Reinvention of Spending
How the pandemic changed the way we pay — likely forever
Will anything ever be the same again?
Photo: Getty Images
Fintech knows a crisis. The 2008 financial crisis and the ensuing distrust of banks led to a decade of innovation, with challenger banks, digital payment providers and robo-advisors sprouting everywhere you looked. It's apt, then, that this crisis has provided such a boost to the sector.
Across all aspects of fintech, things are changing. The way we manage our money is increasingly digital, as is the way we spend it. Stock trading is now so frictionless that it's almost a game, and tech could provide a solution to an old and broken credit-scoring system. And then there are QR codes.
All of these things were already happening before the pandemic, but fintech, as with so many sectors, has been significantly accelerated by the crisis. Governments are catching on, too, speeding up regulatory processes in response to the huge surge in demand for digital financial solutions.
In a series of conversations with fintech experts, the sentiment was resounding: The pandemic has changed people's financial behavior, and those changes are here to stay. Four areas stuck out as being particularly notable:
Let's get the obvious out the way first: Most people don't go to the bank anymore. This isn't an entirely new phenomenon, with internet and mobile banking on the rise for decades. But forced branch closures catalyzed the shift, forcing holdouts to finally embrace apps. Especially when a pandemic means customers can't get into a bank even if they wanted to go.
The number of sessions in banking apps increased 26% between the first half of 2019 and the same period in 2020, according to data from mobile measurement companies Adjust and Apptopia. And those new users look like they're going to stay around: A survey from Plaid found that 80% of Americans now say they can manage their finances without needing a bank branch at all. As John Pitts, Plaid's head of policy, told Protocol: Once you've tried something better, you're probably not going back to the way things were. Banks are taking note, and branch closures are picking up pace — seemingly as a result of the pandemic. European banks are set to permanently close 2,500 branches, while Brazilian banks have already closed nearly 1,500 this year. In some markets, McKinsey estimates, a full 25% of all bank branches might close.
But while you might expect the shift to digital banking to have benefitted neobanks like Chime and Varo in the U.S., the reality is more complex. Those banks' revenues are heavily reliant on interchange fees, earned when you make a payment with your debit card. But the number of payments people typically make with neobanks — coffee, public transport, lunch — has plummeted. "As spending starts to drop," Terese Hougaard, a principal at VC firm Atomico, said, "there's a lot of pressure on interchange fees."
Compounding matters is the reputation of neobanks versus some bank brands that have been around for over 100 years. "What usually happens in any type of crisis situation is you have a bit of a flight to safety," Hougaard explained. That happened this time too, she surmised, with people seeking out the comfort and stability of traditional banks rather than untested newcomers. A bank saying that there's "significant doubt" about its ability to survive isn't the best user acquisition tactic, in other words. That's what U.K.-based Monzo said shortly after it raised money at a $1.6 billion valuation — well below the $2.5 billion it was valued at last year.
It's not all bad news for fintechs, though. Chime recently raised at a $14.5 billion valuation, almost double its valuation in December 2019, while competitor Varo became the first consumer fintech company to be given a U.S. national bank charter. Neobanks are also well-placed to capitalize on the influx of digital savers that the pandemic has inspired. As consumers spend more time online, it's likely their expectations of what bank apps should be able to do will rise, as they search for increasingly nimbler, more personalized experiences that they have on other parts of the web. They may well find themselves drawn to neobanks rather than the cumbersome traditional banks.
The pandemic hit much of the U.S. economy hard, and some 11 million Americans are still unemployed, creating serious financial struggles for many. In times like this, access to credit is crucial — but many people can't get it. The CARES Act, passed in March, was the only relief many Americans have gotten to date, and $1,200 checks don't last forever.
"The CARES Act itself made it really difficult to understand who was actually [financially] healthy and who was not," Nami Baral, CEO of fintech company Harvest, told Protocol. The act changed what could affect people's credit scores during the pandemic — an attempt to make sure that missed payments didn't unduly affect people's financial futures. "Rather than putting a lot of time and effort into figuring out 'OK, this customer is healthy versus not,' most lenders responded by just constraining that flow of credit," Baral said.
This problem isn't going away. "The degree of predictiveness [of credit reports] is going to be historically low," Pitts said, "because there's so many months of unreliable or non-predictive data in those credit files." Credit models simply aren't built to handle the situation we find ourselves in. The human costs of this are immense, Hougaard said. "When we see banks closing up and closing credit lines," she said, "[it's] pretty hurtful to a lot of people who are planning their lives."
The lack of credit availability could give a boost to one area of fintech. "There's quite an interesting opportunity for new alternative [lenders] to come about," Hougaard said, "that have different types of underwriting models that are much more stress-tested to the current environment." Pitts agreed, saying he expects "a dramatic rise in the use of cash-flow underwriting for consumer loans." If the two are right, that would be welcome news for Baral's Harvest, which recently started offering a cash flow-focused credit score. Rather than being a lagging indicator of credit worthiness like traditional scores, Baral said, cash flow-based scores offer a "real-time view into consumers' finances." Lenders, she said, are interested: "COVID has definitely accelerated this new way of thinking."
COVID-19 has also been a boon for other lending-related fintechs. "Buy now, pay later" financing companies are thriving amid the ecommerce boom, with Klarna's valuation doubling to $11 billion and Affirm filing for an IPO, reportedly seeking a $10 billion valuation.
