Chloe's First Take on Substack
2022 predictions of the fintech space
Happy New Year to my readers!
Chloe’s Take was in beta mode last year, and I appreciate all the feedback and discussions from you so far.
Some highlights from last year: the Take with the highest readership was the one on Lending-as-a-Service. The most fun Take was the one on Bilt rewards card, as some of you went on to become Bilt customers (no I’m not getting any commissions).
This year, Chloe’s Take is launching to the world via Substack! As my beta readers, you are getting my very first take here before everyone else.
My ask to you:
Keep the feedback coming
Tell me what other topics you want to hear from me
If you enjoy my Takes, tell your friends
Below are Chloe’s Take on the big trends moving the fintech space in 2022:
The Fed may crash the party sooner than you think
With unemployment rate at sub-4% and consumers flush with cash thanks to yet another around of stimulus checks, the Fed may raise rates as soon as March 2022.
The Fed’s potential move will affect the startup ecosystem in several big ways:
Divergent impact on profitability and thus cash burn
For fintechs that operates under a lending cap (i.e consumer lending), rising rates will likely squeeze interest margin, while for fintechs that aren’t subject to a cap, rising rates-especially when longer term rates rise faster than short term one-could actually accelerate the path to unit profitability.
The fundraising frenzy 🐯 will cool down
In my view, the rush last year was partially driven by a hunt for yield; with fed rate sustaining at near 0%, investors became increasingly amenable to higher-risk, higher-return bets such as venture. But staring 2022, a more normalized rate environment will right-size asset owner’s risk appetite and bring more rationality to the current fundraising environment.
Continued consolidation, especially in PFM
The consolidation is already happening (Chime+Charlie, ML+Even, OPRT+Digit, RKT+Truebill). A more rational capital market will likely re-value similar companies in the space.
Credit taking the center stage
Sure, every company will be a fintech company collecting interchange.
But did you know that interchange revenue is just the appetizer? Credit is the real-deal entrée.
For the next phase in the financialization of all companies, I’m not talking about a repeat of Lending Club; instead, innovation will come from contextual lending, whereas lenders command richer data and can capture high-intent borrowers with the right product at the right time.
To support contextual lending, the industry demands a modern core to provide lending-as-a-service (see point below). Building on top of LaaS platforms-coupled with a robust go-to-market strategy-these contextual lenders will scale rapidly.
Some early movers in contextual lending have arrived, such as CapChase, Parafin, and Wisetack, but this is still largely a greenfield.
There will be billion dollar companies among the new batch of LaaS providers and contextual lenders
Fintechs will go deeper into the stack, tackling lending-as-a-service
I’m personally most excited about this one 🤩
To take a step back, the fintech stack can be divided into roughly three layers, starting with the customer-facing layer and going deeper into the stack: UI, orchestration, and core processing.
Fintechs such as Lending Club mostly tackled the UI layer, whereas financial activities went from paper-based to fully digital.
Chime, founded 7 years after LC, tackles the UI layer with some orchestration to enable early pay-check access and free cash deposits.
Plaid and Alloy are some of the leading orchestration providers, whereas one API call into them unlocks access to hundreds of banking and KYC partners that are integrated to their platforms.
BaaS providers are, at the end of the day, also orchestration players. In most cases BaaS companies are like Costco: BaaS customers can go to one store to access everything they need to launch a banking product, with the promise of a volume discount. Just like Costco, BaaS providers “orchestrate” the curation, negotiation, and standardization of many hard-to-source components (think bank sponsorship and compliance), so that BaaS clients can buy things “off the shelf”.
Then, what about the core? In my view, the industry is ready and eager to embrace a modern core.
A modular, flexible core will unlock a new era of lending-as-a-service.
In my last newsletter, I shared my own experience dealing with the ugly ball of wax called core processing. Want to review this newsletter? Drop a comment:
Core processing is the hardest to disrupt. For one, core processors are held to an extremely high standard for data accuracy and system performance while juggling real-time connections to multiple partners such as the card network and payment processors. Building core processing from scratch takes serious time and commitment. For another, the uses cases for core processing, especially lending core processing, are messy and complex. (I dived into this in my last newsletter).
Yet core processing needs to be updated. Legacy systems are not keeping up with modern use cases. Simply wrapping a layer of APIs on top won’t solve the fundamental challenges.
So it’s extra exciting to see companies such has Highnote and Peach re-writing the core processing stack FROM STRATCH.
In 2022, I look forward to more disruptors in the orchestration and core processing space.
Fintechs will face delinquency-caused cash crunch for the first time
Lending is not for the faint of heart. After spending my career in both junk bonds and subprime lending, I’ve lived through the risk firsthand.
Fintechs that started lending in the last 10 years have enjoyed a super-cycle of lax monetary policy.
However things are already changing: severe delinquency rate has been rising, and the Fed may crash the party in just a couple months.
Delinquency could cause a downward spiral ending with a cash crunch: faced with sudden spike in late-paying customers, inexperienced lenders may knee-jerk react and pull back all lending, reducing potential revenue it could earn from good customers; lenders’ cost of capital may increase due to covenant breaches and worsening market reception, reducing the lender’s profit margin. This downward spiral will burn through cash quickly.
The solution? Have a data-driven go-to-market strategy that’s scalable and resilient. Drop a comment below to learn more
Monetize that data
Everything is powered by data: BaaS, LaaS, and everything in between. The industry has been collecting a vast amount of data, but very few have found ways to cleanse, standardize, and model such data for actionable insights. Plaid is famously (infamously?) not in the game of data categorization, and subsequently its data is as messy as the back offices of the thousands of banks it works with. Plaid’s strategy creates an opportunity for other companies to fill in the gap. A precedent is found in Nova Credit, which is standardizing credit bureau data across borders.
In 2022, I look forward to companies tackling the data challenge via connection, standardization, or insights extraction.
Web3
A 2022 prediction is not complete without mentioning web3. I’m super intrigued by its potential but I haven’t done the “I spent the whole weekend going down the rabbit hole called web3” thing. So stay tuned. In the meantime, any recommended readings for me? :)
What are you looking forward to in 2022?
