Europe's fintech sector faces an "existential crisis", says McKinsey, as sources of funding dry up during the ongoing Covid pandemic.
To navigate the economic fall-out from Covid-19, Europe’s fintechs will need to adjust their playbook, says the consultancy, which points to a deep drop in funding for the sector.
After growing more than 25% a year since 2014, investment into the sector dropped by 11% globally and 30% in Europe in the first half of 2020, says McKinsey, citing figures from Dealroom. In July 2020, after months of Covid-19-related lockdowns in most European countries, the drop was even steeper, 18% globally and 44% in Europe, versus the previous year.
"This constitutes a significant challenge for fintechs, many of which are still not profitable and have a continuous need for capital as they complete their innovation cycle: attracting new customers, refining propositions and ultimately monetizing their scale to turn a profit," states the McKinsey paper. "The Covid-19 crisis has in effect shortened the runway for many fintechs, posing an existential threat to the sector."
Analyzing fundraising data for the last three years from Dealroom, the consultancy found that as much as €5.7 billion will be needed to sustain the EU fintech sector through the second half of 2021 — a point at which some sort of economic normalcy might begin to emerge.
It is not clear where these funds will come from, however. Fintechs are largely unable to access loan bailout schemes due to their pre-profit status. In addition, government-backed wage support/furlough packages have income caps well below the typical salaries of fintech engineers and other skilled talent, which represent a large proportion of the fixed costs of these businesses.
"While the VC and growth investment community will continue to back some companies, they cannot meet the aggregate demand on their own," believes McKinsey. "European governments have stepped in to help, but they too are only a stopgap. For instance, the UK created a coronavirus Future Fund to invest in growth sectors of the economy, of which £320 million has been dispersed to fintechs through a convertible loan that matches funds raised from venture investors. Germany and France have also launched similar funds."
Sub-sectors such as digital investments, digital payments, and regtech, which have had tailwinds from crisis-related changes in behavior, appear set to take a greater share of the funding pie, states the firm.
However, digital banks like Monzo with a cash-consumptive business model that requires continual investor funding, face a worrying future.
On average, customers at digital banks hold 1.5 products, as compared to five for traditional banks, according to a 2018 McKinsey survey. In addition, digital banks rely on transaction fees and commissions for the bulk of their revenues, and only a few have been successful in having customers sign up for a subscription/account fee.
"Fintechs that are skewed towards customer acquisition (as opposed to driving positive unit economics) are particularly challenged," states McKinsey. "Given the contracted funding environment, many digital banks cannot sustain a cash consumptive business model in the medium term. Instead, a laser-sharp focus on expanding their revenue engines, coupled with a shift in customer acquisition strategy to pursue more economically viable segments, will be required."