The Turnaround in Interest Rate Will Create Winners and Losers in the Fintech Sector

Corporate credit card provider Pliant is buying multi-banking app Friday Finance, lending platform Auxmoney is taking over Dutch competitor Lender & Spender, and Deutsche Bank is rumored to be thinking about acquiring neobroker Scalable Capital. There has been a lot going on in the fintech market in recent days. So is the big wave of consolidation coming now? And how interest rates will affect the sector?

All startup founders today have to be more convincing to still find backers. Overall, the volume of startup funding has dropped significantly. According to the EY Startup Barometer, the total volume of venture capital awarded to startups almost halved in 2023: Compared to the first half of 2022, the total amount invested in the first six months of this year slumped by 49 percent to €3.1 billion.

Just under a year and a half ago, however, fintechs in particular were still posting lavish rounds of funding and record valuations. Today, many of them are struggling all the more with potential investors over follow-up financing, and some are having to lay off employees and see their company value melt away.

“But you can’t make a blanket statement that the fintech sector is doing badly,” said Christopher Schmitz, who covers the fintech sector at consultancy EY. He says there are still very successful fintechs that are also growing strongly. “But for many, the environment has certainly become dramatically more difficult to bring financing in-house.”

Private equity investors, who in 2021 were still more likely to back fintechs with rapid customer growth, are now looking much more critically at the companies’ business case, especially their sustainable profitability.

One thing is clear: The turnaround in interest rates will also produce winners and losers in the fintech sector. So far, the big wave of consolidation has failed to materialize, even though there have already been major deals with the sale of Penta to French competitor Qonto or the acquisition of Kontist by Denmark’s Ageras Group in 2022.

“We will see some more consolidations, but they will be driven by fintechs that are already well established and now have no problems with the macroeconomic environment,” Schmitz said.

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Who is suffering from the interest rate turnaround

According to Schmitz, a look at the banking world currently paints a fairly positive picture. “Many banks are benefiting from the turnaround in interest rate and have recently presented very good results because deposits are bringing money back into their coffers,” says Schmitz. A new bank, however, does not have this advantage, he says, because most are not active on the interest rate side.

That may explain why once-celebrated fintechs have now come down to earth. Shares in German neobank N26, for example, are said to have lost two-thirds of their value – which is only known because investor Allianz X wants to get rid of them. The company’s valuation also shrank at its British competitor Revolut – by 46 percent compared to the last financing round.

Young financial companies that have a very selective business model and were heavily dependent on the low-interest phase are also now naturally coming under pressure. “A good example of this is the so-called buy-now-pay-later business,” says Schmitz. Startups like Mondu had benefited greatly from the low-interest phase, but are now running into problems “because upfront financing, which is ultimately the key driver in this environment, has suddenly become much more expensive,” Schmitz says.

As a result, the business model is under pressure. Mondu was able to close a financing round at the beginning of the year but recently had to lay off employees. Fintech star Klarna had to live with a dramatically lower valuation in its last financing – and recently regained more flexibility by outsourcing customer service.

The market for real estate loans has also largely ground to a halt. “New business is almost negligible, and a company like Hypoport, which relies very heavily on processing such loans, naturally has problems in this market environment,” analyzes the consultant.

Who benefits from the interest rate turnaround

On the other hand, there are also young financial companies that are benefiting from the interest rate turnaround. Take Raisin, for example: the interest rate platform has long been strong in the interest rate differential business – and now offers a highly sought-after product. Raisin had already acquired the B2B open banking platform Deposit Solutions in the summer of 2021.

It’s a very similar story now at Auxmoney, whose business is apparently doing so well that the lending platform can afford to acquire its Dutch competitor. “Auxmoney has always taken a higher risk than the market typically allows. In a rising market environment, the company then naturally has advantages because it has a good grip on its risk models,” explains Schmitz.

The current deal of Pliant or the acquisition of SME loan broker Compeon by banking-as-a-service provider Dock Financial at the beginning of the year are signs of the incipient consolidation in the market. These examples show that companies with a solid foundation, “i.e., with a profitable business model and very strong private equity financing, see opportunities in the market and are not scaling back their involvement,” said EY consultant Schmitz.

“They are going with a different strategy than the companies they are acquiring – and then buying their way into new countries, new product lines or new business models,” he says. Others are targeting acquisitions primarily to expand competitors’ customer portfolios or gain access to other distribution channels.

Private equity investors, however, are primarily looking for companies that are “asset light,” i.e., that “have virtually no balance sheet and are more software-driven,” says Schmitz. One of the companies they are finding are so-called reg-tech companies. These are fintechs that specialize primarily in regulatory requirements such as something like money laundering compliance.

“The prototypical strategy of the PE investor is then to buy in a company and gradually integrate other companies on this platform,” says Schmitz. The idea is to increase market coverage and generate a growth story.

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(Featured image by wir_sind_klein via Pixabay)

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