The Rise of Challenger Banks and the FinTech Phenomenon
Thank you for joining us for this edition of the NovaBlock newsletter. Here, we explore the intersection of technology, finance, politics, and of course, the crypto asset space.
The arrival of mobile apps and handheld devices enabling secure internet connectivity have ushered in the financial technology (“fintech”) explosion of the 2010s. Fintech touches finance, banking, and wealth management, offering products and services that better serve audiences already comfortable interacting and transacting digitally. The fintech space captured the minds of investors and developers alike as the traditional banking and financial services sector was begging to be disrupted. Global fintech funding and M&A activity by venture capital, private equity, and incumbents totaled $111.8 billion in 2018; up 120% from $50.8 billion in 2017 and $2.5 billion in 2011.
In the last decade, traditional banks raised fees across the board for their basic consumer banking products. Consumers paid $34.4 billion in overdraft fees in 2017, the highest amount since 2009. Average overdraft fees are now over $30, up 50% compared to 2000. In 2018, monthly maintenance fees were up 8% compared to 2013, averaging over $13 a month. Additionally, ATM fees were up 10.7% compared to 2013. The number of traditional banks offering free checking accounts has dropped from 37% in 2013 to 29% in 2018. (Source: https://ftpartners.docsend.com/view/suxcjc4)
As traditional banks continue to charge exorbitant fees, become bridled by archaic legacy technology and branch infrastructure, and suffer from ongoing fraudulent activity and scandals, challenger banks and fintech startups have emerged to offer banking products with a superior user experience. These challenger banks shirk traditional brick-and-mortar branches, instead offering a mobile-centric user experience with sleek user interfaces, higher interest payments, lower fees, no minimums, and real-time expense reports and account management.
Most challenger banks were born in the United Kingdom, for two reasons. Compared to the US, Britain is not as saturated with large banks and their physical branches, creating an opportunity for non-traditional financial institutions to arise. Second, the UK was an early adopter of digital banking going back to the late 1990s and early 2000s. Some of the largest challenger banks in the UK are unicorns Revolut, Monzo, and Starling, raising $337 million, $425 million, and $344 million respectively.
Challenger banks are not unique to the UK and have been popping up around the world. Brazil has Banco Original and Nubank, and Germany has SolarisBank and N26. Asian players include China’s MyBank, which is backed by Alibaba and WeBank, which was launched by Tencent. The US has seen similar developments with the rise of SoFi, Robinhood, Wealthfront, Betterment, and others, all emerging in the last decade.
As the US Federal Reserve continues to artificially pin interest rates near 0%, US banks are constrained in terms of the amount of interest they can pay depositors and remain profitable. The national average interest rate paid out on traditional banks’ savings accounts is currently approximately 0.1%. Robinhood, Aspiration, Varo Money, Empower, SoFi, Wealthfront and other fintechs are now offering near 2% APY on their accounts as a way to increase their customer base and assets under management.
Source: https://ftpartners.docsend.com/view/suxcjc4
Even telecom companies like T-Mobile are entering the field, offering a no-fee, high-yield checking account through its mobile app T-Mobile Money.
Source: https://ftpartners.docsend.com/view/suxcjc4
These seemingly “high interest” savings accounts pale in comparison to historical rates that reached 8% in the 1980s. To be fair, the high interest accounts offered in the ‘80s were largely driven by high inflation. Yet, despite whatever interest rate banks offer, banks still charge usurious interest on unsecured consumer credit products reaching near 30%.
Banks and lending institutions make money by charging interest on a loan and financing the loan by paying a depositor a lower interest rate. The difference between the amount charged to the borrower and paid to the depositor is known as net interest margin. Encouragingly, the average net interest margin has been declining since its peak in the early ‘90s, driven down by increased competition amongst banks and companies offering banking and lending services.
Source: https://fred.stlouisfed.org/series/USNIM/
As competition increased between new fintech startups and incumbents to offer digital banking services, customer churn rates and customer acquisition costs both spiked. According to Customer Think, the cost of acquiring a new banking customer is estimated to be $200, while the customer generates only $150 in revenue per year. For consumer credit products, customer acquisition costs can reach $800 per customer when factoring in teaser rates, cash bonuses for first purchases, and free loyalty points. The annual churn rates on new customers hover around 20-25% during the first year, with half not making it past the first 90 days after opening their accounts. On average, consumers own 5.3 accounts across all types of financial institutions, and customers are revealing they are comfortable shuffling between different banking providers based on the latest promotions and their specific needs.
In response to the rise of new competition geared towards millennials and younger users more comfortable with digital banking, large banks have launched their own products or partnered with existing tech companies to serve these cohorts. Goldman Sachs, the high-end investment bank previously focused on serving wealthy clientele, rolled out their digital retail savings account product named Marcus by Goldman Sachs in 2016. Goldman Sachs is also the financial institution powering the Apple Card, tapping into Apple’s distribution and superior card-less user experience through the iPhone. Late last year, Google and Citigroup also announced their intention to throw their hat in the ring with their new “smart checking account” product in partnership named Cache.
By forming partnerships, technology companies can bring products to market faster and bypass the need to file and receive regulatory approval for the necessary banking and money transmission licenses already possessed by the partner banks. At the same time, banks can leverage the distribution and sleek user interfaces these tech companies are known for.
As fintechs continue to grow and offer better user experiences, they are forcing the hand of traditional banks who will need to evolve to retain market share. As we’ve seen, some traditional banks are building products themselves and others are partnering with tech companies to tap into younger audiences. The fintech wars are just beginning to heat up as challengers, incumbents, and tech companies all fight for the privilege to hold customer assets and offer banking services.
Quick Bits
Square Crypto, the arm of Square focusing on Bitcoin development, announced the Lightning Development Toolkit. Rather than creating a standalone Lightning node, the team is building a Lightning Development Kit that gives wallet and application developers a convenient way to create custom experiences. It will include an API, language bindings, demo apps, and other tools to make integration of Lightning easy, safe, and configurable. Square Crypto may prove to be one of the most important companies in the space, as they are committed to supporting open-source Bitcoin development without seeking short term profits. They are funding Bitcoin developers and building tools to push the industry forward.
Bitcoin’s halving event captures growing interest among good searchers. The event in which Bitcoin’s inflation rate is cut in half is expected to take place on May 12th of this year. Currently, 12.5 Bitcoin are produced approximately every 10 minutes representing an annual inflation rate of 3.68%. This will be cut to 6.25 new Bitcoin per block, and the new annual inflation rate will be 1.8%. There is a big debate as to whether the halving is already price in. We are of the belief the event is NOT priced in for several reasons. Although Bitcoin holders are expecting the event, many will continue to accumulate more Bitcoin on a regular basis. Furthermore, new buyers enter the ecosystem every day and will continue to be a fresh source of capital.
The Fed has bought 70% of net treasury issuance since October. The net increase in outstanding US treasury securities from October through December 2019 was $330 billion. During the same period, the Federal Reserve’s holdings of US treasury securities increased by $221 billion. These figures do not include the $256 billion net increase in theFed’s repo holdings during the same period. While the Fed is quick to assure the public this recent round of asset purchases is “not QE”, it has all the markings of expansionary monetary policy indicating there are structural market issues. This may be the first step towards full-blown MMT policy in which the Fed monetizes its debt, which hasn’t worked out well for countries like Japan in the past.