Investor pressure is forcing Fintechs to reconsider inclusion goals
Financial inclusion, especially providing services to those people and small businesses that traditionally avoided full-service banking, has long been a calling card for financial technology firms.
“We help drive innovation, inclusion and access across the industry,” boasted Chime, which since launching in 2013 has emerged as one of the biggest so-called neo-banks.
Near-zero interest rates and an untapped market of millions of adults helped industries flourish, from financial services firms to cryptocurrency startups.
But inflation and interest rate increases have slowed new funding to a trickle. As investors’ pressure for profit grows, so do concerns that fintechs will abandon their promises to cater to the underserved.
Consider online bank Varo Bank, which raised $510 million and boasted a valuation of $2.5 billion last September. Then, like many fintechs, it hit a wall in 2022.
With losses mounting, it laid off 75 employees, cut advertising and changed strategy, moving away from expanding its overall customer base and shedding what CEO Colin Walsh called “expensive customer acquisition” in an interview this month with Axios.
These expensive customers typically end up coming from black, brown and other marginalized communities that cost more to reach and generate the lowest revenues, said Mehrsa Baradaran, a professor at the University of California Irvine School of Law and author of the book “How the Other Half Banks.”
“When you’re squeezed at every end, clearly the least profitable are the first to go,” she said.
Acting Comptroller of the Currency Michael Hsu highlighted the issue this month at a fintech conference at the Federal Reserve Bank of Philadelphia.
“History is changing now. The story is now about profitability. It’s about unit economics,” said Hsu. “Where’s the inclusion in that?”
Usually unprofitable
About 80 percent of American adults use a full-service bank, but a report released this week by the Congressional Joint Economic Committee found that 40% of black Americans, 29% of Hispanics and more than 33% of households making less than $25,000 a year are still without a bank or sub-bank.
These consumers were part of the market many fintech startups targeted in the last decade. But they really caught the eye of venture capitalists in 2018.
Venture funds pumped $14.7 billion into 1,131 fintech deals with a total valuation of $83.9 billion in 2018, according to Pitchbook, a firm that tracks venture capital investments.
That jumped to $55.2 to 2,058 deals with a total value of $488.4 billion in 2021, Pitchbook found. The pandemic caused a “shift to move online, and fintech was a big beneficiary of that,” said Robert Le, a Pitchbook fintech analyst.
New funding has since fallen flat, as the Fed raised interest rates and inflation rose. According to Pitchbook, money into fintechs dropped from a breakneck pace through the first half of this year, with 1,181 deals valued at $18.8 billion through July.
And those who were already starting began to scale back. Klarna, a privately held Swedish BNPL and consumer finance company, announced plans to lay off around 10% of its workforce in May, after its valuation fell by more than half at the start of the year.
Chime in February confirmed plans to delay the long-awaited IPO, citing the collapse of fintech stocks and valuations of private fintech companies.
The falling private valuations mirrored the collapse of many listed fintechs. One example is buy-now-pay-later firm Affirm Holdings Ltd., which saw its stock collapse in the first half of 2022, down as much as 60% by April.
The other problem fintechs faced is that at this point early in their existence, many are not yet profitable.
“Fintechs are by definition growth companies, and venture-backed fintech organizations are typically unprofitable,” said Joe Zhao, a managing partner at Millennia Capital, a venture capital fund focused on fintechs.
Pension funds, family offices, foundations and other institutions that contribute to venture funds are starting to look for safer investments instead of riskier bets with fintechs and other startups, Zhao said.
“I’ve had conversations with CEOs and CFOs of portfolio companies and told them you have to cut costs,” said Zhao, a former Fed economist.
The first cuts will come to marketing budgets. If these are not sufficient, fintechs and other companies will start to cut staffing. Several fintech and crypto firms, such as Varo Bank, have announced thousands of layoffs this year.
Jonah Crane, a partner at Klaros Group, a financial services advisory firm, said the trend could lead to more customers being dumped because an acquiring firm is only interested in the technical side of a fintech, or their data is being used in ways that customers did. have not thought.
“You can have a situation where consumers’ data becomes the only thing to make money from, and the data can end up in places they might never have expected,” said Crane, a former Obama Treasury Department official.
Focus on core customers
The fintech fallout ripples in other ways.
Brex, a San Francisco-based fintech, launched in 2017 with a focus on venture capital-backed startups, primarily in the biotech and fintech industries. Airbnb was one of the early customers.
As the business grew, Brex began serving traditional small and medium-sized businesses, such as restaurants, retailers and independent operators like Debra Gail White.
White, a Los Angeles musician, approached Brex in 2020 for a business credit card and payment services for her small record label, 27 Club. The services came without any fees – Brex makes its money from reseller brokerage fees and flat fees for software subscriptions – and worked reasonably well. White says between processing payments and using the business card, she ran about $100,000 through Brex over two years.
Then the pandemic, inflation and the Fed’s interest rate hikes took a toll. Brex doesn’t appear to have a funding problem — it was valued at $12.3 billion at its last funding round in October — but realized some of its original startup customers might.
In June, Brex said it would drop thousands of small businesses from the platform to focus on its original and core customers.
Brex co-founder Pedro Franceschi called it “an incredibly difficult” decision in a tweet. “We learned that we could not serve smaller businesses well at the same time, and focus was the only way to deliver a level of service we are proud of,” he wrote in a blog post.
White says she would be willing to pay service fees to join the platform, but guesses “it’s faster and cheaper” to drop customers like her.
CFDIs Fill the Gap
Fintechs insist they will continue to push for greater financial inclusion even in the tighter economic climate. For some, the business model requires trying to get more customers, which should increase services to marginalized communities.
Companies like
And venture-backed firms with growth business models will have no choice, Pitchbook’s Le said.
“If you’re Chime, you can’t say you’re not going to serve lower-income customers because that’s their bread and butter,” he said.
Even as fintech values have fallen, Chime has expanded its offerings to include allowing customers to deposit money into Chime accounts at more than 8,500 Walgreens Inc. stores around the country as of June.
But other lenders are bracing for fintech to cut back, particularly small business borrowers.
Poised to fill the gap are community development financial institutions — small, community-based lenders that focus on providing financing to largely women- and minority-owned small businesses with less than $1 million in revenue, said Patrick Davis, senior vice president of strategy. at Community Reinvestment Fund USA.
The Biden administration has committed to more than $1 billion available through CDFIs for the smallest startups. Banks have also increased their contributions to CDFIs with the express goal of getting money to hard-to-reach small businesses.
“Fintechs don’t want to look at these startups at all,” Davis said. “CDFIs will.”
