Chime and the rise of Neobanks — Part I

Published in

FinTech@Kellogg

5 min readNov 5, 2020

Last September, Chime, a US-based neobank, announced that it had raised a new series F funding of $485M, valued the business at $14.85B. This valuation makes Chime the most valuable consumer fintech startup, surpassing Robinhood, the popular stock trading platform. Within the 18 months of previous funding, the company grew its valuation by 900%. Chime has more than 8 million account holders or around 2.4% share of the US banking market. This is a very fascinating growth that Fintech@Kellogg would like to introduce readers to the Neobanking space.

What is Neobank? And How is it different from a traditional bank?

Unlike a traditional bank, neobanks, or so-called “Challenger bank” is a digital-only financial institution that offers financial services with no physical branches and limited service options. Mainly, Neobanks provide essential banking services such as checking/ savings accounts, debit cards, money transfer, and budgeting/ education tools, with some extending to cash advance, credit card, and lending.

The Unique Value proposition of Neobanking

Neobanks are very well positioned for younger generations who are tech-savvy and prefer to complete most of their transactions online and quickly. Moreover, there are b2b neobanks who target startups and SMB to achieve similar goals.

Low/No cost — Fewer regulations, less product offering, cloud computing, and operating with no physical branches lead to low cost-to-serve. Hence, Neobanks are able to charge customers with an inexpensive fee or even no fee at all.
Seamless and streamlined user experience — Since the entire services are done through a smartphone app, neobanks, designed with a customer-centric approach, are able to provide a delightful user experience with quick processing time for services such as account opening, cash management, payment, etc. User transactions are analyzed to understand customer behavior and offer personalized services. For example, pre-qualification for a credit card, budgeting forecast, and insights reporting.

How can Neobank offer financial products?

Given complicated regulations in becoming a chartered bank, Neobanks usually partner with larger, chartered financial institutions to ensure deposit accounts on the backend operations for example The Bancorp Bank and Stride Bank which are supporting Chime.

However, some neobank get FDIC approval to become a licensed bank. Varo is the first US neobank that has officially received a national bank charter after 3-years of application journey.

So what are attributes that Neobanks have similar to traditional consumer banks?

At a core, Neobank is still a bank so as the way they generate income. The revenue streams of the banking industry consist of 2 main sources

Interest income from lending products such as Home loan, Business/ Personal loan
Interchange fees from payment activities when customers use debit/ credit cards, transfer money, etc.

Neobanking is currently focusing on the 2nd revenue stream: Interchange fees. Interchange is the fee that banks charge to the merchant who processes a credit card or debit card payment in order to cover the costs associated with the authorization and processing of card transactions. Neobank will get the margin of the interchange fee from every transaction that customers use their cards to purchase products/services. Therefore, customer acquisition and customer repeat are important for neobank to maintain sustainable growth.

However, with more and more user data in the ecosystem, Neobanks start to develop a risk profile and expand to offer lending products to drive revenue growth similar to how traditional consumer banks generate the majority of their revenue, Interest income. The Neobank’s challenge in expanding into the lending business is its customer base profile. Even though the majority of its customer base is a younger generation, neobanks also attract subprime consumers, a limited deposit base, and those who are underbanked. This segment tends to have a higher risk profile and not the main target for traditional banks.

Is Neobank a threat to a traditional bank?

Even though traditional banks are very complicated businesses in terms of regulation, customer behavior, and competition, Neobanks emerge as a major threat. McKinsey estimated that up to 40% of banks’ collective revenue could be at risk from the new digital competition by 2025. With the customer experience-focused product, neobanks will continue to acquire, and retain customers in the platform while cross-selling or bundling to other banking as they scale and have more data.

In response, traditional banks put more emphasis on improving digital/ mobile offering products to protect and retain customers in their ecosystem. One of the prominent trends is banks launching their own Fintech brand, for example, Marcus by Goldman to offer online loans and saving accounts to the growing digital-savvy customer segment.

The future outlook of neobank

Neobanks are here to stay. They will continue to onboard customers into the ecosystem through seamless and accessible product offerings with exceptional customer experience at a core. Product extension into other financial products, especially lending, will be an important part to improve the unit economics and path to profitability. Moreover, each company will continue to innovate its specialization and unique selling points to maintain its competitive advantage and enter a new market segment. As the companies grow past the early stage, they will have to face challenges of higher acquisition fee (CAC) and lower customer lifetime value (LTV), which is driven by

High competition with all neobanks targeting similar customer profiles
Traditional banks respond by launching their own digital arm to compete in neo banking space
More resource drain into expanding to customer segments that are the target customer for traditional banks

In the next part, I will deep dive into the business model of Neobank across the globe to understand the different market dynamics and how neobank in each country positions itself for success against the incumbent. Stay tuned!

Give some claps if you learn something new from this post. All feedback is welcome Ice Suphawit S. :)