COVID-19 will expose fintech’s over-reliance on interchange fees

Unlike incumbent banks that receive the bulk of their income through interest, challenger banks will be badly burned by COVID-19 as falling retail sales cause interchange fees to temporarily dry up, exposing their major weakness to investors.

With governments around the world now enforcing restrictive measures to tackle coronavirus, the impact on retail has been severe. In the UK, year-on-year total retail sales in March fell by 18%, mainly driven by a 34% drop in physical sales as part of a trend seen across the global economy.

While a weaker economy will be a concern for incumbent banks, it shouldn’t dramatically affect interest income, their main revenue source. GlobalData’s Global Retail Banking Analytics shows that incumbent banks typically make 85%+ of their profit through lending. Neither should it badly affect newer balance sheet banks such as Tandem and Atom Bank as they also rely on interest.

However, the main marketplace banks – Revolut, N26, Starling, and Monzo – have barely begun to lend, instead relying predominantly on interchange fees, which makes them vulnerable to sudden economic shocks. Unlike loan interest that has been deferred, sometimes at double-digit interest rates, interchange fees are simply lost, intensifying cash flow problems and continuing the net losses these banks have been making. Monzo and Starling have already begun furloughing employees, with Monzo additionally seeing lower account openings growth and even fending off accusations of collapse.

And while retail sales are likely to pick up after the COVID-19 crisis, it lays bare just how vulnerable fintech firms are to losing their one main source of revenue that is itself prone to such change.