Investor pressure forces fintechs to rethink inclusion goals

Financial inclusion, especially providing services to people and small businesses that have traditionally avoided full banking services, has long been a calling card for fintech companies.

“We help drive innovation, inclusion and access across the industry,” boasted Chime, which since its launch in 2013 has become one of the biggest so-called neo-banks. .

Near-zero interest rates and an untapped market of millions of adults have helped the industry thrive, from financial services companies to cryptocurrency startups.

But inflation and rate hikes have slowed new financing to a trickle. As investors’ quest for profit increases, there are also fears that fintechs will abandon their promises to meet the needs of the underserved.

Consider online bank Varo Bank, which raised $510 million and boasted a valuation of $2.5 billion last September. Then, like many fintechs, it hit a wall in 2022.

With losses mounting, it laid off 75 employees, cut advertising and changed strategy, moving away from growing its total customer base and getting rid of what CEO Colin Walsh called “costly customer acquisition” in an interview this month with Axios.

These expensive customers usually end up in black, brown and other marginalized communities that cost more to reach and generate the lowest incomes, said Mehrsa Baradaran, a professor at the University of California School of Law. in Irvine and author of the book “How the Other Half-Banks.

“Once you’re pressed on every end, it’s clear that the less profitable are the first to go,” she said.

Acting Comptroller of the Currency Michael Hsu highlighted the problem this month at a Federal Reserve Bank of Philadelphia fintech conference.

“History is changing now. The story now is about profitability. It’s a matter of unit economics,” Hsu said. “Where’s the inclusion in that?”

Generally unprofitable

About 80% of American adults use a full-service bank, but a report released this week by the Joint Economic Committee of Congress found that 40% of black Americans, 29% of Hispanics and more than 33% of households earning less than 25 $000 a year is still unbanked or underbanked.

These consumers were part of the target market of many fintech startups over the past decade. But they really caught the attention of venture capitalists starting in 2018.

According Pitch booka company that tracks venture capital investments.

That jumped to $55.2 in 2,058 trades with a total valuation of $488.4 billion in 2021, Pitchbook found. The pandemic has caused a “shift to go online and fintech has been a huge beneficiary of that,” said Pitchbook fintech analyst Robert Le.

This new funding has since fallen flat, as the Fed raised rates and inflation soared. According to Pitchbook, money for fintechs fell from its blistering pace in the first half of this year, with 1,181 transactions valued at $18.8 billion through July.

And those that were already operational began to scale back. Klarna, a private Swedish BNPL and consumer finance company, announced plans to lay off around 10% of its workforce in May after its valuation more than halved earlier this year.

Chime in February confirmed plans to delay its highly-anticipated initial public offering, citing slumps in fintech stocks and valuations of private fintech companies.

The plunge in private valuations mirrored the collapse of many publicly traded fintechs. One example is buy-it-now and pay-later company Affirm Holdings Ltd., which saw its stock crash in the first half of 2022, down 60% in April.

The other problem faced by fintechs is that, at this early stage of their existence, many are not yet profitable.

“Fintechs are by definition growth companies, and venture capital-backed fintech organizations are generally not profitable,” said Joe Zhao, managing partner of Millennia Capital, a fintech-focused venture capital fund.

Pension funds, family offices, foundations and other institutions that contribute to venture capital funds are beginning to seek safer investments rather than riskier games with fintechs and other startups, Zhao said.

“I’ve had conversations with CEOs and CFOs of portfolio companies, telling them you need to cut costs,” said Zhao, a former Fed economist.

The first cuts concern marketing budgets. If that’s not enough, fintechs and other companies will start to downsize. Several fintechs and crypto firms, like Varo Bank, have announced thousands of layoffs this year.

Jonah Crane, partner at Klaros Group, a financial services consultancy, said the trend could result in the dumping of additional customers, as an acquiring company is only interested in the technology part of a fintech, or its data is used in ways customers have not. not the intention.

“You could have a situation where consumer data becomes the only thing to monetize, and data can end up in places that they may never have expected,” said Crane, a former head of the department of Obama treasure.

A focus on core customers

The fallout from fintech ripples out in other ways.

Brexit, a San Francisco-based fintech, was launched in 2017 with a focus on venture capital-backed startups, primarily in the biotech and fintech sectors. Airbnb was one of its first customers.

As operations grew, Brex began serving traditional small and medium-sized businesses, such as restaurants, retailers and independent operators like Debra Gail White.

White, a musician from Los Angeles, turned to Brex in 2020 for business credit card and payment services for her small record label, 27 Club. The services came at no cost (Brex makes its money from retailer interchange fees and recurring fees for software subscriptions) and worked reasonably well. White says that between processing payments and using the corporate card, she’s spent about $100,000 through Brex in two years.

Then the pandemic, inflation and Fed interest rate hikes took their toll. Brex doesn’t seem to have a funding problem – it had a valuation of $12.3 billion in its last funding round in October – but realized that some of its original startup customers might do it.

In June, Brex announced that it would remove thousands of small businesses from its platform to focus on its original and core customers.

Brex co-founder Pedro Franceschi in a tweet called the move “incredibly difficult.” “We learned that we couldn’t serve small businesses well at the same time, and focus was the only way to deliver a level of service we’re proud of,” he wrote in a blog post.

White says she would have been willing to pay a service fee to stay with the platform, but assumes “it’s faster and cheaper” to drop customers like her.

CFDIs fill the void

Fintechs insist they will continue to push for greater financial inclusion, even in a tighter financial climate. For some, the business model requires trying to get more customers, which should boost services to marginalized communities.

Companies like loan club, which is publicly traded and has an insured bank, will continue to lend capped at 36% annual percentage rates within these communities. Consumer advocates say the rate is still safer than higher-interest loans they say are predatory.

And venture capital-backed companies with growth business models won’t have a choice, Pitchbook’s Le said.

“If you’re Chime, you can’t say you’re not going to serve low-income customers, because that’s their bread and butter,” he said.

Even as fintech valuations have fallen, Chime has expanded its offerings to include the ability for customers to deposit money into Chime accounts at more than 8,500 Walgreens Inc. stores across the country in June.

But other lenders are bracing for fintechs to cut spending, especially small business lenders.

Community development financial institutions are gearing up to fill the gap – small community lenders that focus on financing small, largely women- and minority-owned businesses with less than $1 million in revenue, said Patrick Davis, senior vice president of strategy at Community Reinvestment Fund USA.

The Biden administration has committed more than $1 billion accessible through CDFIs for smaller start-ups. Banks have also increased their contributions to CDFIs for the express purpose of bringing money to hard-to-reach small businesses.

“Fintechs won’t look at these startups at all,” Davis said. “The CDFIs will.”

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