A few months back, the valuations for fintech companies were soaring sky high. The Russia-Ukraine war, looming fears of inflation & recession, and the resultant rate hikes have appeared as dark clouds on this until recently hot sector.
In addition to product innovation and disruption, the market conditions will be a significant factor that will shape the industry as it passes through this recessionary period.
What lies ahead is probably a massive consolidation in the industry, as many may not be able to survive this downturn. However, startups with proven capabilities, a robust tech stack, strong marketing, sticky customers, and the ability to generate revenues with a clear path to profitability will be able to cope with the times. The fintech which continues to innovate, solve the industry problems and address the gaps while having a clear revenue & profit model will continue to survive and thrive.
Despite the external factors, few trends will be visible in months to come. In this blog, we capture a few.
Embedded Finance is the way to go
Embedded finance is a financial service integrated into a larger product or a non-financial service or product offering. It enables companies to offer credit without the customer leaving their platform. According to Statista, the embedded finance market will reach 7.2 trillion US dollars by 2030 globally.
It encompasses several segments of finance – lending, payments, insurance, investments, etc. An essential element of embedded finance is the 'Buy Now Pay Later' option or 'After Pay,' as called in a few countries. We'll discuss BNPL separately in the blog as that in itself is a hugely growing market.
The embedded lending practice has caught up with the trend and is expected to pick up steam going forward. It becomes all the more lucrative, especially during a recession, as these expenses do not look into your face directly.
Various marketplace platforms are increasingly looking to embed products to enhance customer value. This trend is leading to M&A activity in the product segment. E.g., JP Morgan bought a stake in the payments platform of Volkswagen. Similarly, Walgreens and InComm Payments launched 'ScarletTM', a new bank account and a debit card.
An N26 official said, very rightly so, that going forward, personalization will be a crucial element of embedded finance. He went on to say that such personalization will be possible with AI making the products suitable to individual needs. The segment, however, will attract regulatory scrutiny as the embedded offerings are made through non-regulated entities. The regulators will look to protect and make the consumers aware of the implications of embedded finance.
Blockchain hogging the limelight
A new favorite of the VC firms, blockchain firms are getting higher multiples in the fundraising rounds. The evolution of blockchain and fintech going hand-in-hand is invincible. With many large and small businesses starting to accept various cryptos as payments, it's bound to happen.
Blockchain is making the finance world truly democratized. For the uninitiated, a blockchain is a distributed ledger system in which each new block records the information of the entire chain before it in addition to the latest data recorded on it. Any change in any particular node must be with the consent of all other nodes and reflect on the entire chain. It eliminates the need for an intermediary, a bank, and offers data security and privacy.
Payment processing firms, lending firms, and others in the finance ecosystem will all have to innovate and incorporate ways to embrace cryptocurrencies increasingly. It is vital in the online and retail business. From the industry, Microsoft was the first large one to start accepting Bitcoin for its online Xbox store. Several prominent brands, such as Overstock.com, Shopify, and Etsy, accept cryptocurrencies as payments.
Big tech companies, too, are incorporating blockchain solutions for multiple purposes. The top use cases in blockchain include payments, P2P transfers, KYC processes, clearance, and settlement, fundraising, and trading. Several crypto firms offer financial products such as lending against cryptos, savings products, staking, and yield farming. We may also see a rising demand for Blockchain-as-a-service going forward as more and more firms look to incorporate blockchain solutions into their tech stacks.
Enter the Metaverse
Metaverse promises interoperability in a digital world where various participants engage with each other and conduct financial transactions. As the technology picks up, we may see several changes in the financial services universe, including functions such as KYC, lending-borrowing functions, essential banking functions are deposit and withdrawal of funds, etc.
We may see a rise in inclusivity in the banking system with the coming of the metaverse. That looks evident from the fact that metaverse is expected to be an $8 trillion industry in the near term, as predicted by Goldman Sachs. It is expected to provide a fillip to the already burgeoning digital economy.
Many large banks worldwide have already started implementing it or are looking to adapt to the meta world in the future. BNP Paribas, Citi, and JPMorgan are already looking at adapting to the metaverse landscape. BNP Paribas is already enabling virtual transactions through a VR app. Citi Bank is trying to make financial trading possible in the metaverse. Kookmin Bank of South Korea is making customer engagement happen in the virtual branches in the metaverse.
Rise of cross-border transactions
As per a study conducted by Accenture, cross-border payment flow is growing by five percent per annum and is expected to reach $156 trillion by 2022. The pandemic has increased this trend as consumers conduct more online transactions.
