The emerging financial technology sector has big challenges to overcome
FRANCESCO GUIDICINI FOR THE TIMES
Seldom has a warning seemed so prescient, so quickly. Last month, as Investec pulled the plug on Click & Invest — its robo-advice venture, which had gobbled up £32 million of its parent’s cash without showing any prospect of turning a profit — the co-chief executive of the London-listed bank issued a damning assessment of the entire financial technology sector.
It was, Hendrik du Toit said, “hyped” and based on a misapprehension. “To think you can create a parallel financial sector to the existing one is a fallacy,” the 57-year-old industry veteran argued.
A week later Loot went into administration. Though Royal Bank of Scotland had ploughed in £5 million for a 25 per cent stake in the digital current account start-up, and despite the business attracting 212,000 customers since its launch in 2014, it had run out of cash.
The warnings haven’t stopped since then. According to David Brear, 38, a co-founder of 11:FS, a digital bank advisory firm, Loot is unlikely to be the last financial technology company to go belly-up. He fears that the sector faces “a couple of years of reckoning”, and it is not hard to see why. Challenges loom on all sides, not least in crossing the watershed into profitability. Trailblazing digital banks such as Monzo and Revolut, which claim between two and four million customers apiece, remain conspicuously loss-making, according to their most recent accounts, despite being far bigger than most rivals.
Even reaching the industry’s target market is far from straightforward. Most of those embracing the financial technology revolution are “early adopters”, younger, tech-savvy consumers for whom queueing for a cashier is anathema. Yet in many cases they are using their new accounts in a secondary role rather than as the primary accounts into which salaries are paid.
Driving customers to change behaviour isn’t proving easy. Monzo insists that it is making solid progress on convincing its users to make its service their primary account, yet the top ten banking apps by usage are still those of the established high street banks, according to research by Ogury, a mobile data analytics company. Hopes that the so-called open banking revolution, based on the idea that large banks would share data with approved third parties in areas such as account information and payments, would drive a switch in accounts, or of customer behaviour, have yet to be realised.
Money is pouring into fintech, nonetheless — last year Monzo completed the second phase of a £20 million crowdfunded capital-raising in the space of less than three hours — but critics suggest that it may have peaked already. The total fell from £2.676 billion in 2017 to £2.357 billion last year, a near-12 per cent decrease, according to Fintech Global. The number of UK fintech start-ups appears to be in sharp decline, too. It hit 344 in 2014, but fell to fewer than 100 in 2017.
That reflects the fact that investors are becoming pickier, preferring to back proven, later-stage companies with the capacity to generate lasting scale and enduring profits. Kausik Rajgopal, a senior partner at McKinsey, the consultancy, recently predicted a possible “endgame” for the financial technology sector: if early stage investment dried up, he said, loss-making firms with models based on burning through venture capitalists’ cash were doomed to follow Loot into the abyss.
Mr Rajgopal and some of his McKinsey colleagues are similarly sceptical about the cryptocurrency boom that its supporters hoped would disrupt the established order in global and retail banking, commerce and consumer payments. They have expressed doubts about blockchain, the record-keeping technology behind bitcoin and its cryptocurrency peers.
“A particular concern, given the amount of money and time spent, is that little of substance has been achieved,” McKinsey said in research published in January. “The bottom line is that despite billions of dollars of investment and nearly as many headlines, evidence for a practical, scalable use for blockchain [in financial services] is thin on the ground.”
“Billions” is a word that crops up often in the financial technology sector. Companies with billion-dollar valuations are the so-called unicorns that politicians and entrepreneurs dream of, but those values are not locked in stone. Indeed, the private market valuations being ascribed to some of Britain’s fintech unicorns seem to some to be heroically optimistic.
So will investors head for the exit? Maybe not, if only because one of their favoured “exit” routes may be closed, or at least less enticing. When Funding Circle, the loss-making peer-to-peer lender, listed its shares on the stock market last October, they opened at 440p. They plunged by 24 per cent on the day of the IPO and are now trading at around 240p. Cashing out now would be costly.
Nor do the risks end there. Peer-to-peer lending, comprising the online lending brokers that make up one of the more mature areas of the fintech industry, has been subject to concerns that some platforms may have been lending irresponsibly. When Lendy, a peer-to-peer player that had £160 million in outstanding loans, of which £90 million was in default, went bust on May 24, worries about the wider sector were amplified.
Ian Rand, Barclays’ business banking chief, recently warned of a bubble in the UK’s peer-to-peer market, saying that too much of the sector had been picking up high-risk credit that had been turned down by banks — the inference being that bubbles burst. Should it happen in Britain, it is unlikely to be on the scale of the one that exploded in China, where hundreds of lending platforms have collapsed in recent years. Nor is it likely to be across the board. Mr Brear insists that at least three of the present digital banks will survive in the long term, noting that it took First Direct, launched by Midland Bank way back in 1989, three decades to gain its 1.45 million customers.
“The SME space, with all the RBS money sloshing around — [the state-rescued lender was forced to set up a £775 million alternative remedies package to provide to rivals after its failure to spin off Williams & Glyn as a standalone bank] — is going to kick in now, with some very different opportunities,” he said. “And wealth management is also going to really kick in, with people like Freetrade [a stock investing app], flying that flag.”
In short, Mr Brear’s “reckoning” is not going to be the end of the story. Once the hype has died down and financial technology players have become less dependent on generous infusions of venture capital cash and more focused on sustainable growth, then they will start to disrupt the existing players out of existence — rather than merely talking about it.
Carney looks to technology to ease the path to finance
Last week’s Mansion House dinner was overshadowed by climate change protesters and the rough treatment of one of their number by Mark Field MP, but financial technology companies had something positive to remember about the event (James Hurley writes). Mark Carney said that the Bank of England would open up its balance sheet to a new generation of payment providers, giving a big boost to fintech start-ups.
Historically, only commercial banks have been able to hold funds overnight in interest-bearing accounts at the central bank. Now that ability will be opened to all payment providers willing to meet the bank’s regulatory standards. The move would increase competition and would reduce the reliance on the big banks, the governor said.
The move will be perceived as a threat to incumbent banks that have been able to profit from acting as intermediaries to other payments companies.
Mr Carney, 54, also made supportive noises about the potential for fintech to improve the ability of small businesses to access finance. He noted that small companies faced a £22 billion funding gap, that half did not plan to use external finance and that there was a mismatch between how traditional lenders write loans and the needs of modern entrepreneurs.
“Part of the problem is that the assets that [small businesses] are seeking to borrow against are increasingly intangible — the value of a brand or user base — rather than physical assets, like building or machinery,” he said. Small companies that have not borrowed previously, meanwhile, lack the historic data that lenders require for credit scoring, he said, while “legal requirements to prevent money laundering and ‘know your customer’ make the process especially burdensome for a small business with limited resources”.
He said that technology promised a future in which lenders and borrowers could rely on a broader set of information, thanks to data generated by online activity. Mr Carney cited the example of Iwoca, a lending start-up, that has made more than £900 million of loans to 25,000 small businesses, with factors such as online sales and customer reviews used to determine whether a borrower is creditworthy.
This article was published in The Times on 24 June 2019