But there could be pain ahead. With the future of U.S. stimulus still unclear, and some predicting a more typical recession on the horizon, defaults could be about to soar. While traditional banks started lending more conservatively after the last downturn, the same isn't true for fintechs — most of whom have never experienced a downturn before. Fintechs' lending models, Hougaard said, are "going to be stress-tested."
"The average sessions per day surged 88% for investment apps [between January and June] — which is crazy," Adjust's Isabel Ferreira said. And many of those people were going to one place: Robinhood.
"We definitely saw an increase in what I kind of think of as boredom trading, or entertainment trading," Dan Egan, managing director of behavioral finance and investing at robo-advisor Betterment, said. Stuck at home and without sports gambling to keep them occupied, people — men, more often than not — started turning to stock trading and its promises of riches instead. "It's not uncommon for a client to say 'I'm thinking about putting $5,000 into a Robinhood account,'" said Ian Yamey, CTO and co-founder of retirement-planning site Retirable. "They hear that the stock market is doing so well, and they see all this stuff about Robinhood [as] one of the areas where people are making money."
But while many Robinhood investors were making ill-advised bets on bankrupt companies with sometimes fatal consequences, investors in Robinhood were doing rather nicely. The company's valuation surged from $8.3 billion in May to $11.2 billion in August. But that doesn't mean risky behavior is here to stick around. "That behavior is starting to drop off a little bit," Egan said, pointing to behavioral finance papers that say it typically takes a few months for the fun to wear off — though "for some people, it's up to two years."
Beyond Robinhood, wealth management is moving online in the same way everything else is. CB Insights predicts that "one long-term effect of COVID-19 will be the mainstreaming of hybrid robo-advisory services," while Yamey said the pandemic is a tailwind for Retirable. Its customers — typically homeowners in their 60s getting ready for retirement — have been hit hard by the pandemic, he said. "Many of them were pushed out of the workforce earlier than they intended, and so they're having to rethink their retirements." With in-person retirement planning out of the question, many are turning to companies like Retirable. "I think [COVID-19's] really flattened or reduced the obstacle of getting online financial planning," Yamey said. Egan said Betterment saw an influx of customers in the second quarter of the year too, suggesting it may have been driven by people who realized they need more stable finances and wanted help achieving that.
Once they are online, investors' behavior is shifting too. After the Black Lives Matter protests, Egan said, Betterment saw an increased interest in "socially responsible investment strategies" — strategies that people use to invest in-line with their morals, often shunning things like defense stocks in favor of tech companies. Hougaard, meanwhile, said people were increasingly conscious about climate-friendly investing, too: Going through one crisis, it seems, has made it easier for people to envision others.
I live in London, so whenever I visit the U.S. I'm forced to relearn how to write my signature — most of the rest of the world has moved on from having to sign for things when you buy with cards or digital payments. If there's one upshot of COVID-19, it may be that next time I visit, I won't have to do that anymore. Contactless payments are soaring, with Mastercard reporting a 40% year-over-year increase in the first quarter of 2020. Cash, it seems, is finally on the way out: McKinsey's Aaron Caraher said via email that in the U.S., cash is estimated to represent 40% of in-person consumer payments this year — a number that could decline to 34% by 2024.
That's excellent news for payment firms, including newcomers such as Square, who will soon have a much bigger pool of transactions that they can take a cut of. And it could provide an opportunity for something even bigger: QR codes.
In much of the West, QR code payments never really took off. "We were all challenged because we were trying to change consumer behavior without the compelling reason to do so," PayPal's Jeremy Jonker said. COVID-19, he argued, may have changed that. PayPal took its "skunkworks" QR code project out of cold storage, and turned it into a "moonshot" project.
"We've never utilized that vernacular at PayPal before," Jonker said of the QR project, so "it communicated to the entire company that QR codes is going to be a No. 1 priority." Within eight weeks, the company launched a product. As of October, it had "hundreds of thousands of SMBs" that had claimed a QR code they could accept payments with, Jonker said, and "approaching millions of consumers actually utilizing our QR code around the world." Being free of a POS terminal, he explained, opens up a new meaning to "contactless" payments: You can pay for curbside pickup by scanning a sticker on the side of a building without getting out of your car, for instance. And Jonker said he thinks QR codes are here to stay. "It's actually a commerce enablement platform," he said, pointing to PayPal's integration with CVS, where customers will be prompted to sign up for a loyalty card if they scan a QR code to pay. That loyalty card, in turn, drives more sales for the pharmacy.
The real shift in payments, though, isn't cash vs. contactless: it's physical versus ecommerce. The entire retail industry has been upended as consumers have been stuck at home for the majority of their shopping needs this year. Ecommerce now represents about 16% of all retail sales, roughly double what it accounted for in early 2019. Companies like Stripe and Adyen, for instance, have soared as shopping moves online, with the latter's stock price more than doubling since January. That comes at the expense of traditional in-person payment hardware providers, such as Verifone and Ingenico — a gap exacerbated by the higher transaction costs of online purchases, which are seen as riskier. While the shift from traditional payment providers to digital-first brands was already happening, Hougaard said the pandemic accelerated the shift. Stripe, which powers much of online commerce, is an indicative example. Valued at $36 billion in April, it's now reported to be fundraising at a valuation that could approach $100 billion.