The COVID-19 pandemic has had a detrimental impact on most industries, but one sector that has fared comparatively better than most is fintech. According to a new study by The Cambridge Centre for Alternative Finance (CCAF), the World Bank Group, and the World Economic Forum, the fintech industry continued to grow, with firms reporting growth in transaction numbers and volumes of 13% and 11% respectively. Data gathered from 1,385 fintech firms in 169 jurisdictions revealed that 12 out of 13 fintech sectors reported year-on-year growth for the first half of 2020, compared to the same period the previous year. While it is undeniable that COVID-19 had an impact on fintech deal activity in H1’20, global VC investment in fintech remained robust, accounting for US$20 billion globally according to research from KPMG.
OakNorth specifically focuses on commercial lending or the “lendtech” part of fintech, so for this article, I will reflect on some interesting observations and learnings we’ve noted from that during the last year.
When it comes to commercial lending, banks rely on risk models to make decisions. These models have been built up internally over decades of lending across thousands, if not tens of thousands of loans, but COVID-19 has exposed unexpected flaws in them. The first issue is that these models are based on historic data which doesn’t adequately reflect the unique situation we now find ourselves in or take into account the future challenges that the world will be facing as it enters into the worst recession in three centuries.
This is a view shared by executives of some of the largest banks globally – Bill Demchak, Chairman and CEO of PNC, said earlier last year: “as we entered this crisis, it became clear that everything we thought we knew was proven incorrect”. Mark Mason, CFO of Citi said: “No stress scenario that’s been created thus far would’ve contemplated the amount of fiscal and monetary response that we’ve seen in short order, and so that’s not modeled.” Meanwhile, Jamie Dimon, CEO of JP Morgan said: “This is such a dramatic change of events. There are no models that have dealt with GDP down 40%, unemployment growing this rapidly, etc”. It’s uncharacteristic for the leaders of some of the world’s largest banks to be so blunt but given the unprecedented scale and dynamics of the COVID-19 crisis, they were right on the money.
The second issue is that they make broad assumptions about entire sectors rather than developing an understanding of the portfolio at the granular loan level and taking into account the individuality of each business. Take a fine dining restaurant and a pizza chain for example: under lockdown rules, the fine dining restaurant is unlikely to experience any business whereas the pizza chain may see more business than usual as people are at home more. However, fast forward to when lockdown eased and restaurants were allowed to re-open but with strict social distancing and cleaning measures in place. Then suddenly, the situation for the two restaurants is quite different. The formerly empty fine dining restaurant, which had always spaced customers far apart to create an intimate feel and had a lengthier turnaround service to change the tablecloth, silverware, etc. is now experiencing a rush in reservations as many diners look to make their first meal out in months “special”. In contrast, the pizza chain may see demand for deliveries shrink slightly as people rush to enjoy the outdoors and take advantage of their freedom.
The third and final issue is that these models don’t take into account how quickly the situation is changing – take the forestry sector for example, for most of the year 2020, demand for printing paper would have been subdued as a result of remote working and companies moving to electronic agreement solutions such as DocuSign. However, this trend may not be evident in forestry businesses’ performance metrics as the reduction in demand for printing paper has been countered by the increase in demand for cardboard as people are getting more home deliveries. The likelihood is that companies’ move to paperless is a permanent shift, whereas the increase in demand for cardboard is temporary and will likely subside once people can return to highstreets and shop as they did before. Businesses in this industry therefore need to be thinking ahead about the impact this will have on their future performance and what other products or revenue streams they could introduce to make up for it. Banks meanwhile, need to be able to re-run analysis continually, and update parameters to reflect the real-time situation, as well as using alternative data to help inform models and ensure they’re as up to date and future-proofed as possible.
Looking ahead, my hope for the fintech industry in this year (2021) is that it will lead to the creation and growth of some of the strongest, most innovative, and resilient fintech businesses, as well as the birth of whole new areas of fintech as we saw post the financial crisis of 2008 with crowdfunding, peer-to-peer lending and “challenger banks”. One of the reasons for this is because a crisis leads to capital scarcity which means businesses have to build in a completely different way. They don’t have the luxury of spending the money they raise on experimenting. They have to be a lot grittier, roll up their sleeves and bootstrap, which ultimately creates a much healthier and more robust organisation. Historically, profitability has been considered a nice to have rather than a need to have in the fintech industry, but COVID-19 is changing that.
About the Author
Sean Hunter is Chief Information Officer at OakNorth, the next-generation credit science platform. Sean was one of the first commercial engineers at Palantir Technologies in Europe where he led trader oversight partnerships with large financial institutions, a strategist at Goldman Sachs for eight years, working in several areas including equities, fixed income, and algorithmic trading, and was an IT director at a dot com start-up writing their initial systems and managing a growing development team through two IPOs.