Fintech funding is down and has been in decline since 2021. Industry insiders, however, see the trend as more of a stabilization than a downturn — and describe an environment of opportunity for regional and community banks to get in on the fintech partnership game.
The numbers are stark — in the years leading up and into the pandemic, fintech funding was rising dramatically year over year, with a sharp increase in interest in areas such as cryptocurrency and blockchain technology. Investment in the blockchain and crypto space soared from $5.5 billion in 2020 to $30.2 billion in 2021, according to a KPMG report. Payments investment during the same period rose to $51.7 billion from $29.1 billion. But this gold rush during those years can be viewed more as a boost to fintech in a new and uncertain environment, rather than the beginning of a funding trend fintechs could rely upon for years to come.
“I think it’s a flawed assumption that there is no funding,” said Charles Potts, executive vice president and chief innovation officer of the Independent Community Bankers of America. “What is happening is that in a rising interest rate marketplace, all investors — whether venture capital, seed investors, angel investors, or private equity — are a lot more circumspect, thorough and diligent. It’s not that they were careless before, but in a 0% interest marketplace with a lot of money available, you spread it around. There is still an abundance of funding available, but folks are more conservative.”^
Potts’ outlook lines up with recent data. While funding is down, VC dry powder, i.e. committed but unallocated investment funds, are spilling over the sides swelling from $530.26 billion in 2022 to $566.61 billion in 2023, according to S&P Global Market Intelligence and Preqin data. The money is available and investors are looking for the right companies in the right markets and sectors with promising revenue models in which to invest.
Dig deeper:
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A Catch-Up Period
Many banks across the U.S. are digitized and others are digitizing. A decline in fintech funding does not equal a decline in availability of technology partners that will continue to help banks modernize. As later-stage fintechs are maturing and proving themselves to be profitable, more and more banks will be able to make use of tried and tested technology — especially regional and community banks.
A great example is bank marketing technology. Recent data from the American Bankers Association showed that among institutions that use marketing tech, almost half are using a CRM (customer relationships management platform). Of those, 48% agree that “there is not widespread adoption and the platform is not communicated or understood.” There is opportunity here for financial institutions to continue to mature their use and understanding of the technology they have already invested in.
“There is still an abundance of funding available, but folks are more conservative.”
— Charles Potts
“Banks will continue to focus on finding the best solutions to support their businesses,” said Brooke Ybarra, senior vice president of innovation and strategy for the ABA. “Those solutions come from a variety of sources, whether novel startup ideas, large legacy technology providers, or in-house developed solutions. Fintechs play an important role in the ecosystem by pushing the envelope for what is possible, how operations can be more efficient and how customer expectations can be better met. Even with a decrease in funding for fintechs, that innovation and drive to develop something of value will persist and banks will continue to be part of it.”
The same ABA survey also found that bank adoption of AI-powered marketing tools is low at 17%. But 23% plan to begin using such tools within the next 12 months — which aligns with investor interest in AI-powered tools of all kinds.
The New Wave: Artificial Intelligence
This publication recently reported the likelihood of investor excitement over artificial intelligence “seeping over” into fintech. This is already coming to pass. The Fintech Innovation Lab New York, run by Accenture and the Partnership Fund for New York City, announced their class of 2024 last month — and almost all of the selected companies use AI in some way. The Lab notes that this is the most AI-focused group in its history.
But it’s valuable to look closer at the class’s offerings to understand what is attracting investment interest: Their solutions are focused on solving some of the financial industry’s most pressing issues — including cybersecurity, fraud prevention and using data and analytics to improve the customer experience and business outcomes.
“One theme we’re seeing in fintechs that are landing deals is the ability to meet banks’ risk and cybersecurity requirements out of the gate,” said Steve Murphy, Accenture’s Financial Services industry solutions lead and executive sponsor of the FinTech Innovation Lab New York. “Some fintechs with great solutions may have gaps in their security architecture, opening the door to third-party risk. Data privacy, cybersecurity, regulatory compliance and IP are of course major concerns for banks. We’re seeing investors reward those that come with air-tight solutions for security and privacy.”
