FinTechs experienced exponential growth, soaring valuations andsignificant media coverage during the height of the pandemic. However, FinTechs are facing a significantly more challenging environment as interest rates rose and the broader economy slowed down, which led to a moderation in growth rates and a sharp correction in valuations in 2022. These challenges are likely to extend into 2023 with cessions appearing more probable in the U.S. So, what does the new normal look like for FinTech companies this year? In short, it is growth rates leveling off, more disciplined cost structures, increased regulation, and industry consolidation.

Nonetheless, we do not expect broader theme of disruption in financial services to be deterred. Instead, the coming year will likely serve as more of a weeding out process where the best positioned business models will distinguish themselves from their peers that have deeper structural issues. The resetting of Fintech growth expectations and capital investment should ultimately be healthy for the industry’s financial performance.

The reality is FinTech has been slowly adjusting to a new normal for the last several months. Cutting their workforce and operating costs, tightening underwriting standards, recalibrating their funding models, and reprioritizing capital investments are some of the changes that have been underway for several prominent Fintechs.

In general, FinTechs are now bypassing the ‘growth at any cost’ philosophy and becoming more conservative in their capital allocation. They are prioritizing investment in their core business over building “super apps” and new product launches that could take years to become profitable. Much of the change is being driven by investors seeking higher and more stable returns in light of greater macro uncertainties and a materially higher cost of capital than existed in the past decade.

FinTech Challenges may be Bad News for Consumers

So what does this all mean for consumers who have become accustomed to the products and services provided by Fintechs? From a consumer perspective, access to Fintech products and services could diminish while their cost to consumers rises.

Since Fintechs often lack the economies of scale that large financial institutions have created over decades, they tend to offer higher yielding products and services that can offset their higher unit costs. As a result, FinTechs typically target households that fall into the lower quality “near-prime” or “subprime” categories. One of the positives from a societal perspective is that Fintechs have enabled access to broad array of financial services for the underbanked and unbanked populations and emerged as viable competitors for some of the largest financial institutions in the country.

"​Following a sharp contraction in Fintech valuations over the past year, it would not be surprising to see traditional FIs explore and execute M&A in the Fintech space, further blurring the lines between traditional financial services and Fintech"

One example of this is Buy Now Pay Later (BNPL) platforms, which have challenged other well-established forms of payment such as credit cards. BNPL payment platforms became increasingly popular following the pandemic’s onset given the massive shift to online shopping. However, BNPL providers face growing competition, higher funding costs, weakening credit performance and more intense scrutiny from the Consumer Financial Protection Bureau (CFPB) that could result in a sharp deceleration of growth.

Regulation Delayed but not Denied

Increased regulatory scrutiny will also be part of the new normal for Fintech for 2023 and beyond.

Crypto regulation remains front and center, with clamors for regulation likely to grow louder in the wake of the bankruptcy filing of FTX, which follows the failures of several other industry participants over the past several months. Substantial debate and concern voiced by various regulatory bodies over the growth in cryptocurrencies such as stable coins have yielded little progress toward establishing a cohesive regulatory framework for digital assets and the underlying blockchain technology to date. A robust regulatory framework that takes measures to ensure consumer and investor protections while also creating uniform industry standards that improve transparency could provide a catalyst for growth by enabling more institutional participation, particularly in light of the aforementioned failures.

The CFPB’s recent report on BNPL cited several concerns with the industry including the lack of consistent credit bureau reporting and data privacy. The CFPB also recently announced it would be issuing a proposed rule under Section 1033 of the Consumer Financial Protection Act that, if adopted, would promote more competition among financial institutions and give consumers greater control and security over financial data.

Fintech Converges with Traditional Finance

The more challenging macro environment has not deterred banks, insurers, and other traditional financial firms from continuing to investin their own fintech capabilities, with some of the largest financial institutions having technology budgets in excess of $10 billion annually. In fact, one could argue that there are several fintechs housed within some of the largest financial institutions. Nonetheless, following a sharp contraction in Fintech valuations over the past year, it would not be surprising to see traditional FIs explore and execute M&A in the fintech space, further blurring the lines between traditional financial services and fintech.

Conclusion

Fintechs undoubtedly have an uphill battle in regaining the market value lost over the past year. Nonetheless, their growth and impact on both financial services and the broader economy is still in the early innings, and innovation and disruption of financial services is likely to continue for the foreseeable future.