Neobanks are Relentlessly Burying Traditional Banks and Conquering the market

Neobanks vs Traditional banks

1. WHAT IS A NEOBANK?

Neobanks are digital-only banks that don't have any physical branches. Essentially, they operate exclusively online or through mobile apps, allowing customers to manage their money conveniently from their smartphones or computers. Neobanks are a logical step of leveraging technology to modernize the banking experience so that each customer can benefit from it. Thus, we as customers can utilize traditional services like savings accounts, payments, and even investments using modern tools provided by the fintech industry. What distinguishes neobanks from traditional brick-and-mortar banks are user-friendly interfaces, lower fees, and a more agile approach, all of them promising convenience and better user experience.

However, most neobanks do not have a banking license and cannot operate stand-alone — most neobanks partner with licensed banks to provide financial services. Here is a more detailed differentiation between the two types of banks.

Even though neobanks typically don’t offer lending capabilities, such as for mortgages, car loans, or even traditional credit cards, they still can provide unique services that appeal to certain customer segments. That is often their specialty - the specific niche group they fit in perfectly. Let’s look at some specific target groups and how Neobanks adjust their business models accordingly:

• Challenger banks: Challenger banks are neobanks that offer a full range of banking services, including checking and savings accounts, loans, and credit cards. They typically target consumers who are looking for a more affordable and innovative alternative to traditional banks. Examples of challenger banks are Chime, N26, Revolut, Monzo and Starling Bank.

• Niche neobanks: Niche neobanks focus on a specific customer segment, product or service. For example, some niche neobanks target millennials, Gen Z, or small businesses. Others focus on specific products, such as loans, credit cards, or investment services. Niche neobanks are Credit Karma (loans), Stash (investments), Aspiration (sustainability-focused banking).

• Embedded finance neobanks: Embedded finance neobanks partner with non-financial companies to offer financial services to their customers. For example, an embedded finance neobank might partner with a ride-sharing company to offer its drivers instant loans. Good examples of those are Klarna (buy now, pay later) and Affirm (point-of-sale financing, Stripe (payment processing).

If we need to categorize Neobanks in terms of the target customer segment, we can distinguish between those focusing on individuals, SMEs or specific industries,. Let's explore some common types of neobanks offering tailored solutions to meet the diverse needs of their target group:

• Neobanks for Individuals: These neobanks focus on providing convenient and customer-centric banking services to individual consumers. They offer features like easy account setup, budgeting tools, automated savings, and personalized financial insights.

• Neobanks for SMEs: Neobanks are also revolutionizing banking for small and medium-sized enterprises. SME neobanks provide specialized financial services tailored to the unique requirements of small businesses. These services may include seamless payment processing, invoicing, expense management, simplified lending, and real-time financial analytics. Thus, SME neobanks empower entrepreneurs to focus on growing their businesses while leaving the banking complexities to the experts.

• Neobanks for Specific Industries: Some neobanks target specific industries, such as freelancers, gig economy workers, or international travellers. These neobanks design their services to address these niche customer segments' specific financial needs and pain points.

Different neobanks offer a wide range of financial services, including:

• Checking accounts

• High-yield savings accounts

• Free peer-to-peer money transfers

• Early access to paychecks

• Overdraft protection

• Alternative ways to build credit

• Financial education tools

• Investments, stocks, cryptocurrency

As neobanking continues to reshape the banking landscape, customers are benefiting from enhanced convenience, personalized experiences, and innovative financial solutions. Whether it's individuals seeking seamless banking experiences or SMEs looking for specialized services, neobanks are paving the way for a digital banking revolution.

