Fintech companies have long positioned themselves as disruptive and aim to utilize technological advancements to revolutionize the delivery of financial services. As COVID-19-induced lockdowns swept the world, fintech’s potential of providing secure, efficient, and contactless financial tools to a vast customer base only became even more apparent.
It was time for the fintech sector to perform due to factors ranging from dwindling finances amid a global recession to making good on the promises of disrupting the finance sector.
But not all fintech startups are created equal, and the hype was set to be eroded by the disruptions caused by the COVID-19 pandemic. As discussed in a previous report by the Centre of Excellence on Emerging Development Perspectives (COE-EDP) titled “Fintech post-COVID 19: Spelling the end for mediocre startups”, the pandemic could push the industry towards maturity, meaning that endeavors in the sector could get the exposure needed to reach their full potential albeit with some casualties.
In this report, we aim to track how the fintech sector has fared since our initial report was filed in May 2020 amid a developing pandemic situation.
A rapid assessment study under a joint initiative of the World Bank Group, the World Economic Forum, and the Cambridge Centre for Alternative Finance (CCAF) at the University of Cambridge Judge Business School, published in December 2020, showed that most types of fintech firms reported strong growth for the first half of 2020 compared to the same period in 2019. On average, firms in different fintech verticals including digital asset exchanges, payments, wealth management, and savings reported growth in transaction numbers and volumes, the survey showed.
This growth trend in transaction volume was reflected across all geographic regions but with some variations. The Middle East and North Africa reported the highest increase of 40 percent followed by North America and Sub-Saharan Africa.
However, it was not all smooth sailing for the sector as digital lending slumped eight percent by volume of transactions, while the sector also suffered a nine percent jump in outstanding loan defaults.
Focussing on the positive impact initially, the following points discuss how the disruptions caused by COVID-19 opened up new opportunities for the sector.
- Social distancing
Fintech markets with more stringent COVID-19 lockdown measures reported higher growth in transaction volume, according to the rapid assessment study quoted earlier. The study grouped countries according to the stringency of lockdown measures in response to COVID-19. On average, fintech transaction volume growth in high-stringency markets was 50 percent higher than those in low-stringency jurisdictions. This trend was most evident for Digital Payments, where fintech firms in high stringency jurisdictions reported a 29 percent growth, twice the average growth reported by Digital Payments providers in low stringency jurisdictions during the same period.
Market Provisioning Fintech firms also reported similar growth trends across different jurisdictions depending on the stringency of lockdown measures. Transaction volume growth in these fintech firms was 20 percent for high-stringency jurisdictions compared to just 2 percent for low-stringency jurisdictions, according to the survey, which says that fintech activities have served to support the digitalization of financial services as lockdown stringency increased.
- Increased growth in new customers
Fintech firms were also able to tap a relatively less tech-savvy audience base as well during COVID-19. In the United States, Gen Z (people born between 1997-2012) and Millennials (people born between 1981-1996) had the most fintech accounts overall, according to McKinsey. However, older generations are also joining them in increasing numbers. 37 percent of respondents between the age of 40-55 in the McKinsey study said they were already using fintech while 7 percent said they were new users. 2 percent of respondents between the age of 56-74 said they became new fintech users during the pandemic. The study also said that existing users across all income groups in the US also opened new accounts on fintech platforms.
The growth in new fintech users wasn’t limited to developed economies. In the Philippines, for example, transaction volume through the leading mobile wallet company GCash jumped 700 percent year-to-year in June alone, and registered users on the platform doubled in the first half of 2020.
Fintech firms in emerging markets and developing economies are reported to have witnessed higher growth compared to their counterparts in richer countries. Apart from transaction volumes, fintech firms in emerging countries also reported higher growth in new customers and higher customer retention compared to those in rich countries. However, operational challenges, costs, and risks were also higher for firms in emerging countries.
- Adjusting to turbulence
COVID-19 and the accompanying recession brought major turbulence to the finance sector and the shocks were also felt by FinTech firms. Many of the companies responded to the challenges by mixing up their current offerings while also launching new products, services, and policies.
In the assessment study by World Bank, Cambridge Centre for Alternative Finance, and World Economic Forum, more than 65 percent of fintech firms surveyed reported making two or more changes to their products or services to better respond to COVID-19, while 30 percent said they were in the process of doing so. Fee or commission reductions and waivers, changes to onboarding criteria, and payment easements were among the most prevalent changes across all verticals in the fintech sector.
A range of new products and services were also launched by fintech firms during the pandemic with as much as 60 percent of those surveyed for the study reporting that they launched a new product or service. A further 32 percent reported that they were planning new launches. Types of launches varied across verticals with Digital Payment firms most commonly developing and deploying additional payment channels. Digital Lending firms, on the other hand, most commonly increased value-added non-financial services while Digital Capital Raising firms started hosting COVID-19-specific funding campaigns, according to the study.
- Notable competitors to traditional financial institutions
In several instances, fintech firms even helped governments as delivery partners of stimulus packages. Although these cases were not widespread and mostly in the richer countries, they could prove to be a turning point for the sector as they position fintech firms as serious competitors to traditional banks and other financial institutions.
