As mentioned above, financial regulators are creating specific requirements based on scope, size and risk of the business model. Although Fintech innovation is broadly welcomed, Fintechs, by nature, operate in the financial market, which is heavily regulated. So, it is important to have a good understanding of the minimum requirements to each solution you are trying to create.
As this is an evolving environment, sometimes you will face different variations of the same challenges, make a call on how to proceed while being alerted to changing rules and dynamics. A good example is the Brasilian Central Bank and the new instant payment system called PIX. The central bank is changing its rules and requirements based on the ongoing experience of the implementation and gradually incorporating new features. If you are in such an environment, you need to adapt and be ready to take advantage of any change.
We must talk about minimum business requirements. Sometimes Fintech entrepreneurs forget they are building a financial institution which will be subject to regulation. As some solutions are created from different perspectives, some Fintech start-ups, after a brief period of operation, find themselves in difficult positions because they have neglected basic business dynamics. These dynamics could involve basic balancing or funding requirements, or risk appraisal, recovery tools, and so on.
For example, any seasoned banking professional understands the need for a lending solution to secure a stable flow of funding as the portfolio grows. This does not seem to be the case with Fintech start-ups, which seem to believe that they will find a solution as they go. The same happens with “unexpected” levels of credit delinquency, or limited re-insurance contracts, or even the size of service bills from third-party providers when transaction numbers have not been properly scoped. Not all investors will accept such mistakes. Many great ideas have failed because of a failure to understand the basic dynamics of the proposed solution.
It is crucial to understand the path to profit. Take digital banks as an example: their challenges in getting to profitable scale were nontrivial. On average, customers at digital banks hold 1.5 products, compared to five for traditional banks (according to a 2018 McKinsey survey). In addition, digital banks rely on transaction fees and commissions for the bulk of their revenues, and only a few have been successful in having customers sign up for a subscription/account fee. Incumbent banks generate income from multiple sources beyond transaction fees, such as packaged accounts, commercial and consumer credit products, mortgages, and investments.
As a result, many digital banks have a cash-consumptive business model that requires continual investor funding. Fintechs that are skewed towards customer acquisition (as opposed to seeking a profitable business model from the start) are particularly challenged. In times of contracted funding environments, many digital banks cannot sustain a cash-consumptive business model in the medium term. Instead, they must turn to focus on expanding their revenue engines, coupled with a shift in customer acquisition strategy to pursue more economically viable segments.