Fintech 🧠 Food - 11th Apr 2021 - CBDC Wars, Plaid's royal flush, the rise of embedded marketplaces, and in search of level playing fields

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Weekly Rant 📣

Why Jamie Dimon's "level playing" field is not a good thing for banks or the economy

Banks have been throwing around the term "level playing field" regulation a lot lately. Like any good bit of lobbying, it's catchy because it sounds fair. I mean, we shouldn't have an un-level playing field, should we!

I couldn't let something like that slide. I think this is the wrong strategy for banks to take.  More regulation is rarely good for anyone.

In Jamie Dimon's annual shareholder letter, he crafts an argument for needing a level playing field, and it's a great anchor to look at the idea.

The whole letter is a tour de force of thoughtful narratives on everything from:

• The rise of China and how the US can react

• How regulation is preventing progress

• The potential for a stimulus inspired boom in 2022

• Lessons in leadership

It's a monster at over 34,000 words but worth reading if you can spare the time. It is both an astonishingly good and a prime example of why even the savviest bankers haven't yet fully understood why fintech is succeeding where they fail. (But it's close)

What the letter says

It's nearly impossible to do justice to a work of that size, so I'll call out upfront; Jamie makes efforts to be balanced and thoughtful throughout, and it is an incredibly well-written letter. That out of the way, here are what I took as some of the core ideas about banking specifically:

1. Banks have been their own worst enemy, bogged down with legacy systems, bureaucracy, and complacency from past success. This is why they face increased competition from fintech and big tech companies.

2. The world is more socially conscious, faces enormous challenges, and the banking industry must be more socially responsible.  Policymakers and industry have been guilty of short-term thinking, which has damaged society and banks' public perception.

"Our [policy] failures fuel the populism on both the political left and right. But populism is not policy, and we cannot let it drive another round of poor planning and bad leadership that will make our country's situation worse."

3. Banks are playing a smaller role in the banking system.  Post financial crisis, demand still exists for lending, banks have not been able to fulfill that demand due to capital constraints.  That demand is now filled by shadow banks that are not subject to the same rules.

4. The post-financial crisis regulation Dodd-Frank worked, but now the regulatory system needs to change to keep up with a rapidly moving world.  The US regulatory system is incredibly complex, which causes a drag on GDP. Significant regulatory risks exist that aren't getting focus on (e.g., cybersecurity, crypto, payment order flow).  More generally, policy is a mess from healthcare to social care taxation.

"Our [policy] shortcomings are not just about inefficiencies; they border on being immoral."

5. The rise of fintech and big tech (in the US especially) has benefitted by the heavy use of Money Transmission Licences (MTLs) and the Durbin Amendment. Their product innovation has solved real customer problems that banks didn't, but they benefit from an uneven playing field.  In effect, big tech and fintech companies can do activities like banks at an economic advantage designed to support smaller banks.

6. Tech like AI and cloud have dramatically changed the game of banking. To get the benefits of AI and cloud, incumbent banks cannot simply "refactor" what they do, but data must be "re-platformed" to work effectively. 

When you lay it all out, it is very rational. When you look past the headlines, you can see why JPMC has done so well as a bank when others haven't. So is he right or wrong?

Why Jamie is right ✅

His criticism of bank complacency is spot on: Pre-financial crisis banks had been so wildly successful they became complacent. The post-financial crisis era has been a period of rebalancing and stability that has worked. But in that time banks, core products haven't changed. Banks haven't launched new products; they've taken the products they had and made the distribution digital.

He's right that fintech and big tech have benefited from regulatory arbitrage: Neobanking and non-bank fintech have been built on MTL licenses in the US. The Durbin amendment made it more profitable to run a debit card program for smaller banks (who passed that on to fintech and big tech via banking-as-a-service). Globally, wherever you see a Neobank, unless they have a full charter, they're running on top of another regulated bank underneath.  

The US regulatory system is complex, and complying is expensive. By abstracting this, banking-as-a-service providers reduced the time to market for entrepreneurs. At the same time, the risk to consumers or the system didn't disappear.

Both things are true, banks have been complacent and new entrants have benefitted from regulatory change.   Banks have under-delivered for customers leading to much better products and services from big tech and fintech companies. But the playing field is not level.  

He's right that it's probably time to stop making post-financial crisis rule implementation the focus.  Issues such as cybersecurity, data, and payment system change are now more critical. The infrastructure of finance isn't fit for the digital age, and thoughtful policy could help here.

So should regulators focus on ensuring fintech companies and big tech are subject to the same rules as banks? Not so fast.

Why Jamie is wrong 🙅‍♂️

Regulation tends to benefit incumbents: There is almost no good example of regulation helping new market entrants. Complying tends to be expensive. New rules for fintech companies or non-finance companies would increase the cost of financial services to the economy.  

