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Changing market conditions will revolutionize the Fintech industry

The rapid growth of the Fintech industry in recent years happened in a decade of exceptional economic climate, i.e. extremely low interest rates (close to 0% or even negative), exceptionally low inflation (less than 2%), a flooding of cash by central banks and an abundance of VC cash.

This resulted in:

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

  • Negative interest rates on business deposits and certain bonds, resulting in scenarios, which put all traditional banking rules upside down.

  • Credits and saving accounts with interest rates close to 0, making it exceedingly difficult to make a competitive difference on the interest rate offered for current or saving accounts. As a result, value-added services and UX experience became more important, i.e. domains in which neo-banks traditionally excelled.

  • Insurers facing issues to still pay-out the guaranteed interest rates on long-term life insurances and pension plans.

  • An overload of money pouring into VC and Private Equity firms as this was the only alternative for a decent return. This made that founders could play out different VCs and Private Equity firms against each other for the best possible valuation.

  • Ever increasing prices on the stock market, giving rise to dozens of new retail 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 increased considerably and VC cash is getting increasingly difficult to obtain, we have arrived in a completely different economic climate. Those changing market conditions already have (and will continue to have) a significant impact on the Fintech industry.

In this blog we analyse how this will (potentially) impact and has already impacted the Fintech industry:

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

  • As central bank interest rates increase, the interest rates offered to customers have become again a competitive differentiator. As such there will be more price competition, i.e. on higher interest rates for deposits/credits, there is more margin to make a competitive difference. As a result, price comparators will become also more important again.
    It will be interesting to see how neo-banks can react to this trend. On the one hand, neo-banks have lower cost-to-income ratios allowing them to return a bigger part of their revenues to their customers (in the form of interests), but on the other hand as neo-banks often do not use the collected deposits for funding their own credit portfolio (as they often don’t have a lending business), their revenue on those deposits can be considerably lower.

  • A lot of neobanks have a business model on interchange fees from card payments. This was already a model which 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 in order for neo-banks to remain relevant in the new economic climate, they need to offer a wider financial product portfolio. As a result they will start looking more and more like incumbent banks, with all associated issues and risks. See my blog "Neobanks should find their niche to improve their profitability"

  • After the collapse of Silicon Valley Bank (SVB), Signature Bank, Silvergate and Credit Suisse, customers have become sensitive for rumors about potential stability issues. As neo-banks and Fintechs rarely have the same capital buffers (and regularly have to raise new capital to refund their growth) as incumbent banks, even small rumors can be fatal. Neo-banks additionally have a few other concerns, specific to the way they are setup, i.e.

    • Many neo-banks have targeted a specific niche customer segment(like tech-startups in the case of SVB) which can have the negative side-effect of accelerating panic (as all customers of same niche are often using same media channels and have a high degree of social links).

  • Many Fintechs only have an eMoney license or use the banking license of an existing bank. When depositors start getting doubts if those constructions (cfr. issues with embedded finance provider Railsr) give the same level of guarantee, this may become an issue.

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

  • The cost-of-living crisis linked to the staggering inflation gives also threats and opportunities as more and more people have difficulties to financially cope. Fintechs that can provide tooling to help their customers to best cope with this, will become more and more important, e.g. guide the customer to the cheapest/best possible way to fund certain projects, providing flexibility in credits (e.g. when not able to repay debt), PFM tooling, subscription management tooling, deals and cash-backs…​ These are all domains where Fintechs can excel, as they are all about guiding the customer through a good UX journey.

  • Crypto-currencies: although crypto-currencies were initially designed to be tolerant against inflation (even marketed as inflation-hedging techniques, due to the amount of coins in circulation, which is programmatically defined), in reality we see they have a strong correlation with the stock market and thus also with interest and inflation rates. Additionally in less economic 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 issues with some of the flagship companies (like FTX, but also Binance) in this industry. Those issues started with over-speculation (too much leverage) in the bullish crypto-market. However when crypto prices dropped, this had serious repercussions 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 different players in the industry. It will be interesting to see if the crypto-industry can properly recover from this.

  • Stock markets have dropped considerably (even though some of the drop was already recuperated in recent months). This will make it less attractive to young and new investors, thus impacting also the Fintech trading platforms, which flourished from the booming stock markets in recent years.

  • The booming BNPL market clearly is facing serious issues (cfr. OpenPay stopping its business and the enormous drops in valuation for Klarna, Affirm and AfterPay). This is caused by increasing credit defaults (linked to cost-of-living crisis) and the increasing cost of capital (due to increased interests and inflation). Currently BNPL is usually offered for free to customers (i.e. no interest), while merchants pay all costs. With interest rates increasing, most of this increase cannot be charged to the merchant (whose margins are already quite low as well), making this model very difficult to be sustainable in current market conditions.

  • Innovative Lending Tech players, who base their credit scoring models on new types of data (like purchase and financial transaction history, social media profile, telecommunication bills…​) now have to deal with completely new conditions, on which their models are little trained (as training based on quite recent data). This in contrast to traditional credit scoring models of large banks, which have been 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 fast growth. Some players will not survive this change in market conditions and others will get acquired, but some will also flourish thanks to those changing market conditions. E.g. the infrastructure players (like PSPs, Open Banking engines or AML fraud checks) remain quite successful even in those new market conditions.

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

Overall, Fintechs will need to be adaptable and responsive to the changing market conditions in order to continue to thrive. This may require Fintechs to pivot 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 cannot only cope with those changing market conditions, but also position themselves for future growth.

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