Buddha: Everything Shall Pass (including many fintech companies)

Some Things Don’t Last

The Japanese have many expressions with no direct translation into English. Mono no aware is an example of one. The expression is linked to the Buddhist concept of ephemerality: everything must pass but, in the passing, there is beauty.

It explains the peculiar Japanese aesthetic that things that don’t last long are more beautiful. And it explains why the people of Japan have such an affinity with cherry blossom. The fragile flower blooms at the beginning of spring in brilliant light but then falls within days.

The history of technology is littered with companies that looked promising, and which burnt brightly for a period, but quickly withered on the vine. The question is will a lot of fintech companies prove to be as ephemeral as cherry blossom? And will we look back at some of the companies as examples of innovative beauty or opportunistic trash?

A lot of money and time has been thrown at the vertical over the last fourteen years or so. There have also been elaborate conferences in fancy cities around the world where beautiful “influencers,” amidst an atmosphere of money and promise, partied with nerdy dropouts and third generation trust fund kids. People declared devotion to functional things like payments, as if it were some profound religious calling. And one former finance titan got a tattoo on his arm celebrating a doomed financial experiment. But despite all the energy, the results have been somewhat underwhelming, to say the very least.

The Religiosity of Fintech

Fintech is a strange tech vertical when you compare it to other tech. It seems to encourage a missionary zeal amongst its practitioners and followers. The fintech fanatics like to throw out terms like “democratization of finance” as if it means something. According to them, fintech will be a panacea for the world. It will mean the unbanked can finally have a bank account and small businesses will finally get the financing they need to continue in business.

There is an anarchic sentiment in the rhetoric too, especially with crypto. Fintech will give power to the people and undermine the elites. The trouble is, as is the case with all revolutionary creeds, it’s not clear that fintech’s promise has lived up to expectations. Isn’t bitcoin ownership pretty centralized? Haven’t most crypto exchange billionaires made their money from excessive rent seeking from “retail investors?” Are commission free brokerages actually free?

And it’s also not clear which elites the fintech fanatics are referring to. Are we talking Jamie Dimon? The Fed? The Rothschilds? It sometimes feels like discussions are soundbite heavy but often lack historical context. How can you discuss financial history without having read Adam Smith, John Law or John Maynard Keynes? It’s table stakes, surely.

The elephant in the room is that most fintech is dependent on existing rails provided by incumbents. It is hard to break free from the status quo when most of the applications rely on existing frameworks. How does a neo bank just for the LGBTQ community (yes, one exists — as if sexuality has some impact on bank preference) ever get the scale needed without an established bank partner, for example?

The answer is it doesn’t. It will either provide a distribution channel for an old-fashioned bank into the community or just be absorbed by an incumbent in the end. That’s a nice trade for a strategic investor or a nice sabbatical for a mid-career banker but is it really that significant? I don’t think so. It has more to do with the inertia of large-scale organizations and their failure to get stuff done than true innovation. It doesn’t deserve the halo.

Fintech: A Real Conundrum For Regulators

If this newsletter is right and some fintech business models do wither away, it will be interesting to see how history looks back on this period of financial experimentation. Were the numerous fintech products profound stabs at innovation or were they just tech stacks cobbled together that, for the most part, helped people with no money spend more of it?

My guess is the verdict will be quite harsh, particularly if we continue to see more failures and scandals. The Wirecard failure in Germany in 2020 resembles the plot of the movie, The Big Short. The German regulators didn’t sufficiently monitor what Wirecard was doing. EY clearly didn’t fulfil their fiduciary duty either. History rhymes as Mark Twain noted.

Regulators everywhere are having a tough time with fintech, to be fair. At the end of the day, how do you monitor a company that acts like a bank but isn’t a bank? It’s not a trivial question and needs thinking through. The moral hazard that emerges is a sophisticated guy like Markus Braun, the old CEO of Wirecard, will find ways to hide things.

The news this week that the CEO of N26 was complaining about the increased pressure from the German regulator on him since the Wirecard scandal emerged is ironic. Isn’t that how it is supposed to work? Regulators exist for a reason. They are there to protect the financial system and the public. Everyone wants freewheeling “capitalism” until a ton of money is lost.

