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Neobanks - Navigating The Digital Financial Landscape

Nowadays, the financial world is changing very quickly. The rise of neobanks has caused a huge change in how people handle their money.

Camilo Wood
Jan 25, 202475 Shares6841 Views
Nowadays, the financial world is changing very quickly. The rise of neobankshas caused a huge change in how people handle their money.
These online banks give you a new way to think about banking by using technology to make services easier and more organized. This article will help you find your way around neobanks and look into how they are changing the way people deal with money.

What Is A Neobank?

Neobanks, or "challenger banks," are financial technology (fintech) firms that leverage apps, software, and other technologies to streamline online and mobile banking. These companies typically focus on specific financial products, such as checking and savings accounts, distinguishing themselves by their agility and transparency compared to traditional megabanks. Interestingly, many neobanks collaborate with established institutions to ensure the security of their financial products.
In the United States, these fintech entities are commonly referred to as neobanks. At the same time, the term "challenger bank" gained popularity in the United Kingdom, describing a wave of fintech banking startups that emerged after the 2007-2009 financial crisis.
The "challenger" label is fitting, as these firms are often likened to digital disruptors in other industries. Neobanks are currently reshaping the banking sector, comparable to how Airbnb transformed hospitality and Uber and Lyft revolutionized transportation. In the U.S., some well-known neobanks, such as Chime, have seen substantial customer growth. For instance, Chime's customer base was estimated to have reached 12 million in February 2021, up from eight million the previous year.
In December 2020, Exton Consulting conducted research that revealed there were 256 neobanks worldwide, demonstrating the significance and prevalence of these cutting-edge financial institutions on a global scale.

Impact Of Neobanks

The journey of building from scratch has endowed neobanks with unparalleled flexibility and inclusivity compared to established institutions. This adaptability has enabled them to cater to vulnerable or underserved customer segments successfully. An example in this realm is Monese, which provides services specifically valued by migrant workers.
Neobanks, in collaboration with other FinTech entities, contribute to the evolving segmentation of the market. Typically, they start by focusing on delivering a specific product or service. These newcomers often outshine traditional banks in terms of customer service, product offerings, and profit margins when introducing their offerings to the market. Prime examples include Habito in the mortgage sector and Revolut and TransferWise for international transfers.
Established financial institutions have made a notable error by underestimating the impact of new entrants and relying on their size or selection of products to maintain dominance. However, if neobanks and other disruptors continue to attract customers away from lucrative revenue streams, incumbents might find themselves facing challenges in sustaining their competitive edge.

Neobanking And Fintech

Neobanks are a subset of the broader field of fintech, which refers to all financial activities made possible by technology. From ATMs to instant online money transfers and demat accounts, any technological advancement in the financial sector falls under the fintech umbrella. This includes computer programs designed to support financial operations.
In contemporary times, fintech has become a ubiquitous part of our financial landscape. The notion of physically going to a bank to make a money transfer now seems outdated, thanks to the rapid integration of technology in finance. As a result of this technological surge, traditional banking is swiftly evolving into a predominantly digital experience.
The fintech landscape is teeming with businesses that self-identify as "fintech firms." These entities specialize in developing software, apps, and computer systems tailored for various financial activities such as banking, investing, and lending. The continuous growth of technology within the finance sector is reshaping the way we manage and interact with our finances, making digital solutions increasingly integral to our financial experiences.
A man banking online with a phone and a laptop
A man banking online with a phone and a laptop
The market is saturated with a plethora of neobanks, and Forbes Advisor recently published an insightful breakdown of some of the leading online banks, encompassing both neobanks and "hybrid" platforms that provide digital services while being affiliated with traditional institutions.

Chime

Chime, with a user base exceeding 12 million, stands out as one of the most recognized neobank brands in the U.S. Known for eliminating common fees associated with traditional banks, Chime offers credit-building opportunities, early access to direct deposit payments, and automatic savings features with a competitive annual percentage yield (APY). It's essential to note that Chime is a financial technology company, not a bank, with banking services and debit cards issued by The Bancorp Bank or Stride Bank, N.A., both members of FDIC.

