But as the dust begins to settle, it seems this 12 months of catastrophic destruction has hit the upstarts harder. There’s been a string of collapses, takeovers and little to note in terms of substantial market gains globally – even for the highest profile buy now, pay later (BNPL) schemes. Meanwhile, incumbent, major banks have been picking up market share.
"The reality is in this era the digital mammals are not outcompeting the banking dinosaurs; nor are they an evolutionary dead end.”
And some of the collapses have been truly spectacular. Wirecard, the actually well-established German non-bank payments group, turned out to be a massive fraud and torched $US12.5 billion in value. Other failures weren’t as scandalous but one-time peer-to-peer lending darling Lending Club lost $US9.8 billion, Greensky $US4.2 billion, Funding Circle $US1.5 billion. All up, failures in the fintech sector are estimated to have totalled more than $US50 billion.
Neobanks – start-up, typically wholly digital, challengers – have suffered or evolved too. Some, such as Xinja in Australia, have handed back their banking licences. Others have chosen to take on a major partner like another Australian fintech start-up, 86 400, which was bought by National Australia Bank.
These are high profile events but – just like media stories proclaiming every new fintech is going to revolutionise banking – they don’t reflect the day-to-day reality of creative destruction. The fintech/neo-bank/non-bank universe is vast. The reality is in this era the digital mammals are not outcompeting the banking dinosaurs; nor are they an evolutionary dead end.
What we are seeing is really what we always see in periods of economic and technological upheaval: a constantly shifting environment where start-ups more often than not fail – but their ideas don’t always fail with them. Some are absorbed into existing institutions. And a few do succeed.
Nor are the investors in these start-ups all the same. Venture capitalists (VC), fund managers, hedge funds and banks all have different mandates and motivations. Most banks, while they may have in-house VC-like functions to gain access to deal flows, are looking for ways to improve their own operations – not make a 10-bagger on a particular trade or suddenly morph into a different corporate species.
Most of the engagement of the major players with start-ups receives little coverage as it is incremental not transformational.
For some years now the narrative around challengers has shifted, from taking over the establishment to working with the establishment. Start-ups offer innovation, agility and digital efficiency. But they typically lack customer bases, capital, scale and regulatory imprimatur – which incumbents have.
According to KPMG’s latest Fintech Landscape report, there are a total of 733 currently active fintechs in Australia alone, up from 629 in September 2019. KPMG noted an increase in the number of fintechs “within the lending category supported by new players in both consumer and SME lending sub-sectors, as well as an increase in BNPL providers”.
There was growth in blockchain and cryptocurrency-associated fintechs and – despite the headlines and regulatory complexities – further evolution in the neo-bank sector.
In its FinTech Australia Census, EY argues despite the pandemic “the Australian fintech industry is sustaining its revenue base, with more paying customers and plans for future global expansion”.
“Fintechs say this moment of crisis is driving a step-change in consumer digital adoption and has adapted quickly to grasp new opportunities,” EY said.
Globally, the situation is no different. Yes, there are unicorns aplenty in fintech and digital start-ups but there is still Citibank and HSBC. Rather, thousands of start-ups are invigorating and recasting traditional offerings and new products and services.
CB Insights’ latest State of Fintech report found “fintech finished 2020 on a strong note, with Q4’20 deals up 11 per cent, reversing the space’s four-quarter decline in activity”.
Neo or digital banks too are far from extinct. “Despite facing monetisation challenges, challenger banks remain formidable competitors for incumbents,” according to CB Insights.
And while there has been no shortage of notable failures, investors have hardly lost faith in fintechs and the digital revolution.
“Mega-rounds drove fintech funding in Q3’20,” CB Insights found. “The 25 mega-rounds ($US100M+ deals) in the quarter accounted for 60 per cent of total fintech funding — the highest percentage share since Q2’18.”
The other fundamental evolutionary force is regulation. Whether it be BNPL, cryptocurrencies, peer-to-peer lending or specialist digital banks, regulators can – and inevitably will – tilt the landscape.
If, for example, BNPL later faces regulation allowing merchant surcharging – so merchants can recoup the cost of offering the service – revenue will be hit. Capital or credit regulation can also dramatically impact business models. Moreover, history shows regulators tend not to act early but only when new players become big enough to be systemically important.
In the case of BNPL, currently favoured by equity investors and some banks, the UK Financial Conduct Authority (FCA) has already moved to regulate with a view to moderating consumer debt.
Nor are start-ups the only focus of regulators. According to Agustín Carstens, general manager of the Bank for International Settlements (BIS), the global regulator, “the entry of large technology firms (big techs) into financial services holds the promise of efficiency gains and can enhance financial inclusion. But the growth of their services raises questions on whether and how the regulatory framework needs to adjust”.
Meanwhile, even established banks have taken very different paths with new investment and digitisation. In Australia, along with NAB buying 86 400, Commonwealth Bank has invested in European BNPL Klarna and Westpac has a stake in Afterpay.
This bank, ANZ, has to date made eight investments via its ANZi innovation business in the fintech space but, as chief executive Shayne Elliott has explained, the motivation is enhancing product and service offerings to customers, not picking winners per se or partnerships which don’t dovetail with the bank’s strategy.
“We don't have a fund looking to make money,” Elliott said, adding being a venture fund is not part of ANZ’s strategy.
He says he’s looking for acquisitions or investments that can help ANZ’s businesses enhance the customer experience and technology which makes it not just better but cheaper. These investments are not revolutionary.
Equally, deals are not necessarily small or acquisitive: ANZ will form a transformative partnership with global payments specialist Worldline to manage its merchant services business, long considered a core part of banking but one which requires leading technology and huge scale.
There is no doubt the relationship between new and old in banking will continue to evolve. Fintech numbers – and the money invested in them – are growing; big tech is increasingly interested in financial services; incumbents are constantly tweaking their own relationships whether that be via M&A, partnerships, co-investment or simply cultural assimilation
But the ecosystem for fintechs and big tech is evolving too. As Grant Halverson, veteran payments industry specialist and venture capitalist, says “fintechs currently enjoy three advantages: record low funding rates, no need to make profits and - in many sectors - little or no regulations”.
“These ‘advantages’ will not last. Bond rates are already moving and interest rates will go up. This will directly challenge VCs and start-ups and could change investor pitches and resume the need for profits. Regulation always lags but it does catch up - timing will be key.”
Andrew Cornell is managing editor of bluenotes