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Where will smart money be as fintechs take on big banks? In the final part of our series stay focus

The stock market float of Coinbase, the cryptocurrency exchange, in April this year typified the rise of companies in the fintech start-up sector


In the first week of July, Wise, a money transfer business, floated on the stock market with a price tag of £8 billion, more than the value of Western Union, the world’s best-known remittances business that works in 200 countries.

Wise’s success in going public sparked excitement in Britain’s financial technology scene, which has been developing since the financial crisis after creative types in finance spotted an opportunity to fuse people’s desire for an alternative to big banks with the boom in technological innovation and the rise of smartphones.

Wise achieved something rare — persuading new investors to part with hard cash for its highly rated shares — but there are others that have hit even more ambitious targets, albeit within the private sphere. Revolut, which offers banking services in the UK, hit a $33 billion valuation in a summer funding round, about the same market capitalisation as NatWest, one of the country’s biggest banks. Revolut and three other online lenders — Monzo, Starling and OakNorth — reached 22 million customers by the end of last year, up 45 per cent in a year, according to Citibank, establishing them as credible challengers to the big banks.

Nigel Morris, the Briton who co-founded Capital One, regarded by many as one of the most innovative financial services companies in the 1990s, now runs QED Investors, a venture capital business in the United States. He believes that digital financial businesses are accelerating to a new dimension of growth. The pandemic, technological development and clusters of expertise have contributed to an opportunity for investors where “there is more upside than there has ever been”.

According to Morris, a third of venture capital money is going into financial services, while 10 per cent of revenues generated in the sector is coming from financial technology — fintech in industry parlance — and payments. “That has taken over ten years. In the next ten it will go up very, very substantially.”

Britain is striving to be at the forefront of that boom, with the government keen to capitalise on the UK’s historic deep expertise in finance, its record for creativity and to bolster its future outside the European Union. In a Treasury-commissioned report, Ron Kalifa, a businessman, suggested ways to encourage Britain’s fintech industry to flourish, including helping start-ups to grow, encouraging fintech centres around the country and improving visas to bring in talented staff more easily.

Alastair Lukies, who co-founded Monitise, one of Britain’s first fintechs, believes that the Kalifa review and Lord Hill of Oareford’s proposals to shake up the listings regime will “support fintechs at all stages of their journey, from early seed stage investment to growth capital to London listings”. Helping fintechs also should boost the economy. “Fintechs are instrumental in supporting small businesses, which are the most vital part of the economy.”

The sector has expanded far beyond payments and banking. It incudes trading, where Robinhood, the commission-free app, has had a flotation as dramatic as the meme stocks its users flocked to, and insurance, where Marshmallow, the British fintech that covers immigrants and others without an extensive credit record, is on track to achieve a $1 billion-plus valuation. Then there is the “buy now, pay later” boom, where Klarna, of Sweden, has hit a $45 billion valuation; there are businesses offering immediate access to wages; and there is the world of cryptocurrencies, where Coinbase — one of the largest exchanges — went public with an $85 billion valuation in April.

Morris puts fintechs into three categories: those that steal business that traditional companies are conducting; those that break into new areas; and a group that provides support services to the mainstream players. All three, he believes, “are growing quite nicely”.

The fintech sceptics It is not all plain sailing. Doubters question whether the valuations that many fintechs have achieved from private investors will hold up in flotations. Some Revolut investors are restive, for example, and would like to cash in part of their holdings, but could the business, which does not yet have a UK banking licence and last year made a £208 million loss, sustain its $33 billion valuation through a listing?

Receiving ever more adulation and higher values from the venture capital community can be “like amphetamine” for business founders, according to Morris, but that risks “down rounds”, when investors decide that the story is not quite living up to its promise. That, in Morris’s view, is very difficult to manage and young businesses should avoid it.

Fintechs trying to break into mainstream banking face questions about their fundamental worth. Many have been great at gathering customers, but have not yet demonstrated that they can convert that into revenues and profits.

Citi found that several British digital banks made only £14 of revenue on average from each customer last year, compared with £370 at Lloyds. Wise is profitable, as is OakNorth, which lends to small and medium-sized businesses. Starling broke into the black in October. Monzo and Revolut are loss-making, which they say they could change easily by cutting investment but possibly not without significantly stunting growth.

Sceptics also highlight fintechs’ sources of income. OakNorth stands out from its competitors in generating most of its revenue in net interest income — the sum made on loans after expenses. Starling is making progress in generating fees from lending thanks to its inclusion in government Covid loan schemes last year. The others rely on interchange and card fees, made when a customer makes a purchase using a card.

TS Anil is the chief executive of Monzo, the fast-growing digital bank

The difficulty is that almost all digital banks start as deposit-takers. To be viable in the long term they need to lend, too. Nubank in Brazil is a notable exception, with an early emphasis on using sophisticated technology to lend, drawing on the lessons of Capital One. Nubank, which has 40 million customers in Latin America, is rumoured to be planning to float in the United States, valued at about $40 billion.

