer (KYC) process for customer identity verification and uploading and sharing of documents. From there, all parties will receive status and notice updates to ensure a fast, secure, and easy lending process.

This seamless setup makes it possible to increase your services to more SMBs without taking on more risk.

Compliance and Risk Management Layering

An effective and successful embedded lending program depends on many factors, including speed and a great customer experience. But strong compliance and risk controls are also essential. As a regulated entity, your bank is responsible for ensuring all activity meets federal and state banking regulations.

The Bank's Role in Compliance

Banks that implement BaaS and embedded lending must ensure that all lending activity is compliant with guidelines released by the FDIC, OCC, and state banking regulators. These encompass Know Your Customer (KYC) and Anti-Money Laundering (AML) screenings that identify applicants and help avert fraud and criminal activity.

Your systems should also be designed to meet fair lending laws like the Equal Credit Opportunity Act (ECOA), which ensures that all borrowers are treated equally well regardless of their race, gender, or background.

How to Stay in Control

Maintaining control starts with using your own underwriting models to analyze each applicant. You can also use compliance-as-a-service providers or create your own tools to filter for risk, fraud, and regulatory issues. Make sure the API logs all activities and decisions with full audit trails. Real-time monitoring identifies issues before they become problems.

Data Security

Security must be incorporated from the outset. This means strong encryption, tokenization, and secure API gateways to protect sensitive customer data, ensuring your bank is compliant with data privacy laws. It can also help your financial institution build trust by prioritizing the security of borrower data.

Partner Onboarding & Integration Considerations

Partnering with third-party platforms for your bank’s embedded lending program involves more than adding lines of code. A strategic approach for partner selection, technical integration, and legal alignment is key to long-term growth and success.

Finding the Right Platforms

The first step is evaluating and selecting embedded finance providers that currently support small business customers. Choose platforms that have an active user base that can naturally support a lending platform, such as accounting software, invoicing systems, e-commerce websites, or point-of-sale systems.

The best partners are those whose users often engage in cash flow management or financing applications. Also, consider the embedded finance platform's ability to provide seamless integration with your systems, both operationally and technically. They should have a development team, support staff, and be willing to work closely with your bank during the onboarding process.

Technical Onboarding Steps

Once a partner is selected, offer a sandbox environment where team members can test the lending flow before going live. Keep technical documentation straightforward, with example code and software development kits (SDKs), to speed the integration.

Staying current with new API versions is important, too. Discuss API updates from your system and ensure your partner is able to facilitate an open connection with the right processes when there’s a new version of an API.

Make sure your partner knows how to handle updates without breaking the connection. Uptime and stability are important. Agree on service level agreements for system availability and support response times.

Legal and Operational Alignment

A good foundation that lays out the legal and operational responsibilities of each stakeholder can build trust and avoid confusion down the line.

Pre-launch, all parties should have clear agreements that outline what is to be done by whom. That is, who does which part of the customer journey, who keeps what information, and how issues will be resolved.

Set up data-sharing agreements that detail how customer information is used, stored, and protected. Set up mutual service expectations, such as how quickly customer service teams need to respond and how loan approvals will be communicated.

Underwriting Logic and Capital Deployment

Ensuring that embedded lending works for your bank will, in part, depend on how well it manages risk, capital deployment, and underwriting control.

Your Bank’s Role in the Embedded Lending Underwriting Process

Maintaining command of the underwriting process is essential to managing credit risk effectively. With your bank backing the embedded lending platform, you should stay in control of the credit decisioning process, regardless of where the application is initiated.

To achieve this, your bank will need to impose its own credit policies, lending criteria, and regulatory screening to ensure prudent decision-making.

By utilizing historical credit performance data and external sources such as alternative data, your financial institution can create adaptive underwriting models that more precisely measure creditworthiness.

Experiment with segmenting candidates based on such variables as risk profile, loan type, or industry vertical. Tiered loan offers, tailored to each candidate's risk grade, can minimize default risk.

Benefits of API-Based Underwriting

API-based underwriting facilitates quicker loan decisions and conveniently delivers them across the platforms your small business customers are using. Because API underwriting streamlines the loan process and delivers a more tailored experience that meets customer needs, it leads to higher customer engagement, which often leads to long-term customer loyalty and retention.