To be fair, some of the people working at the regulators now are very credible people. Gary Gensler of the SEC, although seemingly late to the party on a few things, is no dummy. It would be a mistake to dismiss him as fintech fanatics often do.

Banking is and will always be a boring (and hopefully prudent) business. The fancy UX on an app doesn’t change that. Aren’t we seeing that basic credit checks are subpar at the neo banks like Dave? Has anyone noticed how bad the bad debt problem is with BNPL plays? Perhaps we will look back in 5 years’ time and realize we should never have a young man with floppy hair running a financial institution again! Time will tell.

Let us hope the Germans get on top of it. For what is a conservative nation, which has rejected some of the excesses of corporate leverage elsewhere in the world, it’s had its fair share of issues with its banking system. Look at the mess a bunch of non-Germans caused with Deutsche Bank for example.

A Comparison With Micro Finance

Before we look at fintech’s short history (I exclude the founding of PayPal here, which was very innovative), it might be worth thinking through another financial innovation that has similarly fallen short of expectations: micro finance. It sheds light on why so much optimism has been directed at fintech and why it’s become such a cause for people.

Micro finance is a banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services. It is not new. It’s been with us for 50 years. It just became a topic of conversations at dinner parties of the affluent when Muhammad Yunus got his Nobel Peace Prize for it in 2005.

The truth is most of us are uncomfortable with the wealth poor divide. And it sickens us that poverty still exists around the world. As we have stopped giving charity to organizations every Sunday and because we have fully embraced the monetarist idea that anyone can sort themselves out with a bit of enterprise, microfinance is very appealing.

If all it takes is providing credit to the poor, then that’s good, no? If I give $200 to a farmer in Bolivia, and change his life, then why not? It makes me feel more comfortable about getting the express ski lift ticket for the winter holidays in Niseko. If George Michael is right, and charity is a coat we wear only twice a year, an app like Kiva lets us feel like we were doing more than most. Unfortunately, the truth is more nuanced.

There is plenty of evidence that microfinance has not worked out the way we thought it would. A loan can encourage entrepreneurial energy and business development in poverty-stricken areas, but it turns out that most people don’t want to run their own business; they want a job. How is that different from most white-collar workers who get laid off? Don’t most people want a long leash rather than complete freedom?

And given the only time Jesus got angry in the Bible was when he kicked out the money changers in the temple, one wonders what would he say if he saw the rates charged on micro loans? Te Creemos in Mexico is one of the most profitable banks in the world because all it does is micro loans. It seems it’s hard not to make a bundle when you charge 125 percent per annum. 125 percent per annum is real Merchant of Venice stuff.

As has been the case since Biblical times, however, such rates have very bad consequences for society. There have been many suicides of the indebted in places like India and Kenya. It’s even worse when you realize the debt collection involves brown skinned Lenny McLean types with cricket bats knocking on poor people’s homes.

Of course, for years we have ignored the issues and hoped for the best, or as George Michael would put it, “prayed for time.” The fintech movement from 2008 provided another vehicle for optimism. Perhaps a bit of software and idealistic young people would be able to change the lot for the common man and the very poor. Who doesn’t like a good David vs Goliath story?

It is this author’s opinion that we are starting to see similar inconvenient truths emerge now with fintech similar to what we saw with micro-finance. And IF we do see a recession, the bad loans people have got themselves into due to access to capital or stock market leverage will become much more apparent.

Fintech History: One Failure After Another

Fintech only really became a thing after the GFC. This was for a variety of reasons. First, the cloud made it possible to have more agile and flexible business models. For example, cloud technology enables Fintech companies to store and manage user data in a secured and trusted way.

Second, young people graduating after 2008 had a front row seat to what could go wrong with the financial system. The generation saw the limitations of the Fed’s omniscience and saw how banks could turn on borrowers in a downturn. Previous generations had seen banks turn on their borrowers (e.g. the early 1990s in the UK) but there hadn’t been any existential angst about the financial system for decades.

