European neobanking market: review of 2020 and outlook for 2021
At the beginning of 2020 neobanking market in Europe started showing signs of reaching maturity and the growth started to slow down. Combined with the Covid-19 crisis that brought a significant uncertainty to the market, further disrupting neobanks stellar growth trajectory. This led to a number of market movements summarized in this article.
Key drivers that shaped the neobanks market in 2020:
1.Pandemic slowed down European neobanks growth and largely negatively affected revenues, as some of the leading neobanks use cases collapsed. New lockdown reality and forced closure of bank branches accelerated the shift to banking online. Interestingly, the massive channel shift to online didn’t result in a major uptake for neobanks, as someone might have expected. Instead, the online-only neobanks sign-ups fell off the cliff when the lockdowns started in Europe in March 2020. According to Fincog, a neobanks’ consultancy, internet search frequency (which is a proxy for new user growth) declined 10–20% in Jan-May 2020 for top European neobanks like Monzo, Revolut, N26, Monese. Lockdowns effectively shut down the favorite neobanks’ uses cases — travelers stopped spending money abroad, the flow of migrants and subsequently remittances slowed down, offline shopping and Horeca spending hit the wall. Some use cases, as investment/brokerage and SME/retail short-term lending actually gained momentum during the pandemic, but only a handful of neobanks had those services in the portfolio (e.g. Starling, Robinhood). As a result majority of leading neobanks saw a sharp decrease in overall user spend/deposits and consequently lower interchange revenues, which for many neobanks remain the key revenue component. Interestingly, neobanks outside of Europe, where the neobanking market is in a lower maturity stage, haven’t been affected as much and managed to maintain growth (see the graph below).
2. Concerns regarding neobanks safety induced deposit outflow and limited growth options. For customers, using an online-only bank definitely sound convenient for spending and daily servicing, but doesn’t solve for the key banking function — safe money storage. As a result, the model of keeping funds at the high-street bank account and spending through a neobank card gained popularity. In 2018–19 neobanks have put significant effort into luring customers to deposit salaries/savings and generally use neobanks accounts as primary ones — and with certain success (around 12% of users deposited their salaries with a challenger in 2019). However, the pandemic triggered the massive outflow, fueled by public concerns with regard to neobanks stability and solvency in times of crisis, along with ambiguity around deposit protection, as many neobanks operate under e-money license and are not covered by government deposit protection schemes. Scandals like Wirecard fallout effectively suspending Holvi, Curve, and other fintechs as well as N26 staff rebellion also negatively affected public trust in neobanks in 2020. According to an Accenture UK survey, only 10% of Brits place ‘a lot’ of trust in neobank and only 45% believe that neobanks will exist in 12 months' time. As public trust in neobanks was still low, it effectively remains an obstacle to the market development, limiting the deposit base and users' growth.
3. Incumbent banks pushed into digital banking. We see more and more incumbent banks launching and developing their own neobanks: Markus (Goldman Sachs), Mettle (Natwest), Bo (RBS), Fyrst (Deutsche Bank), Openbank (Santander), etc. For cash-rich incumbent banks, it is an easy and quick way to enter the neobank market, without the need to disrupt the operations of the main business. As this push grows, independent neobanks will face more and more dangerous competition from incumbents backed neobanks, which have solid cash warchests and customer trust stemming from being associated with the large banks’ brands. This is actually another strong sign that having a digital and tech-rich offering is not a differentiator anymore, but rather a hygiene factor. As incumbent banks strike back, it is of utmost importance for neobanks to innovate further and specialize — in order to survive. Even if it’s clear that banking will continue migrating online in the future, it is still an open question whether it will be dominated by online-first neobanks with evolved product portfolios or by traditional banks mastering the online channel.
4. Investors’ mindset has shifted from growth at all costs to sustainable growth, mid-term profitability became a pressing issue. Valuations slumped after the Covid-19 crisis began and several neobanks had troubles getting additional runway cash (e.g. Monzo, Monese). Investors are becoming much more concerned about profitability than they were 2–3 years ago. In an early-stage market being non-profitable and focusing on growth was the right thing to do. But now, on an overcrowded maturing market with close to zero switch costs and the possibility to have several providers at zero monthly costs, plain scale becomes more of a hygiene factor than a differentiator for the investors. The real differentiator is the ability to have a consistent net revenue-generating relationship with customers. In the near future, the neobanks that will not be able to accomplish this might close their (virtual) doors, even despite the large customer scale.
