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four years after its IPO, and appeared to have lost its way. Lending Club began as a replacement for banks, then was a vehicle for banks to return to personal lending, and finally became a bank itself. Lending Club bought Boston-based Radius Bank, known for its fintech-forward focus, and now seeks to reverse its fortunes through more traditional avenues.

The phenomenon of new companies, soon to be known as fintechs, taking over individual functions previously only performed by banks became known as the unbundling of banks. Banks offer a dizzying array of different products and services. This concept was once a selling point, that an individual or a business could get every product and service related to their financial lives in one place. They were built to be the one-stop shop for your financial needs. Checking and savings accounts, mortgages, credit cards, wealth management and investing—the list goes on, and your local bank can generally do it all. Before fintech, banks competed with other banks on price, and rates, and in some cases geographical convenience, but the products were generally all the same.

      The rise of fintech makes sense when you sit back and think about it. How could a single bank with a limited technology budget be expected to create a dozen first-class financial products serving all their customers in a customized way? Add to this that the thousands of community banks in the US lacked—and generally still lack—the technological resources to create top-quality digital products. While they have an abundance of data that should enable them to tailor their offerings, they typically don't have the technology or resources to extract the key pieces of data. Each bank is reinventing the wheel, with thousands of banks each building the same products in parallel and competing with the bank down the street, often while having the same core providers powering them. In general, bank products are generic. You and your neighbor may have very different financial situations, but you are both using the same financial products.

      Technology companies operate very differently. These companies are skilled at customizing solutions and offering bespoke options based on the sophisticated use of data about their customers. When this is applied to financial services, the result is an influx of fintech companies specializing in one service that they believe they can do better than anyone else. By offering what they think is a best-in-class product or service, they can own that piece of the pie. This “unbundling” applied to all parts of the ecosystem from international transfers (Wise), investing (Nutmeg), to lending (Funding Circle). To start out with, all of these companies focused on delivering a unique and smooth experience for this single service only.

Partner at Bain Capital Ventures, Matt Harris breaks down the evolution of fintech into two components. The first focus is digitization. As Matt puts it, “If you go back 20 years, that's what the world needed. All financial service companies—banks, insurance, and wealth companies—are extremely analog. This is true from account opening through to servicing, underwriting, everything they did required in-presence work and tons of paper.” The early fintech companies answered this need. Companies like OnDeck, Lending Club, Square, the first neobanks like Moven and Simple. These early fintechs took well-understood and utilized products and digitized them. While this sounds simple, it is actually quite hard to execute well and the companies that did got big rewards. Many of the companies that were created and grew from the first version of fintech Matt described have gone on to become public companies with valuations in the billions or be acquired for hundreds of millions. There was real traction here, but Matt questions how innovative it was: “It really wasn't changing much about those products other than the user experience. It improved the lives and experiences of consumers and businesses but it wasn't actually fundamentally disruptive.”

      So what does disruption in financial services look like? That is wave two, according to Matt. In wave two.

      Once you digitize these products, you can embed them in software that consumers and businesses are already using all day. By embedding it, you can make them less expensive and you can inform them with the data that these software products contain. Embedding is not an incremental step forward from that analog to digital phase. It's actually transformative, and we've got room to go here.

A prime example of this in action is through fintech companies like AvidXchange or Bill.com. Their account payable software allows companies to save an incredible amount of time by automating the process, which is a vast improvement from using a lock box operator. As AvidXchange shares on its website,¹⁰ the goal of the software is to “give teams the flexibility, security, and efficiency to approve invoices and make payments anytime, anywhere.”

The companies that utilize the data and resources around them to truly understand their customers are the best positioned to offer them financial solutions, which is another point in favor of embedded finance.

      With the advent of fintech, banks slowly came to understand they were not only competing with other banks, but with tech-forward upstarts. Soon they would realize there were even more competitors in the market than they dreamed of. If we look at the advantages of technology, data, and a deep understanding of your customer, it is reasonable to think that, at least in part, nearly every company in the world has the potential to be a financial services company!

      The new fintech companies focused their efforts on one product, or even one aspect of one product, and devoted their skills and expertise in order to execute it perfectly. With regard to lending in particular, bankers have long argued that Silicon Valley technologists lack the expertise to build the right product and manage the risk, but increasingly these functions are automated and software does the work. As financial services become more digital, technology companies feel more at home with these products.

      The first question investors ask entrepreneurs is often, “What problem are you solving?” Fintechs were developed to take on specific problems, such as consolidating credit card debt for which banks no longer delivered solutions. For the generation that came of age in the wake of the financial crisis, there was a feeling that banks were simple utilities rather than companies looking to delight their customers and deliver elegant solutions. And we will see later in the book on why this utility angle, called “banking-as-a-service,” is an opportunity banks cannot miss, given the opportunity it represents for them in the era of embedded finance.

Banks foreclosing on the homes of buyers who were encouraged to take out a loan they couldn't afford reinforced this perception. Fintech companies capitalized on this in the early days, emphasizing that banks make money when customers suffer, when they can't pay off their credit card balance every month, or when they overdraft their account. Customers wondered with some justification if their bank was even on their side. This misalignment of interest between banks and their customers led to further alienation and made consumers more likely to seek out nonbank solutions.

This misalignment is not just theory. In 2020, US banks in aggregate collected about $8.8 billion in overdraft fees. This is an unusually low figure from a very unusual year (Figure 2.1). The previous year, banks collected over $12 billion. JP Morgan Chase and Bank of America collect the most in absolute dollars, but overdraft contributes a smaller percentage of their bottom line than regional and midsize institutions.

Figure 2.1 Aggregate overdraft/NSF (non-sufficient funds) fee revenues by year in the call reports.

      Source: CFPB report Dec. 2021 / Consumer Financial Protection Bureau / Public domain

THE ENTRANCE OF THE NEOBANKS

      The unbundling of the bank continued throughout the 2010s, with virtually every banking function being reproduced and in most cases improved upon by fintech startups. Even backend functions that are remote from the customer experience were re-created by fintech startups.

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