“What the [heck] is a bank branch?”

Each year, my highschool and college students are presented with a slide from the CFA Financial Literacy curriculum entitled: Big Banks vs. Small Banks. The material, developed no more than five years ago, argues one should consider the number of bank branches when deciding which bank to use. “A major benefit of bigger banks is they have more branches! More branches leads to better customer experience and added convenience...” It’s as if Bank of America sponsored the course.

Each year, without fail, hands shoot up from across the classroom. It’s always the same question, “What the [heck] is a bank branch?”

It is possible, someday in the not so distant future, we too may no longer know.

The information age, with an assist from a nationwide lockdown, has catalyzed the digitization of banking services like payments, cash management, and lending. Daylit is likely not alone in thinking we are just at the beginning.

“Lollipop on the way out.”

Today, the average person spends roughly 10 hours per day staring at a screen. That number surpasses 12 when you filter by the regularly employed. It’s only natural that banks are going digital to reposition themselves in front of the next generation of customers.

The challenge is, be it brick and mortar or online, we still don’t like going to a bank. It’s no coincidence that banks place a bowl of candy in the line. You are offered a lollipop on the way out to help justify the painful experience.

Dealing with finances, personal or as a small business operator, is often stressful stuff. We don’t check our credit score because we’re worried it’s low. We don’t look at our bank balances because we fear the same. When you add unnecessary hurdles such as a confusing process, excessive wait times or required travel, it’ll take more than a few suckers to get someone to engage.

The digital banking renaissance is supposed to solve for this. What we have found, even with endless automation and mobile convenience, is the industry is far from a satisfying solution (dare we say: several licks away from the center).

“Simple, fast, and here.”

Ask Kabbage 10 years ago and they would tell you they are changing the world. Ask BFS Capital (now Nuula) 20 years and they would argue the same. In fairness to these two disruptors, they certainly did.

Access to small business funding transitioned from hopelessly pleading with your bank to warding off MCA brokers “selling you cash” in under a decade. We won’t comment on whether these MCA options are any good (hint: they are not) but we will commend the creation of a roughly $100bn credit market.

These two businesses have dramatically changed. Yet, even with their new owners or facelift, we’d argue that they still miss on the three most important dimensions - simplicity, speed, and location. We can run them and others through the Embedded Checklist: is it simple, is it fast, and is it here?

Kabbage, FundBox, Pipe, [.... insert your favorite internet lender] are moving in the right direction. The web applications are designed to be simple - often allowing one to “connect apps” with a few clicks. The speed has improved - usually you’re funded within 24 hours. The location is creeping closer - online just like their customers!

That said, we examine these companies’ exorbitant cost of customer acquisition to suggest they are far from perfect options. Why is it so expensive to get and keep customers?

“Embedded sounds good.”

Technology companies have been making waves in the lending space for some time. Perhaps you’ve read our piece on the Big A.S.S lenders (Amazon, Shopify, and Square) and their success in small business financing.

The business case for technology vendors as lenders (“tech lenders”) is simple. Tech lenders generate real-time data that their customers rely on to make decisions on business operations. That same data can be used to assess credit quality. The beauty of this data, also known as Truth Files, is its immutability. Lenders and customers can put aside Akerlof’s lemon problem and trust the data is reliable and symmetric.

Technology companies are increasingly seeking tech lender solutions. The build, rent, buy discussion usually lands on “embedded sounds good.” Embedded finance companies are designed to easily consume the Truth Files, perform an underwrite, and then return the customer an offer. This can be any form of lending, insurance, banking, or payments solutions.

How does the average “embedded fintech” perform on the Checklist?

Simplicity and speed. These all depend on execution. The best embedded finance products must include a beyond simple application process and instant decisioning. This is typically born from management teams with years of small business funding experience - both underwriting and platform research.

Here. The execution on location is subtle but arguably most important. The customer should never have to leave their current webpage. Anything else is just a referral link.

“The most valuable real estate.”

Back to our Financial Literacy students. Where will the future small business leaders be spending their time if not walking past bank branches? We begin by defining a small business. In its simplest form, it is an organization made up of a product, data to fine tune it, and capital to execute on it. We recall countless stories of small business operators up at night staring at the computer screen. The decisions made to guide their business are driven by the data consumed from their technology vendors.

It should come as no surprise that technology vendors - POS, ERP, Payments, Ad-tech, Talent Management, etc. - will continue to see the most digital foot traffic and likely become the most valuable real estate for a financial institution.

Therefore, technology vendors should be ultra-selective - embedded finance platforms that do not check all three of the boxes (simple, speed, and here) run the risk of lost rent. If a customer cannot silently share data, instantly access an offer, or navigate the tools from their current webview it is not an embedded finance solution.

“So what’s the future?”

Building a fully embedded solution takes time and resources. The technology lift is an ongoing challenge, the underwriting efforts require a growing team, and the balance sheet management is not trivial. It is no surprise that many technology vendors are outsourcing these operations.

There are additional considerations including portfolio diversification, use of equity dollars, types of funding products, evolution of services, and cost of capital. We’ll drill in on the last one.

Banks do serve a few good uses beyond the occasional hard candy. Namely, their bank charter allows the institution to draw funds from the federal government at the lowest possible rates. Small or mid sized technology vendors rarely qualify for a bank line of credit. Their customer concentration, limited compliance, and platform equity risk scares off most banks and leaves alternative credit funds to fill the gap at higher rates!

So what’s the future?

Our vision is simple. Imagine one embedded finance platform that any technology vendor can easily install. The platform is designed with user simplicity in mind, offers instant decisions, and can be quickly launched or hidden without leaving the current webpage. It’s equipped with simple funding products designed for several use-cases (revenue-based finance, supply chain, etc). Customers can manage all of their finance products across several technology vendors or all directly from their mobile phone. And finally, since the borrower-base is sufficiently diversified, customers can access the most affordable financing options on the market. We believe this model exhibits the perfect embedded finance solution.

The banking world is quickly changing and today’s industry leaders will undoubtedly be disrupted. We eagerly await more innovation in embedded finance and invite you to join this discussion.