In a positive sign for Monzo in the UK, TS Anil (the initials stand for Tummalapalli Sai), its boss, spent five years at Capital One and has worked in senior positions at Citi, Standard Chartered and Visa, so knows how to put technology to work to generate revenues as well as how to do old-fashioned lending.

Fintechs are also expanding through acquisitions and by moving into new areas: Revolut is going to launch a service to pay customers’ salaries early and Nik Storonsky, its chief executive and founder, has ambitions to turn Revolut into a “global financial superapp”, adding travel and other areas.

Rupak Ghose, an adviser to fintechs and previously head of corporate strategy at Icap, the interdealer broker, questions how successful such visions will be: “What is going to make a £1 billion revenue, 40 per cent operating margin business like Facebook or Google? What is going to keep people on their screens? If you create an app, you have to have good products and it is not proven outside some places like China that fintechs can do that.”

WeChat, the messaging and social media business developed by China’s Tencent with more than a billion users, has morphed into one of the world’s biggest payments businesses. Alibaba, the Chinese ecommerce group, has added Alipay to its online universe. But those businesses mushroomed in particular circumstances — a huge population, patchy levels of people having bank accounts and a freewheeling approach to allowing technology businesses to enter financial services. That is now in reverse and Chinese authorities are cracking down on those businesses.

Banks fight back For all the challenges that British and other fintechs have in trying to scale such heights, they have issued a huge wake-up call to traditional financial terms. How are they responding?

One of their main actions is spending billions of pounds on better technology, including ambitious projects to transfer increasingly critical parts of the business to cloud computing from old-fashioned systems.

As well as making processes more reliable and quicker, it will help big banks to offer to their tens of millions of customers the type of service that fintechs can provide for much smaller groups. According to one senior executive at a large bank, switching important operations to the cloud will enable “processing of eight times the data, fifteen times faster”.

Klarna has drawn a big following with its buy now, pay later model

Big banks did not get to their size without making hard-nosed decisions and that is what they are doing now. Their fat credit card revenues may come under threat in future from the buy now, pay later sector, but in the meantime banks are pushing the area as an important source of revenue. The same goes in foreign exchange payments, where fintechs allow customers to buy products in other currencies with no or almost no commissions, while big banks continue with fees of a few per cent, while they feel they still can.

There are also some deciding that “if you can’t beat them, join them”. Goldman Sachs has started Marcus, its own fintech, and JP Morgan is on the verge of launching Chase, a digital lender, in Britain. Banks are experimenting, too, in targeted areas, such as Barclays in buy now, pay later finance.

The other side of the equation for traditional banks is what to do with their expensive branch and cash machine networks. There is talk that big high street banks want to shrink their networks to about 400 branches each, which would mean collectively closing about 2,000 branches around the country. Executives are wrangling with the government over the matter.

One outcome is likely to be potentially hundreds of shared branches, using the Post Office and start-ups such as OneBanks. Ironically, this shared presence may provide an opportunity for fintechs to have physical contact with customers, giving them a chance to seem like real businesses to more people and providing practical solutions, such as allowing small businesses to pay in money. It could be another example of what Tom Merry, managing director of banking strategy at Accenture, believes is happening in the banking world — “convergence, not divergence” about the future of banking.

New and old players are trying to work out the long-term implications of “open banking”, the technology that allows safer transfers of data, which big banks were ordered to adopt by the Competition and Markets Authority to make it easier for small players to compete. Open banking should help challengers because customers can ask their existing bank to send their information easily to other businesses.

So far, take-up has been low. Matt Hammerstein, chief executive of Barclays in the UK, said recently that only 1 per cent to 2 per cent of a potential 20 million customers had given permission to Barclays to access their data under open banking.

However, supporters believe that in the long term open banking will be revolutionary, as it will unlock changes that people might like, for example using their data to enable those keen to do more to support the environment to take action.

Silvia Mensdorff-Pouilly, head of banking solutions in Europe at FIS, a payments specialist, said: “A number of banks are looking into technology, which can link spending behaviour and action; leveraging the data not only to help people to understand their environmental impact, but to assist in making more ecological decisions in the future.”

That raises questions about privacy. People are already suspicious about what their banks know about them — surely they do not want those boundaries to be pushed back further?

Morris argues the opposite, that fintechs in the world of credit-checking are giving individuals more power over their own information than was the case with the incumbents and, in future, people will have their own “lockbox” of data, which they will be able to sell or rent to businesses.

Have fintechs fulfilled their promise? With a few exceptions, their valuations look shaky, but they have had a clear impact on traditional finance, which will only get bigger as the effect ripples out further. Tom Blomfield, co-founder of Monzo and now an angel investor in start-ups, noted that “ten years ago internet businesses were all niche, online-only and quite specific. Now the internet impacts every single part of life.”