Fabricio Mercier, founder of WinYield
Are hundreds of European fintech start-ups heading for a dramatic explosion? New research suggests this could be the case, with the authors saying there is a significant risk of systemic contagion following such a crash.
Fintechs across Europe have raised more than $12 billion this year to lend to small and medium-sized businesses (SMEs) and consumers, the credit fund highlights. Gain yield, with venture capitalists providing equity capital and institutional investors such as insurers providing loan financing. However, WinYield warns, many of these fintechs have little or no practical experience investing through different credit cycles – and he says their supposedly sophisticated new technology may not be up to par. height.
The study is based on interviews conducted with around a hundred fintechs specializing in the lending market across Europe. WinYield found that fewer than one in ten start-ups had a staff member with relevant experience in the credit market. She also examined the companies’ technology underwriting models, concluding that many of them consisted of very basic analytical tools that did not provide sufficiently robust backtesting of loans under various credit market conditions.
“Conducting these interviews over the past 18 months has given us a real sense of déjà vu,” says Fabricio Mercier, Founder and CEO of WinYield. “The conversations we had are very similar to those leading up to the 2007 global financial crisis.”
One problem identified by WinYield is that many fintechs may have overestimated the size of the markets they are targeting. For example, lending to e-commerce players is an increasingly popular strategy among fintechs, but these loans are repaid very quickly, as customers settle their accounts, which significantly reduces the credit that fintechs hold in their books.
Mercier also believes that many fintechs have simply set up their business with a model that is not economically viable. “Many European fintech lenders are opting for a multi-product approach and aggressive marketing budgets that are favored by their American peers,” he warns. “But this doesn’t work in a fragmented European market where the portfolio break-even point is far too high.”
WinYield is particularly concerned about the risks faced by fintech venture capitalists, who have invested approximately $550 million in equity stakes in these start-ups. This money may be at risk if fintechs fail to achieve profitability. On the other hand, institutional investors who provide debt capital benefit from at least some security, thanks to the first charge they generally hold on advances made by lenders.
However, a major explosion in the sector could cause major problems. “Credit is a market characterized by greed and fear,” Mercier warns – participants tend to overreact in good times and bad, he says. “The question is whether we can get these fintechs to adjust their models quickly enough to avoid a contagion effect.”
In practice, fintechs’ commitments are much lower than those of bank lenders, reducing systemic risk. However, international regulators are increasingly concerned about the “shadow banking” sector – non-bank institutions, such as fintechs, that act as lenders – and its potential to destabilize the financial system.
In recent months, for example, the Financial Stability Board, the global regulator, and bodies such as the Bank of England and the US Securities and Exchange Commission, have all issued warnings about different parts of the shadow banking sector. Although fintechs are not specifically targeted, problems with technology-focused lenders could lead to increased scrutiny.
Mercier believes, however, that regulatory intervention in the financial technology sector is not the right way to deal with the problems facing credit start-ups in the current context. Instead, he urges investors and fintechs to take a closer look at the models they’ve developed – and focus on reducing risk before it’s too late, especially as venture capital funding for the sector has now largely dried up.
“It became clear that the 2020 bull market was creating an irrational bubble in fintech lending,” says Merciar. “While there are still many bad apples, we believe the shortage of venture capital could bring European fintechs back to their senses by allowing them to regain some degree of discipline and rationality in their decision-making. »