Regulation tends to harm innovation: As it becomes more costly to create new products and services in the industry, entry barriers become higher. Imagine if two people with an idea had to comply with the regulations set by this web of regulators. 👇

Fintech is solving social challenges that banks can't: The widening of inequality since the financial crisis is something Jamie calls out in his letter, but it's also something incumbent banks by themselves had done little to fix. If you read the letter, JPMC has plenty of initiatives to help in the community or lend to business, but none of them involve changing their product.  The risk models most banks use haven't changed materially in decades.

If we introduced a new regulation that made it more costly to create new fintech products and services, would we have seen 

• Stimulus checks issued early? 

• PPP loan distribution led by fintech companies?

• Neobanks by and for underrepresented communities?

So you have to ask if we create a level playing field. How does the consumer benefit?

Big boy pants time 👖

Bankers often bemoan being GSIFI (Globally significant financial institutions). They're subject to costs, governance, and overhead that other market players are not. JP Morgan overcome this with an ever-larger and painstakingly managed balance sheet ("fortress balance sheet") that produces economies of scale.  

But their "window" of addressable risk in the market is shrinking. They have new competitors entering. The fortress balance sheet is a category-leading strategy, but in a category that isn't seeing growth in share prices, revenues or ROTE.

In the past decade, it's true; other market players have filled the gaps left by banks. It's also true that this may create new risks that the economy and society are not protected against.

It's hard to be a bank, expensive to be a bank, and post-financial crisis, it is less profitable to be a bank, and there's more competition.

What if you turn that on its head?

If everyone wants to offer finance, but nobody wants to be a bank. Isn't that more of an opportunity than a threat?

Banks are in the business of managing risk.

What if banks saw managing those new risks as a commercial opportunity? 

That cost, that overhead, and that governance is an asset. The ultra-low risk appetite of being a GISIFI is an asset. Banks are already protected by regulation.  

Embedded finance is changing how financial products are manufactured and distributed. Imagine what a bank could do if it played its assets correctly?

What if, instead of only trying to defend a dying business, they attacked a massive growth opportunity?

Instead of trying to originate all the risk, manage it.

I genuinely believe banks have far more upside from aggressively leaning into the embedded finance future than trying to fight it. Fighting it is short-term, complacent thinking.

What if regulators could enable that somehow?

4 Fintech Companies 💸

1. Bondaval - Micro bond platform (UK)

• Bondaval allows small businesses to manage the cash flow gap between paying for inventory and selling goods.  Bondaval issues Micro bonds to SMBs to allow them to pay their suppliers or address any other cash flow gaps.  

• SMB financing has been massive in the past year and looks likely to continue. Micro bonds have been the subject of many academic and innovation lab projects but historically had issues getting the cost low enough to make them profitable. Bondaval leadership has a strong industry background and solid backing from Passion Capital (early Monzo investor).  If they get this right, it could be massive, essentially bringing an enormous segment into the bond market. Think Pipe.com for bonds.

2. Reconcile - Track and automate refunds 

• Reconcile creates a simple way to track any refunds. For example, if you return an e-commerce purchase, delivery is late, or you canceled a SaaS service. You may be owed a refund, but did it land?  Chasing all those refunds is hard; why not outsource that.

• Reconcile seems neat and would materially improve the user experience of shopping. I wonder if it's a feature more than a product. It could be a solid wedge product into other things I'm not seeing, but imagine this as an API. Wouldn't every Neobank use it?

3. Mulberry - Point of sale embedded insurance

• Retailers partner with Mulberry to design and embed insurance in their e-commerce journey.  The pitch is to create incremental revenue streams for the brand without the overhead of managing an insurance product or program. Mulberry offers a consumer app to manage claims and any customer support in a single interface. 

• Mulberry's pitch feels Klarna like in that they're selling higher revenue and partner with the merchant to implement the insurance service. The lesson from Klarna is these deep merchant partnerships drive conversion over time and become a flywheel back to the product. In China, Ping-An is the master of this type of embedded insurance, which drives massive revenue.  POS insurance is a category to watch, and I'm sure we'll see many more players emerge.

4. Vybe - Neobank for teens (France)

• Vybe allows under 18s to get an account with a Mastercard and IBAN (account number).  It includes typical features such as spending limits (and merchant category blocks) that parents can manage,

• With over 250k pre-orders, the market demand is significant. In the week, US-based Greenlight raised a round valued at $2bn; it is an excellent time to be a bank for teenagers. It is interesting to me, though, that rarely do these services retain users past 18 (despite user demand). Also, the natural extension appears to be into managing family and household finances. Maybe we will see that in time, but it feels like tons of opportunity there not taken (yet).

Things to know 👀

1. Plaid raises at $13.4bn Valuation 

• Months after its $5.4bn acquisition by Visa fell through; Plaid is raising at a much higher valuation.   

