Fintech isn’t just a hip portmanteau anymore. It’s a category of start-ups and fast-growing companies that has disrupted markets and incumbent firms around the world, attracting more than $30 billion in funding every year for five straight years. But the upheaval of Covid-19 will test many fintech firms, which will be hit by a double-whammy of challenging economies and a drop in funding.
We don’t yet know the full impact Covid-19 and its associated containment measures will have on our economies. At Forrester, we are forecasting three different economic scenarios – best case, more damaging, and dangerous. The second scenario is most likely, and assumes that virus containment efforts to “flatten the curve” of infection have partial success but don’t prevent a flare-up of the virus in the autumn or winter. It also assumes that stabilisation programmes are unable to halt the downward drag from fearful consumers and shell-shocked businesses. In this scenario, we forecast that 60 per cent of fintechs will exit the market, either as outright failures or low-cost acquisitions by tech vendors or incumbent financial services firms.
Why such a high share? The last six months have given us ample evidence of the stark realities facing fintech firms. Covid-19 has challenged the business models of direct-to-consumer fintechs such as challenger banks and peer-to-peer lending platforms. Many fintechs operate on narrow margins, can’t sustain large marketing campaigns, and need scale to achieve profitability, so the key to survival is acquiring new customers efficiently. However, the uncertainty has dampened consumers’ appetite for change. For example, UK current account switching saw a massive drop in Q2 2020. Whereas in March 2020, 113,037 current account customers switched to a new provider, this fell to just 27,965 by June. Customers often use digital banks as secondary accounts, which impacts challengers’ profitability. For instance, only about 30 per cent of active Monzo users used the bank as their main account in 2019 (the bank measures this as customers who have monthly deposits of at least £1,000). Convincing them to switch will be even more difficult now.
More than half of UK online adults have cut back on spending
Many fintechs have also seen a sharp drop in revenue as a result of falling consumer spending and remittances, and an increase in defaults. Lockdowns, furlough or unemployment have curtailed spending dramatically, with up to a third of French, Italian and UK online adults delaying big-ticket purchases such as cars and holidays due to the ongoing uncertainty. More than half of UK online adults have cut back on all but necessary spending. But many fintechs are reliant on income from card transaction fees. And analysts are forecasting a global reduction of $100 billion in remittance, which impacts fintechs such as TransferWise that have built a business on international payments. Fintechs will also not be able to compete on price for much longer. For instance, the UK’s biggest peer-to-peer (P2P) lender, RateSetter, slashed the interest rates it offers to savers by half in preparation for a wave of loan defaults.
But it’s not just the direct-to-consumer fintechs that will struggle. Those that have relied on selling their technology to banks will also face a much tougher environment. The pandemic and recession will drive European tech spending down, with 2020 tech purchases dropping by 5 to 7 per cent from 2019, with a 4 to 6 per cent recovery in 2021. But longer and deeper recessions would cause 8 to 9 per cent decreases in tech spending in 2020 and little or no growth in 2021. Many banking CIOs will try to protect investment in digital technologies and automation but will be forced to cut down on other areas of tech spending.
Monzo and Revolut posted losses of more than £100 million for 2019
Most fintechs will not be able to tap investors to help them weather this storm. Even before Covid-19 struck, many were loss-making, with investors happy to bankroll them in hope of future returns. For instance, Monzo and Revolut posted losses of more than £100 million for 2019. These losses will only widen in 2020, with all fintechs struggling to secure the same level of investment. Fintech funding has been declining since just before 2020, with funding plateauing in Q2 and Q3 2020. Private financing decreased significantly after recent downturns in 2001 and 2009, and this time won’t be different. We expect an acceleration of existing trends: investors hedging their bets with late-stage rounds in established, even crowded sectors such as digital banks, digital lenders, and payment providers.
So what does it mean for the future of fintech? Only those that have market traction, are profitable, or have already secured a big funding round will survive the impact of Covid-19 and the upcoming consolidation. Acquisitions will rise as incumbents and surviving fintechs pick over the carcasses. But those that do survive will face reduced competition and will become market leaders.
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By Oliwia Berdak, Research Director, Forrester