Changing market conditions will revolutionize the Fintech industry

The rapid growth of the Fintech industry in recent years occurred within a decade exceptional economic climatei.e. extremely low interest rates (close to 0% or even negative), exceptionally low inflation (less than 2%), a flood of central bank cash and an abundance of VC cash.

This resulted in:

• Challenging times for incumbent financial players such as interest the spread was very low.

• Negative interest on business deposits and certain bondsresulting in scenarios that turn all traditional banking rules on their head.

• Loans and savings accounts with an interest rate close to 0, making it very difficult to make a competitive difference in the interest rate offered for current or savings accounts. As a result, value-added services and UX experience became more important, i.e. domains where neo-banks traditionally excelled.

• Insurance companies continue to face problems pay out the guaranteed interest on long-term life insurance and pension schemes.

• An overload of money flowing into VC and Private Equity companies as this was the only option for a decent return. This allowed entrepreneurs to play off different VCs and Private Equity firms against each other for the best possible valuation.

• Ever rising prices on the stock marketgiving rise to dozens of new trading platforms and bringing thousands of new investors (especially a young generation) to the stock exchange (for the first time).

Now that interest rates and inflation have risen significantly and VC cash is increasingly hard to come by, we have come to a a completely different economic climate. These changing market conditions are already having (and will continue to have) a significant impact on the Fintech industry.

In this blog we analyze how this will (potentially) affect and has already affected the Fintech industry:

• With less VC cash available (as investors become more risk averse and there are more options due to the increased interest rates) and asking for higher and shorter ROI (to compensate for inflation), valuations of Fintechs are now more realistic. This resulted in severe value cuts in new funding rounds (e.g. Klarna, Checkout.com or Stripe), but also in a decline in new unicorns rising up in the Fintech world.
  In addition, VCs ask for more concrete and shorter plans for a profitable business. This means that innovative Fintech start-ups with long trajectories to profit will be much harder to find in the coming years.

• As central bank interest rates increase, the interest rates offered to customers have again become a competitive differentiator. As such, there will be more price competition, i.e. with higher interest rates on deposits/credits, there is a greater margin to create a competitive difference. As a result, price comparisons will also become more important again.
  It will be interesting to see how neo-banks may react to this trend. On the one hand, neo-banks have lower cost-to-income ratios that allow them to return a larger portion of their income to their customers (in the form of interest), but on the other hand, as neo-banks often do not use the collected deposits to finance their own credit portfolio (as they often do not have a lending business), their income on these deposits can be significantly lower.

• Many neobanks have a business model intermediary fees from card payments. This was already a model that was difficult to be sustainable due to its low margins (especially in Europe). In a context of high inflation and high interest rates, this becomes even more unsustainable. This means that for neo-banks to remain relevant in the new economic climate, they must offer a broader financial product portfolio. As a result, they will start to look more and more like established banks, with all the associated problems and risks. See my blog “Neobanks should find their niche to improve their profitability” (2020/12/neobanks-should-find-their-niche-to.html).

• Following the collapse of Silicon Valley Bank (SVB), Signature Bank, Silvergate and Credit Suisse, customers have become sensitive to rumors of potential stability issues. Since neo-banks and Fintechs rarely have the same capital buffers (and regularly need to raise new capital to reimburse growth) as incumbent banks, even small rumors can be fatal. Neo-banks additionally have some other concerns, specific to the way they are set up, ie

• Many Fintechs only have one eMoney license or use the banking license of an existing bank. When depositors start to doubt whether these structures (cf. problems with the embedded finance provider Railsr) provide the same level of guarantee, this can become a problem.

• As neo-banks usually are purely digital, a run-on-the-bank can happen at lightning speed (as money can be withdrawn digitally). There is no bank that can withstand such a scenario and definitely no new bank. With markets that are very nervous, this can be potentially very dangerous, as the result of such a bank run is inevitably a bankruptcy or a forced takeover by another financial player within days (e.g. takeover of Credit Suisse by UBS or SVB UK by HSBC).

• The cost of living crisis linked to the staggering inflation also presents threats and opportunities as more and more people are having difficulty managing financially. Fintechs that can offer tools to help customers best cope with this will become more and more important, e.g. guide the customer to the cheapest/best possible way to finance specific projects and provide flexibility in credits (eg when they are unable to repay the debt) ), PFM tools, subscription management tools, agreements and repayments … These are all domains where Fintechs can excel, as they are all about guiding the customer through a good UX journey.

• Cryptocurrencies: Although cryptocurrencies were originally designed to be tolerant to inflation (even marketed as inflation protection techniques, due to the amount of coins in circulation, which is programmatically defined), in reality we see that they have a strong correlation with the stock market and thus also with interest rates and inflation rates. Additionally, in less financially stable times, people tend to experiment less and return to stable, less risky investments, which also has a negative impact on crypto businesses. Finally, there have been serious problems with some of the flagship companies (like FTX, but also Binance) in this industry. These problems started with over-speculation (too much leverage) in the bullish crypto market. However, when crypto prices fell, this had serious consequences for companies in the industry, and as always, the fall of 1 company resulted in a snowball effect in the industry, due to the high connectivity of various players in the industry. It will be interesting to see if the crypto industry can properly recover from this.

• The stock markets have fallen significantly (although some of the decline had already been recovered in recent months). This will make it less attractive to young and new investors, thus also affecting the Fintech trading platforms, which flourished from the booming stock markets in recent years.

• The flourishing BNPL market is clearly facing serious problems (cf. OpenPay stops its operations and the huge drops in value for Klarna, Affirm and AfterPay). This is caused by rising credit defaults (linked to the cost of living crisis) and rising cost of capital (due to rising interest rates and inflation). Currently, BNPL is usually offered free to customers (ie no interest), while merchants pay all costs. When interest rates increase, most of this increase cannot be charged to the retailer (whose margins are already quite low as well), making this model very difficult to be sustainable in today’s market conditions.

• Innovative Lending Tech Players, who base their credit scoring models on new types of data (such as purchase and financial transaction history, social media profile, telecommunications bills…) now have to deal with completely new conditions on which their models are poorly trained (such as training based on fairly recent data). This is in contrast to traditional credit scoring models for large banks, which are optimized on decades of financial data.

Clearly some Fintechs will face tough times, but this will force Fintechs to become even more customer-centric and innovative and will push them to be more cost- and profit-focused, rather than just on rapid growth. Some players will not survive this change in market conditions and others will be acquired, but some will also prosper thanks to the changed market conditions. For example, the infrastructure actors (such as PSPs, Open Banking engines or AML fraud checks) remain quite successful even in the new market conditions.

The hope is that most of the billboards of the Fintech industry, such as the biggest neobanks (e.g. Monzo, Revolut, Starling, NewBank, Chime, Varo …) and crypto players (e.g. Binance or Coinbase), can survive, as these form an inspiration for many bright people to invest or work in the Fintech industry.

Overall, Fintechs will must be adaptable and responsive to the changing market conditions to continue to thrive. This may require Fintechs to change their business models, find new sources of funding or develop new products and services that are more relevant to the current market. By being proactive and innovative, Fintechs can not only cope with the changing market conditions, but also position themselves for future growth.

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