Embedded Finance. Scarlett Sieber
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Lehman Brothers went bankrupt in September of 2008, the largest bankruptcy filing in American history, and disappeared. Bear Stearns also failed and was bought for a fraction of its previous value by JP Morgan Chase. Merrill Lynch was similarly acquired by Bank of America. A week after Lehman's collapse, Goldman Sachs and Morgan Stanley announced they would become traditional banks offering deposit services to retail customers. American Express also became a bank around this time. This move afforded the banks more protections by bringing them under closer supervision from federal agencies, which was, for a brief period, an attractive prospect. Japan's MUFG Bank subsequently bought a considerable portion of Morgan Stanley, which also borrowed more than $100 billion from the federal government, more than any other financial institution. Goldman Sachs has since seen considerable success innovating on the retail model with its digital bank, Marcus, named for the company's founder, Marcus Goldman, and more recently with its newly launched transaction banking division and TxB platform, which already supports embedded finance use cases.
The financial crisis resulted in a significant tightening of consumer credit, with some banks pulling back entirely from lending to consumers and small businesses outside of established channels such as credit cards. Just because banks no longer wanted to lend didn't mean that the needs of consumers and small businesses changed. They still needed to borrow money, but the traditional providers were no longer available.
THE TECHNOLOGY THAT MAKES IT POSSIBLE
Smartphones, following the birth of the iPhone in 2007, came of age in the wake of the financial crisis, delivering internet access and computing power to consumers wherever and whenever they wanted it. Apple sold nearly 1.5 billion iPhones in the 2010s, according to company sales figures. Here are a few data points to consider. Nearly all adult Americans (97%) own a mobile phone. Most (85%) of adult Americans own a smartphone, and 62% of them have made a purchase on the device.4 The average amount of time a person spends interacting with a smartphone is more than three hours per day.
As of May 2021, China counted more than 911 million smartphone users, and India 440 million. The US was next with 270 million users, out of a population of 329 million. One of the marks of a highly developed economy is the percentage of its population that uses a smartphone. The cutoff is generally 70%, though Japan is a notable exception at only 60%.
Deloitte estimated in 2018 that 59% of the global population had used mobile phones for banking needs.5 This number is likely considerably higher today, especially in response to the pandemic and an acceleration of digital adoption.
As smartphones proliferated in the developed world, feature phones, mobile phones with internet access but lacking the advanced interface of a smartphone, became ubiquitous in the developing world, including the Global South, such as Latin America, Southeast Asia, and Africa. While smartphones allowed consumers in developed nations to avoid the bank branch for everyday issues and to make purchases, feature phones allowed consumers in countries with underdeveloped financial systems and very few bank branches to access financial services for the first time.
Most consumers, some 70%, in Latin America and Africa are underbanked, meaning they lack access to traditional financial services. The transformation of financial services in countries that had underdeveloped banking infrastructure is far more dramatic than the changes happening in countries with advanced banking systems. Smartphone penetration is also expanding rapidly in the Global South, and with it, so are more sophisticated financial services. Brazil counts 110 million smartphone users, and Indonesia,160 million.
One thing we can say is that using mobile phones for finance can be tremendously empowering. With a few clicks, users can see balances, pay bills, and send money to friends and relatives.
Mobile phones open up a whole world to the curious and seekers of knowledge. The potential is endless, though the reality may sometimes fall short. But on a fundamental level, mobile phones opened up rather than closed off humanity, and connected us with every other mobile user.
While much of the focus has centered around mobile phones, the other component to mobile phone success is mobile internet. Mobile internet access has changed the world forever. Mobile, unlike most previous technology, moved from the consumer sphere to the workplace instead of the other way around. Adoption scaled rapidly, we might even say virally, in the consumer world, forcing companies to adopt policies around bringing these powerful devices into the workplace. When we think about the leading indicators that drive the evolving changes in mobile, they lead back to consumer behavior. This behavior not only drives the consumer but also the business world that interacts with consumers. The consumer has never before been as empowered as they are now, and the way they are consuming cultural products such as books (Kindle), movies (Netflix, Hulu), food (Deliveroo, InstaCart, HelloFresh, JustEatsTakeaway), and music (Spotify, Apple Music) is constantly evolving. This has repercussions across their expectations toward other industries, including financial services, as the lines are now blurred on what specific industry offerings look like as consumers want all experiences to be as simple and easy as the last.
The internet provides communication and information tools to the majority of humans on Earth. It has toppled governments, upended industries, and changed the way people live. No business is insulated from its effects. As hard as it may be to believe today, when the internet was young, many experts downplayed its effects and ridiculed it as a toy or fad. Those predictions are laughable now, but underestimating the internet has happened again and again, always with the same result. Embedded finance represents another evolution along this arc.
Many in the banking industry doubted the internet would have much effect on their business. But, like many other industries, it has fundamentally shifted the way that humans interact with the companies they do business with and with each other. The ubiquity of the internet as a truly global platform is a primary reminder that technology and the ability to connect should not be underestimated. Shoppers now search online for deals first even if they intend on making their purchase at a brick-and-mortar store. How many times have you been at an airport, an appliance store, or an electronic store staring at that item that caught your eye to then go online and see how the price compares to a similar shop?
From the youngest to the oldest in society, this has become the norm. As with anything in life, macroeconomic factors from natural disasters, global health crises, etc. change the way that humans operate in their day-to-day life. When applied to the present, the Covid-19 pandemic, and resulting lockdowns, forced many businesses around the world to shift their business model and interact digitally first with their customers. While this had broad scale implications, it was felt strongest with brick-and-mortar shopping experiences and mom and pop businesses. The pandemic caused them to adapt or die and unfortunately, many of them failed as a result of the inability to connect with their customers digitally. The car rental giant Hertz was among these casualties, as were the retailers JC Penney and J Crew.6 While the pandemic is a deeply timely and personal example for many, it is important to note that there will continue to be large-scale factors that will push consumers online for many of their everyday needs.
Let's now bring this back to the financial services world, one industry that saw both the positive and negative impact of Covid. Those institutions that were already digital first or at least had an adequate digital strategy fared better than those that had digital as a roadmap item that was never quite checked off as complete. Why has this continuously been a theme where banks are slower to adopt change than most, as with the financial crisis of 2008? It goes back to a relatively simple concept: trust. Banks (and other banking institutions such as credit unions, etc.) are the trusted custodians of our financial lives. The financial services industry is conservative with good reason. It is charged with securing the movement and storage of money for both consumers and businesses. It cannot be overemphasized how important a role this is and may be a strong reason why the industry as a whole still uses technology built as long as half a century ago. This has made