We forget but unlike today, there were very few people who even talked about the Federal Reserve before 2008. Ron Paul, for example, was perceived to be a whack job wanting it to be audited in the 1980s. And to be fair, the Federal Reserve was reasonably well respected from about 1985 to 2007. Volcker had succeeded in calming inflation. And Greenspan did a good job throughout the 1990s of acting like the father of all things rather than the wizard behind the curtain. The generation behind fintech, however, was much more aware of the underlying issues with the Federal Reserve and the banking system, thanks in part to the internet. And to be fair, there was reason to be optimistic about technology and finance. PayPal and M-Pesa by then had already been transformative.

Venture capital is, of course, the most important protagonist in the story. Low interest rates meant a boom in risk capital, epitomized by the explosion of venture funds over the last 10 years. Venture capital is, by its nature, part innovation, part showbiz and fintech represented an attractive narrative for the VC marketers to get behind, second only to “software will eat the world.” Who didn’t believe the way banking worked needed revolutionizing?

Fintech was also a great vehicle for venture capital firms to deploy the ever-increasing amounts of capital they received from allocators, who had grown tired of real mark-to-market. Most fintech companies had very capital hungry business models. Neo banks, for example, required large amounts of capital (mostly marketing expenses etc)! The total addressable market, a key slide in any pitch book, was always huge and the benchmarks for success were easily defined. If there was loan or deposit growth, more and more money could be invested at successively higher valuations. Ponzi scheme, anyone? The availability of wholesale funding from the sovereign funds meant lending in scale was also so much more possible compared to ten years earlier.

Against this backdrop, it’s hardly surprising we have had a boom in financial technology. And some of it has been good. Businesses have seen huge improvement in processes thanks to B2B payment solutions. It’s become so much easier thanks to solutions like Venmo to send money around the world. Digital lending to small and medium sized businesses has worked in many countries. POS systems have made life easier for retailers. And underwriting solutions for insurance risk seem to be credible.

But overall, the actual results have been a bit disappointing. The peer-to-peer lending hype of 2012 proved misplaced. It turns out that lending to strangers is never smart without a lot of due diligence. Crypto payments are dominated by the underworld and most of the projects are not well built (Solana). It turns out many dropouts should have finished their course at university. And as the economy stumbles, it’s becoming clear that some lending apps will produce large levels of bad debt.

If that was it, then it wouldn’t have been too bad but the vertical has also seen staggering losses thanks to a combination of youth, lack of experience and fraudulent behavior. Let’s recap:

Germany: Wirecard fraud lost US$12.5 billion

China: Ezubao fraud lost US$9.9 billion

USA: Lending Club stock collapse lost US$9.8 billion

UK/Oz: Greensill lost US$4.6 billion

USA: Greensky Inc stock collapse lost US$4.2 billion

USA: On Deck Capital stock collapse lost US$ 1.8 billion

USA: Funding Circle stock collapse lost US$ 1.5 billion

Abu Dhabi: Finablr stock collapse lost US$ 1.4 billion

As I write this, Celsius Networks, the biggest lender in the crypto currency world, and the poster child for decentralized finance, looks like it will see huge potential losses. When you are getting 18% returns, it turns out it’s always good to remember what Madoff did, I guess. Crypto bros would often argue the overcollateralization of their loans meant the volatility of the underlying asset wasn’t a problem. I guess you need a LOT of overcollateralization when the asset is as volatile as crypto.

BNPL: The Most Ephemeral Of Them All?

Thanks, in part, to a gifted entrepreneur in Australia, who saw an opportunity and went for it, BNPL became a huge global industry all by itself. In Australia alone, there were around eight listed companies — what does that tell you about group think amongst the “intellectual elite”?

It promised a new way of providing credit but in reality, it was a regulatory arbitrage at best based on a simple payment practice that has been with us since at least the Second World War at retailers, the lay by.

BNPL thrived on the fact that it was easy to sign up to the app and easy to get credit. These things tend to be ok in a bull market; they end up being horrible in a bear market. The business model made no money in good times and now that it seems the consumer is wobbling, the bad debt issue is raising its head. The market cap losses for the sector are huge and private companies like Klarna are being written down massively. When we look back at the last year, we might realize that the sale of Afterpay to Block was the greatest trade sale in history. Nick Molnar walked away with a fortune leaving Block with a massive headache.

