Fintech’s Pitch: We’re Cheaper, More Mobile, More Focused

(Bloomberg Businessweek) -- If you’re under 40 and looking for help managing your finances, there’s a long line of companies eager to sell you something. Most likely, it’ll be a service built to work on your mobile phone.

Younger consumers are moving away from big banks for payments, borrowing, saving, and investing. They’re finding apps that bypass aspects of the financial system they’ve come to loathe, from credit card fees to overdraft penalties to credit checks. The fast-growing financial technology industry includes zero-commission brokerages, online investment advisers, “buy now, pay later” lenders, and so-called neobanks—digital-only companies that offer services such as debit cards and savings accounts without necessarily being banks themselves. (They can outsource those parts to insured deposit-taking banks they have partnerships with.)

In 2021 the number of neobank customers in North America and Europe approached 80 million, according to research firm PitchBook. By 2026 it’s projected to hit 224 million. Neobanks’ revenue is expected to rise 580%, to $61 billion in 2026 from almost $9 billion in 2021.

The fintech model looks simpler than it really is. Here’s the obvious part: Start by identifying one of

the perhaps dozens of products a bigger competitor provides that you think could be made cheaper and more convenient. Build an elegant user interface. Then promote it heavily, with help from venture capital funding. “When everyone has a powerful computer in their pocket, that opens up a lot of possibilities,” says Eric Johnson, a business professor at Columbia. “Younger people in particular demand levels of service and interaction that are similar to other things they use. If I can order my salad for dinner tonight with three clicks, I expect to be able to do transactions with three swipes.”

At this level, fintechs may look like marketing and web design companies. But behind the scenes, a successful startup also has to find a revenue source, which may be hiding in plain sight within the financial system. Often this money can help pay for free or low-cost products for retail customers, helping to win market share.

The classic example of this is Robinhood Markets Inc. The mobile app with the colorful, easy-to-navigate interface made stock trading free to millions. Its key source of revenue is payment for order flow—fees paid by market intermediaries who execute stock and options orders for Robinhood’s customers. These firms are willing to pay because they can profit from tiny differences in market prices. While Robinhood wasn’t the first broker to accept such payments, it recognized that they made zero-commission trading a viable business.

It’s a similar story with neobanks. There’s Chime Financial Inc., which offers no-fee banking and such products as a “credit builder” card, which requires no credit check and has no interest charges or annual fees. Banking customers also can get money from their paycheck up to two days faster if they sign up for direct deposit. A key part of Chime’s and other neobanks’ business model is the swipe fees merchants pay when customers use their debit cards.

Buy now, pay later lenders such as Afterpay Ltd. and Klarna Bank AB discovered that retailers would pay them for helping sell more goods. They offer consumers short-term, interest-free installment loans on purchases and make money by charging stores a fee.

Other fintechs still go directly to the consumer for their revenue; they’re taking advantage of falling costs and lower barriers to entry. Investment fintechs, for example, offer advice and portfolio management to a wider range of investors with apps that give users access to low-cost exchange-traded funds and even fractional shares of stock.

Venture capital keeps pouring in. By the end of last year’s third quarter, investment in the industry had already hit a record, with fintech companies worldwide raising $88.3 billion, almost twice as much as in all of 2020, according to PitchBook. Yet fintechs face a battle to expand their business. “It’s good for smaller, more nimble tech companies to be picking off” existing financial companies, says Dan Egan, managing director of behavioral finance and investing for the online investment adviser Betterment LLC. “But they have to realize part of the game is reaching the target audience at scale.”

Most mobile finance apps start with a single service, such as payments or trading, then add on. Acorns, which rounds up your purchases and invests the change, began by helping consumers save money and later expanded into banking. SoFi Technologies Inc., which launched with refinancing student loans, now offers a credit card, retirement accounts, and personal loans. PayPal Inc. has expanded from its ubiquitous payment button into the buy now, pay later business and even crypto.

For consumers— and regulators—all this ferment presents a challenge. People are being bombarded with novel products with new features, new kinds of costs, and new risks to figure out. Easier credit options are great for retailers but can draw people into debt if they don’t understand how they work; frequent free trading may be great for market middlemen but counterproductive for many investors.

Soon enough, a few of these upstarts will be the new establishment. As neobanks start acquiring bank licenses, consolidation is inevitable, says Robert Le, senior fintech analyst at PitchBook. “In about a decade or so you’re going to see a lot fewer neobanks, but they’re going to be very large, and they will be able to compete with incumbent banks,” he says. It remains to be seen, though, if any of these companies can evolve into the thing that Wall Street has for decades tried to create: the all-in-one financial supermarket.
 
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