Will A COVID-19 Vaccine Inoculate FinTech Startups Or Lead To Their Demise?

by Nizan Geslevich Packin
(originally published in Forbes

Despite the global pandemic, substantial venture capital investments fueled a massive wave of challenger bank startups in 2020. Challenger banks, which are digital banking startups, have gained traction in the last few years by offering consumers a digital banking experience through mobile apps, APIs, software integrations, and much more. Although it may seem counterintuitive given the economic uncertainty, 2020 was a banner year for such startup businesses. The big question now is whether they will continue to thrive.

During the early stages of the pandemic, startup doom and gloom captured headlines. Uncertainty drove startups into survival mode—many laid off employees, terminated leases and prepared to cut as many of their costs as possible. Yet, despite the gloomy predictions, the worst never came. In fact, the opposite seems to have happened, at least for FinTech startups. 

Despite the raging pandemic, FinTech startups are raising more funds than ever before at very high valuations, and even getting overwhelmed with new funding offers from investors that are fighting each other to give the startups money.  For example, Robinhood, the stock trading app, pulled in $1.25 billion in 2020, reaching an $11.7 billion valuation. Likewise, in 2020, neobanks such as Chime, Varo, MoneyLion and others gained millions of new users and massive amounts of money in funding, both of which highly appeal to investors. In the third quarter of 2020, startups raised $36.5 billion in funding, a 30 percent increase from the prior year. 

The FinTech startup investing rush is powered by more than a rising demand for digital services. It is also fueled by low interest rates, which are driving investors into ever-riskier assets as they seek higher returns, as is apparent from Bitcoin’s recent new peak. Moreover, the booming stock market positively impacts startups’ IPOs, including Fintech IPOs. Finally, big tech acquisitions continue to motivate investors seeking healthy returns to focus on smaller tech companies.

Investing in FinTech during the pandemic has paid off. Most FinTech companies have prospered not only despite the pandemic, but because of the pandemic. 

There are several logical reasons for this seemingly counterintuitive phenomenon. First, the shelter in place mandates forced both the markets and consumers to adopt new technologies within several months, when such adoption normally takes many years. Second, with traditional banks’ branches being closed, and people encouraged to stay at home, FinTech services became more than a convenience, they became a necessity for banking needs. Third, as in any time of economic uncertainty, consumers and business became more cost-conscious. FinTech startups were able to leverage their technological innovations to offer their users cheaper services with improved, tailor-made, customer experiences. Fourth, the pandemic had a significantly greater impact on the operations of brick-and-mortar banks than it did on their digital rivals. That meant that traditional banks—who typically move more slowly than startups even in a non-pandemic environment—were at an even bigger disadvantage than usual in terms of turn-around time. In a rapidly-developing global pandemic, consumers and small business sought urgent help and immediate services.  Thus, it was only natural for them to turn to FinTech startups to process loans, payments, transactions and even data when their regular banks told them to wait in line.  Even the Federal government eventually relied on FinTech companies to join the banks in helping to quickly distribute some CARES Act PPP funds to businesses in need. Finally, as systemic racism was front of mind for almost everyone in the United States in the wake of the George Floyd tragedy, FinTech companies proved themselves to be faster (and better) at lending to minorities than traditional banks.

But what will happen after the pandemic ends? Can the market support so many FinTech startups?

In answering this question, we must first be reminded that FinTech startups began to rise well before the onset of the 2020 pandemic. They gained traction in the years following the 2008 financial crisis (and continue to gain traction) by focusing on, and serving the needs of, specific niche clientele. For instance, a startup named Daylight focuses on LGBTQ customers, and another named Step focuses on teens. FinTech startups enhance financial inclusion, through catering to less-serviced groups like immigrants, gig workers, or college students, and through helping bring unbanked and underbanked populations under the financial services umbrella.  As a result, they are likely here to stay, particularly in a Biden administration where financial inclusion is a priority, as it should be. 

