There are more than 5000 financial technology (fintech) startups in the world now. Many unicorns are emerging among them. There are now about 50 fintech-unicorns (tech firms valued at more than $1 billion) on the loose. Along with many established players becoming larger, new startups are launched monthly, if not weekly. This staggering growth is a reflection of the hype around fintech, where a plethora of start-ups are using technology to compete against or collaborate with established financial players. The result is a dramatic increase in company valuations as investors look to get in on the ground floor of the next big thing.
The magical combination of geeks in T-shirts and venture capital that has disrupted other industries has put financial services in its sights. As shown in the latest Money of the Future report, by Singapore-based fintech venture capital firm, Life.SREDA, and INSEAD, from payments to wealth management, from peer-to-peer lending to crowdfunding, a new generation of startups is taking aim at the heart of the industry—and a pot of revenues that Goldman Sachs estimates is worth $4.7 trillion. According to a September report by McKinsey & Co., tech companies could wipe out as much as 60 percent of profits on banks' financial products. Like other disrupters from Silicon Valley, fintech firms are growing fast by questioning the status quo of a very traditional and highly regulated industry.
The fintech firms are not about to kill off traditional banks. But they will reshape finance—and improve it—in three fundamental ways. First, the fintech disrupters will cut costs and improve the quality of financial services. Second, the insurgents have clever new ways of assessing and innovating around risks. Third, the sector’s newcomers will create a more diverse, and hence stable, credit landscape.
If fintech platforms were ever to become the main sources of capital for households and firms, the established industry would be transformed into something akin to “narrow banking”. Traditional banks would take deposits and hold only safe, liquid assets, while fintech platforms would match borrowers and savers. Economies would operate with much less leverage than today. But long before then, upstarts will force banks to accept lower margins. Conventional lenders will charge more for the services that the newcomers cannot easily replicate, including the payments infrastructure and the provision of an insured current account. The bigger effect from the fintech revolution will be to force flabby incumbents to cut costs and improve the quality of their service. That will change finance as profoundly as any regulator has.
But the fintech scene doesn’t yet seem set to create a globally-dominant wave of financial technology giants. Too many firms are built to exit, rather than to compete. $1 billion valuations don’t automatically mean exit or success. Vast potential seems to be sacrificed too early. Young unicorns are culled. Why is that?
Incumbents fight back
The banks are doing what the old adage tells them: keeping friends close but enemies closer. BBVA, Santander, HSBC and Citi are among those that have set up fully fledged venture-capital-like arms to deploy hundreds of millions on such enterprises. Others, including DBS in Singapore, run their own start-up mentoring programmes, exchanging cash and staff time for a small stake in a budding enterprise. Barclays, Wells Fargo, and Bank of America are hosting or sponsoring finance-tech accelerators, awarding cash and guidance in exchange for a small stake in the companies and an ongoing relationship.
Despite their contempt for their incumbent rivals, partnerships and acquisitions are an important way for fintech start-ups to gain a foothold. The same ideas are advanced in the recent report that I co-authored with 500 Startups.
The start-up ethos is also changing the way bankers think about their profession. One common refrain among incumbents is that they need to become less product-focused and more customer-focused, which is true but easier said than done.
Will they grow?
Whether fintech makes a significant dent in global finance or not will depend what happens in 2016, which will be a pivotal year for the future of the sector. Over the next 12 to 15 months, as recent and upcoming exits play out, we’ll likely get better insights into which new business models are overvalued, poised to grow into their valuations over time or prepped for mass-market disruption.
The initial public offering market has been unwelcoming lately. Elevate Credit Inc., an online subprime consumer lender, delayed an IPO scheduled for this week, citing difficult market conditions. That follows an indefinite postponement of an IPO by online mortgage and consumer lender LoanDepot Inc. late last year.
The future of fintech
Nevertheless, investors, analysts and banks still see a big future for financial innovation.
Autonomous Research in a new report estimated that digital lenders would collectively triple to roughly $100 billion in loans globally by 2020, roughly 10 percent of the total market for small business and consumer loans. The report also noted that there were more than 2,000 firms globally now competing in digital lending.
Looking at the global picture, while North America continues to account for the bulk of funding to VC-backed fintech companies, 2015 was the first year Asia, Europe and North America all saw over $1 billion in total funding. Asia has seen the largest explosion in funding, with $880 million in deals in 2014 to $3.5 billion so far this year across 102 deals, according to a recent Accenture report.
Asia is also emerging at outstanding speed as an innovation hub. China, India, Singapore and Hong Kong are fueling Asian fintech and emerging as significant competitors globally. As one more interesting trend, Fintech startups also have attracted investment from a variety of corporations globally. Of the 72 corporate deals since 2012, the US has accounted for just under half with 35. Asian corporates were quite active, with China and Japan ranking second and third. Besides the usual U.S. suspects like GV and American Express Ventures, Chinese internet heavyweights such as Renren, Alibaba, and Tencent also had a strong presence.
The struggle with Series B
But fintech enthusiast, Max Levchin, cast a cloud over funding prospects heading in to the next year. "My general view of the world is that raising money for series B will be harder in 2016 than it was in 2015 in fintech," he told the mag. "My guess is that you will see a lot of M&A and failure activity."
Less than half (40%) of companies that raised a Seed or Seed VC round in 2009-2010 raised a second round of funding. A total of 225 (22% of) companies that raised a Seed in 2009-2010 exited through M&A or IPO within six rounds of funding (one exited after the sixth round of funding, for a total of 226 companies). Nine companies (0.9%) that raised a Seed round in 2009-2010 reached a value of $1B+ (either via exit or funding round). Meanwhile 77% of companies are either dead or dormant and 56% of companies that raise a follow-on round after their Seed are then able to raise a second follow-on round after that. In other words, it’s easier to raise the second post-Seed financing than the first post-Seed financing (as noted, only 40% of companies are able to raise a post-Seed round). Series B is usually hard for the simple reason that this is where the rubber hits the road and big promises have to be met with numbers, projections and, crucially, confidence.
For the time being though, finance is now riding an entrepreneurial wave. Demand for upstarts' services is strong, driven by widespread frustration with big banks. Many big banks are embracing technology to reduce costs and attract new kinds of customers. Banks must reinvent their business models or other players will do it for them.
Fintech’s new entrants are spread across many sectors. Among 2015’s rising fintech unicorns and semi-unicorns 29 percent of them are from the lending sector and 27 percent are from payments. The next biggest, interestingly, is real estate with eight percent. Insurance and investing focused fintech startups represent 6 percent.
Low interest rates have made capital, cheap and plentiful. You may get your next business loan from Lending Club, OnDeck, or Kabbage, instead of an it-takes-forever bank. You can now look to Kickstarter, Indie-gogo, or CircleUp to raise financing. Your company's transactions could be processed with fewer headaches by Square, Stripe, or WePay. And you can manage your money automatically at Betterment or Wealthfront and not pay for investment advice that may or may not outperform the market. You can even start replacing money itself using Coinbase, Circle, and other digital-currency options. The future of financial industry is here and it’s here to stay.
This article is republished courtesy of INSEAD Knowledge Copyright INSEAD 2016.
Serguei Netessine is The Timken Chaired Professor of Global Technology and Innovation at INSEAD.