How would FinTech respond to a recession?

Following the steps taken by the US central bank, the Bank of England has increased interest rates to 1.75%. Now at its highest level in 27 years, the move is part of the central bank’s strategy to curb spiraling inflation.

Still, the interest rate announcement was followed by a warning from the governor of the Bank of England, Andrew Bailey, who acknowledged that the economy is heading for recession.

At a time when the private sector is scrambling to recover from the COVID-19 pandemic, the announcement has been met with caution. Analysts are now assessing how various sectors will perform in a recession, including FinTech.

Companies that have drastically increased their workforce during the pandemic are now at risk of being overstaffed. Valuations can also be affected, as well as long-term investment activity.

Given the relative infancy of FinTech as an industry, a recession can have significant implications. Would it finally halt the momentum that has fueled FinTech growth for the past decade, or will it start a new wave of innovation?

There is also a larger question about market sentiment towards FinTech companies and big banks, and how both entities are positioned to support the needs of their customers during a recession.

The bank crash

FinTech was a product of a crisis. It arose out of necessity, responding to an era when banks and major financial institutions were unable to meet new market conditions caused by the global recession. Their complacency with legacy systems and resistance to innovation was a product of their industrial monopoly – with no real challengers, there was little impetus to change their ways of working.

The global recession changed all that. In the following years, a wave of new institutions offering digitized and sophisticated banking services led to the emergence of the FinTech sector. Banks had been undermined by innovation, forcing them to transform how they operate and take into account the services provided by FinTech startups, including challenger banks.

Rising interest rates, rising inflation and market volatility have made the possibility of a recession all the more likely. What does this mean for FinTech? Based on history, there are two potential scenarios.

Scenario 1

The first is the end of FinTech’s disruptive run. In short, a recession will be detrimental to FinTech startups, which lack the capital and assets of bank competitors to withstand significant market pressure. Evidence of this scenario is reflected in recent company ratings and recruitment cuts.

Buy now, pay later platform Klarna’s valuation fell 85% to $6.7 billion in July. Recently, trading platform Robinhood said it has cut just under a quarter of its staff, citing high inflation and the crypto market’s trading volatility.

Scenario 2

The second scenario is more optimistic, expecting a repeat of the FinTech innovation seen in the years following the global financial crisis. As before, FinTech companies would take advantage of their agility and offer tailored products and services to support consumers, businesses and investors during the recession. At the same time, a new generation of FinTech companies may also be on the rise.

Investment activity in FinTech supports this forecast. For example, in June, London FinTech Summarize raised a £507m funding round giving the company an enterprise value of €6.9bn. Data from Innovation Finance also shows that UK FinTech investment grew to $9.1 billion in the first half of 2022, representing a 24% increase on the figure recorded in the first six months of 2021.

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Economic challenges

There is also a role for FinTech startups to play in supporting companies and individuals in dealing with the financial challenges that a recession brings. As covered on BusinessCloud, Cleo raised £66m in Series C funding in June to support the financial health and wellbeing of Gen Z.

Obviously, with a recession looming on the horizon, there will be challenging conditions to navigate. However, this is the reality for all financial institutions, including large banks.

Regardless of which scenario unfolds, the fact is that FinTech companies will remain an integral part of the future of financial services, ensuring that they can respond to changing market needs through the efficient deployment of next-generation technology.