Embedded Finance Living Hell for Bankers, The Economist in Denial of Bank Fragmentation, India's CBDC has 3 Surprises
IMF says "stormy waters" and "the worst is yet to come" for the economy.
Cranial Gravitational Orbits, Rafael Sergio Silveira, 2012 The idea behind this art was that bankers will be staring wide eyed into embedded finance and having “cranial orbits” of their own! I thought it was catchy and I couldn’t bare to use images from Hell which are far too bleak! This is fun and get’s the idea of shock across nicely!
1) Embedded finance is living hell for bankers (2 parts)
2) The Economist in denial about global banking fragmentation!
3) India’s CBDC, 10 key design decisions, and 3 surprises!
4) IMF says “stormy waters” and “worst yet to come” for economy
What’s in it for you by subscribing? 1) CBDCs are coming and love ‘em or hate ‘em you want to see the future. 2) You want to see China’s fintech discussed without bias. 3) You want the week’s best fintech PDFs!
1) Why embedded finance is a living hell for bankers (2 parts)
Just got a subscription to Dall-E2 the AI picture generator! I had to test it out with this rendition of a “banker in hell.” Not half bad! Talk about disruption for illustrators?
Part 1: McKinsey makes it sound easy, it’s not!
McKinsey proclaims an “embedded finance revolution,” true but here's why this will be living hell for bankers.
In typical consultant fashion McKinsey makes embedded finance sound easy and cleanly lays out four key decision points for Banks.
Bankers reading these four key decision points should be afraid because they are far harder than McKinsey makes them out to be. Let's analyze:
🔹 Choose where to compete. For most banks with proprietary distribution, embedded finance represents a significant cannibalization risk.
Counterpoint: “Where to compete” is the hardest part! Banks will have to go “hat in hand” to big tech and other platforms to sell highly commoditized services. Then watch them compete with their established branch or corporate banking relations. I pity the banker selling these deals! I get that they have to do it but it won’t be easy! Commoditization means you can only sell price and maybe name if you’re a top 10 bank.
Apple Goldman is the closest thing to the celebrity “Brangelina” embedded finance marriage ever achieved. But for how long will Apple pay up? Can you see a day when Apple says “we want a better deal” and sues for divorce? What is Goldman’s balance sheet worth when a hundred others are available?
🔹 Build and enable a modern developer experience.
Counterpoint: I am sure that many forward-thinking bankers hoping to lead the charge of embedded finance at their bank were stopped dead in their tracks by the first meeting they had with their CTO! Embedded finance dreams collide head-on with tech stack.
This is why fintechs or digital native banks will dominate this market. They are tech-centric and will run rings around a typical mid-tier bank.
🔹 Adapt to B2B2C and B2B2B sales motions:
Counterpoint: Yes and this is what hurts the most! Banks think of themselves as your trusted partner. Embedding kills primacy in the banking relationship. For many CEOs this will be a tough transition.
🔹 Develop support and risk services.
Retailers, manufacturers, telecoms, and other distributors of embedded finance may not have the capabilities to build, sell, and service financial products.
Counterpoint: No doubt! Finally, McKinsey gives us something that the banks can really sell! Risk and regulatory departments will be critical. How banks digitize these to make them accessible to distributors will be key. How digital is your bank?
-Part 2: Bain nails it, but underestimates free payments
Bain talks embedded finance and warns that “traditional financial services have reached an inflection point.”
Bain nails it and produces a great report that will help you get a handle on embedded finance, but please ignore all the numbers including the following:
Bain predicts that the 2021 US market for platforms and enablers currently worth $22 bn will more than double to $51 bn by 2026. I don’t buy it, and neither should you!
Hold that thought and let’s focus on what Bain gets right:
🔹 Embedded finance can provide a much better value proposition. Yes, consumers don’t want to go to your stupid bank website, they want you to come to them.
🔹 The new value chain favors platforms. Yes, and as most incumbent banks are incapable of understanding what a platform is, this rules them out. Fintechs have a shot!
🔹 Traditional financial services have reached an inflection point. They can either step up to this opportunity or perish.
So what is embedded finance anyway? Bain’s definition:
“Embedded finance as a nonfinancial software platform providing an adjacent financial service, for which it takes some degree of economic ownership. This allows the platform’s customers to take advantage of a value-added offering within the native customer journey.”
It then goes on to define two versions of embedding:
• Thin stack: a deep reliance on enabling partners for infrastructure and domain expertise. Example: A bank on Amazon.
• Full stack: to being entirely insourced and owned by the platform directly. Example: A bank builds a platform.
