“In consumer banking, you have what is one of the largest industries in the United States, in terms of profits, and at the same time one of the least disrupted industries, and the most unpopular with consumers, that has attracted nearly a million customers. Those three things create a perfect storm for disruption.”- Andrei Cherny, Founder Aspiration
Of late there has been a lot of optimism and investor interest in Neobanking and the potential it holds especially in the Indian market.
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What is neobanking?
Simply put a neobank is a 100% digital direct bank that reaches customers on mobile apps and personal computer platforms only. Not operating traditional physical branch networks unburdens them from the legacy systems of traditional banking competitor’s aka incumbents.
The term became prominent in 2017 to describe fintech providers challenging traditional banks. These banks first originated in the UK with the rise of players such as Monzo and Atom Bank. Lowering costs and expanding banking services to the unbanked are the two prime reasons for their birth.
Global market size and growth drivers
Globally neobank market has been growing at a CAGR of 50.6% from 2017–20 according to Allied Market Research.
Convenience and lower interest rates as compared to traditional banks have been the biggest growth drivers. Other factors include transparency, faster and smaller ticket size loan approval and user-friendly interface. The ability to collect, analyze data and understand consumer behavior through cohort classification can become strong ‘moats’ for neobanks.
Neobanks are also taking a crack to attempt a ‘mindset shift’ by offering a customer-centric approach to services. The vision is to transform the way banking is viewed by the public and market especially post the 2008 crisis which created fear and distrust in the financial system.
Trends in Different Markets
Europe is seen as a shining example for neobanks. Regulatory support (Payment Services Directive Law) has created an open landscape to allow fintech firms to securely access customer account data hitherto the sole right of traditional banks. The govt. has made it extremely simple to get a banking license throwing open doors for startups to innovate.
According to ATK research, European neobank customer base has grown by 15m+ since 2011 while retail base customers has declined by 2m. By 2023, these banks will likely reach 20% of the population over the age of 14 and capture 85m customers.
Other success examples have been seen in Latam with Nubank being valued at $10b and hitting exponential customer growth. Recently Hong Kong & Taiwan have also rolled out virtual banking license with Singapore, Thailand and Malaysia expected to do so in the next year. UK based Revolut is also expanding to APAC.
The biggest attractive market however remains China estimated to witness the highest growth till 2025. Massive pool of underbanked customers coupled with surge in mobile banking customers will herald this change. Further legacy e-commerce players such as Alibaba, WeBank are quietly bringing a revolution in lending through a neo-banking platform called MyBank. In just 4 years the bank has disbursed ~$300b to 16m small companies with a 1% default rate!
Neobanks have however seen mixed success globally. While US has housed some of the oldest neobanks (Simple founded in 2009 and Moven in 2011) yet only 3% of millennials have opened a neo account in the past decade. Regulations and banking charter have been the major undoing making it difficult to obtain a banking license as each of these banks had to leverage an incumbent bank’s system. Simple was bought out by BBVA while Moven pivoted to become a tech vendor to help banks better acquire, retain and grow customers. Late last year Robinhood, a direct stock trading platform announced checking and savings accounts with 3% interest rate but had to backtrack in a day as Wall Street knocked on doors with regulatory concerns. Still the opportunity is tantalizing and recently German bank N26 announced a US launch in partnership with Axos Bank.
Global funding stats
2019H1 has seen $2.5b in VC funding across 55 deals. This has already surpassed the full-year figures for 2018 at $2.3b depicting that investor momentum continues in full swing. LatAm and Europe are the leaders by region in funding.
Other markets such as US are rapidly catching up. In 2018 neobanks in US got 4x funding than 2017 and 10x funding as in 2015 according to CB Insights. The opportunity is massive and spilling beyond US and Europe. Judo, an SME challenger bank raised $365m to become the largest funded private player in Australia this year.
Trust especially post the wave of anger unleashed by the financial meltdown of 2008. According to a Yougov survey in 2017, only 37% of individuals trust their bank in Italy while 27% in France feel that banks are a force for good.
Profitability is another big issue. According to Sukhjot Basi- CEO, Bank Yogi, neobanks offer services below cost to attract new members. The problem amplifies in no-fee and no-mark-up international money transfers and during revenue share with incumbents (supporting their accounts and transactions).
Further CAC growth can outpace revenue growth. In its annual report for Feb18, UK-based neobank Monzo revealed that it had increased its user base to 750,000 customers, but across the same period its losses more than quadrupled from $10m to $42m.
The biggest problem, however, is that new customers are giving neobanks a try, but not using them as their main account, meaning they are a financial burden instead of an asset. Only 12% of customers in UK have closed their conventional bank accounts to move wholly online. Moreover, on an average, Monzo customers have less than $190 in their accounts.
Inevitably despite their phenomenal growth finding a sustainable business model has remained a mirage. Some are switching from a ‘freemium’ approach to a subscription model to improve the bottom line. This further risk a higher churn with customers returning to the incumbents.
The list of incumbents launching their own mobile-only app-based banks is also rising. In Oct 2017, JPM launched Finn aimed at young consumers (which was promptly shut in a year). Wells Fargo has launched Greenhouse which blends consumer banking and money management. Goldman launched a lending product called Marcus that offers customers 2.05% for deposits and plans to expand to a full-service online bank. Other in the works include HSBC launching Iceberg and Natwest working with Starling to launch Bo.
