For those that attended Innovate Finance in the UK last month, there would have been little doubt that fintech is attracting big money. Indeed according to Tech.eu, 95 financial technology companies in Europe and Israel raised capital in the first quarter of 2016, three times as many as in the same quarter a year ago, and almost double the amount from Q4 2015. That's one fintech company getting backed for every day of the first quarter and with a combined €500 million in funding its the hottest vertical in the region.
There's no doubt that the financial services sector is a massive industry with inefficiencies and opportunity for greater customer intimacy. However it’s clear to me that the level of hype around the current crop of fintech companies is unjustified and recent events suggest investors should exercise caution. Part of the issue is that investors have been funding peripheral businesses - delivering services such as money transfers, factoring or pay day loans. These are great niche businesses but they're not transformational. There will doubtless be many great companies that come out of unbundling the various financial services typically delivered by a bank, but they're not going to become the billion dollar companies that we desperately want Europe to produce. Only by going after the core and redefining how the industry operates can fintech entrepreneurs create massively valuable businesses. But the incumbents are protected by considerable regulation, have vast resources and will not fall over easily. While they undoubtedly have inefficiencies, they are also very well rehearsed in what they do. It is of course encouraging to see a new generation of mobile first 'challenger banks' emerge however they do face another major hurdle - trust. As much as we love to hate banks and as much as the financial crisis demonstrated it is time for change, we ultimately want somewhere safe to store our hard earned money. Even LendingClub, one of the very few fintech companies that has exited, is doing only hundreds of millions of dollars in revenue - no wonder the performance of its stock price since IPO has been so abysmal. The recent resignation of its CEO and discovery of weaknesses in its internal controls throw up further red flags, elucidating the myriad of complexities that new entrants must overcome in order to build a scalable business. Fintech companies have underestimated this problem and it’s going to make it extremely difficult to build mainstream customer bases. Allegations that crowdfunding platforms have been encouraging companies to drip-feed money from other sources into their campaigns — to create the impression of investor demand — won't help their cause. Nor will stories of crowdfunded companies calling in administrators shortly after presenting a full bill of financial health. It's clear greater regulation is required. The other problem is that fintech 'innovators' are competing on price. While some have improved the user experience, this won't allow them to move fast enough and anything other than free is simply indefensible. Let's not forget that payments has been a recurring theme for a long time and is drawing the interest of tech titans such as Apple and Facebook. The blockchain of course holds promise here and real-world applications for this paradigm-shifting technology are getting closer to fruition. While fintech companies have done a remarkable job so far at creating an illusion, the cracks are now emerging. In recent days, TransferWise has been caught out for misleading customers about how cheap it is compared to banks while LendingClub sent shockwaves through the fintech sector when it revealed on its earnings call that the CEO had been removed for unethical behaviour. Furthermore, Prosper has had to lay off a third of its staff, Nutmeg has replaced its CEO and Wonga reported seeing losses double in 2015. This sad but predictable turn of events serves as a reminder that when any sector is flooded with money, it is typically a good time to take a step back and reassess. From where I've been standing it looks like people have been drinking way too much Kool-Aid. Venture capital investors have been falling over themselves to give fintech companies money and losing sight of the realities of what it takes to succeed in this sector. Many will now begin to question the business models and we’ll likely see many casualties, just as we do in any any other area of technology. Yet I still believe that innovation will come and remain hopeful that the next generation of fintech companies will deliver. Let’s not lose sight of the prize because when we do see a truly transformational business emerge, we’ll know it was well worth the wait.
This article first appeared on Finextra.com, May 13, 2016
* This post was first published on LinkedIn