🚀 The Winter '24 Release is here — with smarter bill pay, spend limits, and more >

Blog

Articles

The enduring val...

Journal Home

The enduring value of funding-driven fintech

headshot photo of Michael Tannenbaum

Michael Tannenbaum

·

4 min read

4 min read


MT-funding-article-preview
MT-funding-article-preview
MT-funding-article-preview
MT-funding-article-preview

The enduring value of funding-driven fintech

Higher for longer

The dramatic change in the interest rate environment over the past 18 months has disrupted a number of valuation and economic paradigms in the technology landscape. While no one can predict the future, the latest yield curve - and particularly the movement in the yield curve over time - suggest a structural and step-function change upward in long term interest rates.

MT-graph01
MT-graph01



Deposits (and other funding or liability-driven business models) have more value in higher interest rate environments. This is due to two factors, the first is the inelasticity of deposit pricing relative to loan pricing. Specifically, most loans are priced to a benchmark rate (e.g. Prime) plus a spread, so their pricing adjusts automatically with an increase in interest rates, while deposit pricing does not adjust automatically. This delta in repricing creates economic value as funding becomes relatively cheaper.

The second reason deposits have more value in a higher interest rate environment is the scarcity of funding, as institutional and retail dollars seek higher rate alternatives to deposits such as those found in the money and bond markets, which means that banks and other funding-hungry companies will pay more for liquidity.

Dissecting fintech value capture

Fintech business models tend to pick apart the valuable parts of the financial services industry, which is broadly three categories: (1) assets (e.g. loans, that earn a spread over their funding costs), (2) liabilities (e.g. deposits or funding which in turn fund assets as cheaply as possible) or (3) fees, which have more in common with non financial business models such as software and services.

As outlined in a paper by NYU Economist Thomas Philippon, financial intermediation (broadly the domain of the financial services industry and fintech alike) has not gotten more efficient over time - unlike for example the situation in consumer technology. Therefore, the rewards in fintech have historically accrued to the innovating platforms, rather than the end consumer, which makes the industry so lucrative and attractive to financial investment. The financial services business model has endured over the years and over a number of different interest rate environments.

MTGraph02
MTGraph02

A historical perspective

From 2010 - 2020, interest rates were at or near 0, which was historically anomalous, but therefore largely hid the embedded value in funding-oriented businesses. During this time, fintech investment and value creation occurred either in asset-generating companies or fee-generating companies, with negligible value generated in deposits or funding. Examples of asset-generating franchises include marketplace lending (e.g. LendingClub, Prosper, SoFi) earlier in the decade and BNPL platforms (e.g. Affirm, Klarna, AfterPay) later in the decade. Fee-generating examples include those in asset management (e.g. Robinhood, Wealthfront, Betterment) and in the payments space (e.g. Square, Stripe, Checkout).


However, considering the history of fintech from a longer historical perspective reveals the enormous value that deposit and funding oriented franchises have created. Disruptive deposit-oriented ING Bank - famous for its urban cafes and innovative marketing - was launched in the U.S. in 2000 when the Federal Funds rate was around 6.5% and was ultimately sold to Capital One for $9B in 2011. Capital One itself, founded by Stanford grad Richard Fairbank, entered the deposit gathering business in 2004 and is now worth $40B today. Innovative discount stock broker Schwab, also founded by a Stanford grad disruptor, ($120B market value today) earned over 57% of its revenue from deposits in Q1’23. The past 10 years aside, history shows that deposit and funding franchises can create billions of dollars of economic value.

Revisiting my assumptions

I have spent my career in fintech and the structural interest rate shift is particularly jarring to me given my career trajectory. Right out of school, I worked on the $3B sale of ING Bank to ScotiaBank in 2011. The franchise was almost all consumer deposits and had very little assets (in the form of mortgages or other loans). To determine the fair value of ING Bank of Canada in that transaction, we spent days running various interest rate and economic scenarios to determine both the elasticity (stickiness) of the deposits.

However, as interest rates hovered near zero over the next decade and so much of my time was spent at SoFi (asset-based in the form of student loans, personal loans, mortgages) and Brex (fee-based in the form of charge cards and SaaS), I forgot the economic value of deposits!

Even with Brex business accounts, which has billions of dollars of deposits, I typically thought about its value in terms of customer retention and acquisition (companies need a bank account before they need expense management and corporate card) rather than directly economic. Yet, this was clearly short-sighted given the long term economic prognosis for interest rates to remain well north of zero.

The future

Fintechs benefit from enduring business models that have thrived in a variety of interest rate environments. Recent history has diminished the value of disruption focused on funding models like deposits, but the market is clearly shifting. Goldman Sachs - one of the savviest and most sophisticated financial companies, has recently looked to shed its asset-oriented fintech businesses (e.g. GreenSky and Marcus personal loans) but has notably sought to keep its consumer deposit-gathering fintech business. Apollo, KKR and other large sophisticated financial companies are spending billions of dollars acquiring life insurance platforms - another liability-driven business model - certainly pointing to a brighter future for fintech business models built around life insurance.

My advice to the fintech founders, operators and investors in the space - embrace the liability-driven business model. It’s lucrative and enduring: the future is funding!

bottom-cta-bg
bottom-cta-bg
Closed-loop-dark
Closed-loop-dark

See what Brex can do for you.

Learn how our spend platform can increase the strategic impact of your finance team and future-proof your company.

Contact salesOpen an account

Related articles

Heirloom

Heirloom achieves 96% employee expense policy compliance with Brex

See how a fast-growing climate technology company uses Brex budgets and receipt automations to save time and money.