To say that fintech startups are cautiously optimistic about their prospects in the New Year might be generous.

After a scandal engulfed Lending Club -- the online lender that was recently found to be peddling faulty loans -- and as Prosper, a competing alternative lender, struggles to scare up funding for its loans, the fintech industry is more than a little shell-shocked. Regulators are calling for more transparency from these firms, as conflicts of interest emerge when smaller startups partner up with more traditional financial institutions (as when these lenders source loans from hedge funds, for instance).

Tack on the known unknowables, like the rise of Donald Trump as U.S. president and the Federal Reserve's recent decision to hike interest rates, and 2017 is liable to be a doozy.

"Once we see 1.5 or 2 percent [interest rates,] you'll see people taking money off of risky assets. That's going to take some oxygen out of the room," said Dan Egan, the director of behavioral finance at Betterment, a New York City-based automated investor, or "robo-adviser," that manages around $7 billion in assets. The company generates revenue by charging users a quarterly management fee of between 0.15 percent and 0.35 percent.

Egan was one of dozens of entrepreneurs and investors who gathered on Wednesday at the offices of New York City loan refinancing startup CommonBond to discuss the future of the banking industry. Here are the biggest trends they see shaping the future of fintech in 2017:

Snapping Up Startups

While deal flow in 2016 wasn't anything to write home about, this year will surely present opportunities for startups looking for buyers. Deals to VC-backed fintech companies reached a five quarter low of $900 million in Q3 of 2016, according to CB Insights and KPMG data.

The rise of fintech startups -- including companies offering to lend, manage, process, and even create virtual currency -- hasn't been lost on traditional banks. Consider that in 2016, several high-profile companies swallowed up smaller, data-driven startups, as when Goldman Sachs bought Austin-based retirement manager Honest Dollar in March. CommonBond's CEO and co-founder, David Klein, told the audience he sees similar such mergers being a dominant "theme" this year.

Somesh Khanna, the financial services head for McKinsey's digital arm, also expects that 2017 will herald more M&A activity. "A lot of the perceived arrogance of banks comes from their own instincts that they could easily go back and build [financial technology] themselves," he said. "They have been humbled by the speed it takes [companies like Betterment] to get to $7 billion in assets. I see more humility creeping in, and more interest in partnering," he added.

Valuations Get Grounded

That will necessarily affect valuations. While there are currently more than 20 fintech companies valued at $1 billion or more, these valuations have declined steadily over the past few quarters, noted Brian Hughes, a co-leader of the KPMG Enterprise Innovative Startups Network.

"In 2017, in an environment that might be big business friendly, tech valuations are also settling back down to earth," Klein added. "The environment is relatively ripe, and a lot of traditional financial companies are looking at tech as a way to get ahead among the current competitive set."

Back to Basics

The fintech execs also pointed to a few specific areas where venture capitalists are likely to look, including companies that process the hard data.

"In the banking industry, there is the whole ecosystem of vendors doing the unsexy work of processing deposits and underwriting loans," said Charlie Kroll, co-founder of financial planner Ellevest. "These are all legacy systems that have been around for decades," he added. The startups coming in to fix outdated systems and disrupt the incumbent players are the most likely to win capital in 2017, he said.

That's a key competitive advantage for today's enterprising fintech startups, echoed Khanna: "Addressing the core banking system problem is the most exciting opportunity." He noted that startups offering to personalize the investing experience -- perhaps with custom resources and advice -- are also likely to get more attention from funders.

Published on: Jan 19, 2017