Some Disadvantages of Neobanks Each type of neobank has its unique advantages and disadvantages. For example, challenger banks offer a full range of services, but they may not be as well-established as traditional banks. Niche neobanks may be more innovative, but they may not offer all of the services that consumers need. Embedded finance neobanks are convenient, but they may not be as regulated as traditional banks. When choosing a neobank, it is important to consider your individual needs and preferences. If you are looking for a full range of banking services, a challenger bank may be a good option. If you are looking for a specific product or service, a niche neobank may be a better choice. If you are looking for convenience, an embedded finance neobank may be the best option for you. Money guarantee Many customers are curious about the safety of their funds in a neobank, questioning whether there are regulations in place to safeguard their deposits. Typically, neobanks form partnerships with traditional banks possessing a bank charter, adhering to necessary regulations, and securing FDIC insurance. The eligibility of FDIC insurance for funds in a neobank account depends on the account opening process and the location of the held funds. However, certain neobanks function as standalone banks. For instance, Varo obtained national banking status in 2020, complete with its FDIC insurance. Neobanks with FDIC coverage can engage in lending, protect deposits, and provide financial services akin to traditional banks. Deposit insurance from the Federal Deposit Insurance Corporation (FDIC) enables consumers to place their money with confidence at FDIC-insured banks and savings associations (insured banks) across the USA. May be you are wondering why aren't all neobanks FDIC-insured? The process of obtaining a banking charter is time-consuming, often taking several years. Consequently, many neobanks opt to collaborate with traditional banks, where the latter manages insurance and regulatory aspects, leaving the neobank responsible for customer service and online accessibility. While considering a neobank it is crucial that users check for FDIC insurance or collaboration with a partner bank possessing a charter and FDIC insurance. Notably, some neobanks also offer investment options like stocks and cryptocurrency, which lack the same insurance coverage as deposits.

2. UNDERSTANDING THE KEY DIFFERENCES

Neobanks and traditional banks differ significantly in various aspects, ranging from their operational structure to technology adoption and physical presence. Understanding these distinctions is crucial for comprehending the impact they have on the services offered to customers.

Operational Structure

Traditional banks typically operate through a network of physical branches staffed by employees who handle customer inquiries, account management, loan applications, and other banking services. In contrast, neobanks function entirely online without any brick-and-mortar locations or face-to-face interactions with customers. Instead, they rely on digital platforms and mobile applications as primary channels for delivering financial services.

One notable example of a traditional bank is Barklays bank which is considered a systemically important bank by the Financial Stability Board and traces its origins to the goldsmith banking business established in the City of London in 1690. It operates thousands of branches across Europe. In comparison, Revolut stands out as an influential neobank that offers its services exclusively via its app-based platform.

Technology Adoption

While traditional banks have been incorporating technology into their operations over time, neobanks are built upon cutting-edge technological infrastructure from inception. Neobanks leverage modern technologies such as user-friendly mobile and web applications, data analytics capabilities, biometric authentication systems, and now artificial intelligence (AI) to enhance user experiences while streamlining processes like account opening or loan approvals.

Physical Presence

Traditional banks maintain a physical presence through branch networks where customers can access in-person support or conduct transactions at designated locations during specified hours. On the contrary, neobanks lack physical branches altogether due to their digital-only nature; thus relying solely on remote communication channels like chatbots or phone helplines for customer assistance.

This difference has tangible implications for customers. Traditional banks ensure face-to-face interactions with bank representatives, which some individuals may find more reassuring and trustworthy. However, neobanks offer the convenience of 24/7 access to customer support without geographical constraints.

An interesting fact is that a renowned London-based bank announced that it will shut at least 214 of its bank branches throughout 2023 and 2024 – more than a third of its entire UK network. This comes as a hint towards the future of traditional banking physical presence in the light of the pressing need of branch network optimization.

Impact on Services Offered

The gap/differences between neobanks and traditional banks significantly impact the services they can provide to customers. Neobanks' digital-first approach enables them to offer swift transactions, real-time financial insights, customizable budgeting features, competitive foreign exchange rates, and instant notifications through their mobile applications.

For instance, Monzo provides users with real-time spending notifications, categorization of expenses, and the ability to set budgeting goals directly within their app. These features empower customers with greater control over their finances and promote financial literacy.

In contrast, traditional banks may struggle to match the agility and convenience offered by neobanks due to their legacy systems and bureaucratic processes. Traditional banks often have longer processing times for transactions or loan approvals, causing delays that can frustrate customers.

3. SOURCES OF INCOME FOR NEOBANKS

Neobanks primarily generate revenue through: Interchange fees, interest on loans and credit cards, transaction fees (e.g., bank transfers, ATM withdrawals, money transfers), subscription fees (offering premium services for a monthly fee, like Chime and Revolut), FX (Foreign Exchange) and investment services. The specific revenue model of a neobank can vary depending on its business strategy, target market, and geographic location.

