In our latest blog, we discuss why fintech investment is so important for investors, SMEs, consumers, and the global economy in general.
If the fintech sector had a mission, it would read something like this: fundamentally improve the antiquated financial services available to small and medium-sized enterprises (SMEs), by using technology that supplants the old-fashioned methods used by brick-and-mortar banks.
This ambitious goal was a response to the shortcomings of the traditional financial services industry that were laid bare during the 2008 global financial crisis. Fintech’s power to disrupt financial services suddenly changed how they are structured, delivered and consumed. This paradigm shift relied on significant investment from banks, insurance and wealth management firms, and non-banking corporates. In 2019, global investment in fintech hit $156 billion – up from $67.1 billion in 2014.
This made it one of the fastest-growing sectors in the global economy – and the future looked bright: In 2018, it was predicted that the sector’s compound annual growth rate (CAGR) would be 25%, meaning $310 billion was expected to be invested globally by 2022.
Why it’s good to invest in fintech
The exponential growth in investment in the fintech sector was driven by the compelling benefits on offer:
Investment for growth
This strategy focuses on increasing an investor's capital, typically by investing in young or small companies whose earnings are expected to grow at an above-average rate compared to their sector or the overall market. Fintechs fall squarely in this category of investment opportunity, with global fintech revenues, which were about €92 billion in 2018, expected to grow to more than €188 billion by 2024 (a pre-pandemic forecast).
Helping businesses provide customers with enhanced products
Investment in fintech helps drive the democratisation of innovative financial services that streamline previously clunky processes in an industry that has traditionally lacked agility. The resulting financial inclusion – such as digital lending platforms that allow SMEs to apply for finance in a few minutes – closes the lending gap that traditional financial institutions don’t have the appetite for.
The cyclical nature of the credit cycle means there are recurring phases of expansion and contraction in access to credit. It’s been shown that banks are typically slower to respond to a loosening of credit in the market. Fintechs offer investors the chance to gain access to an agile participant in the market, with the potential to pick up the slack where banks are failing to deliver the financial services needed by SMEs.
The reason that fintechs can offer a superior customer experience compared to traditional finance institutions is their streamlined operations and smart use of technology. It’s for this reason the fintech industry sees a lot of strategic investment from legacy institutions. Investing in fintech gives strategic investors access to potentially significant value-added operational and technical insight, which they can apply to their own organisations. It’s this area of strategic investment that has the potential to be resilient through all market conditions.
The current fintech investment landscape
The fintech investment landscape – both debt and equity – has become littered with roadblocks since the COVID-19 pandemic blindsided the business world in March 2020, obstructing its steep growth trajectory. The pandemic – which triggered another recession – prompted the sector’s largest market capitalisation loss, with global fintech investment dropping to $105 billion in 2020. While this represented the third highest annual total in the sector ever, it marked a significant decline from the previous year.
The pandemic has also moved fintech up the regulatory agenda, with financial regulators implementing sector-wide and fintech-specific measures to mitigate pandemic-fuelled risks – particularly concerning cybersecurity and operational risks. While these regulations also aim to harness opportunities, their power to mitigate risk has prompted concern among investors that they could stifle innovation. Added regulatory scrutiny is being driven by the importance that fintechs now hold within national economies – UK fintechs were amongst the largest distributors of CBILS / BBLS loans throughout the pandemic.
Another global seismic event has reset investors’ mindsets when deciding which organisations to back: Russia’s invasion of Ukraine. According to a poll of over 2,000 visitors to investment platform interactive investor, more than half of investors are conscious of how their money is invested in the wake of the invasion in February 2022. This determination to prevent themselves from unwittingly helping to fund the Russian regime also led almost half of respondents to say they were considering investments that align with their moral values amid the conflict.
The conflict and other forces, such as the pandemic, changing market conditions and soaring interest rates, are causing investors to tweak their risk profile. According to the poll, 55% of respondents said they are making changes to their profile:
Reallocations of assets through investor nervousness very rarely benefit growth industries such as fintech.
Meanwhile, fintechs in the lending space are feeling the heat of soaring interest rates as central banks attempt to cool red-hot inflation. The ripple effect of rising borrowing costs is forcing lenders to increase their rates to counter them. Arguably fintechs are more sensitive to rises in borrowing costs than their traditional peers, so there remains questions about their ability to continue to serve the ‘underbanked’ with the financial services they need in an inflationary environment.
A combination of runaway inflation, rising interest rates, and slowing economies in the UK and the US have also stoked worries that both nations could slip into recession this year. This would pressure fintechs to fill the lending gap as this vital service continues to shift away from traditional banks.
These challenging conditions have dealt a chastening blow to the lending industry. Compared to other fintechs – particularly the payments industry, which continues to receive significant levels of investment – lending has suffered from declining valuation multiples. Consequently, as the playing field becomes increasingly uneven, venture capitalists lack enthusiasm for an industry they once valued, causing investment levels to drop.
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