The last 10 years of low interest rates led to a boom in fintech lenders. By focusing on innovation and optimizing the user experience, they challenged banks and that changed the game of financial services. But today’s recessionary environment is threatening their existence and giving the competitive advantage back to banks. This dynamic will threaten long-term progress in financial services if banks don’t carry fintech’s innovation torch.
Born out of the 2008 credit crunch and decades of stagnation in traditional finance, fintech lenders reaped the benefits of a strong venture capital market, made even stronger by low interest rates that dampened the relative returns investors could get from debt and made equity investments more enticing. This gave fintech lenders a decade of cheap money. They used it to profitably lend out money at a rate only slightly higher than banks, while offering a superior user experience. What followed was a decadelong boom as fintech lenders gave banks a run for their money.
Fast forward to 2023 — higher interest rates, disappointing stock performance and a looming recession are making VC investors much more cautious and risk averse. Put simply, there are fewer risky places to put your cash for higher returns. This presents a huge issue for fintechs that don’t traditionally hold deposits and rely on VC capital and private credit funds to lend. Banks don’t have this problem and are able to continue lending at the same cost by leveraging deposits, while the revenue they make from each loan soars.
Our recent research shows small-business customers are already feeling the pain, reporting their biggest qualm with the current credit market is the high cost of capital. Since the cost of a fintech loan compared with a legacy bank has increased significantly, even the smoothest customer experience won’t persuade someone to pay more for their small-business loan.
Many fintechs are laying off staff to gain efficiencies, and we’re likely to see a number get acquired or go bust as the market matures.
Canapi Ventures, which works closely with some of the largest banks in the country, says the current high-rate environment gives banks a substantial advantage over fintech lenders, since their core deposit base acts as sticky, low-cost funding that allows banks to continue originating at competitive yields.
“Nonbank lenders will continue to see their cost of funds move higher, in line with Fed tightening, either forcing them to raise rates on their products, or watch their margins get further compressed. We believe banks will capitalize on this relative advantage to make significant strides in their product offerings and technology stack differentiation,” said Jeffrey Reitman, a general partner at Canapi Ventures.
Banks were once forced to follow the lead of fintech providers as they set a new quality standard for products and customer experiences. Now that fintechs are struggling to compete, banks find themselves in an advantageous situation. However, in a recessionary environment where emphasis naturally shifts more toward reducing risk, the tendency will be for banks to take their foot off the gas when it comes to innovation. This cannot happen. It will leave thousands of small and medium-sized businesses missing out on the capital they need to survive and death to a decade of progress in financial services.
“Established banks have well defined and time-tested risk appetites,” said Justin Norwood, vice president of product at nCino, a market leader in cloud banking software. “In this macroeconomic environment, banks will be even more focused on proven, dependable strategies rather than experimenting with riskier innovative financial products that proliferated over the last decade.”
But this is no time for banks to relax. While the threat from fintechs has lessened, user experience as a competitive differentiator is here to stay, and the contest between banks themselves is heating up. In an economic downturn, banks must compete even more for the lower number of high-value customers that remain. Conditioned by a decade of fintech progress, these customers won’t settle for anything less than a seamless experience at an affordable price.
Banks have a golden opportunity to step up to ensure the innovation momentum we’ve seen in financial services continues. They must use this time wisely by investing in cutting-edge solutions, while they have the additional profit to do so, in order to settle the banks-versus-fintechs debate for good. Even if fintechs aren’t waiting in the wings to eat their lunch, banks must continue their innovative legacy for their own sakes and for the good of the industry at large.