Can FinTech startups replace banks in future?

Can FinTech startups replace banks in future?

The valuation methodology for fintech companies depends on the segment in which they operate, the stage of their evolution etc. 

Matured companies having an established business, constant cash flows can be valued by traditional methods such as discounted cash flow (DCF) method, comparable transaction method (CTM), price to earnings ratio of comparables etc. 

For very early-stage fintechs, if they have not reached a critical mass or market share in a specific region or niche segment, there are specific approaches that can be used for appraising investments, such as the scorecard valuation method, berkus method, risk factor summation method, venture capital method etc.

There are specific multiples that can be used for the valuation of a fintech having visibility based on the business segment. For example, a fintech company that has a loan portfolio that can be valued using enterprise value to loan book ratio, a company operating in the payments segment can be valued using the comparable ratio of enterprise value to the number of active users or a multiple for transaction value, an asset management fintech company can be valued using enterprise value to assets under management ratio etc.

Fintechs gaining at the cost of traditional banks

As per reports, existing fintech companies in India have gained one-third of new revenue at the cost of traditional banks. 

There are various segments even in the Indian fintech space providing solutions in specific financial areas such as digital payments lending insurance, wealth management, peer-to-peer lending etc. apart from the payments business, which was how the fintech space started, and these have tremendous growth opportunities. 

Hence, just like regular start-ups, for players operating in the fintech segment, it is not about EBITDA or profitability, but being in a sector that has an addressable market. 

That's why a merely low margin payment business may not have significant value and such entities may not get acquired by companies wanting to build an ecosystem or a traditional business wanting to add a technological edge, like how Axis Bank acquired Freecharge, Bajaj Finance launched Bajaj Pay and, in the process, launching five marketplace products to eventually become a fintech. 

Further, we see that the era of being only in the payment business is over as many fintechs have graduated from payment business to developing an ecosystem. Take for instance Paytm. 

Another recent example is PhonePe which along with Centrum has been keen on expanding into a technologically enabled banking system by acquiring a small finance bank license. Eventually, the large addressable market can be an opportunity to cross-sell and there is a huge opportunity once a fintech has an ecosystem in place.

Valuation based on sum of parts

Depending on the sub-sectors of the businesses like payments, lending, investments etc., the ideal way will be to value these businesses on a SOTP (Sum Of The Parts) basis for businesses having different risks and rewards. 

A fintech could embody different sub-sects and all of these may not require a banking license as the law stands today. 

There are various segments such as Wealthtech, Insuretech, P2P lending etc. which do not require a banking license. 

Hence the majority of fintechs are coming up in these sectors. Take Cred for instance which as a fintech has a great data bank to use the information to cross-sell. 

Even though fintechs do not have a banking license they offer P2P payments services, however, the limiting factor is that they cannot hold customers' money as deposits. 

Banks on the other hand are continuously losing customers to such fintech players. Hence, a collaborative environment between banks and fintech players is shaping into Banking as a Service (BaaS) wherein banks can share their infrastructure with these fintech players. 

We can see that holding a banking license could help fintechs to have a larger ecosystem and scale up faster due to the technological edge, providing a massive data mine to cross-sell.

Fintechs banking ambitions

The last couple of years saw several fintech companies obtaining licenses to operate as a bank and - ultimately - become a bank. 

PhonePe and Centrum's recent acquisition of a Small Finance Bank is a case in point. Fintech's through innovative, marked by agility and faster decision making, desire to disrupt the traditional model. 

For these companies to go down the traditional banking route though seems counterintuitive, one has to note that these fintechs are disruptive because of the technology they offer and that is exactly what the traditional banking system lacks.

Therefore, fintech companies are not only developing ecosystems but other fintech marketplace platforms, like insurance platform Policybazaar has announced to partner with Paytm and Ola Financial, as well as private sector lender IndusInd Bank and a handful of consortium players to set up a New Umbrella Entity (NUE) to build a national payments infrastructure company.

As said earlier, knowing this fact many established banks have attempted to acquire fintech start-ups, partner with them, or develop their own digital offerings. 

Examples of these are Citi's investment in lending companies C2FO, BlueVine, FastPay as well as JP Morgan's investment in Prosper, LevelUp or Gopago.  

Now, fintechs are trying to be more like banks. From a payments business to a lending marketplace, we can see all sorts of fintechs across regions moving towards obtaining a banking license.