Higher interest rates are here to stay, with Russia’s invasion of Ukraine punching a massive hole through the transitory inflation thesis. We have previously addressed both the benign and less positive aspects of the rising rate environment and burgeoning inflation for the banking sector, but how will fintechs be affected? Naturally, given the huge diversity of this sector, the impact is likely to vary significantly. In this note, we highlight the key factors investors need to consider and drill down to the relative sensitivity of different business models.
The key drivers of fintechs' interest rate sensitivity
We highlight below some of the key factors that investors should consider:
Wholesale funding dependence
With interest rates at historic low levels across the globe for much of the past few years, fintechs have not found themselves to be too disadvantaged relative to deposit-taking institutions, such as banks, even when their business models have depended on plentiful access to cheap funding. Clearly, these conditions no longer hold. Most negatively impacted, in our view, are lending-based models. In contrast, businesses that are able to collect deposits, such as digital wallets, should be able to benefit; typically, they can only invest in risk-free securities such as government bonds but, increasingly, even these can generate healthy nominal yields.
With fixed income instruments delivering higher yields, the required return on equity capital is increasing. Moreover, the return premium that investors demand for taking on risk appears to be rising (evidenced, for example, by the increasing preference for value over growth stocks). Fintechs typically employ less capital-intensive business models than traditional peers, but the most efficient capital structures are likely to offer the best protection against investors’ increased pricing of risk.
Our previous studies have indicated that fintech customers are extremely price-sensitive. Therefore, fintechs may find that they are unable to pass on to their customers any higher costs relating to tighter monetary policy. For some products, low pricing is key to their appeal. For example, most customers may consider that buy now pay later (BNPL) credit facilities are free; usually, the merchant covers the cost of these loans via a fee paid to the fintech. Higher funding costs erode the margin that this product can generate; if merchants are unwilling to raise the fees they pay to fintechs for providing the facility then it is the latter's margins that will get squeezed. The market power of the BNPL fintech and merchant will ultimately determine which party takes the hit.
Liquidity and leverage dependence
Some fintech products are effectively plays on liquidity. This is particularly the case in the investech arena, where many clients use leverage to bulk up their exposures. Cryptocurrency has often been touted for its inflation-proof credentials, but investor behaviour suggests a stronger speculative element to the story; as inflation and interest rates have picked up, crypto trading volumes have collapsed. Crypto exchanges could be some of the biggest fintech casualties of higher interest rates.
Customer spending power
Households are finding that higher fuel and food costs are hitting spending power. Higher input costs and rising financing costs are pressuring corporate profitability. In both cases, the willingness and ability to make use of fintech services may become constrained. More discretionary products, such as savings and investments, could be more affected.
Our fintech scorecard highlights the most interest-rate sensitive business models
We use these factors to provide a framework that will help us gauge the relative prospects of various fintech business models in a rising interest rate environment.
In broad terms, we think that firms with high pricing power could even benefit from the current environment. But businesses that depend on plentiful liquidity and easy access to leverage, or those that require customers to have good spending power, could see their profitability and growth potential deteriorate.
Drilling down to different fintech business models, we think consumer payments fintechs and digital banks could potentially benefit in the current environment, as the income they can generate from deposits improves. However, we think most business models are likely to suffer, particularly certain lending businesses such as Buy Now Pay Later and SME financing.
We highlight below two fintech businesses that, based on our analysis, could potentially benefit from the high interest rate environment (Nubank, Paytm), and two that are likely to suffer (Konfio and Tabby).
Nubank (Digital banking, Brazil)
Nubank is a digital bank providing services in Latin America, principally Brazil. It has a growing suite of financial services for individuals and SMEs, including payments services (eg cards, QR code-based, and PIX instant payment network), saving products, investments, lending, and insurance. As of December 2021, the company had 53.9mn customers, monthly active users accounted 76% of this number. Nubank has been able to acquire customers at a low cost; at an average of US$5.4 per customer in 2021. The bank’s revenue has grew by 130% yoy to US$1,698mn in 2021, from US$737mn in 2020.
Paytm (Consumer payments, India)
Paytm is an Indian super app offering payments, other financial services (lending, insurance, etc), commerce and cloud services to 333mn consumers and over 21mn merchants (as of March 2021). In FY 2021, the firm oversaw INR4.0tn gross merchandise value (GMV) (ie US$53bn) via 7.4bn transactions, generating INR2.8bn revenue. It has set up 64mn payment bank accounts for its customers and holds INR52bn deposits and has INR52bn assets under management. Last year, Paytm disbursed 2.6mn loans.
Konfio (SME banking, Mexico)
Konfio provides credit solutions, both credit card and lending, to businesses by leveraging the proprietary algorithm that combines data and technology to measure credit-worthiness. It has two additional core products, KonfioPay and Gestionix. The former is a B2B payments management solution, while the latter provides cloud-based business systems for operational, accounting and financial management. In September 2021, the company raised an additional US$110mn in Series E round extension, raising its valuation to US$1.3bn.
Tabby (BNPL, UAE)
Tabby, founded in 2019, has in a short span of time become one of the leading BNPL providers in Saudi Arabia and the UAE. It has 1.1mn active users and 3,000 merchant partners. Tabby allows customers to pay for their purchases in four interest-free payments, billed monthly. The company generates revenues from merchants on its platforms, and through late payment fees. Tabby has so far raised US$185mn in debt and equity, and it was valued at US$300mn in August 2021. The company’s transaction volumes are growing strongly; up 8x since August 2021 and 50x in full-year 2021.