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Fintech sector faces "existential crisis" says McKinsey

Fintech sector faces "existential crisis" says McKinsey

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."

Comments: (6)

A Finextra member
A Finextra member 16 September, 2020, 13:08Be the first to give this comment the thumbs up 0 likes

Pruning is sometimes neccesary to remove the dead wood and to give the sprouting branches a better chance of survival. During serious droughts, agressive pruning may be the only option to save orchards. Business is no different.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 16 September, 2020, 13:29Be the first to give this comment the thumbs up 0 likes

According to common wisdom, (a) If you have better UX / CX and give better service resulting in higher CSAT, you'd be able to cross-sell more products to your existing customers, AND (b) Neobanks have better UX / CX / CSAT compared to Traditional Banks. The Products / Customer metric reported in this article - 5 for Traditional Banks versus 1.5 for Neobanks - totally contradicts the common wisdom. 

From this, it follows that (1) The reported metric is wrong OR (2) Traditional Banks have better UX / CX / CSAT than presumed OR (3) UX / CX / CSAT have nothing to do with cross-selling success rates. 

Russell Bell
Russell Bell - Fastbase Ltd - Wellington 17 September, 2020, 01:591 like 1 like

The government response to covid doesn't resemble that of an orchadist aggressively wielding pruning shears.  More like fire-hosing liquid fertiliser in every direction including on barren ground.  Fintechs continuing to receive generous taxpayer funding is a sign of these strange times, one of many examples.  Welfare for the well-heeled.

A Finextra member
A Finextra member 17 September, 2020, 12:22Be the first to give this comment the thumbs up 0 likes

The customer rating on neobanks versus "incumbents" is obviously biased. Most people and companies still bank with the "incumbents" and have not left these. Most customers that use neobanks have only one product from them and the remainder of services in the "incumbents". The general public has not "voted with their feet. People replying on neobank attraction are the ones that recently elected to pick up a service from a neobank and are still pleased with their choice giving a biased result on these polls. Furthermore, banking is a reasonably low interest industry to the general public and in many such cases it it sufficient to be "good enough" to keep the customers. "Better" does not trigger the customers to move. Most neobanks still have not shown what their sustainable business model is and customers have not seen the pricing requirement, most services are for free for the customer and therefore neobanks run at a loss and will post corona have difficulties to get new investor capital to burn for operations and risk costs until they can evidence the positive business case and make the investors believe in a bright future. Asking for tax-payer bail out for companies that are not essential to society will not be successful. Governments are fully occupied in getting the economy to move at speed and need to borrow monies for that - with a better investor security than VC companies or neobanks could offer.  So available money will be siphoned by the governments to fund unbalance budgets.

Matthew Key
Matthew Key - keyinnovate.com - London 17 September, 2020, 13:17Be the first to give this comment the thumbs up 0 likes

The longer term benefits of Fintech- from secuirty to digital payments, will outweigh any short term but understandable investment fluctuation. I expect this sector to recover quickly.

A Finextra member
A Finextra member 17 September, 2020, 13:31Be the first to give this comment the thumbs up 0 likes

Unfortunately modern society is a delicate ecosystem. The corona disruption may take several years to overcome before we are in BAU state. Governments need to cater for feeding the unemployed, socio-economic disadvantage measures, rising health care costs and tax breaks to boost economy woith borrowed money  while the private sector adjusts to the new normal with large change pressures requiring investment resources in many industries.  If investment capital is scarce and not too inclined to take risks, it will remain to be seen if the PE sector can attract funding for their "fin-tech"  investment funds in the same volume as pre-corona.This is the essence McKinsey is talking about.