This rising trend is an opportunity for both enterprises looking to cater to the international market and fintech firms as consumers seek more accessible payment options. Out of the total pie, B2B payments occupy the larger share of $150 trillion. A fast-growing subset within Cross-border payments is eCommerce payments.
Fintechs offer solutions to many prevalent issues with traditional cross-border payments, such as time-consuming cumbersome processes and transaction costs. The area that opens up a plethora of opportunities within the cross-border transactions is the low-ticket size business. This segment is a high-cost, low-yielding business for banks, hence not a preferred area.
However, due to changing customer patterns and increased trade, especially post the pandemic, this is a lucrative area for fintech, which work on an aggregation model and provide the back-end network to facilitate interoperability with banks and other entities for cross-border payments.
The Rise of BasS and PaaS
First, what are these jargons?
BaaS is Banking as a Service and PaaS is Platform as a Service.
Bass is a model which allows fintech and other parties to access banks' data and infrastructure via APIs. Infrastructure access helps the outside parties to build their product offerings on top of it.
Baas is emerging as a major trend in the financial services space. As the legacy banks look to participate in the digital evolution and monetize their data, they would increasingly offer Baas to the fintech firms. The latter would also increasingly look to banks to help them with data and for various offerings such as cards, loans, payments, etc. Embedded finance and open banking are two areas that would emerge as big winners, with more and more banks providing Baas facility.
Now, let's come to PaaS.
In the last couple of months, several fintech has been looking to project themselves as a platform as a service. It makes economic sense as those who have managed to build a robust technology stack can monetize it to gain higher valuations. For traditional banks with old infrastructures, it makes sense to buy the tech stacks from fintech to save time and cost.
Separately, fintech will also try to project themselves as data organizations that happen to do finance to gain higher valuations.
More Super Apps to Emerge
Corporate giants worldwide will be taking over by combining several product and service offerings under one single app. We already have AliPay and Wechat doing it in Asian Market. In India, big corporates are eyeing the space. Tata Group launched its super app, Tata Neu, recently. However, the trend is yet to take off in the western world. PayPal is one entity that is targeting to become a super app.
Digital Only or Neo Banks
Neo Banks make banking facilities easy for consumers and build up the retail banking experience from scratch. They're digital banks without any branches. Neo banks offer various basic banking services such as savings accounts, loans, FDs, payments, trading, and P2P transfers.
Several neo-banks such as Varo, N26, Chime, Aspiration, and Stashfin have risen in the last few years. Although neo-banks make banking easy for customers, there are certain concerns as well, cyber security being the primary one. Moreover, consumer grievance redressal is also a crucial factor as one will eventually feel the need to visit a branch in case of any major mishap in the financial transaction. The lack of human touch is a factor missing in Neobank offerings.
In the current economic downturn, however, a couple of leading neobanks, like most other fintech companies, have come under pressure. For instance, neobank Dave has said it will have limited capacity to invest in the second half. For Varo Bank, too, costs are outweighing the income and put pressure on the Balance Sheet. Chime, too, has delayed its IPO plans amidst the current market condition.
Could this be just a temporary phenomenon based on the current market conditions? Some factors could pose serious challenges to the future of neo banks.
The number of primary customers with neobanks is much smaller than that of megafintechs and the acquisition cost is much higher. The competition from megafintechs comes in addition to the competition from incumbent banks.
Moreover, the interchange revenue, too, gets challenged by the use of merchant apps by consumers, BNPL services, and embedded finance offerings by non-financial brands. Neobanks need to diversify their revenue streams to compete with mega fintech and non-financial brands.
BNPL is here to stay
Looking past the current market condition, BNPL is here to stay, more prominently in emerging markets. As per a report by Redseer, the BNPL market in India is expected to reach $45-50 billion by 2026 from the current $3-3.5 billion dollars. The number of BNPL customers in the country is expected to increase from 10-15 million to 80-100 million. Globally the market size is expected to be $166 billion by 2023.
In the current times, though, the BNPL model will be tested. The industry leader Klarna has announced layoffs and is now looking to raise funds at 30 percent lower valuations than its last round of fundraising.
In addition to this development, what would work against the company and BNPL firms, in general, is the bad debts, which may explode. Most customers being subprime in nature, have a higher tendency to default, especially in an economic downturn. With Apple entering the segment, several players are expected to feel the heat even more.
In addition to the above trends, we can spot many more in various segments of the vast fintech landscape- payments, wealth management, etc. Using the latest technologies such as AI, and ML, in addition to blockchain and metaverse, will also shape the fintech and banking industry going ahead.
The current recession, however, may come down heavily on some players, and we see M&A activity in the sector. Regulations will also play a crucial role in the sector's development going forward, especially in the cryptocurrency space.