The first half of 2023 is in the books for the financial services industry. The turbulence that was we experienced with crypto in 2022 spilled over to the banking sector in Q1 2023 (as we covered in our 1st Qtr. QBR).

The downward spiral seemed to slow down in Q2 as the spread of bank runs and collapses stopped. Funding in startups (especially) post Series A showed signs of picking back (outperforming Q1 performance). Even public valuations of fintech companies have bottomed out and are showing growth signals into the 2nd half of the year.

Regulators continue to be active throughout the industry, but recent rulings in the US may have early wins for companies looking to stay active with cryptocurrency trading, transfers, and custody in the US. Here’s an industry recap for Q2.

BANKING

After the fallout from Silvergate, Silicon Valley Bank, and Signature Bank in March, many expected other banks to show signs of weakness and either shut down or be bailed out by regulators.

First Republic Bank did get caught in the headwinds of negative bank sentiment, but found a new home as part of JPMorgan Chase (after the FDIC took over in early May). Despite jobs being cut back (85% of FRB employees retained), customers had minimal impact with existing accounts and funds — all which were transitioned to JPMC by end of May.

To combat liquidity risk, the Fed instituted the Bank Term Funding Program to provide banks with one-year loans and pledge high-quality bonds as collateral. Banks would no longer need to sell bonds at a loss if a liquidity need arises in the future (which is what led to deposit runs in Q1).

There was concern on earnings for Q2 as many feared the outflow of deposits and increased reserves would decrease the ability for financial institutions to generate revenue (especially through lending). However, deposits held steady throughout the industry and net income jumped up due to the Fed increasing rates (see chart for large bank’s performance).

In the mid-size, regional bank tier, there have been acquisitions of smaller banks across the US. Consolidation started to pick up in the aftermath of bank collapses as customers still feared if their funds would be accessible should another deposit run take place. Community banks not planning to expand their physical footprint OR have Banking-as-a-Service (BaaS) activities are the most likely targets.

Outlook for the rest of 2023: The concern with the liquidity risk of banks has subsided for now. Customers still trust that their money is safe in a financial institution backed by the FDIC. Moving funds to larger banks (in early Q2) helped alleviate much of this worry, especially for high net worth clients carrying large balances.

The consolidation trend for small and mid-sized banks should continue through the end of the year. Many of these smaller institutions aren’t in a place to revamp their banking core infrastructure to enable BaaS or a modern digital bank of their own. These banks also may not be able to comply with increased oversight of 3rd party partners, which regulators are hyper-focused on this year.

CRYPTO

The struggling sector gained a much-needed win earlier in the month as a judge ruled in favor of Ripple — stating that XRP wasn’t a security. The value of the token quickly shot up as soon as the announcement went through. Other US crypto companies also in the sights of the SEC (Securities Exchange Commission) see the ruling as favorable to pending cases.

Despite Bitcoin (BTC) being up nearly 30% since the start of the year, crypto in the US is at a standstill. Banks are no longer providing custody or payment processing if money movement involves cryptocurrency. Top exchanges (such as Coinbase) responded to findings from regulators and are still waiting for responses. Without guidance or clarity, companies are left in the dark about what they can or can’t do.

No replacement to Signature or Silvergate Bank has come through in the US. Pressure from regulators still seems to be there when it comes to crypto-heavy banks making a comeback. The majority of activity has shifted outside of the US for crypto-banking, with no clear leader dominating the space.

Outlook for the rest of 2023: Crypto-affiliated companies are still active in the US, especially in Web3. This includes blockchain analysis, security, protocols, and proof protocols. Investors and funding syndicates still interested in the sector are focused on supportive services in the near-term.

The startups directly offering tokens, custody, or exchange (including stablecoins) are mostly gone for now. Investment for direct-to-consumer (D2C) platforms in the US is non-existent due to the lack of banks supporting cryptocurrency. Any banks that still allow some type of payment processing are likely focused on institutional clients that need custody.

With no indications that regulators will clear a path forward in the US, crypto won’t be making a comeback to pre-2022 activity levels this year.

FINTECH

The FinTech sector started to pick up in terms of investment activity at the end of Q2. The first half of 2023 mainly focused on pre-seed and seed stage startups gaining funding and left out companies already in market.

From the end of May into mid-July, more Series A+ rounds have come through in the US and across the globe. The chart shows the jump in activity from Q1 to Q2. Weekly announcements in our newsletter (FinTechtris Weekly) highlight more Series B funding.

InsurTech (insurance companies leveraging technology, such as AI) remains a popular area across the market. As more insurtechs add embedded insurance (allowing 3rd party partners to offer insurance products on their platforms), investors should follow with additional funding.

Property management firms (especially of single-family, rental properties) are also showing increased demand. Being able to better manage expenses, vendor relationships, maintenance services, and tenants is a critical need for property owners and operators. Multiple fintechs are actively taking on this challenge and providing custom programs for small and enterprise-level managers.

There’s also been an uptick in acquisitions of startups, which we expected coming off of Q1. Established fintechs are adding product, staffing, new geographies, and licensing quickly by buying companies in this down market.

Outlook for the rest of 2023: Investors waiting on the sidelines in Q1 & Q2 will now make moves in Q3. There are infrastructure and service-support plays that can lead to wins going into 2024.

Financial institutions with budget set aside for technology initiatives are shopping products from fintech startups — data, analytics, user experience, budgeting, and financial planning are ‘hot’ features that banks are buying. Finnovate (Spring & Fall) showcases how much demand there still is as half of attendees come from financial institutions — strategy, corporate development, partner, and innovations teams.

Compliance, risk, and fraud prevention startups are also in the limelight this year. As regulators push on banks to beef up 3rd party oversight, these companies are partnering with more and more financial institutions and enterprise fintechs. Audits, bank reporting, transaction monitoring, risk policies, and fraud detection are all services delivered by fintech startups.

How Does the industry end 2023?

There won’t be a bounce back going into 2024, but certain areas will start to showcase a recovery.

The cryptocurrency sector needs to gain regulatory clarity for the industry to completely bounce back. This will take time as complaints and cases are being reviewed by multiple regulators in the US. We have seen Europe take the early lead in proposing new legislation as industry guidance. The hope is that the US will follow suit shortly with its own bills.

The dust will continue to settle in the banking sector. No more tech or crypto-focused banks remain in the US. Small and mid-sized banks will make strategic decisions to merge with regional banks or launch new programs that can win new business. Interest rates are keeping smaller players afloat a bit longer, but only until the Fed decides to lower rates based on the economy improving.

With FinTech, we will have a good idea of who the strongest players are at the end of the year. Either through partnerships, acquisitions, or product launches, fintechs that made moves in early 2023 will now whether it’s paid off or not by 2024.

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