By digitizing and automating the application and processing of the US government relief package, a US-based banking solution provider helped to ease the government disbursement of funds. Businesses impacted by the pandemic turned to the fintech firm, which teamed up with Digital Lending companies to automate requests, collect necessary documents, conduct all underwriting, and close loans. Banking startups Chime and Current were also in the headlines recently for crediting stimulus payments faster than big banks.
During the pandemic, a Hong Kong-based digital bank also launched an initiative to get people the government stimulus check sooner, in the form of fee-free and interest-free loans.
The potential of fintech has also been acknowledged by development banks in supporting the recovery from COVID-19. Asian Development Bank (ADB) also approved a $500 million loan in December 2020 to promote fintech-led financial inclusion for micro and small enterprises and marginalized groups in Indonesia.
- Operational and funding challenges
As predicted in the earlier report by CoE-EDP, fintech firms are likely to face funding uncertainty due to a global recession that accompanied COVID-19. The rapid assessment survey by World Bank and others also affirmed that although FinTech operations across the globe have grown, they have been subjected to several operational and fundraising challenges.
Fintech firms are facing operational difficulties as a result of COVID-19, as well as higher costs. When compared to the same time period last year(Q1- Q2), FinTechs reported a 5 percent rise in agent or partner downtime and a 7 percent increase in the amount of failed transactions, queries, or access requests, according to the survey quoted earlier. It also showed that onboarding expenses increased 8 percent while data storage expenses increased 11 percent for fintech firms.
Some of these issues tend to be more difficult for fintech firms in developing countries. Firms in these countries, in particular, recorded higher onboarding and storage costs. Cybersecurity concerns were also higher for companies in developing countries, with a 19 percent increase over the same period.
Fundraising problems were among the most notable issues flagged by fintech firms while responding to different surveys from across the world. The rapid assessment study quoted earlier even reported that fintech firms’ financial position deteriorated during the pandemic. More than 50 percent of firms said the pandemic hurt their capital reserves with 21 percent said to have faced a major impact while 30 percent had faced a minor impact. About 40 percent of the firms reported a negative impact on their valuation while 34 percent said it negatively impacted their future fundraising outlook.
- Regulatory scrutiny
As fintech becomes more systemically integral to financial systems and the “new normal”, it will undoubtedly be subjected to increased scrutiny. An IMF Departmental Paper published in July 2020, just a couple of months after CoE-EDP’s initial report was published, affirmed that regulatory authorities are facing challenges.
“Regulatory authorities we spoke with noted the wide-ranging challenges they are facing. These included catching up with the fast-changing landscape, facing budgetary constraints or lack of expertise, and managing lobbying pressures from traditional financial institutions,” the paper said.
The hesitance of regulators was also evident by the fact that most fintech firms were not involved in the delivery of COVID-19 relief measures even though there was an indication of interest by them, according to the survey by the World Bank. This shows the untapped potential for fintech firms in serving as a delivery partners to reach a large scale of population in a short period of time.
“Fintech, Regtech & the Role of Compliance in 2021” report by Thomson Reuters Regulatory Intelligence also said that participants surveyed for the report said that “volume of regulatory change and the tracking of evolving regulations and subsequent management of that change” were among the key challenges for fintech firms.
“Unsurprisingly, the existing regulatory framework is geared toward supervising more traditional financial services providers which can be more easily categorized as banks, insurers, and asset managers,” the report says.
- Unviable business models
As discussed in our previous report, COVID-19 could seriously damage startups with unviable business models who have previously breezed through several rounds of funding to sustain. Few such cases sent shockwaves across the industry during the pandemic.
The Wirecard scandal was undoubtedly the biggest and most widely reported case of a fintech business failing in 2020. A senior European Commission had said after the collapse of the German payments firm that the case has sparked reviews of how the European Union regulates the finance industry as it evolves to fintech firms from traditional banks.
Wirecard was a hybrid business that handled electronic payments while owning a bank as well, which caused regulators to disagree about how it should be regulated. After revealing a gaping hole in its accounts that its auditor EY said was the result of a sophisticated multinational scam, the firm collapsed on June 25, owing creditors nearly $4 billion.
Another case was of Australia’s Xinja Bank, which gave up its banking license in December 2020. The company only received the license just a little over a year ago in September 2019. It blamed the failure on “an increasingly difficult capital-raising environment”. But experts flagged its huge operating costs and failure to launch a successful lending product that can offset the interest it needed to pay on deposits.
COVID-19 has undoubtedly accelerated the adoption and use of fintech while highlighting the potential of the budding industry. However, as discussed in the previous CoE-EDP report, a balance must be struck between innovation and regulation to ensure fintech firms can survive the occasional turmoil that tends to be inherent to the financial industry. Fintech firms offer services that have always been highly regulated but the current set of regulations in much of the world is not adequate to cover the operations of these firms.
On the other hand, fintech firms need to take a long, hard look at their business models and review their long-term viability in the real world where they face competition from massive financial institutions and more recently, the Big Tech firms. Frequently changing regulatory environments must also be kept into account to ensure companies can continue to deliver good customer outcomes. Moreover, it’s abundantly clear now that as fintech cements its place in the financial sector, accelerated further by the COVID-19 pandemic, it could open the sector to new possibilities by harnessing the power of technology to deliver financial services.