Fintech’s Covid-19 Reckoning
By Dianne See Morrison for University of Oxford executive education course
Covid-19 has reshaped how consumers bank and pay, can fintech survive…and thrive?
By the time the World Health Organisation (WHO) declared the Covid-19 outbreak a global pandemic on 11 March 2020, technology sectors, including fintech, were already bracing for the fallout. Signs that this was a crisis of unimagined proportions were everywhere: China had locked down 11 million residents in Wuhan; the global economy was in freefall; and consumers were stripping bare supermarket shelves. Meanwhile, governments struggled and clashed over how to contain the steadily spreading virus. Amidst this backdrop, venture capitalists were reining back investments, leaving fintechs, many of which had pursued aggressive growth strategies, nervously eyeing their ever-shortening runways.
Fintech, once the darling of tech funding, wasn’t supposed to falter. From 2014 to 2019, fintech investment had been growing steadily, rising more than 25% each year. In 2019 alone, 24 new fintech unicorns were minted–eight of them in Q4. Yet falter it did. By mid-2020, global fintech investment plummeted to $25.6 billion, an 83% drop from 2019’s $150.4 billion, according to KPMG.
Early-stage startups have borne the brunt of the funding collapse. McKinsey has warned that the crisis poses an “existential threat to the sector” and that “...the path to profitable scale for many fintechs has been structurally altered.” Venture capitalists shared this caution. Radboud Vlaar, partner at Finch Capital, told Sifted, “There’s a risk that the foundations of the hyper-growth unicorn story implode like a house of cards.”
Sustainable No More?
What makes fintech startups so vulnerable in the current market? Fintechs small and large have followed a well-trod route: attract new customers, refine their offering, and monetise at scale to eventually turn a profit. To sustain this strategy, they rely heavily on continuous fundraising to keep growing. But if VC funding dries up, fintechs that have pursued this cash-burning business model — particularly the early to mid-stage firms that have not yet acquired a healthy amount of customers — will struggle. According to McKinsey, these startups will need “a laser sharp focus on expanding the revenue engines,” and will have to focus customer growth on the most “economically viable segments”.
Shifting away from this business model won’t come easily, and could undermine one of fintechs' biggest strengths: high customer satisfaction. In the UK, both Monzo and Starling, two of the country’s largest challenger banks, have introduced fees to generate revenues — and customers have noticed. One Starling customer noted that with its fees–including a £2 monthly charge and a negative interest rate on high bank balances–the challenger bank is now more expensive than historic banks.
Shifting Competitive Forces for Fintechs
The continued volatility of the ongoing pandemic has brought shifting competitive dynamics for fintechs, for good and bad. On the plus side, the pandemic has been a highly effective driver of digital adoption. As bank branches shuttered, and central banks began to physically disinfect bills and coins, consumers turned to digital banking channels as never before. A McKinsey survey conducted in April, encompassing France, Italy, the UK, Spain, and Sweden, found that 60% to 85% of respondents preferred to handle everyday banking transactions electronically — even, for the first time, customers over 65. And, while funding was significantly down compared to the previous year, KPMG reported that by 2020, VCs had still poured $20 billion into fintechs.
On the downside, the global economy remains in turmoil, and fintechs are vulnerable to market conditions. Klarna and Affirm, fintechs that allow consumers to buy now and pay later, may be hit when out-of-work customers default on loans. Similarly, SME banks, like Tide, may see fewer customers as more people wait to set up businesses. Even fintech sectors such as mobile payments, which originally saw a surge, are likely to shrink in overall payment volumes in 2020, thereby cutting into revenues.
Start-up Strengths
Where does this leave fintech in the age of Covid-19? Fintechs still enjoy many advantages: they are purpose-built for the digital world; they are typically more efficient and agile; they usually enjoy high customer satisfaction. Well-funded and profitable startups will likely better withstand the pandemic’s impact. Starling and its U.S. challenger, Chime, had both raised funding before Covid-19 struck. Also well-positioned are at-scale startups who have benefitted from the pandemic-driven shift in consumer behaviour. In June, Checkout.com, a global online payments processing fintech, raised $150 million in a Series B round for a valuation of $5.5 billion, thanks in part to the 250% “boom” in online transactions between May 2019 and May 2020.
However, as funding dries up, and valuations are tugged down, fintech has become “a buyers' market”, which could increase acquisitions from other fintechs or from incumbent or corporate investors. In April, Social Finance (SoFi), an online student lender, agreed to purchase payments tech firm, Galileo Financial Technologies, for $1.2 billion. In June, Mastercard acquired Finicity, a real-time financial data aggregation startup, for $825 million to strengthen its push into open banking. In August, American Express agreed to buy Kabbage, the U.S. lending platform for SMEs.
Financial Inclusion
As Covid-19 has spread across the globe, it has laid bare one inescapable fact: the poor and vulnerable are bearing the brunt of the collapsing economy. Yet, as businesses, governments, and societies reassemble in an increasingly virtual world, the pandemic has opened up an opportunity to prioritise financial inclusion for all. And, it makes economic sense. According to the World Economic Forum, widening access to financial services for low-income households and small firms boosts economic growth and reduces income inequality, while the IMF links digital financial inclusion to higher GDP growth. During the Covid-19 crisis, digital financial services demonstrated their ability to cut down on fraud and inefficiency by dispersing quick and secure payments to “hard-to-reach” citizens and businesses in Peru, Zambia, Uganda, and Namibia, among others.
Yet, far too many remain excluded–even in the developed economies. In the U.S., where stimulus payments were sent via physical paper cheques, CNBC reported that between 30 and 35 million payments, distributed in March, remained outstanding in April; by September, nine million citizens still hadn’t received them.
Written for University of Oxford Executive Education Course