· High chances to become mainstream: With near zero capex there is no need to set up branches and buy assets. All neobanks need is a brilliant app and scale-up resources in cloud as per demand.
· AI to be a significant strategic weapon for Neobanks: The ability to maintain a personal touch (akin to what an in-branch service offers), sophisticated virtual personal assistant experience will greatly enhance user experience. Tracking behavioral patterns to validate transactions in real-time could also help spot frauds quicker and offer customers solutions to banking problems before they occur.
· Visits to physical bank branches will slowly end: Think about the last time you visited a physical branch. According to a survey 75% of millennials either never visit branches or do so once a month or less.
· Attacking pain points will be the mantra to win: As the target segment becomes confident with technology and trust is solidified by neobanks, traditional banks who have focused on owning customers than solving problems and simplifying experience might increasingly lose ground. David Furlonger, vice-president at Gartner, says banks face a growing risk of failure if they continue to maintain 20th century business and operating models. Established financial service providers will have to move faster on digital business by building digital platforms or finding niche products and services to sell on others’ platforms.
· Consolidation is on cards: Consolidation is inevitable as neobanks have ballooned over the recent years and strategic acquisitions by incumbents as well as challengers likely.
Indian Market Opportunities
Interestingly Indian startups have learnt from the playbook of the larger global players to focus on niche unbanked segments and avoid a head-on marketing and existing users battle with the incumbents.
Interesting opportunities abound for neobanks which offer amazing analytics on accounting, payments, receivables, etc. and greater flexibility in lending through streamlined operations and costs. There is also the possibility to offer added value to merchants, current account holders and businesses with complimentary functions like book-keeping and financial management tools.
Piggybacking on existing incumbent’s extensive network can yield rich results for these startups. On Aug 19, Open partnered with Visa to launch a business credit card for SMEs for credit, expense management and payment processing for small businesses.
Interestingly from a regulatory perspective neobanks are still not a possibility in India. According to Naveen Surya, Chairman Emeritus Payment Council of India, the RBI does not allow virtual-only bank model or licensing.
That hiccup is not bothering investors though as existing neobanks have taken a ‘collaborator approach’ partnering with incumbents. Funding has accelerated for the existing ones which is likely to attract more to arrive.
Notable deals in India
NiYo: It offers two solutions, Bharat Payroll solutions that provide modern salary account for India’s blue-collar workforce and Global Card that offers banking services for travelers. It claims to be the largest fintech company in the neobanking space with around 1m users. In Jul 19, it raised $35m in Series B from Horizons Ventures and Tencent.
Open: Serves the underserved within the SME segment and offers banking, invoicing and automated bookkeeping. Has 11 banks as partners and crossed $4b of analyzed transactions revenues on the platform. It also has 100,000+ users and adding 20,000 a month. In Jun 19, it raised $30m in Series B from Tiger Global and Tanglin VP.
Yelo: Newest funded neobank which offers savings, remittance and micro-credit solutions to consumers with a monthly salary of less than 30k. In Sep 19, it raised its first round from Matrix Partners and Omidyar Network.
Ezoto: SME focused bank expected to launch shortly. It automates banking and accounting through offering API-driven digital banking for SME’s
· Focus on channel shift: Incumbents’ transition to digital banking will only add momentum for neobanks as it initiates a behavioral change to move from branch to digital banking.
· Opportunities abound: As awareness on digital services translates to adoption there is massive opportunity awaiting in the SME, blue-collar segment among many others
· Favorable regulatory policies: RBI’s moves on adopting a regulatory sandbox for financial innovation will push incumbents to adapt their business models and encourage startups to enter. With the launch of UPI and BHIM by NPCI the Indian Govt. is leading the way in payment innovations at a global level. Such favorable policies are also expected in the neobanking space to encourage innovation.
Generating trust will take a lot of time and ‘patient capital’ especially in India with a high trust deficit to keep/ store money in digital form. The problem will be magnified considering the target segments these startups will be catering to in India. The fear of losing money in online transactions might be higher for the unbanked segments (blue-collar segment, gig economy workers).
According to research conducted by Mastercard last year, just 11 percent of UK consumers currently use a neobank or said that they were “very likely” to use one in the next three years Read it against the fact that it’s the top-funded market in this segment.
Financial literacy is another major impediment since the target has remained outside the purview of online bank facilities. Use of regional language will be necessary along with handholding the users/ developing confidence to understand the process. This is where collaboration with digital chatbots for the next half billion such as Niki.ai and Jiny among others might give an edge.
Long-term cash flows, data privacy and security concerns and creating an alternate distribution mechanism will be the other challenges.
Increased RBI focus on digitalization, maturing India Stack, greater collaboration between fintech and traditional banks and the opportunity for unbanked segments to enter the financial net aided by increased smartphone penetration and digital awareness will herald the next wave of fintech growth in India through the rise of neobanking
The monopoly of legacy banking institutions has remained an unchallenged hegemony for long. With the rise of new-age, agile, digital only banks it will be exciting to see the ensuing battles cum collaborations. Overall the biggest beneficiaries will be the consumers especially the unbanked segments who get an opportunity to be a part of the formal financial system and experience true innovation at its core.
Inputs from CrowdfundUP Team, Worldfinance, NYT, PA Consulting, Entrepreneur, GoMedici, Valustrat, BusinessInsider, HinduBusinessLine
Image credits to Australianfintech
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of any institute or organization he is associated with.