Fintechs are all the rage. Scarcely a day goes by without a new challenger bank or money app making headlines about how it seeks to disrupt traditional banking and solve personal finance problems.
As a result, capital is pouring into the sector – last year, global investment into financial technology ventures more than doubled to $55.3bn, according to Accenture.
But recent developments have caused concern. In July, challenger banks Atom and Curve reported losses of £80m and £10.6m respectively. Earlier this year, Monzo – arguably the poster child of the fintech revolution – recorded an annual loss of £47.2m.
Compounding these dreary financial figures were the recent comments by Maximilian Tayenthal, co-founder of the German digital bank N26.
“In all honesty, profitability is not one of our core metrics,” he told the Financial Times. “In the years to come we won’t see profitability, we’re not aiming to reach profitability.”
Those comments came shortly after N26 had secured $170m in venture capital funding, giving the unlikely-to-ever-be-profitable company a valuation of $3.5bn.
This cavalier attitude to the importance of profitability has been viewed as a red flag, and some are now warning that an economic bubble has formed in the fintech space.
In fact, Rich Wagner – the chief executive of Cashplus, a digital challenger bank established in 2005 – tells City A.M. that we are “past due” on this bubble bursting.
“This bubble is probably taking longer to burst simply because of the amount of capital sitting on the sidelines, waiting to be invested in companies that in the past would not have been investable,” he says. “It is certainly something to keep a watchful eye on.”
A monsoon of easy money
Wagner argues that this bubble has formed because central banks have slashed interest rates to record lows since the financial crisis.
“The risk appetite of the general population has changed because of the low returns offered by regular savings accounts, which has resulted in a number of private equity firms having substantially more money to deploy to increase the returns of what used to be normal savers.”
Many fintechs are now reliant on regular cash injections from these firms in order to survive. But if a recession hits and this money dries up, what will happen?
“The result will be that you’ll see either a consolidation in the market – as smaller fintechs get acquired by someone – or certainly an exit by some of the many players that we currently have in the fintech space,” he predicts.
If fintechs don’t see these risks, it may be because many of them are just a few years old and are only used to trading in a time of economic growth. This naivety from businesses that have never experienced a recession or downturn is now leading to more scrutiny by investors and commentators, argues John Mould, chief executive of ThinCats.
“We should look at fintechs as you would with any other sector,” he says.
“Is it growing, what is its cash flow, what are its costs compared to its revenues? If the numbers don’t stack up, then they are likely to fail.”
Part of the problem is that fintechs are trying to make revenue in unusual, innovative ways – like through leveraging data – rather than pursuing ordinary banking income such as from overdraft fees and credit facilities. This is harder to measure, and may have stoked fears of a bubble.
But even if the data model works out in the long term, if fintechs want to succeed in the near future, they will have to adopt more traditional models of profitability. Fergus Hay, chief executive of Leagas Delaney, points out that some firms are doing this already. But this approach also has its downsides.
“Monzo has recently shown bank-like behaviour with its latest ‘credit card rate’ loan offering,” he says.
“While this may assure shareholders and VCs, this comes at a cost to its progressive fintech brand identity. Others, such as N26 and Revolut, are championing subscription service fees akin to Netflix. Even Starling’s broker-style marketplace offers an emerging path to profitability, but potentially at the user’s cost.”
Norris Koppel, founder and chief executive of Monese, had a more positive view.
“Fintechs are here to innovate, challenge the status quo, and make customers’ lives easier,” he says. “With this comes new ways of monetisation and sources of revenue. At the same time, customers still want overdrafts, or need loans and savings. So traditional revenue sources will still be crucial.
“The difference is that fintechs can make these traditional products and services more accessible, while driving down the cost for customers, by harnessing customer data and through collaboration. This is something that traditional banks have failed to do.”
The risk of a recession
Wagner is even more negative, warning that those fintechs which have adopted traditional income streams are still failing to make money.
“The real numbers still show that they haven’t proven their revenue model, regardless of what angle you look at it,” he adds.
I ask Wagner if he can name any fintechs that he does like which could survive a downturn, and he comes up short.
“It’s really hard to name a successful model that’s currently profitable and launched in the last four years – that’s pretty sad.”
Of course, these concerns about fintechs presuppose that there will be an economic downturn in the near future that could burst the bubble. Is a financial recession or pullback likely in that timeframe?
The short answer is yes.
“Some countries are already in recession, and other economic indicators suggest that we are heading into a global slowdown,” warns Mould.
“What happens in recessions? Consumers put off spending decisions, and banks tighten lending. We’re very optimistic, but it’s almost certain that many businesses – fintechs included – will fail.”
Certainly, many fintechs are burning through cash in order to stay active, and the disregard for traditional profitability – as well as the massive losses they are reporting – should be a cause for concern to both investors and the customers who rely on the services of these firms.
But if there is a bubble in this space, a downturn in the sector may prove to be healthy, as it would consolidate the market and ensure that the best rise to the top. Then we’ll know which fintechs are truly being innovative, and which are just headline fodder.
Main image: Getty