What is a bank? Like, what is it really?
Once you peel away the layers of systems and regulations, the fancy branch offices, and the armies of smiling suits, what’s left?
Put simply, a bank persuades customers to deposit money and earn a low interest rate. Then, it makes money on the deposited money by lending it out at a higher interest rate.
These deposits and loan repayments are what make a bank tick—and grow. However, they depend on customers, which may soon be in scarce supply.
Companies with no previous financial products are taking customer-centricity to a new level, introducing services like financing and integrated payments that deepen their relationships with customers at the expense of banks. This new approach, called embedded finance, is an existential threat to the banking industry.
Embedded finance isn’t an intentional attempt to overthrow banking; most companies are just trying to meet customers where they’re at (in-app, for example) when it comes to payments. With insight into customer earning and spending, providing more financial services is convenient and beneficial to both parties. It just makes sense.
Big tech has already been catching on to embedded finance in a big way. Recently, Facebook announced their new Facebook Financial initiative. A dedicated group will focus on embedding financial services like Facebook Pay inside messaging and apps like Facebook Shop. While traditional payment options are still available, the infrastructure now exists for customers to stash their money more conveniently within the platforms they already use every day, no bank account or credit card required.
Giants in the eCommerce space like Shopify, Paypal, and Stripe are taking it one step further. These platforms handle payments and have detailed data about users’ businesses and finances. Recently, they’ve been using that data to offer competitive business loans based on actual sales, revenue, and forecasted income. Since these platforms stand between customers and merchants, they can lower their lender risk by automatically collecting payment when merchants get paid.
It’s not just commerce, either. Last year, Uber rolled out Uber Money to provide debit accounts and cards, credit cards, and a digital wallet for contracted drivers and couriers. Now, eligible drivers will also find a Loan section in-app and can apply for loans at 0% APR with no fees or credit check and the option to use a percentage of earnings for repayment. No branch visits, no more mountains of paperwork—no brainer, right?
When companies that already have customers’ attention provide banking in the same place, they improve their customer experience, and give banks a run for their money.
Imagine you wanted to start a software company twenty years ago. You would have to buy a server and physically hook everything up yourself. Today, that’s unnecessary. You can get an AWS account in five minutes and be off to the races.
The same is now true of financial services. You can easily use Marqueta to offer credit cards, Plaid to connect customers to their banks, or any other number of platforms to easily collect payments or offer credit. Fintech startups are bypassing banks and shaping the future of banking.
Embedded finance isn’t new. Retailers like Costco and Walmart have provided their own closed-loop credit cards for decades, and even old-school store credit looked a lot like the embedded finance we see today because it kept money out of banks. The difference now is that the internet enables a fully-integrated banking experience on a massive scale. Once this experience is built, it can be infinitely replicated thanks to existing fintech infrastructures.
It’s not a matter of whether embedded finance will disrupt banks, but when.
For a glimpse into the future, China’s Alipay may offer some insight. Alipay is Amazon competitor Alibaba’s ubiquitous mobile and online payment platform. Today, people across China use it to pay for everything from train fare to retail products, online or offline. The platform saw $15 trillion in transactions last year, and its parent company, Ant, is set to make an IPO of over $200 billion.
You could make the argument that compliance requirements and regulations in the US will keep non-banks out of the banking game for decades to come. That would make sense if only fintech startups were involved, but Facebook is the fourth-largest internet company in the world, and big tech has a history of using resources to lobby for legislation that favors them.
Massive companies like Google, Apple, Uber, and others on similar trajectories have the advantage of intimate customer data and relationships, as well as influence. It’s hard to imagine they’ll let embedded finance be regulated like banks without a fight.
And if you’re a traditional bank, it’s time to start gearing up for a battle of your own—one that isn’t necessarily going to be on home turf.