Fintech in an Era of Rising Interest Rates and Economic Headwinds

Interest rates may be the most relevant metric in the financial world. No other single variable has such a profound and universal impact on the prospects of financial services firms and their customers. Rising interest rates affect everyone, but they don’t affect everyone equally. Predictably, savers and borrowers experience rising rates differently. This blog considers some of the consequences that rising rates have on banks and fintechs – and their customers – and how modern technology can help them safely weather the economic headwinds.  

The financial and economic realities of 2023 give us a newfound sense of perspective in terms of where we are compared with where we’ve been. We now look rather nostalgically on the 2010s as a halcyon period for fintechs, startups and business in general: Interest rates seldom moved, and when they did the changes were minor and predictable. But now, a period of rising inflation has forced central bankers to act decisively and frequently. For example, policy rates across a sample of 58 rich and emerging economies that averaged 2.6% at the beginning of 2021 reached 7.1% by the end of 2022. Collectively, these countries amassed total debt of around $298 trillion, owing approximately 342% of their combined Gross Domestic Product (GDP).[1] These eyewatering numbers show that the more indebted the world is, the more sensitive it becomes to interest rate rises.

The ripple effects of rising interest rates can wreak havoc on business models. Many fintechs and digital banks were launched during a period of historically low interest rates, and they flourished in an era of cheap money. This created a relatively carefree environment where digital startups focused on innovations and customer experience without much worry about interest rates. Likewise, digital lenders granted personal and business credit confident that there was a high likelihood of repayments. But times change, and the financial world has entered a period of uncertainty with interest rates. This environment has significant implications for digital banks and fintechs.

The End of the Casual Consumer

When prevailing interest rates were low and deposit accounts only earned a fraction of a percent, most people were not concerned about leaving money in apps or digital wallets that paid little or no interest. Consumers were content to have ready access to funds, or simply couldn’t be bothered with moving their money to an interest-bearing account. But rising interest rates and runaway inflation may well bring this customer inertia to an end.

Many people are caught up in the rising rate/inflationary spiral and feel squeezed. This is particularly true of young mortgage holders and prospective home buyers who are experiencing rising rates for the first time. For them, higher interest rates are not just an expense but a wake-up call to put their money to work. They are less casual about leaving money in an app and will shop around for a return. With digital banking, consumers can easily “comparison shop” for a deposit account that pays an attractive rate, then open an account and transfer funds within minutes.

Deposits Are on The Move

Digital banks that focused more on offering a “cool customer experience” at the expense of a good return may see customers draining account balances or maintaining little to no balance.  All banks will have to work harder and be prepared to pay more to attract and retain deposits, without relying too heavily on income from interchange fees and other charges. But paying more for deposits will have consequences for the bank’s balance sheet and may require adapting investment strategies to fund the expenditures. For some digital banks, this is uncharted territory; they will need the flexibility and means to do things differently in the changing economic environment.

Economic Headwinds and Pathways to Success

Strong economic headwinds are curtailing the previously unfettered enthusiasm for fintech funding. Although many “unicorns” have flourished, there were also some costly experiments and many different outcomes along the continuum of success. Today’s rising rates and difficult economic conditions will challenge and test the new business models pioneered by digital banks. Diverse business models, such as SaaS, transaction or volume-based pricing or commission structures may behave differently in a downturn. Success ultimately will correlate to key factors such as leadership quality, management expertise, a fit-for-purpose technology stack, reliability, adaptability, and customer satisfaction.

Opportunities for Incumbents

Private equity has entered a cautionary period. Rising interest rates and a sluggish economy will make private funding less abundant and more expensive for fintechs, which will have an impact on their investment strategy, business model and planning horizon. This may create opportunity for incumbents. With their strong brands, loyal customers, and wealth of practical expertise, established banks have everything to play for. But they need to reduce the cost of customer acquisition. Harnessing advanced technologies will be key across the full spectrum of lending and deposit taking.

The Lending Outlook

Higher rates are often perceived as beneficial for lenders, but they have a mixed impact on different lenders and loan types. Higher rates tend to put downward pressure on volumes of secured loans, such as home mortgages and auto finance, as consumers consider whether they can afford such purchases now or should defer until rates come down again. In contrast, unsecured lending such as credit cards or overdrafts will tend to increase as consumers borrow to make ends meet. 

During a downturn, expect an increase in delinquencies across all loan types, but ultimately the credit losses will depend on the demographics of each customer base. Banks with the right technology are likely to fare better as they will have a holistic view of each customer’s financial position based on timely and accurate data.

The Future of Lending is Digital

Technology is crucial to continue lending throughout a downturn. Banks need to really know their customers to be able to help them, and digital technology is essential. With the right data and technology, banks can make better and faster credit decisions – giving customers the credit they need, when it’s needed. Key elements of a successful digital lending program include:

• Quality information. Banks have a wealth of customer data at their disposal and can augment the data that drives traditional credit score models. They can also tap into external sources such as local socio-demographic and web data using artificial intelligence (AI), machine learning (ML), and advanced analytics. 

• Scalable, open technology. Digital lending is about more than the customer journey – it is also about end-to-end processing. Success in digital lending means having the ability to integrate digitally-enabled apps using APIs to make instant credit decisions using multiple datapoints.

• Embedded lending. Customers have growing confidence in digital services and regard finance as part of the journey. Embedded finance offers banks the opportunity to reach new customers cost effectively while allowing companies to provide lending as part of their offering. Embedded lending is an integral component of a digital lending strategy and customer satisfaction.

Rising interest rates and economic turbulence affect everyone and can create a plethora of challenges. Those with a digital-first approach are best positioned to do well and weather the headwinds. 

[1] https://www.economist.com/finance-and-economics/2023/02/19/the-worlds-13trn-interest-bill