2008 and 2020: Turnaround Points for the Financial Sector

It was not long ago that I found myself sitting in a cubicle at Freddie Mac, one of the “Government Sponsored Enterprises” in the US and a main character in the 2007 financial crisis. I was watching the unthinkable happen. At that time, we were witnessing what has since been dubbed “The Great Recession.” The world came crashing down for many, exposing the cracks in our highly interconnected global financial system. Of the roughly 12 years since, I would spend three working with some of the institutions responsible for weathering its impact, stabilizing the financial system and implementing recovery and assistance programs in the US, Asia, and Latin America.

As is the case with any crisis of that magnitude, the Great Recession resulted in some long-lasting changes, it also accelerated technology-driven trends that had been ongoing, and forced us to reimagine many things, affording us the opportunity to reinvent them. Despite the pain and suffering, these new realities, of course, bred opportunities. In the years since the crisis, I have transitioned into helping entrepreneurs, corporations and investors leverage technology to create new business models and spur innovation. We have seen first-hand how these trends result in new solutions and would argue that there is no industry where the resulting transformation has been more evident than in banking and financial services. As the transformation occurs, a few things become evident:

• The continued and accelerated rate of adoption of mobile devices and the internet have turned digital channels into the cheapest, most effective way to reach consumers, not only on a mass scale but also in the most relevant context and at the right moment. This massively increases effectiveness for companies offering products and services as well as value and convenience to end users.

• A secondary effect of this is the creation of massive amounts of data, which coupled with ever increasing computing power, result in deep knowledge of customers that is more relevant and accurate than, for example, information submitted in any credit form.

• In that context, the traditional banking model with its product-first approach, heavy reliance on physical infrastructure, and generalist and heavily centralized structure is not only expensive but also substantially less effective and inferior in its ability to create perceived value for end users.

• Compounding this, the risk-averse, tight-credit world that resulted from the crisis and the general discontent of consumers and distrust of banks opened the door for a fintech revolution where new entrants have focused on creating solutions that are customer-centric, digital-first, highly specialized and relevant.

• Ultimately, consumers are not seeking financial services. They are seeking ways to exchange and store value, consume what they need and invest in what they believe will generate value for them. Mobile devices and the internet are a far more efficient way to “bank” large, traditionally underserved segments of people. This is particularly true in places like Latin America, where we have focused most of our work.

• In this sense, the world does not need banks. However, due to the complex and heavily regulated nature of the industry, there are plenty of back-end functions that only properly organized and capable institutions can fulfill, at least for now. This backbone is essential to both fintechs and other entrants who may seek to embed financial services into their digital channels.

What has evolved, are the new underpinnings of the future of financial services, where, from a highly simplified perspective, three types of players emerge. 

• Channel and platform owners have the reach, brand power and relevance to consumers. In most cases, creating these channels comes at significant time and expense. However, once they exist, they have the ability to offer complimentary products and services like financing and insurance, which are highly valuable when offered within the right context. This can all be done at a zero or close to zero incremental cost of acquiring the customer, adding substantial value to the channel.

• Specialized fintechs focus on specific, more complex components and can be leveraged by channel owners and financial institutions. For example, payment platforms, alternative data credit-scoring models and loan underwriting and servicing.

• Banking platforms, using an “as a service” model offer channel owners and fintechs the access to licenses, risk management, regulatory compliance and other specialized core banking functions, while allowing consumer experts and specialists to design and deliver the services.

There is the potential for massive value creation in the interaction between these players, where the scale, efficiency, and relevance of financial services will continue to grow exponentially. The combined market size of these business models, which have been dubbed “Banking as a Service” and “Embedded Finance,” is estimated to reach US$2 trillion within the next 10 years, according to research by Simon Torrance and others.

WHAT THIS MAY MEAN

Today’s pandemic and resulting recession may be like no other in its speed, depth and intensity. Although its full long-term structural effects remain to be seen, one of its most salient legacies will certainly be the millions of people and businesses forcibly coming online, particularly in geographies with proportionally lower penetration, such as Latin America. There is pressure to create better and more efficient digital channels and trends like the “gig economy” and self-employment, fueled by an ever-increasing number of online platforms, will continue and intensify. As a result, consumer and business demand for financial services will continue to evolve, opening up new opportunities for sophisticated channel owners and fintechs, resting on an increasingly robust banking “platform layer.”

In Latin America in particular, there are localized challenges and opportunities that channel owners should consider as they prepare to take advantage of these dynamics. For example, large retailers should not only be thinking about expanding their traditional digital channels, but also on leveraging their scale and efficiency to further penetrate the market in partnership with smaller players and corner stores that comprise the majority of commerce in the region, embedding financial services throughout. In turn, large manufacturers should be looking to partner with banking platforms and fintechs, leveraging their own proprietary data and understanding of their value chain to embed financial services across their different components. Finally, banks should consider offering their core know-how as a platform, partnering with fintechs and channel owners to more efficiently provide relevant and contextually driven financial services.

Ultimately, the opportunity is that when the dust settles, we will herald in an era of substantially more inclusive financial services, providing an engine for recovery and future economic well-being that could transform the region.