Questionable business models in Fintech have been exposed, as predicted, in response to rising interest rates. In Europe, the UK and US, rates have risen from near zero levels at the end of 2021 to the present levels of: 3.5% (Europe), 5% (UK) and 5.25% (US). Insight Partners, an aggressive New York based Fintech VC with US$ 90bn of assets is closing its latest fundraisings early, unable to raise new investment. It talks about a “Great reset” in Fintech, whose investors have suffered “a painful reversal in tech valuations over the past 18 months”.1 The highly successful Andreesen Horowitz firm is effectively closing its new Fintech investment activity and ‘merging’ its team into its AI business. Values in the Buy Now Pay Later sector on which we reported in May 20222 have plummeted across the board by 90%. The Q1 2023 global VC funding total for fintech was US€15 bn, half of the Q1 2022 figure.
How are central banks likely to respond? We believe the main focus of the ECB and the Bank of England will be on the narrower NeoBank category of firms, particularly the larger ones. NeoBanks start life as firms, typically licensed as e-money institutions, offering online only (app based) financial products. Some remain as e-money firms, others aspire to offer a wider range of financial products, and subsequently succeed in getting licenced as banks. In this Newsletter we look at both models.
Berlin based N26 is one of Europe’s biggest NeoBanks but is actually a bank, having obtained a German banking licence in 2016. Its latest accounts, for 2021, raised eyebrows. N26’ net loss was up 14% at €172 million, against revenues of €182 million. N26’s costs were growing twice as fast as revenues. N26 has never made a profit since its 2013 inception. One wonders whether some of its respected specialised investors such as Peter Thiel, Insight Partners (see above) and China’s Tencent, might be beginning to wonder as to the viability of its business model? Revolut has a broadly similar model, claims to be profitable, and wants to convert to a full service bank. The following paragraphs look at Revolut and compare its model with the very different one of another large global Neobank, Wise.
Founder Nikolay Storonsky set the firm up in response to his experience of conventional banks’ high charges for international payments and foreign exchange. With its user friendly app and successful marketing Revolut quickly grew, expanding its products and services into crypto trading (2017) and commission free share trading (2019). Today it categorises its revenue streams into six classifications: subscription plans, rewards, interest on cash, personal loans, trading and insurance. It has 30 million customers in 37 countries using up to 50 products.
Despite its success in raising a total of US€1.7 billion in a series of private funding rounds culminating in its 2021 valuation of US$33 bn, Revolut has been the subject of a steady stream of compliance concerns and questionable reports from independent analysts. In 2019 it failed to block thousands of transactions flagged as ‘potentially suspicious’ by its own algorithms3; in 2020 it reported the opposite: it had in error suspended a number of compliant accounts. The reason was that its algorithms were flagging too many requested activities as suspicious, resulting in account suspension until a member of staff could look into each flag, and it had not enough staff. No wonder given that a further concern has been high staff turnover caused by pressure to work antisocial hours and sometimes without pay4.
Compliance concerns have been heightened by the gap between management hype and subsequent reality. Management have repeatedly insisted that Revolut was on the verge of being granted a UK banking licence, deemed essential if Revolut is to become its customers’ main bank. Then came its long delayed 2021 accounts, again provoking controversy. Published in March 2023, and signed off by the fifth largest UK auditor BDO, these indeed showed a net profit of GBP 21 million, but were heavily qualified to the extent that BDO said that it had checked the cash balances of the bank accounts but that owing to a lack of documentary evidence outside of the IT system….5:
“As a result we were unable to satisfy ourselves by the execution of such procedures or by alternative means concerning the completeness and occurrence of revenue within these streams totalling £476,856k which is included in the Statement of Comprehensive Income and Note 6 of the financial statements for the year ended 31 December 2021. Consequently, we were unable to determine whether any adjustments to this amount or related amounts were necessary.”
This qualification of the accounts may encourage Revolut to relocate to Europe, where it has a banking licence issued by the central bank of Lithuania, since its stated position is that without a banking licence it will be unable to become a public company via a stock market IPO. Shortly after publication of these accounts, CFO Mikko Salovaara, having declared that its IT systems were not up to scratch, resigned, the latest in a series of senior executive departures.6
Wise’s two (Estonian) founders also founded the company in 20117 in order to arbitrage excessive foreign exchange charges being levied by bricks and mortar banks throughout the western world. But there the similarities with Revolut end. Notably, as early as 2013 they banned transactions in cryptocurrency. Four years older than Revolut, and growing rapidly but markedly slower in terms of number of customers (Wise today has about 16 million customers compared with Revolut’s 30 million), Wise went public in July 2021 with a valuation of GBP 11 bn. It has not sought a banking licence; it has never aimed to become its customers’ main bank.
Wise recently published its 2022 accounts; revenue up 73% to GBP 964 mm, profit before tax up 230% to GBP 146 mm, and crucially responsible for GBP 11 bn of cross border (cross currency) payments per month, the personal share of which representing about 4% of such global personal payments. Although Wise product mix has expanded in its 12 years of existence, it has remained focussed on its core strengths, classifying its products into three categories:
- a personal account for cross border and cross currency payments;
- a business equivalent, with some added features;
- a ‘platform’ which other NeoBanks such as Monzo, N26 and Googlepay use because Wise’s method of currency conversion is essentially internalised along ‘Hawala’ lines.
In summary, the contrast between Wise’s and Revolut’s models could hardly be more stark. Wise’ strengths are threefold: a narrow product range, very good systems and absence of controversy or hype, and an intense focus on compliance and in particular relations with regulators. Managing customer deposits is just about the most heavily regulated area of banking and fintech, so there is nothing to be gained. Not surprisingly, Wise claims its present stellar growth is primarily due to word of mouth recommendations, not advertising or financial inducements.
Conclusion – Strong UK Government Support for Revolut, Why?
In the immediate aftermath of the Great Financial Crisis, regulators recognised that they had failed to appreciate the non-viability of banking business models, and both the Bank of England and ECB declared that the assessment of business viability, termed ‘strategic risk’ was an important part of their remit8. They asserted their intent of regulating strategic risk as one of the risks, along with credit, operational and liquidity risks which they would be assessing for every regulated entity. But after this initial flurry of concern the subject was quietly dropped.
Does that mean that central banks are even capable of assessing the ‘strategic risk’ of varying NeoBank models? We doubt it. By contrast, and sadly, the political appeal of hosting a tech success has seen UK politicians fawning over Revolut. Shortly before the controversial 2021 accounts were published, UK Finance Minister Jeremy Hunt met with Revolut’s Mr Storonsky and declared the firm a “shining success”9. Two months after the results, responding to reports that Revolut was considering rebasing itself in continental Europe, and clearly worried that such an abandonment would impair the UK’s reputation as a promoter of successful Fintech, several ministers met Revolut in an effort to dissuade them from leaving10.
In brief, banking regulation remains problematic. Whether we’re talking about Revolut or legacy banking problems, there is no ‘tech’ solution to bad regulation, bad loans, mismarked books, etc. Payments and foreign exchange are not so problematic, as Wise shows, but the lending and credit core of banking is in as much of a mess now as it ever was. Nothing has been cleaned up and tech doesn’t solve these problems. But the world of politics keeps sending wrong signals to the public.
7 then known as Transferwise
Photo by Mariia Shalabaieva