FinTech startups also gained traction on traditional banks through their focus on AI and the automation of financial services. Not being subject to all the traditional banking regulations, and using advanced technology tools, FinTech startups offered customers various automated services including online investing, early access to wages, tracking budget apps, and even automated credit-building tools for low fees. Consumers are currently accustomed to those services and are unlikely to willingly part with services that they now take for granted.

But to survive, FinTech startups cannot rest on their laurels. They must continue to innovate because traditional banks have started adopting many of the technologies as well as the innovative spirit that characterizes FinTech startups. Some banks have launched their own digital banks, offer more custom-tailor services, and started reaching out to niche groups too. 

Moreover, technological competition might not be the only thing causing a bumpy ride for FinTech startups once the pandemic ends.  

First, although the pandemic did influence more consumers to use digital services and rely on FinTech apps, there is a growing gap between what customers believe they know about the startups’ methods of gathering and using consumers’ financial data and what actually happens. And a reckoning might soon be in order regarding how consumer financial data is collected and shared. As I have written about (see Show Me (the Data About) the Money!),  consumers want to use FinTech apps to get cheaper, faster, effective and custom-tailored services, but surveys show that they also want to keep their information private and secure, and to control how their data is accessed and used.

In October 2020, the CFPB announced that it is looking into regulating consumer financial data sharing under Section 1033 of the Dodd Frank Act.  With a new administration that is more open to regulatory requirements, it is clear that the regulatory landscape will change for FinTech startups, but how this will impact their liability exposure, operations, and even appeal in the eyes of investors, is yet to be seen.

Second, customers still probably trust Fintech startups less than they trust the incumbent banks. So although some FinTech startups will likely continue to be successful in providing an online replacement to community banks by targeting specific demographics with high value products, others are currently overvalued because they have only a temporary appeal to specific niche groups, and could find themselves in trouble if trust issues take hold of those groups.

Third, additional financial regulation might be coming to Fintech companies. Although the currently less strictly regulated operational framework of FinTech startups allows them to quickly put innovation into action, and also facilitates faster services enabling them to quickly process various types of transactions and data, this regulatory arbitrage can have consequences. For example, in the case of distributing the CARES Act PPP funds, for instance, PPP scammers made FinTech companies their lenders of choice, taking advantage of how companies such as BlueVine, Kabbage, Square and PayPal tried to move quickly and not limit their activity to their existing ecosystem. 

Finally, tech giants such as Amazon, Google and Facebook can and will present competition to both traditional banks and FinTech startups. For now, we have yet to fully realize how powerful the tech giants will be as financial service providers, but with their omnipotent tech abilities, seemingly infinite funds, and scale of operations, they will be hard to beat.  

Google recently hinted about its plans to become a bigger financial service when several weeks ago it announced major advancements in functionality for its Google Pay digital wallet, and revealed information about its partnership expansion with banks and credit unions, which will start operating in 2021 under the name ‘Plex By Google Pay.’ This move reveals some of Google’s near-term interests in the financial services business, and is a good indicator of what we can expect from the tech giants.

Will the entry of BigTech into the space help FinTech startups’ continuance growth? Probably not. The tech giants’ size and business models reduce innovation as they create a chilling effect on funding of small startups. Why? Because investors are aware of the tech giants’ potential ability to outman, out-fund, and immediately compete with any new innovative player, and are wary of that. So, if and when the tech giants start seriously competing in the financial industry, FinTech startups will have a harder time raising those funds. But like the other FinTech companies, BigTech is likely to face additional regulatory scrutiny in years to come. And the recent lawsuits against Google and Facebook by the DOJ and the FTC in October and December 2020 indicate that regulators may not look kindly on further acquisitions or expansion of BigTech.

So where will FinTech startups be at the end of the pandemic? Probably larger, better funded, and more ubiquitous. But if FinTech is to continue its meteoric rise, it best prepare for a bumpy road ahead, as only the strong and adaptive will survive.