Next year challenges for Neobanks:
1.Challenge to differentiate in an already overcrowded space, and find new target use cases. Amid many of the old use cases losing their customer appeal amid pandemic and monetization challenges looming, new neobank use cases and business models, potentially even targeted at new customer groups, should be developed. Neobanks used to leverage UI/UX and low pricing as key differentiators. Both of these advantages are going to be hard to defend in a situation when sustainability becomes a concern, the marketplace is overcrowded by copycats and incumbent banks are starting to move deeper into online. Therefore, now in order to be successful and sustainable neobanks should build their differentiators around providing value-generating services for specific target customer groups. We are already seeing many neobanks tailor their offer to a specific use-case/customer group, e.g. freelancers and independents (Tide, Fyrst, Holvi), the unbanked and underbanked (e.g. Pockit), women (e.g. Elas, First Women’s Bank), the elderly (e.g. Longevity Bank). We are likely to see more and more neobanks to specialize and develop more differentiated laser-focused propositions in the coming year, e.g. focused on specific professions (such as lawyers, notaries, doctors), affluent customers, specific SME segments, etc.
2. Challenge to monetize scale and showcase sustainable profitable growth or at least a clear short- to mid-term profitability. As it was said earlier, European neobanks used to focus on customer acquisition, sometimes at an excessive cost, focusing little on customer retention and monetization - that was supposed to happen at some point in the future, similar to Uber or AirBnb. However, in 2020 most players started to shift their focus from customer acquisition to conversion of new customers into net revenue-generating ones and retention of those customers. There are two key levers neobanks have to convert to profitability: short-term — which is to cut spending on growth (marketing, product development, etc.) and long-term — to create new services that generate customer value and are monetizable on a recurring basis. Currently, for the most neobanks, the key recurring streams are interchange and account subscription fees, both of which were affected by consumption dip in 2020 and excessive competition. In 2021 neobanks are likely for new recurring revenue generators. The key one is, of course, lending. According to Fincog, a neobanks’ consultancy, out of major European neobanks only one focuses primarily on lending — OakNorth, which is also the first UK neobank to turn profitable in 2018. In 2021 more challengers are expected to branch aggressively into lending, as we are already seeing some players applying for bank licenses (e.g. Revolut), opening in-house lending capabilities or looking to buy a lender (e.g. Starling). Another good example of a new recurring revenue generator is payments acceptance and acquiring for small businesses which, despite being quite a natural fit, has been for long neglected by the neobanks. In December 2020 Revolut launched its own in-house acquiring and acceptance capability, other SME-serving neobanks are likely to start exploring this business niche as well in 2021. Overall, we are clearly going to see some creativity and experimentation with tailored revenue-generating services, potentially setting a scene for the banking services re-bundling by challenger banks.
3. Challenge to gain customer trust. Pandemic raised the question around the safety and stability of neobanks. Frequently, being small, online-only, and underlicensed becomes a strong negative differentiator for neobanks compared to incumbents, affecting new players' ability to raise and maintain customer deposits. With record levels of debts in the economy and a potential looming new debt crisis, this becomes even more of an issue as young and small neobanks are perceived to fall the first victims of this. Therefore, it is key for the Neobanks to find a way to gain customer trust, e.g. by ensuring proper licensing, participating in deposit guarantee schemes, underleveraging their balance sheets. Another opportunity is getting a cover from parent large banks, e.g. through becoming an acquisition target. In the past, many neobanks founders (e.g. those of Monzo, Starling) were resistant to the idea of selling to the established banks (e.g. Monzo-RBS case in 2017), however, we can see this stance soften next year, opening a way to an M&A wave in the neobanking market.
4. Funding challenge. Many neobanks had trouble raising investor funds last year, some accepted down rounds with losing up to 40% of they valuation post pandemic (e.g. Monzo). It is clearly getting harder for neobanks to justify their valuation to institutional investors with uncertain growth prospects and mostly negative unit economics. Many independent early-stage neobanks will struggle with funding in 2021 and may fail. Relatively established neobanks are likely to turn to alternative funding routes, with the stock market probably being the first choice. If the stock market will continue favoring innovative tech-centric companies in 2021, we might see many late-stage neobanks taking advantage of the market hype-driven momentum and file for IPO. This will allow not only to attract new funds on a recurring basis but potentially also bring the valuations to the next level.
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