4. NEW BANKS FACING OLD CHALLENGES

Neobanks have grown rapidly in recent years, as they offer several advantages over traditional banks. However, neobanks also face a number of challenges, including:

1. Regulatory compliance issues

Neobanks are subject to the same financial regulations as traditional banks, but they may have more difficulty complying with these regulations due to their smaller size and less experience. For example, neobanks may need to invest more heavily in compliance technology and personnel.

Some other regulatory compliance issues include:

Capital requirements: Neobanks may be required to hold a certain amount of capital to reduce their risk of insolvency. The amount of capital required may vary depending on the jurisdiction and the specific products and services offered by the neobank.

AML/CFT (anti-money laundering and combating the financing of terrorism) requirements: Neobanks must implement AML/CFT measures to prevent their services from being used for criminal purposes. These measures may include customer identification and verification procedures, transaction monitoring, and reporting suspicious activity to the relevant authorities.

Consumer protection requirements: Neobanks are subject to consumer protection requirements that are designed to protect consumers from unfair or deceptive practices. These requirements may include disclosure requirements, advertising restrictions, and dispute resolution procedures.

2. Trust-building among customers due to lack of established brand names

Neobanks may have difficulty building trust with customers because they are not as well-known as traditional banks. Customers may be hesitant to deposit their money with a neobank that they have never heard of before.

3. Data security and privacy concerns associated with digital-only platforms

Neobanks are more vulnerable to data breaches and other cyberattacks than traditional banks because they operate entirely online. This can make customers hesitant to use neo-banking services. Examples of data security and privacy concerns associated with digital-only platforms:

Data breaches: Neobanks may be vulnerable to data breaches, in which hackers gain unauthorized access to customer data. This can lead to identity theft, fraud, and other financial losses for customers.

Cyberattacks: Neobanks may also be vulnerable to other cyberattacks, such as denial-of-service attacks and malware attacks. These attacks can disrupt noe-banking services and make it difficult for customers to access their accounts.

Neobanks face a number of challenges, but they also offer a number of advantages, such as lower fees and more innovative products and services. By addressing the challenges they face, neobanks can position themselves for success in the growing digital banking market.

5. WHAT CAN WE EXPECT AS FUTURE DEVELOPMENT OF NEOBANKS

Neobanks are a relatively new phenomenon in the financial services industry, but they have rapidly gained market share and are poised to play a major role in the future of payments.

The future of neobanks is bright. The neobanking market is expected to continue to grow rapidly in the coming years, driven by factors such as the increasing popularity of digital banking, the growing demand for innovative financial products and services, and the increasing availability of venture capital funding for neobanks.

Neobanks are also expanding into new markets all over the world. This is because neobanks are relatively easy to launch and scale, and they do not require a physical presence in the markets where they operate.

As the neobanking market matures, competition is increasing. This is leading to neobanks offering more innovative products and services, and to lower fees and interest rates. Neobanks are also increasingly collaborating with traditional banks to benefit from each other's strengths.

Here are some specific ways in which neobanks are shaping the future of the payments industry:

• Neobanks are offering new and innovative payment solutions, such as peer-to-peer payments, mobile wallets, and buy now, pay later solutions.

• Neobanks are using artificial intelligence and machine learning to improve the customer experience and prevent fraud.

• Neobanks are partnering with non-financial companies to offer embedded financial services.

• Neobanks are expanding into new markets, such as developing countries and underserved communities.

Despite the challenges that neobanks face, such as lack of brand recognition and regulation, they are well-positioned to succeed in the future. Neobanks are more agile and innovative than traditional banks, and they are better at meeting the needs of the digital generation.

Overall, the future of neobanks is bright. Neobanks are poised to play a major role in the future of payments by offering new and innovative products and services, and by making financial services more accessible and affordable for everyone.

6. TOP NEOBANKS FOR BUSINESSES IN EUROPE

As of 2023, the following financial giants are recognized globally and have already cemented their status, boasting turnovers that rival those of established traditional banks.

