Perhaps the most widely desired news coming from the world of monetary policy is the continued lowering of interest rates around the world, especially in the wake of the coronavirus outbreak. As seen just this week, the stock market reached its highest point in over a month, buoyed in part by a sense that the economy will be supported by financially accommodating moves by not only the People’s Bank of China, but also other central banks around the world.
But should fintechs feel the same sense of glee?
The Virtues of Lower Interest Rates
Lower interest rates, at least at first glance, point to a state of affairs where young fintech firms will have an easier time business-wise.
Many if not most fintechs are young companies, indeed often upstarts, dependent on early stage capital contributions from venture capital firms, and bank loans. Lower interest rates would seem to make this latter form of financing easier, since borrowing would become cheaper—and in the process help fuel expansion strategies, as well as enable refinancing outstanding debt with higher rates.
Lower interest rates also enable fintech (‘online’) lenders to continue providing loans to borrowers that traditional bank lenders might ignore, or be wary of due to their perceived credit risk. When interest rates are low, so are generally instances of default, and as long as the job market remains strong, the likelihood that consumers won’t be able to repay their debt is low. The risk-adjusted return for fintechs may thus be high—indeed higher for many fintechs than for traditional banks.
Digging a Little Deeper
Still, all too often the causes for falling rates point to greater challenges for fintechs, not less.
When the Federal Reserve acts, it does so purposefully, and the central bank’s moves last year–like the PBOC’s emergency liquidity lines–was a response to data, gloomy data, suggesting growing threats to US economic growth. If fears pan out, it means that a recession may be on the horizon—and with it risks to employment, price stability and the very credit quality of outstanding loans. For the many fintech firms that make (often unsecured) loans, this spells trouble.
Now importantly, when many fintech lenders make loans, not all (or even most) of their risk resides on fintech balance sheets. Depending on the industry—whether real estate finance, mortgage lending, or peer-to-peer lending, etc.—loans originated by fintech lenders may be syndicated out to investors. Which means deteriorating credit quality may not necessarily come to bite platform lenders directly. Still, greater loan defaults will impact their business model, and the attractiveness of a platform and its reputation as a destination to do business. Meanwhile, creditors and investors may be less inclined to support fintechs financially, regardless of lower interest rates. And if these fintechs find themselves starved of capital, the consequences for their operations could be devastating.
Fintechs aren’t banks, which means that a ‘run’ on fintechs, and even widespread failures by fintechs, won’t necessarily mean the end of the global financial system. But you can still imagine plenty of problems. High delinquencies could arise in those fintech sectors where loans are held on the books of firms—or where firms devote their equity to support highly leveraged investments that don’t pan out. And where fintechs distribute or pass on their risk, but also act as servicers—think the mortgage market—bankruptcies could end up slowing growth (or accelerating downturns) in larger segments of the economy.
Still, I could also imagine another possibility—a world where fintechs increasingly become targets of takeovers and acquisitions. This would be a real change of course from the popular narrative of venture capital firms paying a king’s ransom for equity in untested fintech upstarts. But in a world where faith in not-yet-clear business models erodes, or balance sheets come under stress, valuations could fall, enabling (alongside lower interest rates!) more buyouts and takeovers.
Of course, no one can tell the future, especially in an economy like that in the United States shaped by as many commercial and even political forces as monetary ones. But even for fintechs, lower interest rates can be as much a harbinger of things to come as they are a kickstarter for stronger economic performance. Indeed, with the recovery entering an unprecedented tenth year, it’s becoming safer to bet on the latter than the former.