Interest Rate Sensitivity in Cost-Volume Fintech Models

With the European economy grinding to a halt, and Trump trying to revoke the Federal Reserves independence, more and more global economies are looking to the latest whacky tool of monetary policy.

Currently over 16 trillion of the worlds debt markets are operating at no or negative rates, with Switzerland, Denmark, Germany as leading examples of economies taking the plunge into the latest monetary folly.

Not only do I have core concerns for banking in general but the entire blossoming industry of Neo-Banking is in the firing line.

While even amongst the worlds elite economists and industry professionals, no one seems to have any idea about the ramifications in the medium to long term of negative interest rates, a policy that would spin hayek in his grave so fast we could power london for a year, we can make some pretty simple forecasts into how it affects the day to day for banks and their clients.

Currently, every billion dollar Fintech, is a Cost-Volume growth machine, running at steep losses in the hope of generating colossal market shares for potential profitable futures with additional services. I have written on this before, but to me I would rather be small and fundamentally strong than VC pumped valuations and big losses.

But how are negative interest rates at play here?

In the day to day for a bank, you take deposits, you pay the depositor a small amount of interest for giving you the money, you then lend a portion out for a higher rate of interest, and you make the difference, in a nutshell, not too hard to comprehend.

In a negative rate environment, that would mean people pay to hold money with you and people borrowing are being paid to do so….what?

In reality this is often not the case, with Swiss Markets as an example, in the main they absorb the costs and pass on a 0% to their clients, with loans just over 1% generally.

With Fintech Deposits heating up, in the case of a further move to negative interest rates, Neo-Banks have a hard decision to make.

Do they in a competitive market pass on the negative interest rate charges to client deposits, adding to the cost to the user of using the service. Or do they absorb the cost and add to the already piling losses in an environment when venture capitalist pockets might not be so loose.

In the case that the UK moved to negative rates, say -1%, a client with 1000 pounds on the account over the year is paying £10 effectively. Not colossal, but there is an element of loss aversion, those who joined services such as these for the low-no cost, the addition of costs/charges is an irritation that might promote a move to those who do not pass on such charges.

So whats the play?

Consider Revolut in a negative 1% environment, based on the fact their entire business model at launch was on cost free forex for clients, I will take a bold statement and say they will absorb the cost. That would be £9m added to their losses annually assuming deposits stay the same, or an approximate increase of 30% in Pre-tax losses, at atom that would be £17m added to the dumpster-fire year theyre having with losses topping £80m.

In an environment where there will be an extreme difficulty to get further investment to sustain huge losses, they might be pushed to pass on costs. At which point the executioner comes along. Every Major Bank has is or will roll out a consumer banking app in the next three years. They are better capitalised, stronger on cashflow from other income lines and they can throw a mean punch in a price war, look at Marcus and Finn even in the backwards US, Incumbent Fintech is on the move.

In the case of negative interest rates in the UK, banks will do what UBS does in Switzerland, customers get 0% just bite the bullet and hope for some future rates raises.

So Fintechs are either Burning money at an increased rate with less ability to raise future finance, or they are passing on charges to price sensitive consumers and defaulting on brand promises of no charges. Lose the company or lose the customers then the company is essentially the question.

This combined with the low interest rate environment pumping alternate investment strategies like VC and PE. We have companies which are good if integrated into larger units, but under capitalised.

Its going to be an absolute slaughter.

All they needed was new revenue lines, and enhanced customer loyalty, thats where Revolut and N26 are doing something right with the metal offerings, which are incredibly underwhelming but a start.

Interest rate sensitivity is a critical measure of the health of a bank, and yet again I believe that Neo-Banks with their WeWork attitudes to stability are simply not prepared for outcomes like this.

Watch this space.