Varo Bank

Originally founded as a neobank, it secured a full-service national banking charter from the Office of the Comptroller of the Currency (OCC) in 2020, officially transitioning into a bank. With approximately 2 million users, Varo Bank provides similar perks to Chime, including no monthly or overdraft fees and no minimum balance requirements. Notably, users can open an account without undergoing a credit check.

Current

Another U.S.-based neobank, Current, has garnered hundreds of thousands of users. It offers advantages such as early access to direct deposit, fee-free overdrafts, and cash back on debit card purchases.

International Neobanks

In the U.K., prominent challenger banks like Revolut (recently entering the U.S. market), Starling, and Metro Bank have gained popularity. Other notable international challengers include N26 in Germany and NuBank in Brazil. This diverse landscape highlights the global presence and impact of neobanks and challenger banks in reshaping the traditional banking sector.

Neobanks Vs. Online Banks

While neobanks provide online banking services, they differ from online banks, which typically possess FDIC insurance and provide a comprehensive range of conventional products such as checking, savings, CDs, investments, and loans.
Some traditional brick-and-mortar banks have dedicated online-only divisions that deliver a complete suite of digital accounts that are accessible and manageable through computer or smartphone apps. Given that these accounts are affiliated with a traditional bank, these divisions are more accurately characterized as online banks rather than neobanks.
It's important to highlight that numerous traditional banks also offer online access to their standard accounts. However, these banks are not exclusively online. Customers still have access to physical bank branches, and the accounts often come with monthly fees and comparatively lower interest rates.

Pros And Cons Of Neobanks

When deciding between neobanking and traditional banking, it's crucial to carefully evaluate the advantages and disadvantages. Here are key considerations:

Pros

  • Digitally advanced -Neobanks operates exclusively online and through mobile apps, catering to users comfortable with technology and those who prefer seamless digital banking experiences.
  • 24/7 mobile access -Users enjoy the convenience of managing their finances anytime, anywhere using smartphones. This flexibility is particularly beneficial for individuals with busy schedules or those prioritizing on-the-go banking.
  • Low or no fees -Many neobanks differentiate themselves by offering reduced or no fees compared to traditional banks. The absence of numerous fees can translate into significant cost savings for users.
  • Early access to direct deposits -Neobanks often provide users with early access to direct deposits, facilitating immediate access to funds. This feature is particularly advantageous for individuals with pressing financial needs.
These advantages highlight the digital convenience, cost-effectiveness, and accessibility that neobanks can offer to individuals seeking modern banking solutions.

Cons

  • No branches -The absence of physical branches may be a drawback for individuals who prefer in-person interactions. Neobanks rely solely on online channels, potentially limiting the personalized customer service experience available at traditional bank branches.
  • Limited product offering -Neobanks often focus on core banking services and may not provide a comprehensive suite of financial products. Customers seeking specialized services like mortgages and auto loans may find their options restricted compared to traditional banks that offer one-stop shopping for various accounts.
  • FDIC insurance variability -Not all neobanks guarantee the same level of deposit insurance as traditional banks with FDIC coverage. It's essential to verify the deposit protection measures in place when considering a neobank, as some may partner with chartered banks to ensure FDIC coverage. This variability in deposit insurance can be a concern for individuals prioritizing the security of their funds.
A person using mobile banking on a phone
A person using mobile banking on a phone

How Do Neobanks Make Money?