Bain nails the fundamental reason why traditional banks must embrace embedding: they “face potentially deteriorating economics as providers of commodity services, and should view embedded finance as an opportunity to reinvent their core business.”
So $51bn sounds great right? There’s one problem. Bain conveniently ignores three disruptions coming to consumer payments, 60% of their calculated revenue stream.
The three disruptors are: 1) FedNow, 2) Stablecoins, 3) CBDCs. All of these will bring free, or near free instant payments to the US market! Granted CBDCs will come in around 2030 but they still can't be ignored.
Currently, the "take rate" on embedded transactions is a usurious 75 bps! That money belongs to you! Bain acknowledges a drop to 38bps for their calculations but who pays the 38 bps when payment is free? I don't buy it and neither should you!
Emedded Finance Takeaways:
As good as embedding will be for consumers, and I honestly believe it will be great, this will be a living hell for banks!
Traditional banks have no choice but to participate as their business faces “deteriorating economics” due to commoditization.
Because banking is highly commoditized, how long will it take before this seriously deflates bank margins? Embedding will hasten this process.
Large tech-savvy banks, fintechs, and neobanks are going to own this market. Most mid and small banks without tech will simply be sidelined.
Technically unsophisticated banks are going to get hammered.
Platforms will have their choice of partner and they know it. Banks are severely disadvantaged in these negotiations.
2) The Economist is in denial about global banking fragmentation!
Like a graffitti artist I take apart the Economist’s vision of banks getting together and singing Kumbaya in a period of war, sanctions and raising rates. Economist report: here
The Economist promotes three possible bank futures but is in denial as to how fast we’re fragmenting right now!
This is a solid read on banking’s future in 2035, but it made me mad! The Economist is either blind or in denial as to the speed of changes coming at us right now.
So let me say it even though it is perhaps more depressing than the Economist or sponsors SAS can stomach. Of the three scenarios they propose only the third, "a fragmented banking system" is likely and it will happen not in 2035 but in 5 years.
The Economist’s 3 scenarios are:
1: Transformed banks regain trust
2: Climate action paradigm shift
3: A fragmented world
Here are four reasons why this fragmented world is inevitable:
The Economist seems in denial over the magnitude of sanctions and their role in fragmenting the world today. The best examples are the Saudis in active discussion with China over buying oil in RMB, and India and China both buying oil from Russia in rupee and yuan all without rebuke from Washington. If that isn't fragmentation what is?
In 1971 John Connally, President Nixon's Treasury Secretary bluntly told a group of European finance ministers “The dollar is our currency, but it's your problem.” This comment is as valid today as it was then.
This is why a distressed Josep Borrell, the EU’s high representative for foreign affairs, said this yesterday:
“Everybody has to follow [USD], because otherwise their currency will be [devalued],” “Everybody is running to increase interest rates, this will bring us to a world recession.”
The US’s rates policy is not loved by all.
🔹 Tech war
Paul S. Triolo a friend from Twitter said it best in the FT a few days back:
“The US has essentially declared war on China’s ability to advance the country’s use of high-performance computing for economic and security gains”
The US actively trying to sabotage, delay and contain China’s advanced technology development. This is a whole new level.
🔹 CBDC and de-dollarization
Within 3 years you can expect all BRICS nations to have CBDCs. Do you think that they will all continue to use US dollars? Countries like South Africa and Brazil are already in difficulty due to the dollar’s rise.
Now one thing that should make this a bit less depressing. Even within this fragmented banking world, there is hope for climate action. China’s banks and many others are working on environmental finance programs. Even in a fragmented world, there is hope.
Depressing? No, just saying what the Economist would not.
Banking fragmentation is not a possible scenario, it is the only scenario
The Economist is in denial of the speed with which these changes will occur.
Climate goals can persist even with banking fragmentation.
3) India’s CBDC, 10 key design decisions, and 3 surprises!
Download Reserve Bank of India’s report: here
🔥NEW CBDC🔥 India’s CBDC, 10 important design decisions and 3 surprises you need to know!
The Reserve Bank of India (RBI) is a digital payments master and they have done a great job on this “concept note” that explains their CBDC thinking.
There are three big surprises in these design decisions:
1️⃣ One or two-tier design:
"Hybrid" or two-tier of course! By now this should not be a surprise.
2️⃣ SURPRISE 1: Wholesale and Retail!
BOTH! The RBI is doing something very interesting by separating retail and wholesale CBDCs! Two different systems with different technology for each! Read next…
3️⃣ SURPRISE 2: Token and accounts!
This is the biggest surprise! "The CBDC-W may be issued in account-based form, as legally, it attempts to offer instant settlement and their legal status is well understood and established."
