Rising Rates and Lenders: An Interest-ing Story

                                                                    Photo by Adeolu Eletu on Unsplash

The entire world is on the verge of a recession that has been spurred by the rise in global commodity prices arising from the Russia-Ukraine crisis and compounded by the pandemic-induced damage. In its latest Global Economic Prospects Report, the World Bank slashed the global growth forecast to 2.9% this year from 5.7% projected earlier in January 2022. World Bank economists have anticipated stagflation similar to the 1970s, where the growth rate continued to decline while inflation kept on rising. As a result, central banks around the world are raising interest rates to keep inflation under control. The current inflationary environment will test the business models of fintech lenders as mortgage lending did for banks during the financial crisis.

The Lending Space before Rising Rates

The past decade has been a boon for lenders and financial institutions due to extremely low-interest rates. Lower interest rates led to an increase in consumer spending, further resulting in higher demand for financial products such as loans and credit cards. Also, low interest rates allowed lenders to have a low cost of capital. Another important aspect for fintech companies in the past decade has been investor confidence. With extremely high investor confidence, Fintech funding surged at a record-high of 169% from 2020 to $131.5 billion in 2021. 

How higher rates pose a challenge for lenders?

From a consumer perspective, the demand for financial products will decrease along with a higher risk of loan defaults in a recession. Additionally, companies that rely on deposits will offer higher deposit rates to remain competitive, which reduces their profitability. Eurozone player lending will be highly impacted as consumer confidence has reached its all-time low of -23.6 in June as per data from the European Commission. Consumer confidence is measured on a scale of -100 to 100 calculated using data collected from European households, where -100 indicates extreme lack of confidence, 0 neutrality and 100 extreme confidence.

The deteriorating macroeconomic environment has made investors rethink their fintech investments and cast doubt on the actual potential of the sector. A funding winter is already here for Fintech companies with funding dropping by 18% in the first quarter from the previous three months to $28.8 billion. Many experts have predicted a massive consolidation in fintech,  with those who fail to adapt being either shut down or acquired.

With more companies struggling to meet revenue targets.

What separates the winners from the losers?

While most lenders brace for an economic crisis, some are looking to capitalize on this opportunity. Two such companies are Starling Bank and Lending Club. Starling Bank is regarded highly among the investor community as being one of the few fintech lenders that are profitable. Instead of making risky investments, the company is focusing on supplying its SaaS banking platform “Engine” to leading banks and financial institutions around the world. Recently, Starling Bank acquired Fleet Mortgages, a move targeted towards diversifying its asset portfolio and creating new revenue streams.

Lending Club is another fintech that is looking to benefit from the rising rates. In 2021, Lending Club acquired Radius Bank for $185 million. The acquisition has boosted the growth prospects of Lending Club by allowing them to collect deposits and hold on to loans. As a result, Lending Club now holds 20-25% of the high-quality loans (FICO Score of >670). Owning a banking charter has opened new revenue streams for the company and lowered expenses, leading to higher profitability. Credit quality of borrowers will be the key differentiator for lenders in these challenging times.

Many other lending players in Europe such as Revolut, Lunar, Bunq, and N26 have publicly disclosed their intention to make acquisitions. This allows the lenders to diversify their income sources and reduce the impact of losses from the declining Fintech Sector.

In these tough times, it is critical to maintain your integrity and your reputation as a reliable organization. Lenders that focus on keeping the investors updated at all times along with providing them full information regarding the utilization and safety of their funds are more likely to have loyal customers that will continue associating with them over the long period.

Conclusion

The coming 2-3 years do not look positive for the Fintech sector with fears of a recession, rate hikes, lower consumer spending, and declining investor confidence. Investors are becoming more cautious and focusing on profitability, which will have a huge impact on fundraising and valuations. Lenders need to constantly innovate and look to expand their revenue streams to grow in these challenging times.