The financial technology industry is maturing at a dizzying pace, having exceeded a combined $31 billion in total funding last year alone, according to KPMG’s recent Pulse of Fintech report.
With this sustained influx of funding, innovations within the space are moving traditional banks to partner up with fintech firms. That benefits both sides as well as customers like corporate finance departments.
At the same time, while frequently discussed in the context of banking, the shifts in fintech could upend traditional industries with legacy infrastructure — relatively recently extending to insurance, investments, and payments — as tools and services are brought up to speed for digital-savvy customers.
But rapid advancement often spurs growing pains, even for the most technologically superior companies.
In recent years, several major fintech players have stumbled because they failed to pay enough attention to the financial side of the equation. They’ve focused on driving rapid growth and superior customer experience, but without a strong focus on the traditional measurements that matter to financial services firms, such as credit volume, returns and profitability, risk adjustments, and sustainability.
While emerging technologies drive the headlines, long-term success cannot be achieved without a sound financial framework. Fintech companies that place too much weight on their technological innovations, without building a financial foundation to match, risk becoming casualties of the fintech revolution.
Not Managing Risk Is Risky
From a financial perspective, several processes and procedures must be built in and consistently maintained for financial technology companies to survive. These include credit risk management, interest-rate risk management, and compliance.
On Deck Capital and Lending Club have both recently found themselves in publicly precarious situations related to risk management. On Deck has had to change its strategy several times over the years to address investor concerns. Lending Club experienced a systematic fraud issue that resulted in a CEO departure, stock-price drop, and public cynicism. Other, smaller companies have faced similar problems stemming from a deficient focus on this important role.
While many fintech companies are keenly focused on implementing innovative technologies to revolutionize financial services, there will likely be an increased focus on financial soundness as CFOs rethink their strategies on the heels of others’ mistakes.
Traditional Banks Want In
With the fintech space showing such promise, there will be continued interest from traditional banks that want in on the action. As fintech companies connect with customers in new ways, banks have the capital to partner with and acquire those companies to magnify their own growth.
But to hold the attention of the big fish, fintech companies will need to demonstrate sustainability alongside growth. They must keep in mind that rapid growth and long-term success are two very different things.
In my view, that will drive amplified attention to demonstrating consistent and profitable growth over time, rather than just topline customer-acquisition growth at the expense of the bottom line.
IPO Market Deceleration
Despite the surge in investment over the past few years, activity in the fintech IPO market will slow down, at least for a while. Investors care most about risk-adjusted returns, profit margins, yields, and a compelling business model that utilizes technology. Many of today’s players don’t yet have all of those boxes checked.
Nonetheless, the market opportunity for fintech is bright. Mid-sized and large banks have caught on and are starting to focus on strategic partnerships with fintech firms that will make them more competitive. With banks’ abundance of pre-established resources — such as legacy code and institutional processes — these alliances will allow fintech companies to more effectively manage risk.
That will create a tremendous potential for technology to continue to shake up the way businesses and customers interact with financial services companies.
As fintech companies begin to work their way back to the fundamentals, CFOs across all industries can take note. Fintech’s reduced focus on pure growth, alongside an amplified focus on traditional financial services measurements — especially in highly regulated environments such as health care, pharma, and insurance — will drive increased stability and success.
George Sclavos is CFO of Laurel Road, a national online provider of student-loan refinancing, personal lending, and mortgages.