It’s not just BNPL share prices that have been slaughtered. NuBank, the neobank in Brazil, is now way below the VC pre-IPO valuation and Dave is down massively from its high of US$15.35. Even Kakao Bank, which actually makes money, has lost US$15 billion from its post IPO peak, a 57% decline. Obviously, markets haven’t helped but there’s a real sense that you will lose your shirt if you own some of this paper right now, it would seem.

It’s hard to know where they go to from here. The banks before 2008 chased poor quality lending business. To drive growth to qualify for those ponzi-round valuations, many neo banks had to reduce quality standards and margins in a similar way. The Fed will bail out the incumbent banks if there’s a real crisis. The neo banks would be left hanging on the wire. My guess is the good ones will be merged into the main banks of each country. The bad ones will be shuttered.

Apple: Everything Grinds Towards It

In many ways, China is the role model for Western fintech. It is so much more advanced. But there are specific reasons why that’s the case, which would deserve a whole piece by itself.

If anything, if there is a to be a super-app like what Alipay or WeChat represents in China, it will be a firm that already has a deep ecosystem such as an Apple or even a Paypal. It won’t be a newly VC-sponsored start up. Apple has already successfully moved into a fintech favorite, payments. Apple is now a major player, boasting 50 million US Apple Pay users.

Over the last week or so, we have seen Apple announce it will enter the BNPL space. Affirm said it validated the space but isn’t that what start ups always say when they know they’re in really big trouble? How do less well capitalized start-ups compete with Apple’s scale? This newsletter thinks they can’t. Apple will win and embrace a whole range of fintech “products,” which really are mere features on a large platform.

Bank Reform vs More Pixie Dust

Venture capital funding into fintech remains very high although it has dropped off this year naturally. Behind the excitement, however, one wonders whether a lot of the money and energy is just being wasted. A more important question, perhaps, is does it really tackle the core issues?

The US Dollar banking system is not perfect by any stretch of the imagination but it’s not that bad. It’s expensive if I send money to the UK, but if I make a mistake, there is recourse. Is that the case with crypto? Even Steve Wozniak sent money to the wrong wallet and he’s a lot smarter than me, for example. And anyone who has worked on a trading desk should tell you T+0 is a stupid concept.

The reality is a lot of people feel nervous about transacting money. Will that change? Maybe not. Isn’t that why the mortgage broker industry still exists? Certain financial transactions are too large to be done via an app. The middle man will still probably play a role no matter how “advanced” we become.

What an average Joe wants from a bank is a safe place to put his or her hard-earned money and he wants access to credit for a house and perhaps for a business. It is the latter point where the banks fall down a lot. As Elon said, it’s easier for an 18-year-old to get 10k for a student loan than a business.

Shouldn’t we be tackling those issues in the Senate or in parliament? Should we be asking more from Jamie Dimon than we are? His declarations about bitcoin or the economy are great but we really want him to be lending more, no? Doesn’t the Fed want that too?

Banks should also not be so mercenary with overdraft charges. I don’t agree with Elizabeth Warren on many things but it was insane how much JP Morgan made on overdraft charges during 2020. Chime is trying to run a bank with no overdraft fees. It’s a noble goal but why wouldn’t we also make sure this is properly discussed in politics too?

The Japanese have the wonderful expression of “mono no aware” to express the bittersweet poignancy of things. In the West, we have the wisdom of Doctor Seuss. Doctor Seuss used to say: “don’t cry it’s over; smile it happened.” It has a similar meaning to “mono no aware.” (I know that’s a stretch, Japanese readers!). The question is if the fintech bubble bursts, will the only people smiling be the ones who passed the hot potato before it imploded? Jack Dorsey looks like he’s aged over the last month. He’s definitely not smiling. I’m guessing Nick Molnar is on a tropical island somewhere.

As always, thanks for reading.

Best regards

Mateen (https://discussthetape.substack.com/)

DISCLAIMER: None of this is financial advice. The opinions expressed are purely my own opinions and it is imperative for you to do your own research. They do not represent the views of any company I am associated with.