For some, like the US neobank Chime, interchange fees have resulted in hundreds of millions in revenue. The catch? The fees are limited to a fixed percentage of the transaction amount.
The aftermath of the 2008 Global Financial Crisis inadvertently ushered in a thriving start-up ecosystem. Central banks across the world cut interest rates to stimulate economic activity, creating an era characterised by accessible capital.
The availability of cheap money not only propelled investors to fund numerous tech start-ups but also birthed business models that, in any other scenario, might have been unsustainable.
Nowhere is this more evident than in the fintech sector. Over the past decade, a surge of challenger banks and digital financial platforms emerged, offering superior products from a user’s perspective. But, the inevitable question arises: Are the fintech platforms sustainable in the face of changing economic conditions?
Interchange Fees – A double-edged sword
A critical source of income for many fintechs is the interchange fee, a commission made whenever a consumer transaction occurs. For some, like the US neobank Chime, interchange fees have resulted in hundreds of millions in revenue. The catch? The fees are limited to a fixed percentage of the transaction amount. In contrast, central bank interest rates, which influence a fintech’s borrowing costs, can vary widely.
The situation becomes even more precarious considering many fintechs use a significant portion of the fees to offer rebates and interest rates to attract customers. Such strategies may bring in consumers initially, but they also burn through company resources at an alarming rate, especially when additional funding becomes scarce.
Traditional banks versus new entrants
Legacy banks, with their diversified range of services and lengthy histories, don’t face the same predicaments. Over the decades, the institutions have established a spectrum of products, from loans and mortgages to insurance, providing them with a cushion against interest rate fluctuations. Plus, their ability to hold deposits allows them access to the most affordable funding sources.
On the flip side, many fintechs, especially the newer ones, focus on specific market segments, lacking the product diversity of traditional banks. This makes them vulnerable to macroeconomic changes.
The way forward for fintechs
The rosy economic environment of the 2010s was deceiving for many start-ups. Current inflation rates and rising interest rates suggest that the easy-access capital environment is not coming back soon. However, all is not lost. The fintechs poised to navigate the uncertain times are those ready to adapt and diversify.
A prime approach would be to return to their technological roots. Excellent software, after all, remains a fintech’s primary value proposition. It’s not only about managing transactions, but about offering a user experience that significantly outperforms older systems. Top-notch software can also open doors to licensing opportunities with other institutions, adding another layer to the revenue model. The tech giants of today, like Microsoft, Google and Amazon, have all thrived on diversification.
For fintechs, building and enhancing their software capabilities might seem like a long-term game, especially in the current economic climate. Still, investors value profitability and sustainability more than sheer growth. The ability to demonstrate a long-term vision with a pathway to profitability can significantly aid in securing future funding rounds.
Fintechs need to reassess whether their customer incentives still make sense. Considering the three major bank failures in the US this year so far, and a cautious at best public sentiment, being able to project a sense of stability may be a fintech start-up’s best marketing strategy.
James Browning is a freelance tech writer and music journalist.
BUSINESS REPORT
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