Embedded Finance. Scarlett Sieber

have appeared 3,000 years ago in China and a few hundred years later in Turkey. Both were advanced, literate societies with established social norms and laws protecting persons and property. But the act of borrowing and lending is more fundamental to human activity than the idea of “money,” as any child on the playground can tell you.

      Lending appears to have been a family matter in ancient Mesopotamia, with wealthy families lending from their own reserves. In ancient Greece and Rome, banking became more formal and less personal, with lending and money-changing often tied to the economic activities of powerful entities such as temples or government offices.

The institutions we recognize today as banks originated in Italy during the Middle Ages. Banking groups would finance voyages, gambling that ships would return to port with more valuable cargo than they shipped out. In Renaissance Italy, banking became available to more of the population, what we would today call retail or consumer banking. The word bank comes from the Latin bancus, meaning bench or table. Bankers (banchieri) set up tables outdoors, at the entrance to markets, to help customers solve liquidity problems. They changed currency, operated as pawnbrokers, and made loans to people visiting the market. Wall Street brokers began much the same way, trading securities at tables along the tree-lined streets of lower Manhattan, when commerce was still an out-of-doors activity.

      The consumer banking most of us are familiar with arrived in Europe and North America in the nineteenth century, along with industrialization and the emergence of the middle class. And of course, the twentieth century saw the trappings of traditional financial life become standardized: the checkbook, the bills arriving like clockwork every month, the plastic cards, and the bankers in their suits and ties.

Financial services companies have always been one of the most avid and enthusiastic adopters of whatever new technology is available. We already mentioned the telegraph. Banks were also early adopters of computers, the first to bring computing power to their employees—after all, banks have a lot to compute. Today the idea of banks being tech-forward may seem antiquated, because banks typically seem to be behind the times when compared with technology companies, but a look at the technology budgets of the largest banks shows that bankers’ enthusiasm for technology remains strong. For example, JP Morgan Chase, the largest retail bank in the US, budgeted an astonishing $12 billion for technology in 2022.¹

What has changed is that technology is moving more quickly than banks’ internal processes, and banks must play catch-up. Mobile technology was taken up enthusiastically in the private world, by consumers, before it saw widespread use cases in business (beyond reaching employees at off-hours). This is in contrast to desktop computers, which first saw adoption in business offices before they became known as “home computers.” This gap, along with the stringent regulations banks have followed since the crash of 1929, and later 2008, has created an enormous opportunity for technology companies to enter financial services.

      The intersection of banking and technology, or financial technology now commonly known as fintech, began in the internet era. It got its start with digital banking over dial-up internet connections in the 1990s, the arrival of application programming interfaces (APIs) as a communication tool between applications in the 2000s, and truly came into its own in 2009, as the financial crisis wreaked havoc on consumer credit and the entire business of banking. Why was this the moment? The 2009 financial crisis meant that traditional banks became subject to new regulations stemming from repeated crises, and at the same time millions of smartphones (the first iPhone was released in the summer of 2007) found their way into consumers’ hands. This created a unique confluence of circumstances for the new wave of fintech companies to emerge and challenge the banks.

      Fintech relies on a number of technology layers from a multitude of providers whose interactions can be quite complex, but consumers don't care how all the processes work together on the backend. Very few users know about the financial systems and programming languages used to deliver services to their touchscreens. An important point about fintech is that, whenever possible, it is automated, and performed with minimal human intervention, removing friction as far as possible to complete any desired action. However, when human intervention is needed, fintechs offer this service, and often more seamlessly than the banks because they focus on providing the best possible customer experience.

Though technological innovation is expensive, it is worth the investment, as paying humans to interact with other humans every step of the way (even to check one's balance in a checking account) is even more expensive and does not provide the benefit of scale. The consumer, using sophisticated technology platforms and tools available nowadays, is serving herself and guiding the actions. This means that she should be able to perform the same transaction at 3 AM that she could at 3 PM, and can do it just as well from home or on a train as at the bank branch. She interacts when it is most convenient for her that naturally intertwines with her everyday lifestyle. As we will see, embedded finance takes this key idea even further.

      But to return to 2008, financial services in this era still relied on physical locations to deliver products and services to their customers. Branch tellers and their cordoned-off lines were a familiar sight for millions of consumers every day. But bank branches were expensive to maintain, from rent to cleaning to utilities to supplies to employee salaries, and more. To offset these costs, banks had to make revenue elsewhere, like any other business, or think of a way to reduce those costs drastically. The end result of this necessary cost of doing business negatively impacted the customer. Banks retreated from certain products to focus on others, and fintech entered the breach.

One thing that fintechs collectively aren't focusing on is building storefronts. Since 2008, the US has seen a 12% decline in the number of bank branches.² In the UK the drop is even more dramatic—a 17% decline since the financial crisis struck in 2008.³ These declines are to be expected as digital banking is adopted. Indeed, bank branches have been in general decline since the 1980s, as card payments have taken transactions away from cash, and telephone and internet banking offered different means to transfer money. As you might infer from these numbers, digital banks have had more success in the UK than in the US. Particularly for small businesses, digital offerings in the US financial services sector still have a long way to go. Its revenue model is not aligning with customer needs, because banks make money when customers make mistakes. When customers don't pay back their loans on time, or spend more than they have in their accounts, the banks profit. When customers are financially healthy, banks can earn money alongside them, instead of against them.

A word here about the basic revenue model for a bank. Banks earn revenue by providing loans, including home loans (mortgages), auto loans, business loans, and personal loans, including credit cards, and from interchange fees received from card payments. For the privilege of borrowing money, consumers and businesses pay interest. Banks also hold customer deposits, and sometimes charge for this service. These deposits provide the capital to make loans.

      Customer needs have changed, and the customer base has grown younger and more diverse. New products and services are required to meet the new customers’ needs. Consider how radically other industries have changed over recent decades. It is happening in banking too, but up until now banking has lagged behind the rest of the economy.

CATASTROPHE AS THE MOTHER OF INVENTION

      The financial crisis of 2008 resulted from a cascade of causes within the banking industry and in society at large. Loose regulations led to irresponsible lending and borrowing, particularly in the mortgage sector, and then losses from failed loans led to catastrophe for consumers and financial institutions alike. Ivy League graduates formerly flocked to the large investment banks and the secure life they promised, but in 2008 this changed forever. The five largest investment banks at that time were Goldman Sachs, Merrill Lynch, Morgan Stanley, Bear Stearns, and Lehman Brothers. All five were severely compromised by toxic assets (mortgages in default) that were worse than worthless—they were negative equity.