Automation significantly decreases manual processing time, and all applications are considered with the same criteria. This makes for better risk management and allows your bank to scale embedded lending with many partners without adding operational complexity.

Monetization Opportunities for Banks

Embedded lending enables banks to develop new revenue streams by monetizing the loan product as well as the infrastructure behind it.

Transaction-based Fees

The most straightforward way to monetize embedded lending is by charging transaction fees to platform partners. Each time a loan is processed or disbursed through the API, your bank can charge a fee for providing the service, thereby creating recurring revenue tied to volume.

Interest Income

Interest income is a core driver of profitability for banks. By deploying your bank’s own capital through embedded lending, your bank receives interest in the same way as traditional lending.

The key difference is that your financial institution can maximize its efficiency through less effort in acquiring loans, meaning reduced customer acquisition expenses, but at increased scalability through more loan volume.

Tiered-Pricing

Tiered pricing models can provide great returns. You can assess fees or interest rates that vary by loan volume, partner size, or risk levels of the borrowers. This model allows you to appropriately compensate high-performing platforms while, at the same time, adequately compensating your bank for higher risk loans or those with additional servicing complexity.

Overcoming Implementation Challenges on Embedded Lending Platforms

Implementing an embedded lending program has a few pain points and challenges. But with a little preparation, roadblocks can be overcome.

When introducing new technology into a well-established banking environment, resistance is common. Start small by piloting your embedding lending strategy with one or two well-established platforms.

A successful pilot does more than prove it works for your bank: it establishes internal confidence among stakeholders and lays the groundwork for a broader roll-out.

Internal compliance and risk also provide hurdles. Because your bank is still responsible for all regulatory compliance, it’s necessary to engage your compliance and legal team early in the planning stages. This will help to identify potential issues sooner, before the actual launch, and promote an environment where compliance and risk are a priority from day one.

APIs can be complex, especially if your internal systems don’t support real-time integration. To bypass this challenge, consider working with third-party partners or BaaS providers who specialize in delivering and managing secure, compliant APIs.

Conclusion

While there are many opportunities across the broader embedded finance ecosystem, bank and financial service providers can satisfy their customers' growing demand for small business lending in a digital-first world.

Embedded lending, powered by robust APIs and serviced on trusted platforms, offers a scalable, low-cost way for banks to grow their lending portfolios while staying compliant, secure, and in control. With the proper partnerships and infrastructure, your bank can provide easy access to credit right in the software applications SMBs use.

The opportunity is clear: embedded lending isn't simply a tech stack upgrade; it's a growth strategy. Leverage it now to stay ahead of your competitors, deepen partner relationships, and drive consistent revenue.

Ready to See What Embedded Lending Can Do For Your Bank?

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FAQs

1. What does embedded lending offers that traditional banking cannot?

Embedded lending can extend your bank’s reach well beyond what a physical bank branch or even digital banking can offer. By embedding commercial loan opportunities in applications that startups and small business owners are using, every point of engagement counts, often leading to a higher law of average success than traditional lending.

2. Are there non-financial companies that already offer embedded lending to business owners?

Yes. For example, Shopify offers merchant cash advances to its merchants while Amazon offers lines of credit and term loans directly through its platform. Meanwhile, Stripe offers working capital loans to businesses that use its services. Even Uber offers its drivers cash advances based on their revenue.

3. How can banks keep up with regulatory requirements while offering embedded lending through third-party websites?

Lenders need to ensure that API systems are designed to incorporate compliance checks, such as KYC and AML, directly into the lending process, e.g., customer identity verification, documentation, and audit trails for all decisions.

4. What types of data are used during the underwriting process for decision-making in embedded lending?

In addition to traditional credit scoring models, it looks at alternative data such as transactions from credit and debit cards, bank accounts, and business accounts. It also evaluates data from customer behavior on the platform and suspicious activity that might signal fraud. Finally, embedded lending platforms factor in cash flow data, annual revenue, and time in business.

5. What factors should banks think about when evaluating a third-party platform partner?

Banks should look for partners that have strong experience in providing embedded lending services to small business owners. Platforms should also have the technical capabilities for solid API integration. They should also be open to outlining clear legal, operational, and data-sharing responsibilities in an agreement.