Neobanks typically adopt a distinct business model compared to traditional banking institutions. A significant portion of their revenue is derived from interchange fees and payments made by merchants when customers use their debit cards for purchases. Neobanks, being smaller entities, enjoy interchange percentages up to seven times higher than those available to banks with assets exceeding $10 billion.
There is ongoing discussion regarding the revenue challenger banks receive from customers using out-of-network ATMs. While Axios suggested that this income could be "significant," potentially exceeding 20%, Chime responded by stating that this source of income constitutes only a "small percentage" of the overall company's revenue. Chime emphasized its provision of 38,000 fee-free ATMs nationwide.
Venture capitalists have been heavily investing in neobanks over the past decade. In 2020, Chime secured $485 million in Series F funding, elevating its valuation to $14.5 billion. Varo, in a span of less than four years since its launch, raised $63 million, bringing its total funding to over $482 million.
However, not all challenger banks have enjoyed similar success stories, and skeptics question the lofty valuations. The pandemic's impact on consumer spending dealt a blow to early European neobanks like Monzo, and Australian neobank Xinja folded last year, attributing its closure to the Covid-19 crisis and challenges in raising capital.
In the U.S., BBVA announced the closure of two of its challenger bank acquisitions: Simple, established in 2009, and Azlo, a fee-free bank for small businesses. Speculation suggests that PNC Bank, in the process of acquiring BBVA USA, aims to redirect Simple and Azlo customers to its core offerings. This "strategic decision" underscores the precarious nature of long-term growth trajectories for some neobanks.

Should You Switch To Neobanks?

With the increasing number of customers seeking digital financial services, neobanks offer an appealing option. The convenience of conducting everyday tasks like depositing checks and making peer-to-peer payments online, coupled with minimal fees and faster processing times due to fewer regulatory hurdles, contributes to their popularity.
However, neobanks may not suit everyone. They typically offer streamlined services compared to traditional financial institutions, focusing more on basics like checking and savings accounts than providing extensive credit or mortgage options. Neobanks also seldom establish brick-and-mortar branches, limiting access to in-person assistance with accounts.
For customers contemplating a transition from a legacy bank to a digital-first one, several factors warrant consideration:
  • Available financial products -Evaluate the range of financial products offered, such as checking accounts and money transfer platforms, and how well they align with your needs.
  • ATM prevalence and accessibility -Consider the availability and accessibility of ATMs, as this can impact the ease of accessing funds.
  • Fees and fine print -Be aware of any existing fees or fine print charges, especially regarding overdrafts.
  • Interest rates -Assess the rates available for interest-bearing accounts to maximize potential returns.
  • Financial education and budgeting features -Consider whether the platform provides financial education or budgeting features that align with your preferences.
Also, prospective neobank customers should gauge their comfort level with using technology platforms. Factors to consider include a willingness to download another app, comfort with sharing financial data with the platform, and preference for online-only customer service versus in-person support.
Given concerns about the stability of the European neobank market, it's crucial to consider what happens if a neobank faces financial challenges. The status of federally insured accounts becomes a paramount consideration.
Customers should verify that the neobank is recognized by the Federal Deposit Insurance Corporation (FDIC) or, for international residents, protected by entities like the Financial Services Compensation Scheme (FSCS) to ensure a degree of security for deposited funds in mobile apps or online accounts.

Neobanks - FAQ

Is A Neobank A Fintech?

A neobank is a fintech company that provides financial services through a mobile app or website, including checking and savings accounts, budgeting tools, and cash advances. They typically appeal to customers looking for flexibility, convenience, and transparency in their banking.

What Is The Difference Between Fintech And Neobanks?

Neobanks is a fintech firm that only works in the banking industry and provides digital banking services without physical branches. Neobanks are part of the broader “fintech” landscape, which includes various tech-driven financial services.

Who Started Neobank?

Neobank founder and technologist Anne Boden talks about the changes in the banking landscape that prompted her to start a new institution from the ground up. The British digital challenger Starling Bank has attracted much attention since its launch in 2014, given its audacious start with a full banking license.

Wrapping Up

It is clear that the innovative strategy of neobanks, which is characterized by user-friendly interfaces and lower fees, is having an impact on how people interact with their finances. Learning about the internal processes of neobanks is crucial for adjusting to the ever-changing landscape of digital banking, whether you're looking for the ease of online transactions or thinking about leaving traditional banking altogether.
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