And just as fintechs will need to tighten up their underlying technology to attract funding, banks should be strengthening their foundational data capacities to be ready to embrace AI as the opportunities come. West Monroe’s 2024 Banking Outlook report noted that many banks have underlying data issues that must be addressed before successfully implementing AI. They will also need to improve their ability not just to implement AI, but to explain very clearly to regulators, partners and customers how AI-driven decisions are being made.
Dig deeper:
- Fintech Funding Freeze May Thaw in 2024. But Failures May Multiply, Too
- Webinar: How Will You Survive the Epic Funding Crisis?
The Golden Rule
Investment firms aren’t the only ones funding and incubating the next big fintechs — large banks and even some regional banks have been investors in fintechs themselves and sometimes, eventually, buyers. There is opportunity in this slowed-down, cautious VC environment for financial institutions to leverage their buying and investing power and create strategic opportunities with fintechs who need financial partners.
“Bank investors can demand a lower valuation on a company, for example, so you get a larger share of ownership,” said Potts. “They can command some board oversight, they could get warrants for future equity purchases. It’s the golden rule – he who has the gold, makes the rules.”
And it’s not just the largest financial institutions investing. Cornerstone Advisors’ “What’s Going on in Banking” report has been finding lately that community banks and credit unions are making direct investments into fintech startups, funding exactly the technology they want to be using.
“[Bank investors] can command some board oversight, they could get warrants for future equity purchases. It’s the golden rule – he who has the gold, makes the rules.”
— Charles Potts, Independent Community Bankers of America
Five hundred credit unions invested in fintechs last year. Among credit unions who see fintech partnerships as a driver of growth, nearly half expect to invest in fintechs in 2024 and nearly 3 in 10 will invest in two or more fintechs. About 30 of credit unions who have invested in fintech partners say that their loan volume and productivity has improved by 5 percent or more. Among banks, that percentage is much lower. The Cornerstone report surmises that fintechs are helping credit unions get into lending spaces where the credit unions had little presence, making an improvement much easier.
“I think there are a lot of potential benefits – both to the banks and to the fintech – of banks investing in fintech solutions and I expect that trend to continue,” Ybarra said. “The ability of a bank to provide feedback and influence and shape a solution as it’s being developed is invaluable to finding product-market fit.”
The Gold Rush is Over and Practical Solutions Win the Game
High interest rates and inflation have everyone — from investors to regular citizens — exercising greater caution with their money. And while tech is traditionally an excitable, fast-moving industry, banking has always been a historically cautious sector. This current funding environment shows that excitement over the newest, trendy tech, be it blockchain or AI, is never long-lasting. What does last is secure, robust technology that anticipates long-term challenges.
“In addition to investing or incubating in fintechs, some banks also act as a developer of technology solutions that in some cases can be spun out into a new business,” Ybarra said. “This is especially true when we think of innovations in the back office, where nobody is better positioned to address operational challenges than the banks that deal in that world every day.”
It’s almost symbolic that check fraud, a financial crime as old as paper, is sharply on the rise again. Financial institutions almost don’t know what hit them, with one bank — Regions Financial in Birmingham, Ala. — coming clean to Wall Street analysts that it fell victim to a check fraud scheme costing them more than $136 million in 2023.
“Who knew we’d be talking about check fraud in 2024?” said Potts. “One of the number one areas tech companies can affect change in banking is improving back office efficiencies, reducing cost-of-labor intense, redundant practices and making third party compliance practices easier for banks to manage. If someone can figure out how to solve the rise in check fraud – now that would be useful.”
“The scarcity of capital is forcing new fintechs to be hyper-focused on efficiency and real-world application over the previous approach of “growth at all costs,” added Murphy. “The bar is higher. Financial institutions and VCs are looking for demonstrable, specific products and business models with a much shorter leash on their investments. Potential clients are also aware that many fintechs are running low on funding so are looking closely at their long-term viability before making a buying or investment decision.”
Ranica Arrowsmith is a freelance writer based in New Jersey, focusing primarily on the technology, finance and accounting industries. She has written for Accounting Today, MarketWatch Picks and other publications in the medical technology space.