The Rise and Fall of Digital Disruption

Innovation in the Financial Landscape

Although the last two years will forever be remembered as a global health crisis, whose devastating effects were felt by all corners of the world, during this time the digital space relished an unprecedented amount of popularity, and FinTechs providing digital solutions to newfound pain points had customers, and funding, coming out of their ears.

As the global economy faced turmoil and insecurity, FinTechs saw an opportunity to offer services to customers who were previously unbanked or underserved. Unlike legacy financial institutions, whose fees are complex and administrative processes tedious, FinTechs providing Banking services opted for “freemium” models, eliminating overdraft penalties, account operating fees, and much more.

For the digital space, our pandemic-stricken world in which everything suddenly moved online cemented the idea that tech has become essential to modern-day life, and more than just “an option”. Millennials who came to maturity in lockdowns, who already had a predisposition for straddling between their real lives and virtual ones, adopted FinTechs and other digital services as part of a logical coming of age. For them, the digital phenomenon is nothing remarkable, meanwhile previous generations of young adults didn’t have access to loans at one press of a button, let alone one tap of a screen.

It is important to keep this in mind when observing the Rise and Fall of FinTech, and the way this has disrupted traditional financial services, as young people who have known nothing different when it comes to such services will not see it as a Rise, nor a Fall - it just is.

In 2021, a study by Ernst & Young found that from more than 5,000 US consumers surveyed, the only people who claimed to trust banks more than FinTechs were aged 65 and above. Everyone else trusted FinTechs over banks. This is significant, as although life regains a sense of normality post-pandemic, these few years have arguably changed consumer beliefs and expectations for good.

☝️ The Covid-19 pandemic accelerated existing market trends, whereby digital adoption was pushed into overdrive.

Even before the Covid-19 pandemic, according to CB Insights, 40% of consumers claimed that non-bank institutions were more apt at assisting them with their money management and investment needs. Come 2021, and securities and investment banks only accounted for 5% of total market cap gains during the pandemic.

Meanwhile, Specialist Players in Payments (predominantly FinTechs) reached a market cap value of $422 billion, at 23% of total market cap gains, and are now targeting all other key verticals in the financial services industry. Incumbents expect to risk losing as much as $280 billion in Payments revenue by 2025 competition increases.

When Block (formerly Square) was valued at $110 billion in 2021, this made it one of the most valuable FinTech companies in the world, and embodied the market’s gushing enthusiasm for growth potential, and highly-scalable tech in Payments.

👇 In 2022, however, decreased revenue from fees and commission, trading losses, and rising interest rates due to market volatility have compounded the pandemic’s consequences for both Traditional Banks and FinTechs alike.

Traditional Banks have been feeling these effects for some time - in 2020, the 10 biggest banks in Europe had an average Cost to Income ratio of 68.7%. As a result, many are reducing staff and closing branches in an attempt to scale back and redirect their investments to develop better digital infrastructure.

In Europe, Traditional Banks are underachieving compared to their US counterparts. At the end of 2020, Bloomberg Intelligence reported that the price-to-book ratio (value of shares divided by net assets) for Société Générale, Credit Suisse, and Santander were between 0.6 and 0.2. As they are below 1, this means that these banks are trading at a discount.

One possible explanation for this could be the success of FinTechs in Europe, and the general discontent for Incumbents which is felt more widely than in the US. In 2019, the FDIC released its annual household survey which found that almost all US banked households were in fact satisfied with their primary bank (97.3%), suggesting little desire to change banks.

In the UK and Europe, on the other hand, policymakers have created fertile ground for FinTech entrepreneurs, and given the region's small size compared to that of North America, Legacy Banks are now competing in a market saturated with alternatives.

Having said this, Incumbents aren’t the only ones to struggle. In Lending, just 6 months ago European Buy Now, Pay Later firms were predicted to reach a Gross Merchandise Value of $860 billion by 2028. Despite this, Europe’s biggest Buy Now, Pay Later firm Klarna recently underwent a painful 86% drop in valuation. Since 2019 it has also been losing money, hitting a loss of $730 million in 2021.

As for Neo-banks, Nubank’s stock has plummeted 61% since its IPO. Although it currently holds a 65% market share in Brazil, many of its customers are new to the banking system, and so their credit quality is hard to predict. In Australia, some Neo-banks have either been acquired or requested to return their banking licence, and Volt is the most recent example.

🤝 Given the increasing pressures and competition, Traditional Banks and FinTechs are mutually benefitting through Mergers and Acquisitions.

A cause and effect of market consolidation, M&A is being used more frequently between FinTechs and Incumbents than ever before. As of May, 2022, 8 banks were already in the process of acquiring FinTechs, and we expect this number to reach record levels by the end of the year. Both Incumbents and FinTechs are also investing in cryptocurrency technology, as well as increasing their focus on ESG values.

The relationship between the “old” and the “new” is one of love and hate - Incumbents are discovering innovative ways to save money, improve efficiency and attract customers, albeit under pressure from FinTechs. Legacy Banks are also assisting FinTechs in their expansion and access to licences in return for intellectual property.

As FinTechs take big risks with investors’ money, it is almost reassuring to know that most of them still remain small and flexible enough to be easily acquired - for some, we wonder if this is the end goal from day one. Although it could be seen that FinTechs pose great threat to Incumbents, these Legacy Institutions are partly the reason why so many FinTechs are able to exist, or continue to exist, as larger corporations provide the safety net of acquisition.

Co-branding is also occurring between Traditional Banks and BigTech, such as Goldman Sachs with Apple. As David Vélez, CEO and Founder of Nubank says, “There’s going to be a rationalisation of some of the FinTechs that are in the market… This will enable the survival of the fittest.”

The rise of digital disruption has had exceedingly positive effects on the world economy. It has also changed consumer trends forever, and so regardless of the ballooned valuations of the pandemic-era, and threats of an oncoming recession, Financial Technology is here to stay.

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