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The emergence and spread of COVID-19—in the first place a world health crisis—is also causing unprecedented economic damage across the globe. Most McKinsey COVID-19 scenarios show European economies contracting by 11 percent in 2020 and not returning to pre-crisis levels until 2023. Fintechs are already feeling the squeeze. Venture capital funding has slowed, business model vulnerabilities are being exposed, and competitive dynamics are shifting. This has brought the sector’s underlying profitability and long-term business model sustainability into sharp focus—to a point where we believe the path to profitable scale for many fintechs has been structurally altered.

This is not at all to write off the sector. Fintechs have several long-term advantages—they are native to the digital arena, with more efficient cost structures, organizational agility, and, most importantly, higher customer loyalty. Consumers are now accustomed to quick, easy, low-cost financial transactions, and we believe there is no going back. In this article, we explore how the dynamics for fintechs have changed (particularly in Europe), the opportunities and implications for financial services incumbents, and how fintechs can weather the storm.

Fintech funding has slowed, and scarcity may be with us for a while

In a matter of weeks, venture capital funding for fintech companies went from surplus to scarcity. After growing more than 25 percent a year since 2014, investment into the sector dropped by 11 percent globally and 30 percent in Europe in the first half of 2020, compared to the same period in 2019. ¹ In July 2020, after months of COVID-19-related lockdowns in most European countries, the drop was even steeper—18 percent globally and 44 percent in Europe, versus the previous year (Exhibit 1).

It is only when the tide goes out that you discover who’s been swimming naked.  Warren Buffet

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This constitutes a significant challenge for fintechs, many of which are still not profitable and have a continuous need for capital as they complete their innovation cycle: attracting new customers, refining propositions and ultimately monetizing their scale to turn a profit. The COVID-19 crisis has in effect shortened the runway for many fintechs, posing an existential threat to the sector.

Adjusting the playbook: Four actions to consider

1. Targeted retrenchment combined with big bets

With core economics challenged and capital sparse, it is obvious that many fintechs will have to retrench thoughtfully if they want to avoid burning money unsustainably and spending themselves out of business. This will mean trimming international expansion plans, business lines, products, and initiatives. Fintechs have to focus their energies and capital on areas where they can truly make a difference—and do so quickly. Importantly, this entails not just cutting back, but also placing bigger bets and directing leadership attention to areas with long-term potential. London-based Revolut, for example, in addition to taking steps to adjust its cost base has also indicated it is looking at inorganic options in the travel space.

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2. Leaning into next-normal behaviors

B2B fintechs also have an opportunity to meet new needs. OakNorth, a lender for small and medium-sized companies, sold its platform to two large US banks to help them analyze and monitor the impact COVID-19 is having on individual loans and to automate the customer journey for small businesses applying for and receiving Paycheck Protection Program loans.

There is also an opportunity for B2C companies to expand into B2B markets.

3. Business model course corrections

The potent combination of changing customer buying and consumption patterns, a weaker economy, lower interest rates, and reduced creditworthiness represents a fundamental challenge to many fintechs’ business models. Company leaders need to take a hard look at their economic model and make adjustments, while preserving the best aspects.

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