The past three years have been good to most fintechs, spectacular to some. During the pandemic, stay-at-home banking and shopping surged, funded by unprecedented government stimulus programs. Venture capital seemed limitless and public policy continued to favor credit accessibility to all. As a result, virtually all boats rose with the tide and all business models looked pretty good, even the zombies.
Then the tide began to turn.
Today, inflation and rising rates have eroded deposits and lending volume, partner banks are increasingly concerned about credit quality, investors are keeping their powder dry and regulators are getting more aggressive. It’s a recipe for contraction at the least, and many are asking if a shake-out, long anticipated by many industry analysts, could be upon us.
Despite the headwinds, Curinos believes that fintechs can continue to thrive if they have the right components in place, such as a model for efficient funding and a sustainable revenue-generating business model, and can manage both effectively.
Kitchen-Table Stress Means Funding Stress For Fintechs
While inflation is taking its toll on all households, it’s being amplified among many segments that have been drawn to fintech banks. Rates are up so loan demand is down, and those with existing loans are stressed, with defaults now exceeding pre-pandemic levels. Deposit outflows are increasing, and the value of those that remain is being eroded. There are fewer discretionary purchases funded through credit-accessible products like Buy Now Pay Later (BNPL). In short, inflation, rising rates and the looming possibility of a recession aren’t favorable for most fintech business models — and their funding sources are taking notice.
Although some fintechs have access to deposits through bank partnerships and bank charters, those that rely on funding from venture capital or private-equity firms may be more vulnerable if these investors continue to pull in their horns. Indeed, it is clear that many are already turning their attention elsewhere. Venture capital investments in fintechs in the second quarter of 2022 were down 17.8% from the first quarter, the largest percentage drop since the third quarter of 2018. Serial funding began to slide in 2016 and will likely continue. And exits — generally the last stage of venture capital funding — have stalled as IPO activity has come to a halt.
Public investors are also taking note. Shares of fintech Dave tumbled 97% from its January IPO as of mid-November amid widening losses and concerns about the company’s exposure to short-term consumer loans. Similar concerns have taken Upstart’s share price down 95% from its high in just over a year.
Even access to low-cost deposits, the alternative to investor capital, is becoming less reliable. Fintechs that are authorized to take their own deposits are paying more for them as competition intensifies, and those that rely on bank partnerships are finding that many of these banks have a diminishing appetite to fund higher-risk lending with their deposits.
The Sheriff’s Getting Tougher
Another source of stress for many fintechs is increasing scrutiny from regulators. The Consumer Financial Protection Bureau (CFPB), which promotes accessibility to credit to underserved segments as part of its mission, is cracking down on certain practices. Among its targets for enforcement are subscription pricing, BNPL and military lending in addition to fraud and preying on vulnerable customer segments. Examples of recent actions include:
- Subscription pricing: Online prompt for activation of a paid subscription disguised as a prompt to participate in a charitable event
- Military lending: Imposing membership fees that, when combined with loan-interest-rate charges, exceed the annual percentage rate cap of the Military Lending Act
- Preying on segments: Originating loans to consumers who didn’t request or authorize them
Because the CFPB has said that it is broadening its oversight beyond the biggest fintech banks, many more fintechs will likely come under scrutiny. In addition, the bureau is beefing up its monitoring efforts to anticipate illegal schemes and take preventive actions. Recently, the ripple effect emanating from crypto exchanges on partner banks’ deposits has also been on the bureau’s radar screen.
What Will It Take To Win?
As they confront the triple-whammy of a shaky economy, evaporating investment capital and stricter enforcement, what will it take for fintechs to succeed?
To emerge as winners, Curinos believes fintechs will need a threefold defense. First, in the absence of investor funding, access to enough customers to provide a reliable source of reasonably priced deposits. Second, a credit-worthy lending portfolio. Third, for those less reliant on NIM, a fee structure that is economically sustainable and CFPB-friendly.
The percentage of fintechs with all three is modest. Those with none, although few, do exist and could be among the walking dead. The remaining firms have one or two of these attributes that will have to be put good use to
For example, a business model that’s unique or relies on specialized lending may have continued access to capital markets and therefore not need deposits. A fintech that has reliable access to low-cost deposits may be able to survive even with a me-too value proposition as its less solvent competitors melt away. A firm with a strong lending portfolio may be able to weather the storm even if it’s doing less of what it’s done in the past.
But in all cases, one thing is clear: in their zeal to get though the cycle, fintechs will need to be wary of cutting regulatory corners or otherwise engaging in behaviors that attract the attention of an increasingly vigilant public sector.