Survival Mode for FinTech
The headlines for the FinTech industry are filled with high-profile acquisitions, companies going public, and a bank charter approval — all within the last 7 months. It would seem the investment community can’t get enough of innovative financial services firms and their platforms.
For founders of early stage fintechs and growing startups in 2020, this hasn’t been the case. Due to COVID-19, seed funding for new ventures and projects has dramatically dropped in the first half of the year (see chart below). These young firms are scrambling to make their next move: continue talking to potential investors, postpone a launch into the next year, or pivot to something new altogether.
FinTech’s First recession TEST
The FinTech industry emerged in the aftermath of the Financial Crisis on 2008 - 2009. For new and established fintechs, this is the first test of survival in a declining economy. Neobanks, alternative investment platforms, and crypto exchanges are all facing a drop in usage and volume. Customers are flocking to big banks as safe havens for deposits of government benefits and emergency savings. Despite the low interest rate environment and bank fees, the largest banks continue to see an increase in deposits and transactions.
For FinTech firms, this means less deposit interest revenue from existing customers. Without recurring fee income from transactions or monthly account management, even the most established companies are struggling to cover fixed overhead costs. In particular, challenger banks have seen a 15%-20% drop in consumer spending. Monthly interchange revenue (a critical driver towards profitability for neobanks and other fintech card programs) has dropped to all-time lows in 2020. The industry’s leading digital banks, such as Chime, must find new ways to monetize through existing clients and attract new customers.
OPPORTUNITY to be captured in lending
The industry has started to pivot towards lending in 2020. Installment loans, credit cards, and small business financing all offer a new source of income: loan interest revenue. FinTech companies had their sites set on lending in the future, but the current economic state is pushing both early stage and growth firms into action a lot sooner than expected. Within lending, credit builder cards and programs have made headlines in the last year. Kabbage, a leading provider of business lending for small business, recently announced that American Express will acquire them for $850M. New payroll and cash advances from fintechs have also helped minimize the need for expensive payday lending.
In a time of economic uncertainty and high unemployment, offering new credit is considered high-risk. However, innovative fintechs have been working through alternative lending criteria and scoring models over the last decade. Leveraging the volumes of data from financial services, startups have developed new underwriting factors and scorecards with improved risk profiling and lower default rates. The time is now to put these models to work for low or no-credit tiers of customers that can benefit from small dollar cards or loans.
fintech’s shining light
What has been a strength for FinTech is the need for all-inclusive digital access to financial services. Branch banking was already on the decline before the pandemic. Banks adjusted by cutting down on staffing and resources; these financial institutions are now cutting back on physical locations that carry unnecessary fixed costs in the current economic climate. Bankers and financial advisors, the core revenue-generating force in branches, have all started to go virtual with video appointments and calls. For clients still interested in meeting with someone in-person at a branch, they must make an appointment — through online banking (bank’s website) or mobile banking (app).
FinTechs have benefited with customers looking to avoid teller lines to make deposits or cash checks. Being able to deposit, make transfers, and send payments through an app from home had existed in the last decade, but mass adoption struggled as customers still leaned on banks for walk-in transactions and manual checks. Opening new accounts virtually has also increased from customers who have long relationships with financial institutions and credit unions due to the pandemic.
For customers that have been able to weather the effects from the pandemic, bank deposit rates provide no incentive to save. With the threat of rising inflation, individuals and business clients search for alternatives to diversify their liquid balances and earn higher rates of return. Robo-advisers, crowdfunding, real-estate platforms and other fintechs in the wealth management sector are starting to see a rise in demand in the second half of the year. New offers in credit-building (self-lender) programs and prize-linked savings have sparked interest as well.
DECISION TIME for fintech FOUNDERS
For FinTech founders and builders, a critical decision lies ahead as 2020 comes to a close. A revision on revenue strategy and business models must consider the following:
Deposit interest revenue won’t be a path for monetization until the Fed Funds rate (in the US) gets back to pre-COVID levels. Partner banks are struggling to pass back rates above 0.25% on savings. Companies that are claiming rates above 0.50% are paying out the difference from their own pocket as a bonus and not APY. These incentive programs are temporary bonuses and won’t lead to sustainable deposit growth;
Interchange revenue from card purchases for fintechs is at historic lows as consumer spending has dropped; customers have difficulty paying rent and mortgages, and struggle to find employment;
Lending is a new opportunity that can have immediate traction and profit from loan interest revenue, but requires more investment from capital providers willing to take additional risk in turbulent times. These investors have already cut back on startup investing and may be less inclined to provide loans to low-credit grade consumers and businesses;
Monthly fees are a final option, but go against fintech’s core premise of recurring maintenance costs. Companies offering a premium level or suite of services can find success here with a clear value proposition. 3rd party partnerships and discounts for customers can help build a benefits program worthy of a monthly fee.
Ultimately, for FinTech innovators building a new initiative or add-on service for 2020, differentiation will be the most critical factor. The industry has become saturated with the same business models of virtual banking, peer-to-peer apps, crypto and stablecoin platforms, and lending or investing marketplaces. Focusing your offering on Venmo, CashApp, or a known fintech provides nothing new to the market. Customers can easily choose an older, experienced company over a brand new startup. Providing something remarkable in today’s environment will require a new angle driven from solving a major painpoint with expertise and an innovative business model that can not only survive, but thrive in this economic uncertainty. //
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