How Banks Can Guide FinTechs Through Their First Economic Downturn

From competitors to collaborators, the FinTech boom introduced a field of opportunity for traditional financial institutions to team up with an industry newcomer to become more agile and modern with their own product offerings.

While FinTechs are, in many ways, useful allies to banks, traditional FIs can also be a critical partner to FinTechs that lack the resources or opportunity to acquire their own banking license. According to Lukas Diehl, head of marketplace banking at Germany-based Varengold Bank, said the bank-FinTech collaborative model is particularly important for today’s alternative lenders and other FinTechs amid uncertainty about their growth prospects.

In a recent conversation with PYMNTS, Diehl noted that FinTechs are in a unique position to compete against traditional lenders, and the pandemic doesn’t take away from their ability to provide what is often a more favorable customer experience than that of a traditional lender.

“On the other hand,” he added, “the pandemic doesn’t just spare FinTechs. They, too, experience tough challenges.”

Financing Burdens

While alternative and digital lending FinTechs can be a more agile option for borrowers, the way these FinTechs manage their own loan portfolios can become a particularly burdensome process that Diehl said threatens to take these companies’ focus away from their goal of enhancing borrower experiences, and toward back-office logistics.

“FinTechs typically do not have a huge balance sheet, and it can be very expensive for them to use a large amount of equity to finance their loan portfolio and keep growing,” he explained.

This is where a bank collaboration can become particularly valuable. Varegngold recently announced its own partnership with Wirecard to service joint FinTech clients with a range of financial services.

For Varengold, the offering means connecting FinTechs to debt to refinance their loan portfolios and scale up, as well as white-labeled payments tools. Wirecard, meanwhile, will offer its Banking-as-a-Service offerings, which include prepaid card issuing, loan services, digital banking tools and more.

It’s a tie-up that aims to provide financial services for FinTechs to bolster their own FinServ offerings, and by coordinating lending with Banking-as-a-Service (BaaS), Diehl noted that FinTechs can gain access to services that are integrated and standardized with each other to promote the agility FinTechs offer their own clients.

“Both strings — BaaS and lending — must be combined, and workflows between the involved parties established,” he said.

Readying For Uncertainty

Connecting FinTechs with funding to refinance their own loan portfolios will be an important part of helping these businesses survive the current volatile climate, noted Diehl.

“Many FinTechs are not yet profitable and consequently need further equity to grow,” he said. “The current crisis makes it harder to raise that equity.”

For many of these tech-centered players, this marks the first economic downturn that will test their balance sheets, risk management tactics and business models, and will undoubtedly impact each FinTech in different ways. Ultimately, economic recovery will likely uncover which business and risk models succeeded, and which failed.

As FinTechs wait to see which category they fall under, collaborating with licensed banks could present an opportunity beyond refinancing their own loan portfolios.

That collaboration can take many forms, too. Open banking initiatives, for instance, can enable FinTechs to unlock bank data to strengthen their own risk and scoring strategies and embrace business model flexibility without being tied to banks’ contractual obligations as a result of strategic partnerships or acquisitions, said Diehl.

Overall, coexisting in an ecosystem for both banks and FinTechs can be a mutually beneficial arrangement. Banks continue to embrace the opportunities in integrating user-friendly digital products and services through FinTech partnerships, acquisitions and open banking agreements.

In some markets where the regulatory climate has allowed it, FinTechs are beginning to explore a different path: acquiring their own banking license. There may be value in not having to depend on a traditional bank, but according to Diehl, going it alone may not be the smartest move for FinTechs today.

“A banking license means heavy investments outside of one’s core product offering and into back- and middle-office functions,” he said. “It also means having to deal with complex regulatory and compliance-related points. It’s probably more beneficial for FinTechs to remain focused on creating unique offerings to their clients, while we take care of the bank-related matters.”

With market volatility adding financial pressure on many FinTechs, the current climate means these companies stand to benefit from working with traditional FIs to preserve cash flows, without having to sacrifice maintaining focus on their value prospects. Remaining agile, digital-native, and user-friendly will be key to enduring the market downturn and thriving into the future.