Organizing Digital Banks and Their Role in Emerging Markets
Part 1: Examining new trends in Africa and Latin America, and the factors behind the success of challenger banks in emerging markets.
Since the 2010s, there have been a number of challenger banks and neo-banks around the world that specialize in digital banking with the aim of bringing financial services to more people. We, at UNCOVERED FUND Inc., are quite optimistic about the developments of digitized banking solutions and believe this trend will grow in adoption in Africa. We have conducted research on challenger banks around the world and would like to present some of our research in the next 4 parts…
Table of Contents
1. Challenger Banks and Neo-banks
2. Strengths of Challenger Banks
3. Inclusion of Unbanked People
4. Summary
1.Challenger Bank and Neo-bank
Challenger banks are businesses that have obtained their own banking licenses and provide the same services as conventional banks*, mainly through mobile phones. These services include deposits and withdrawals from accounts, remittances (transfers), debit card issuance, and loans.
There is also a business model similar to challenger banks commonly referred to as “Neo-bank”. Neo-bank is similar to challenger banks in that it provides banking services on a mobile app, but neo-bank does not obtain a banking license and partners with existing banks to provide its services.
In addition, there are cases where neo-banks provide accounts as an e-money provider, but not in partnership with an existing bank, in which case the accounts are not “bank accounts” and are not protected by the deposit insurance system. For example, Revolut, a multinational bank, is licensed as a bank in the EU, but is not covered by deposit insurance as it is a “funds transfer company” in Japan and an “e-money company” in the UK.
The definition of “challenger bank” and “neo-bank” is not fixed, and there are various cases where subsidiaries of traditional banks are included or excluded, or where they are collectively called “neo-bank” regardless of whether they have a banking license or not.
- Mobile based and with banking license >> Challenger bank
- Mobile-based and without banking license >> Neo-bank
- Mobile-based and without a banking license are generally referred to as neo-banks. Both types of banks are sometimes collectively called “digital banks” because they do not have physical branches.
The rapidly growing challenger banks/neo-banks are steadily increasing their user base, especially among those that traditional banks are not able to reach. Startups and companies that were not originally financial institutions are entering the market one after another, and they can be considered as change agents in the banking industry.
Brazil’s Nubank is experiencing a rapid increase in users, partly due to the COVID-19 pandemic, which has led people to focus more on impersonal transactions, and is aiming to increase its customer base from 12 million in 2019 to 33 million by the end of fiscal 2020 and 40 million by June 2021. The company says it’s adding customers at a rate of more than 45,000 per day for the first five months of 2021, and the momentum shows no signs of slowing.
２．Strengths of Challenger Banks
The common strengths of each challenger bank/neo-bank are as follows:
- Opening an account with a single smartphone in a short period of time (about 8 minutes in the case of N26 in Germany)
- Fewer documents required *
- Basic services are free**
- Excellent UI and UX optimized for smartphones.
In other words, it is a smartphone based bank that is free, easy and simple to use. Given these benefits, challenger banks attract young smartphone users and users dissatisfied with the antiquated ways of traditional banking services.
In the days when traditional banks came into existence, of course, there was no Internet nor smartphones, and services had to be provided face-to-face at bank branches. Therefore, it was important to have a network of branches and real locations that were close to people.
On the other hand, in emerging markets the number of bank branches are few, normally in urban areas where a few have access to,, and even after arriving at the bank, one often has to wait in a long line — all in all, a burdensome process For this reason, some people do not dare to open a bank account because of the burden of opening a bank account.
Even in developed markets, opening a bank account used to require a visit to the branch office and a wait at the counter. It can take several days to a week to receive a debit or credit card.
In this respect, Challenger banks are very easy to use, as you can open an account instantly with just a few strokes on your smartphone and have access to an array of services as though the bank branch is in the palm of your hand.
*Example of documents required to open an account
Using the example of opening a bank account in the UK, here is a comparison of the difference in documents required by a traditional bank (in the case of Lloyds) and a challenger bank (Monzo).
Proof of address is a document that proves your “address in the UK”. It is not a problem for people who have been living in the UK for a long time, but for immigrants and international students who have just arrived in the UK, it is a difficult document to prepare immediately.
On the other hand, as long as you live in the UK, you need a bank account to receive your salary and remittances from your home country. Before the advent of challenger banks, it was not possible to open a bank account until you had the documents to prove your address. In Europe, where there are many immigrants, migrant workers, and foreign students, it is important to note that there is no need for written proof of address.
** Bank Charges
Some banks in Europe and the United States charge a fee called “Monthly Maintenance fee” just for having an account, but Challenger Bank and Neo-bank charge almost no basic usage fee.
Chime vs. Traditional Bank — Fee Comparison
3. Inclusion of the unbanked
Although rare in Japan, there are many unbanked people, especially in emerging countries, who do not have bank accounts due to various reasons such as not having a bank nearby or having too low an income. Challenger Bank is reaching out to these people as well.
For example, 20% of Nubank users in Brazil are said to be people who did not originally have bank accounts nor credit cards. In Brazil, 30% of the population over the age of 15 is unbanked — a market segment that Nubank is targeting.
In fact, many unbanked people in emerging countries have mobile devices , so there is a fertile ground for digital finance to spread to emerging countries. In fact, it is precisely because the existing financial institutions are inadequate that there is the potential for a major leap forward.
For example, Nubank in Brazil has about 40 million users, while Revolut, which operates mainly in developed countries, has 15 million users, and Chime in the US has 12 million users. Isn’t it possible that challenger banks will grow in emerging markets where existing financial institutions are insufficient rather than in mature markets where they have penetrated? We think so.
Like Nubank in Brazil, the African countries in which Uncovered Fund invests also have a large number of unbanked people, and the number of bank branches is much smaller than in Brazil (see table below).
In Kenya, where 56% of the population has a financial institution account (2017), unbanked people with smartphones have started using a mobile money service called M-PESA (48 million users), and Challenger Bank may see similar or even greater growth in Africa. Challenger Bank may achieve similar or even greater growth in Africa.
4. Summary
Challenger Bank is a mobile bank that is free and easy to create for anyone with a smartphone (or even a non smart device), and the excellent user experience and localized services will make one more inclined to continuously make use of such services..
So how do Challenger banks make money?
Basically, they attract customers with free services, charge credit card transaction fees (free for the user and paid by the store), charge premium plans, and provide loans, paid premium plans, and interest rates on loans.
Of course, each challenger bank has a different main target and business model. I would like to share the business models of typical challenger banks in the fourth article.
What did you think? Money is an essential part of people’s lives. We hope that financial services such as Challenger banks, which can be used easily by anyone, will play a major role in enriching the lives and business of many people in Africa and emerging economies.. In the second and third articles, I will share the background to the rapid growth of challenger banks — stay tuned!
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