• 🤔 My Analysis: This could not have played out better for Plaid.  The Visa acquisition minted Plaid as a category of company and major player in tech. The acquisition also validated fintech and arguably made fintech the hottest sector in tech. A year later, as Fintech reaches new heights, Plaid can now benefit from a white-hot fintech funding market they helped create.

• 🤔 My Analysis: Plaid now has capital for product development and M&A.  If they acquired 10% of the "Plaid for X market" companies, they'd expand their geographic footprint significantly. 

• 🤔 My Analysis: Plaid still suffers from performance complaints when connecting to accounts (particularly in the US). This isn't entirely their fault (as banks and other providers behind the scenes may be causing the issue). Being aligned with Visa might have helped normalize relationships with banks. But with this funding round, Plaid is now too big to ignore.

2. Riksbank CBDC Pilot Report released

• The Swedish central bank announced the end of its central bank digital currency pilot program.  Key findings include definite resiliency benefits using a blockchain and that it could meet all performance requirements.   The pilot tested offline transactions and found that CBDC is almost the same as cash legally (save for some operational considerations).

• Their next phase would be to test backward compatibility with existing rails, integration with the point of sale, consumer-friendly addressing, and crucially, "who runs the network and how."

• 🤔 My Analysis: With China recently CBDC piloting with 200,000 users, China is in the lead, and all other central banks are playing catch up.  

• 🤔 My Analysis: Sweden has always been a leader in removing cash and has a culture of well-managed public / private programs like Swish.  It is unlikely the European or US central bank will manage to develop at anything like the pace of Sweden or China. I don't think consumers will see CBDC in Europe or the US in the next five years.

• 🤔 My Analysis: If we see CBDC in Europe or the US for consumers, it is much more likely to co-opt a stablecoin (e.g., USDC, GUSD), leaving CBDC for central banks to solve for wholesale (institutional and cross-border) use cases.

Bonus tidbit: Clubhouse announced payments for creators in partnership with Stripe.  🤔 This tipping feature is a way to generate revenue for creators but not for Clubhouse. Clubhouse is selling this as a feature "the creator keeps 100% of the payment." The reality is it is to get around Apple's app store policy. The user covers the Stripe fee, so in effect, they tip 102.5% + $30c.  Fintech can't be revenue for Clubhouse, and Stripe is still getting paid. Will users be cool with that?

Good Reads 📚

1. The rise of embedded marketplaces

• Embedded finance puts payments, lending, and insurance inside a vertical SaaS platform (e.g., Toast for restaurants, Squire for barbershops).  Embedded marketplace allows these vertical SaaS platforms to buy the inventory or assets they need directly through the SaaS platform rather than via distributors, sales reps, or the supplier website.

• Embedded procurement becomes a logical place for these SaaS platforms, which have (for example) lots of restaurant customers and can use bulk buying to secure better pricing with suppliers. The marketplace data also becomes a natural jump-off point for asset or equipment financing (and area historically dominated by banks).

• 🤔 My Analysis: The banking product market now has way better solutions for SMBs and growth businesses directly (e.g., Brex, Ramp, Modern Treasury). It also has better solutions embedded directly in vertical SaaS marketplaces.  We're quickly heading towards an oversupply of finance, where the most delightful and problem-solving experience wins.

• 🤔 My Analysis: The worst place to be is an asset financing or supply chain financing division of a mid-sized bank. Unless you can make that balance sheet work for the new supplier ecosystem, of course, in which case, it could be a great place to be.

2. Investment banking primer and Credit Suisse / Archegos explainer

• When you see Credit Suisse lose $4.7bn, you have to wonder how that's possible.  Marc talks through investment banking and takes a risk, match risk, and source risk. In effect, risk a commodity that investment banks can sell, like canned tomatoes. 

• Marc talks through how competitive investment banks are and how often large trades become a zero-sum game in which another bank has to lose for you to win. In the past decade, European banks have performed poorly, and Marc believes it comes down to culture (you can change the head of a broom, change the handle, but it's still the same broom).

• 🤔 My Analysis: This is the most straightforward explanation of investment banking I've seen and is worth your time.

• 🤔 My Analysis: Capital Markets as an area for fintech disruption is still early. There are specialist fintech platforms aimed at larger banks and the buy-side.  But I'm most interested in fintech aimed at bringing the long tail into capital markets products. Pipe.com created a new asset class; perhaps Bondaval will too. These ideas have been around for a while, but perhaps their time has come.

Bonus reads: 

• Packy unpacks why Ramp has so much momentum (Includes a great perspective on "has venture lost its mind"). "Ramp's goal isn't to make the world's best corporate card; it wants to help companies spend less money." The corporate spend card is a trojan horse for CFO tools.

• Why 12% yields are common in crypto by Bloomberg's Matthew Lessig is a fantastic read. "The irony in the digital assets space right now is that while the global economy is awash in trillions of dollars in new traditional currency, not enough of it can get into the hands of crypto investors."

Tweets of the week 🕊

That’s all folks 👋