The Domino Effect- Exploring How Failed Banks Impact The Fintech Industry

Introduction

Silicon Valley Bank, First Republic Bank, and New York’s Signature Bank!

Can you think of a common factor among these three?

Yes, these are a few recent bank failure examples that have been witnessed by all of us. What makes the banking structure unviable and leads to their bankruptcy?

When banks collapse, lending levels typically drop, which can have a chilling effect on the housing market. When banks collapse, it can have repercussions throughout the economy. When banks collapse, it can have a domino effect on the economy, as less money is available for lending.

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Industry Insights from Experts

Here’s some commentary from Wil Hamory (EVP of Sales, Founder Shield) about the impact of banking failures on fintech.

“It’s no surprise that bank failures can profoundly affect the fintech sector. Here’s why: whether facilitating transactions or providing backend infrastructure, the interplay between traditional banking institutions and the burgeoning fintech sector is significant.

When things go awry, liability concerns often surface. These situations can create distrust between involved parties, not to mention the danger of consumers generalizing banking instability. If consumers view a specific bank negatively due to a failure, that perspective could also trickle to a partnering fintech organization. In that case, it’s a lose-lose situation. Remember that the opposite is also true, and win-win scenarios unfold daily.

Still, the risks come from many angles — regulatory, cybersecurity, operational, etc. That said, regulatory bodies aiming to prevent future failures might tighten controls around all financial entities, including fintech firms. As a result, fintech companies must be agile to seize opportunities arising from traditional banking disruptions and navigate an evolving regulatory landscape.”

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What leads to banks’ failure?

When it comes to the smooth operation of the international economy, a handful of organizations are as important as banks. They make it easier for people and organizations to engage in financial transactions, extend credit, and meet their financial obligations.

Despite the vital nature of banks, failures sometimes occur. Financial crises, recession, and increased unemployment are just some of the negative outcomes that might result from a bank failure. A few possible causes of bank failure are discussed below:

• Lack of mitigating potential risks
• Major gaps in balance sheet
• Poor risk management
• Interest rate risk
• Illegal/ Fraud activities
• Increase in bad loans/ economic crisis
• Regulators failing to identify internal issues
• Culture
• Overconfidence
• Regulator inaction

48% of people do not trust their bank to help them manage their finances during a recession, so how can these banking institutions and open-banking platforms expect to garner trust when engagement is clearly not there? Open banking indeed has revolutionized the way financial institutions interact with their clients evolving at an incredible pace.

Fintech firms primarily cater to customers who have low credit scores or who have multiple challenges while attempting to open a bank account. In most cases, banks would rather do business with dependable customers who have established credit histories. Collateral needs in FinTech transactions are usually minimal and flexible.

Bank failures have typically been an indicator of a looming recession. Even after we had finished our previous prediction, huge upward data revisions indicated that the economy had grown more quickly than we had anticipated in the first quarter.

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How Failed Banks Impact The Fintech Industry?

If not taken proper care failure banks can also lead to economic crisis on a global level. History says it all. We had Lehman Brothers failure in 2008 which eventually led the entire globe into a black hole and destroyed much of its wealth leading to suicides and bankruptcy.

History is a witness to how bank failures have severely impacted the overall fintech industry and led to a global slowdown where investors become furious and fearful at the same time with the probable bankruptcy they will be bestowed upon. In fact, we have several Hollywood movies like – The Big Story, The Flaw, Little Men, Waiting For The Messiah, etc.

A global financial crisis was sparked by the bankruptcy of this 164-year-old company, which was the fourth-largest investment bank in the United States. There could be a run on the bank if depositors realize the collapsing bank won’t be able to pay them back.

Since the bank’s liquid assets will decrease when depositors pull their money, this can exacerbate the problem. The same was the case with the other bank failures as well where we have seen numerous side-effects on the entire fintech and banking industry. The most recent one was in March 2023 where we saw two banks failing one after the other i.e. Signature Bank and The Silicon Valley Bank.

Undoubtedly, the parameters such as the scale of operations of the bank, its net worth, NPA’s, and its balance sheet do decide the extent to which harm could be done. In some cases, the destruction is vast as was in 2008-2009 while in the rest cases, the scalability could be on the lower side, but still, we cannot deny the fact that the bank failures do carry a risk of fintech damage!

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I believe there are resilient fintech companies that can weather a weaker macro environment, even if broad market volatility increases and earnings fall this year. Despite the worsening macro environment, these businesses may enjoy considerable positive offsets from factors including lessened industry competition, more pricing power, decreased customer acquisition costs, and more promising M&A opportunities.

Investors aren’t the only ones whose confidence has been shaken by the string of bank failures. The balance of power in the banking industry appears to have tipped, and financial institutions must now prioritize their customers’ needs.

A delay in a bank’s financial reports, the closure of branches, or rumors that it might be acquired or sold are all possible warning flags that could emerge from financial news items or social media. If the government, regulators, and other industry players act forcefully and quickly in response to a bank’s symptoms of difficulty, they may be able to reduce the amount of damage done to the bank and its depositors. As a result of swift and decisive action, the effects on depositors were mitigated and faith in the U.S. banking system was restored following the bankruptcies of SVB and Signature Bank.

In general, I believe that the current scenario in the US banking sector may ultimately prove beneficial for fintech companies, particularly among more established incumbents in the public investment sphere.

When a bank fails, it is unable to repay its creditors and depositors because it has insufficient funds. They can’t make loans to firms, which makes it hard for those enterprises to get funding. If resources were limited, operations would suffer and output would fall.

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Insights from Global Fintech News

The bank’s bankruptcy ranks as the second-largest in American history and the biggest since the global financial crisis of 2008. Due to the panic that resulted from its failure, the world’s stock markets fell. In premarket trading, shares of major American banks decreased by more than 1%. Regional banks saw losses of between 10% and 20%, including PacWest Bancorp and First Republic Bank. The digital lender was compelled by an increase in yields to sell a portfolio of treasuries and mortgage-backed securities to Goldman Sachs at a $1.8 billion loss. It attempted to raise $2.25 billion in common equity and preferred convertible stock to close the gap, but worried customers withdrew deposits from the bank, causing $42 billion in withdrawals in a single day. The business reported having around $2.2 billion in liquid assets on Friday. By the end of the previous year, it had $209 billion in assets.

Insights from Global Fintech Guest Posts

While it’s anyone’s guess whether there will be more bank failures this year, there’s little doubt that recent bank collapses have shifted the power dynamic. FIs can address the issue of trust and prove their trustworthiness to customers through transparent and educational communications, showcasing their community values, and ensuring simplicity in their online and mobile offerings. Through these methods, banks can reassure customers that their money is safe and secure and prevent a crisis of confidence that leads to attrition. 

Conclusion

Even if market volatility goes up and earnings go down this year, I think there are strong fintech companies that could handle a weakening macro situation. Even if the macro environment continues to get worse, these companies could still see huge positive effects. For instance, they could see less competition in their industry, better pricing power, lower customer acquisition costs, and more attractive merger and acquisition (M&A) opportunities.

I think that the recent situation in the US banking sector could be good for fintech companies in the long run, especially those that have been around for a long time and are well-known in the general investment universe.

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[To share your insights with us, please write to pghosh@itechseries.com ]