1. Revolut

Established in 2015, Revolut is a major European neobank, boasting over 18 million customers and generating over $1 billion in revenue. Revolut provides a wide array of financial services, including multi-currency bank accounts, debit cards, currency exchange, stock trading, cryptocurrency trading, and peer-to-peer payments. Remarkably, it caters to both individuals and businesses, supporting more than 30 currencies. As it expands into the US market, it's on track to become one of the world's largest neobanks.

2. Chime

Founded in 2012 and based in San Francisco, California, Chime partners with an FDIC-insured bank to revolutionize overdraft fees. With an estimated 21.6 million users in 2023, it is one of the larges neobanks. Chime partners with the Bancorp Bank and Stride Bank to provide banking services and to ensure funds are FDIC-protected. It offers mobile-first checking accounts, savings accounts, and a Chime Visa Debit Card. Chime also grants early access to direct deposits, delivers $200 in fee-free overdraft protection via SpotMe, and extends credit to users who may not qualify for traditional credit cards. This approach helps users avoid overdraft charges, reduce reliance on payday loans, and sidestep credit card debt.

3. Varo

Unlike Chime, Varo received a national bank charter back in 2020, so it is officially considered a bank and its accounts are directly FDIC-insured. Varo Bank, founded in 2015 as Varo Money, earned distinction as the first self-chartered neobank, securing a national bank charter in 2020. With approximately 5.4 million account holders Varo offers a checking account, high-yield savings accounts, and up to $100 in interest-free cash advances. It differentiates itself with no credit checks, no minimum balance requirements, and no overdraft fees. Varo Believe, its secured credit card with no fees, enables users to build credit without incurring interest. You also earn cashback, a perk typically reserved for credit cardholders. By providing access to premium financial services, Varo empowers individuals with limited or no credit history to enhance their financial well-being. In addition, Varo has partnered with Zelle, so users can transfer money digitally to friends and family.

4. SoFi

Founded in 2011 to assist students in financing their education, SoFi has grown into a prominent neobank, serving more than 5.7 million users. SoFi offers a comprehensive suite of services, encompassing checking and savings accounts, loans, credit cards, investment accounts, and student loan refinancing. In contrast to traditional banks and student loan providers, SoFi aims to support its customers holistically, whether they are at home, work, or school.

5. Monzo

Established in 2015, Monzo is a UK-based neobank. It introduced its digital banking platform in the United States in 2022. Its notable feature is the absence of foreign transaction fees, including no charges for foreign ATM withdrawals (excluding any fees imposed by the ATM owner). Additional travel-friendly features include real-time transaction alerts and the ability to freeze a lost card. Monzo does not impose monthly or overdraft fees. Monzo provides its accounts through a partnership with Sutton Bank.

6. N26

N26 is headquartered in Germany and was established in 2013. It operates in several nations, such as Austria, Estonia, France, Germany, Latvia, the Netherlands, Poland, Spain, Switzerland, the United Kingdom, and others. It only recently pulled out of Brazil and prioritized Europe. What sets N26 apart as a neobank are its mobile-centric approach and global availability. Operating in multiple European countries and the US, N26 is an excellent choice for individuals who frequently travel or relocate internationally. It offers services like fee-free checking accounts, budget management tools, and mobile payments. N26 had some challenging times in 2021 when it faced regulatory challenges and incurred losses. As of 2023 N26 is valued $9 billion against Revolut for $ 33 billion.

7. Starling Bank

Starling Bank is a neobank based in the United Kingdom, which was established in 2014. Among Starling Bank's standout attributes are its real-time notifications, providing customers with immediate updates on their expenditures and account balances. The mobile app offers various budgeting tools, including spending categorization and insights. It also has a range of protective features such as the capability to instantly freeze and unfreeze your card, establish location-based security settings, and activate two-factor authentication.

7. CONCLUSIONS

While neobanks and digital banks share similarities, there are some key distinctions between the two. Neobanks are exclusively digital and typically operate without any physical branches. They leverage technology to provide seamless and personalized experiences to customers. On the other hand, digital banks are often traditional banks that have expanded their services to include online platforms, retaining some physical branches alongside their digital offerings.

While the fate of traditional banking remains uncertain, one thing is clear: adaptation is key to surviving in this tech-driven era.

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Source: https://www.compareremit.com/what-is-a-neobank/