By Roger Vincent, Trade Ledger Managing Director, UK & Ireland
While tech giants have been dabbling in financial services for well over a decade, the pace is now picking up significantly. Amazon launched its first payments product, Amazon Pay, in 2007. More recently, Apple and Amazon have both launched credit cards; Facebook has launched its own payments system, aptly called Facebook Pay; and Google has announced plans to start offering consumer bank accounts.
The timing of this Big Tech push into banking is not chance. It coincides with the general opening up of the banking value chain, with open finance and internet connectivity enabling account holders to share their banking data with other companies, who can then process it to offer services such as loans. It provides the opportunity for Big Tech players to offer banking services without being banks. And they, as our Corporate Banking Predictions 2021 report said, can embed financial services into social media and ecommerce channels, for example with buy now, pay later (BNPL) offers at the checkout.
In this article, we discuss the opportunities and threats that embedded finance brings to both Big Tech and banks, and how banks can respond. It’s already established, and whatever strategy banks employ should acknowledge that it is both the logical and the inevitable next phase of digitisation. We’ll also address how fintech, once also considered a destructive disruptor of banking, is now firmly allied with incumbent banks to help them take their businesses forward.
From the perspective of consumers, the benefits of embedded finance are manifold – it’s easier for them to buy, or even borrow, at the point of sale; they have fewer suppliers to deal with; and additional services such as insurance can be built in to increase revenues. It’s a logical progression for customer-centric companies like Amazon to want to take this opportunity to offer better service. It is not about disruption for disruption's sake, as some suggest, but more about increasing value-add and reducing the friction of purchasing journeys when customers use services transacting within the platform ecosystem.
Amazon Pay is a case in point. It shaves 70 seconds off the checkout process. Merchants who have implemented it report lower cart abandonment, a 33% rise in conversions, and a 15% rise in average order value. Apple markets its credit card as "The simplicity of Apple. In a credit card." And Facebook's vice president of marketplace and commerce Deborah Liu has called Facebook Pay "part of our ongoing work to make commerce more convenient, accessible and secure for people on our apps”.
Embedded finance is both dynamic and contextual. It is contextual because it leverages the data that the brand has gathered about its customers to be able to offer services that are relevant to the customer’s needs. It is dynamic because it can do that matching in near-real time. So, for example, rather than send a letter offering a store card, a retailer can offer a customer a point-of-sale loan – effectively matching a need with a relevant service at the point when the need arises.
This is why embedded finance is so exciting. It puts lending into customer channels where there is sufficient data to understand customer creditworthiness without the friction and delay of having customers fill in forms, and provides information which is more up-to-date and complete than the snapshot contained in an application form.
And as well as reducing friction and increasing convenience, embedded finance is also likely to increase greatly the size of the addressable market for finance, as we will see next.
How about for small and medium business finance? SME lending is a particularly underserved market and is ripe for embedded finance.
Historically, small and medium-sized enterprises (SMEs) have fallen through the cracks. For traditional banks, the lending sums involved are too small to merit the detailed checks needed to establish creditworthiness, and this has worsened with the shift to a services-based economy, which results in SMEs generally having fewer tangible assets to offer as collateral. Few SMEs meet the criteria of venture capitalists (VCs) and other potential investors. And so, an enormous funding gap has emerged, estimated to be over USD 1.5 trillion.
But embedded finance has an opportunity to address it.
The solution to the SME funding gap lies in data, or data-driven lending.
For many SMEs, internet platforms are integral to their business. They may use AWS as their infrastructure partners, use Facebook to help acquire new customers, and use Shopify to create their virtual store. And they might sell through Amazon Marketplace.
Through the course of these arrangements, the platform providers get incredible insights into these businesses. This puts them in a position where they can understand and anticipate their needs. And so they can start to offer what Joana Negrao from HSBC UK terms “alternatives that provide smart access to funding and help businesses quickly release cash caught up in their sales cycle”.
So Big Tech is in a position to make banking more convenient and to better match supply and demand for finance.
But can they do it on their own?
Big tech firms' aversion to being regulated is well-documented. And this makes it unlikely they'd choose to enter directly into the heavily regulated manufacturing of banking services.
As well as the overheads that regulation brings, the margins don’t make sense. To paraphrase Accenture's global payments lead Sulabh Agarwal, it would be irrational for tech giants to become banks, because they have far greater return on capital as tech companies than they would ever manage as banks.
So, while the distribution of financial services improves the customer experience and conversion rates for existing services, the manufacturing of financial services does not add up for Big Tech. They need partners.
Apple's credit card is a partnership in which Apple handles the technology and the route to customers, while banking giant Goldman Sachs acts as issuer and handles underwriting, customer service, the payments infrastructure, and, importantly, compliance.
Similarly, both Amazon and Google have chosen to partner with banks for their financial services ventures. Amazon has teamed up with American Express, while Google plans to work with several banks and credit unions.
There is no doubt that Big Tech companies interposing themselves between banks and their customers poses a significant threat to banks. Without direct customer contact, banks risk becoming price-takers – unable to have an influence on price or any ability to upsell or cross-sell.
Goldman Sachs partner and head of product at Marcus bank, Adam Dell, said last year that there are two types of incumbent banks: those that are in trouble, and those that don’t know they’re in trouble. Such a view is way too pessimistic in our view. Just as Goldman Sachs with Marcus has created a banking-as-a-service platform that has seen it partner with Big Tech firms like Stripe and Apple to increase its reach, so can others.
This example is illustrative in other ways too. The first is about picking your markets. Goldman Sachs is partnering with Big Tech for markets and products which are outside its core investment banking franchise, such as checking (current) accounts, credit and wealth management. Further, it has a broader strategy to use customer deposits to reduce the cost of capital for the group and to use banking as a service (BaaS) to achieve economies of scale in its Marcus business without having to grow distribution itself.
The fact is that embedded finance can be a win-win, positive sum collaboration opportunity. Big Tech companies have lots of data and high customer engagement. Banks have capital-intensive businesses whose margins can be substantially improved by spreading fixed costs over much higher volumes, especially if they can avoid incurring high customer acquisition costs. Some banks in the US, such as Celtic Bank, are earning returns on equity of 40% plus by focusing solely on embedding their services into third-party channels.
As BBVA USA's president and CEO Javier Rodríguez Soler notes:
"Collaborations with companies like Google represent the future of banking. Consumers end up the true winners when finance and big tech work together for their benefit.”
Not just consumers – SME customers will benefit too.
If banks are persuaded that embedded finance partnerships are the logical and inevitable direction of travel, the challenge then becomes one of technology. Fintech companies are on hand to help.
Over the years, so much has been written about how fintech companies are disrupting banks or eating their lunch, but is has become increasingly clear that fintech is the banks’ friend, not their foe.
Embedded finance is a case in point. Some banks, like Goldman Sachs and BBVA, have created vertically integrated platforms to be able to work directly with Big Tech and other consumer platforms.
But most banks depend on fintech companies to provide the orchestration capabilities to connect their services with brands that wish to distribute them. The best platforms also go further than orchestration, providing deep intelligence that will be essential for banks to sustain high margins in a world where the customer connection is increasingly indirect.