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 the banks and that changed the game in financial services. But the current recessionary environment threatens their existence and restores competitive advantage to banks. These dynamics will threaten the long-term progress of financial services if banks do not carry the torch of fintech innovation.
Rising out of the 2008 credit crunch and decades of stagnation in traditional finance, fintech lenders reaped the benefits of a strong venture capital market, further bolstered by low interest rates that dampened the relative returns investors could earn. of debt and made equity investments more attractive. . This gave fintech lenders a decade of cheap money. They used it to profitably lend money at a rate only slightly higher than banks, while also offering a superior user experience. What followed was a decade-long boom in which fintech lenders gave the banks a run for their money.
Chris Ratcliffe/Bloomberg
Fast forward to 2023: Higher interest rates, disappointing stock performance, and a looming recession are making VCs much more cautious and risk-averse. Simply put, there are fewer risky places to put your cash for higher returns. This presents a big problem for fintechs that traditionally have no deposits and rely on venture capital and private credit funds to lend. Banks don’t have this problem and can continue to lend at the same cost by leveraging deposits, while the income they earn from each loan skyrockets.
Our recent research shows that small business customers are already feeling the pain, reporting that their biggest problem with today’s credit market is the high cost of capital. With the cost of a fintech loan compared to a legacy bank having risen significantly, even the smoothest customer experience won’t convince someone to pay more for their small business loan.
Many fintechs are laying off staff to increase efficiencies, and we are likely to see some acquired or go bankrupt as the market matures.
Canapi Ventures, which works closely with some of the country’s largest banks, says the current high-rate environment gives banks a substantial advantage over fintech lenders, as their core deposit base acts as rigid funding. and low cost that allows banks to continue to source competitive returns.
“Non-bank lenders will continue to see the cost of funds rise, in line with the Federal Reserve’s tightening, either forcing them to raise rates on their products, or seeing their spreads further compressed. We believe banks will capitalize on this relative advantage to make significant profits.” advancements in their product offerings and technology stack differentiation,” said Jeffrey Reitman, general partner at Canapi Ventures.
Banks were once forced to follow the lead of fintech providers as they set a new standard of quality for products and customer experiences. Now that fintechs are struggling to compete, banks are in a head start. However, in a recessionary environment where the emphasis naturally shifts more towards risk reduction, the tendency will be for banks to take their foot off the gas when it comes to innovation. This can’t happen. It will leave thousands of small and medium-sized businesses losing the capital they need to survive and the death of a decade of progress in financial services.
“Established banks have well-defined and proven risk appetites,” said Justin Norwood, vice president of products at nCino, a market leader in cloud banking software. “In this macroeconomic environment, banks will focus even more on tried and trusted strategies rather than experimenting with riskier innovative financial products that have proliferated over the past decade.”
But this is not the time for banks to relax. While the fintech threat has subsided, user experience as a competitive differentiator is here to stay, and competition among banks themselves is heating up. In an economic downturn, banks must compete even harder for the fewest remaining high-value customers. Driven 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 and ensure the drive for innovation that we have seen in financial services continues. They must use this time wisely by investing in cutting-edge solutions, while having the additional profit to do so, in order to definitively settle the bank-fintech debate. Even if fintechs aren’t waiting in the wings for lunch, banks need to carry on their innovative legacy for their own good and for the good of the industry at large.
