Will fintech banks survive falling interest rates?
Fintech lenders have accelerated their swing to profitability after interest rates spiked.
The UK’s neobanks pocketed record revenues in the last 12 months. Revolut’s takings grew 72 per cent topping £3.1bn. Meanwhile Monzo’s revenue hit £1bn for the first time.
But this came as interest rates maintained a post-financial crisis high of 5.25 per cent in the first half of 2024.
Lenders have benefitted from rising rates on the back of the global pandemic, helping many break their inaugural profits, but the pendulum has begun to swing.
The Bank of England has slashed rates four times in the last year, with markets expecting more to come.
For neobanks, this marks a make-or-break moment.
Gautam Pillai, head of fintech research at Peel Hunt, said: “We all know that interest rates will come down. It’s not a question of if, but when.
“So when that happens, can these business models still be profitable – that is the debate.”
Widening revenue streams
Pillai said fintech business models “radically changed” in 2022 after macroeconomics took a beating with Russia’s invasion of Ukraine and the pandemic fallout.
Monzo’s interest income surged over £500m in the space of two years on the back of sky-high interest rates.
Whille rates are not expected to drop to pre-2022 sights, the gradual decline is set to take a chunk out of the firm’s bottom line.
Monzo revealed last year that every 100 basis point shift in rates impacts annual interest income by £34m – the equivalent to eight per cent for the period ending March 2024.
Rates climbed 125 basis points in the period helping drive bumper returns but the fintech was also helped by ballooning customer balances.
At the end of the period, customers were depositing an average of £1,150, compared to £800 the year previous.
Pillai said diversifying revenue streams was “super important” with rates set to fall.
Revolut has significantly reduced its reliance on interest income, with it only making up a quarter of revenue streams in the past year.
Meanwhile, rival Starling still looked to the inflow for 87 per cent of takings in the last 12 months – though a modest drop from 92 per cent the previous year.
Grabbing a market slice
As it sought diversification, Revolut broadened its portfolio significantly in its bid to create an all-in-one super app.
Cash inflows have benefitted from the business’ ventures outside of banking, which included its ‘Stays’ booking platform in 2021, its crypto platform in 2024 and most recently its entry to the mobile plans market.
Revolut’s income from subscription services nearly doubled in 2024 hitting £423m.
Pillai said: “What sets Revolut apart is its pace of product innovation and geographic expansion”.
But he added diversification for firms did not mean they had to adopt “the Revolut route”.
“You can innovate to make the interest rate work better for you, work faster for you… and that’ll be helped by the fact you have better tech.”
Pillai said neobanks who had managed to “carve out a market niche” had strongly positioned themselves against the waning interest rate environment.
He cited the performance of Allica Bank and OakNorth – specialist lenders who cater to small and medium-sized enterprises.
Allica was named Europe’s fastest growing start-up by Sifted and lended over £1bn in 2024.
Richard Davies, Allica’s chief executive, told City AM earlier this year the SME market was a “barren wasteland” five to ten years ago. He attributed the firm’s growth to its “strategic focus” on the area.
The entry of AI
As the Bank of England gradually chops rates, challenger banks will meet their traditional rivals in a new field, where tech could be their leveraging power.
“You can launch a product much quicker to the market, you can respond to something much quicker to the market than probably the High Street,” Pillai said.
“I think it’s an arms race, and [neobanks] are probably better equipped.”
The flurry of new tech products have broadened horizons across the financial services industry but traditional players may struggle to adapt at the rate fintechs can.
He said the entry of artificial intelligence into the market marked an area where fintechs could pull ahead of their legacy rivals.
“This is like modernising your home, you can absolutely modernise your house. You can rip off the paints and carpets – that’s what a lot of these existing legacy players are doing.
“But you can’t touch a foundation,” he explained.
Pillai added the structural framework of traditional banks would make it harder to incorporate AI, compared to a neobank which would be able to “use it to their advantage quicker”.
The Big Four banks – Natwest, Lloyds, Barclays and HSBC – have scaled up their AI through partnership ventures with tech giants.
Natwest partnered with OpenAI earlier this year and most recently Barclays joined with Microsoft for a major AI rollout.
Fintech’s ‘orange flag’
Pillai said a key performance indicator for neobanks ability to keep up with the changing environment would be customer growth.
“If there is a slowdown in customer growth that’s an orange flag – not a red, but a caution,” he said.
Monzo’s customer base climbed 24 per cent in the last year, reaching 12.2m. Revolut rocketed to 52.5m, which surpassed Europe’s biggest lender HSBC.
But Starlings’ momentum struggled compared to its peers. The firm managed to increase customers 10 per cent, but this was half the momentum scored in the previous year.
Pillai added the “most important” factor would be ensuring regulatory frameworks and anti-money laundering compliance was “absolutely solid”.
Like their legacy counterparts, fintechs are no stranger to being slapped with hefty fines for regulatory failures.
Despite its rise in customers, Monzo’s credit loss expenses fell to £152,595 – down from £176,868. The firm also raised its bad loan provisions to £251.2m from £204m.
Starling was scorned last year by the Financial Conduct Authority for “shockingly lax” measures to tackle financial crime.
The fintech was fined £29m after it opened 54,000 accounts for 49,000 “high-risk customers” between September 2021 and November 2022.
And the winner is?
After a booming few years, the downward slide of interest rates is pushing fintechs to new avenues.
Innovation, diversification and customer acquisition are set to define fintech’s future as they weather rate cuts.
But who comes out on top of the new landscape – legacy lender or neobank – remains in the balance.
“I can’t pick a single winner from these new banks because each one is doing something in a niche vertical,” Pillai said.