The fintech sector, made up of companies classified as using technology to make financial systems more efficient, has exploded since the 2008 global financial crisis. In 2010, for instance, global investment in fintechs amounted to around $9bn, but growing appetite for fintech peaked at $47bn in 2015, according to KPMG’s The pulse of fintech: Q4 2016
report. This fell in 2016 to $25bn. This figure was largely impacted by Brexit, fluctuating exchange rates and the perceived slowdown in China.
Despite the fall, there is little doubt fintechs are generating a great deal of interest among investors and that they are now an integral part of the financial services ecosystem. CB Insights’ Fintech 250
from June 2017 reveals that almost 10% of its list has now reached a $1bn valuation. Although many fintechs have brilliant ideas and a culture of innovation, very few are currently generating profits.
Indeed, even high-profile names like TransferWise and Funding Circle have struggled to be profitable, with the latter posting a £35.7m loss in 2016, mostly attributable to continued investment in technology, marketing and staffing, according to BI Intelligence’s Fintech profitability report 2017
With the losses stacking up, will we see a spate of merger activity?
Banks have courted fintechs for some time. Multinational Spanish banking group BBVA has adopted a strategy of acquiring promising fintech start-ups and has purchased Mexico’s Openpay, a B2B payments platform, US online bank Simple and Finland’s Holvi, a digital bank for entrepreneurs. Other banks, such as JPMorgan Chase (MCX), BNP (Compte Nickel) and Swedbank (Payex), have been acquiring fintechs too.
“It’s true that many fintechs are providing a solution to a very specific problem,” says Daniel Marovitz, former head of product management at Deutsche Bank and the fintech entrepreneur who launched Buzzumi – a video platform that helps contributors monetise their online communities. “While this means that they need scale to make money, it also makes them very attractive to financial institutions such as banks, who need the innovation and entrepreneurial spirit that the fintechs can bring to the table.”
That said, not everyone is convinced banks will build a portfolio of fintech capability. Fintech experts like Matteo Rizzi and Udoyan Goyal believe that collaboration is more likely. “I see a lot of partnerships developing over the next few years rather than banks actually buying fintechs,” says Matteo, a co-founder of SWIFT’s innovation arm, Innotribe, and an active voice on the fintech scene for some years. Link-ups have already started, with JPMorgan forming partnerships with companies like Bill.com and On Deck Capital, to name but two. Deutsche Bank has also made a foray into this market, investing in Trust Bills, a Hamburg-based fintech for trade finance.
Udoyan, co-founder of financial services and fintech-focused private equity firm Apis Partners, says banks will only acquire if there is something significant to be gained. “If there’s a competitive advantage, they will buy it. But sometimes they will invest in something that has the potential to become a market standard as part of a wider consortium to ensure they can be a driver of change, and sometimes they will just become commercial partners,” he says. In the world of fintech, significant gains often mean access to transformational technologies such as artificial intelligence, blockchain and biometrics.
"It's true that many fintechs are providing a solution to a very specific problem"
With the growing importance of big data, fintechs in that niche are attracting interest too. A group of US banks, including Goldman Sachs, Morgan Stanley, Citi, Wells Fargo and JPMorgan, have invested in data analytic company Kensho via the type of consortium Udoyan refers to. Another example of this approach can be found in Japan, where a group of banks is experimenting with a new fund transfer system based on blockchain technology.
According to a survey
of bankers by PwC, published in April 2017, banks are very much aware of the challenge posed by these start-ups. More than 82% of respondents said they are planning to increase investment in fintechs over the next three to five years. At the same time, they said they are concerned that around a quarter of their revenues are at risk from the competition posed by this sector.
Here to stay?
The changes in the financial system make fintechs an attraction and also underline that there is genuine substance and sustainability in the sector. While comparisons with the dot-com bubble are inevitable, fintech has grown in the aftermath of the crisis and is a result of the need for disruption in financial services. Additionally, the emergence comes at a time when regulators are pushing for change – a push that is supported by most of the world’s financial hubs, which are doing their best to attract leading fintechs to their cities.
Moreover, investment continues to flow into the sector. According to CB Insights’ Global fintech report Q2 2017
, up to the end of July 2017, almost 500 new venture capital-backed start-ups had come to market, raising some $8bn, compared with more than 900 raising $13bn throughout 2016.
This could change if market conditions become more difficult. “We’re still on the positive side of the curve in terms of innovation,” says Daniel, who is also a former chief operating officer of Earthport, a fintech that powers payment transactions for some of the world’s largest financial services companies. “I see the creative momentum continuing for the time being. If we see a market correction, and the current cycle tells us that we may not be far from that, some fintechs could struggle to get venture capital support when their next stage of financing comes around. There’s a lot of upside, mainly because of the lack of genuine innovation we have seen in financial services over the years.”
This article was originally published in the Q4 2017 print edition of The Review and entitled 'Survival of the fittest'. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.
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