Will Software Companies Become the New Community Banks Due to Embedded Finance?

Small businesses play a crucial role in our economy, contributing significantly to private sector jobs and GDP. However, many small businesses face challenges when it comes to accessing the working capital they need to thrive, as stated by Fintech Nexus. Unlike larger corporations, small businesses often lack a financial cushion and are vulnerable to fluctuations in cash flow and unexpected expenses.

Traditionally, local banks, credit unions, and Community Development Financial Institutions (CDFIs) have been lifelines for these small enterprises, providing them with much-needed funding. However, over the past decade and a half, these community banks have faced numerous obstacles, leaving small businesses struggling to secure financial support.

The aftermath of the 2008 financial crisis hit small banks hard, with government interventions such as TARP and the Dodd-Frank Act inadvertently disadvantaging them further. Compliance costs surged, limiting resources for crucial lending functions, and forcing small businesses to rely on large conglomerates with one-size-fits-all lending policies.

Fortunately, a new solution is emerging in the form of vertical software platforms. As businesses increasingly embrace online operations and card payments, software platforms are becoming the go-to destination for small business owners to manage their operations and access the support they need.

Unlike traditional horizontal software, modern software platforms are verticalized, allowing businesses to handle various tasks in one place. For example, restaurant owners can utilize platforms like Toast or Slice to manage orders, process payments, run marketing campaigns, and more.

The missing piece in these vertical software platforms has been access to capital. However, fintech is changing this landscape. Vertical software platforms possess deep industry knowledge and transaction data, making them well-positioned to become the new community banks on a niche level.

Traditional lending models, based on credit scores, extensive financial statements, and collateral, often create barriers for younger and smaller businesses. Fintech, on the other hand, enables financing to be underwritten directly from transaction data, making it a better fit for young businesses and eliminating the need for collateral.

Vertical software companies already have abundant transaction data at their disposal, but they require fintech partners to provide expertise in capital and risk management. Embedded finance, which connects businesses to financial services through non-financial platforms, is the solution. Vertical software platforms serve as the connection point, allowing business owners to access capital seamlessly within the platforms where they conduct daily operations.

Through secure APIs, fintech lenders can streamline the underwriting process, making it easier for business owners to access the capital they need without cumbersome manual steps. Capital becomes integrated into the tasks that require it, such as inventory management and payroll processing.

This transformation paints a picture of increasingly niche software platforms evolving into the new community banks for their respective industries. With embedded financing solutions, tailored not only to small businesses but also to specific industries, the need for small businesses to rely on traditional financial institutions diminishes. As these platforms expand their services, they gather additional data points, enabling even more customized financial solutions accessible in one place.

Embedded finance is poised to revolutionize the way small businesses access capital by transforming vertical software platforms into the new community banks of the future. This shift not only streamlines the lending process but also ensures that financial solutions are tailored to the unique needs of different industries, all within the convenience of a single platform.