CBDC-R will be a token-based system that would ensure universal access – as anybody can obtain a digital signature – and it would offer good privacy by default.
4️⃣ SURPRISE 3: Fixed denominations:
“Fixed Denominations as in physical currencies in denominations of Rs. 500, 100, 50 etc., shall facilitate in building the same level of trust and experience among public albeit in digital form.”
5️⃣ Remunerated or not:
Here the RBI obfuscates a bit in the text despite the clear-cut picture above. I do believe that they will go with non-interest bearing to minimize any reduction in bank deposits.
“DLT at this point in time is not considered suitable technology except in very small jurisdictions, given the probable low volume of data throughput. However, DLT could be considered for the indirect or hybrid CBDC architecture.”
Anonymity for small value and traceable for high value, akin to anonymity associated with physical cash. AML responsibilities could be handled entirely by the Payment Interface Providers (commercial banks). This arrangement means that the Bank (RBI) would not hold granular personal data on any user, reducing privacy concerns.
8️⃣ Offline use:
"In India out of the 1.4 B population, 825 M people have internet access. This means many Indians will not be able to use CBDCs due to connectivity unavailability. To ensure widespread use of CBDC, offline capabilities need to be incorporated."
9️⃣ Interoperable with UPI:
"An Indian CBDC should be able to utilise the current payments infrastructure like UPI, digital wallets like Paytm, Gpay etc."
Yes to programmability but the RBI doesn’t answer how. Smart contracts and specialized tokens will likely both be used as does China.
India is a digital payment leader and its wholesale and retail CBDCs will be works of art.
When India and China launch their CBDCs 36% of the world’s population will have access.
Watch carefully in Q1 2023 for trials to begin!
4) IMF says “stormy waters” and “worst yet to come” for economy
🔥Fasten Safetybelts🔥 IMF: the global economy is heading for “stormy waters”, “the worst is yet to come, and for many people, 2023 will feel like a recession.”
The IMF’s World Economic Outlook Report “Countering the Cost-of-Living Crisis” makes is clear: “the global economy is headed for stormy waters and financial turmoil may well erupt.”
The IMF’s forecasts are grim:
🔹 Global growth is forecast to slow from 6.0% in 2021 to 3.2% in 2022 and 2.7 % in 2023.
🔹 Global inflation is forecast to rise from 4.7 % in 2021 to 8.8 % in 2022 but to decline to 6.5% in 2023 and to 4.1% by 2024.
Normally I wouldn’t bother reading this report, but as you are well aware we are living in a period of war, supply chain disruption, and rising interest rates. Most of us are living in recession-like conditions despite the fact that one has not been “officially” declared.
This is certainly true in Shanghai where I live where China's Zero Covid policy has reduced growth to 3.2% the lowest in 40 years! China needs 6% just to provide employment to youth.
The IMF presents one of the more complete discussions of our current economic predicament that is worth reading. This is a long document but do read: 1) the Foreword 2) Executive Summary 3) Chpt. 3 Intro on decarbonizing.
I focused my reading on emerging markets as they are getting hit harder than most of us realize. A few sentences spin a story:
🔹 "For many emerging markets, the strength of the dollar is causing acute challenges, tightening financial conditions, and increasing the cost of imported goods. The dollar is now at its highest level since the early 2000s." (“The dollar is our currency, but it’s your problem.” Connally 1971)
🔹 "The sharp appreciation of the US dollar adds significantly to domestic price pressures and to the cost-of-living crisis for emerging market and developing economies."
🔹 In developing economies, up to half of household consumption expenditure is on food, meaning that inflation can have particularly acute impacts on human health and living standards.
🔹 The dollar’s appreciation in 2022—by about 13 % in nominal effective terms as of September compared with the 2021 average––is likely to have further slowed world trade growth, considering the dollar’s dominant role in trade invoicing and the implied pass-through in consumer and producer prices outside the US.
The story? How willing do you think these developing countries be to gradually de-dollarize?
- The outlook is grim with inflationary pressure devastating emerging markets.
- The rise in the dollar is the major but not only factor.
- Josep Borrell, the EU’s high representative for foreign affairs said it best: ‘We have to listen more . . . to the rest of the world. We need to have more empathy’
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Rich Turrin is the international best-selling author of "Cashless - China's Digital Currency Revolution" and "Innovation Lab Excellence." He is number 4 on Onalytica's prestigious Top 50 Fintech Influencer list and an award-winning executive previously heading fintech teams at IBM following a twenty-year career in investment banking. Living in Shanghai for the last decade, Rich experienced China going cashless first-hand. Rich is an independent consultant whose views on China's astounding fintech developments are widely sought by international media and private clients.
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