Tune out the noise on Neobanks in Canada, part 1 of 2

Disclaimer: Opinions expressed are solely my own and do not express the views or opinions of my employer or any other institution. Any information shared on a publicly listed company or digital assets is for informational purposes only and is not a recommendation of an investment strategy or to buy or sell any security or digital asset.

My recommendation —

Keep an open mind to extract value from this article as I genuinely care that our Canadian 🇨🇦 fintech founders and their teams are successful in their ventures —

• This article is presented from the perspective of a Canadian consumer without bias towards any specific neobank, incumbent bank, or credit card company.
• For those associated with a neobank (as a founder, part of the management, or an employee), internally stress-test these opinions through constructive workshops instead of adopting a defensive stance.
• Investors in neobanks or related fintech ventures should challenge founder(s) on original hypotheses, considering the current economic state and the fintech’s performance against fundamental startup/scale-up metrics.
• If involved in the neobank landscape for 5–8 years without profitability or higher cash deposits on the horizon in the next 2–5 years, consider options such as “Sell,” “Pivot,” or “Reinvent.” Prioritize research-driven product development over replicating neobanks from the U.S. or Europe.

What will you learn in this 2 part series?

• In a country with a population of 40 million, you will learn that healthy competition exists across consumer banking in Canada.
• There is still time to bring innovative financial products to grow market share as we wait for Open Banking and Real-time payments in Canada.
• List of opportunity areas for all types of financial institutions, be it neobanks, direct banks, or incumbent banks in Canada.

Role of Financial Institutions —

In the evolution of commerce, the advent of money marked a crucial shift from bartering to enabling trade on a broader scale. Financial institutions, such as banks and insurance companies, emerged as custodians of newly created wealth, providing a secure repository for funds and offering a mechanism to lend surplus money, fueling the growth of ventures and prosperity for those willing to take calculated risks.

While historical narratives reveal instances where political and financial institutions funded monopolistic trading ventures, such as the “The East India Company”, leading to unfortunate events, their primary purpose remains clear: to contribute to economic value, support initiatives addressing market inefficiencies, and enhance the quality of life through employment and commerce.

For the most part, Canadian incumbent banks have done an effective job of upholding these primary purposes while strengthening our economy. We can all thank them for the sound financial system they created in Canada that weathered the 2007–2008 financial crisis, or the Global Financial Crisis (GFC).

As we delve into the venture-funded neobanks and our Canadian financial and economic landscape, a vital question arises: Do Canadian neobank ventures, driven by a pursuit of growth at any cost and reliance on single-feature spending apps, truly embody their foundational role in our nation? The answer, in my view, is a resounding — NO!!

The lack of innovative financial products, coupled with a fragmented customer base, has failed to generate positive impacts on economic growth, market efficiency, and the overall well-being of society. Notably, this lack of growth across neobanks is not directly related to Canada’s progress in launching Real-time Payments and Open Banking (as you will read later).

Understanding Canada’s Banking Sector —

Banks

Let’s start by understanding how Banks are contributing to the Canadian economy. According to the Canadian Bankers Association —

• Oct 2023 — Banks contribute approximately 3.6% (or almost $70 billion) to Canada’s GDP.
• Taxes paid in Canada in 2022 (by the six largest banks): $18 billion.
• In 2022, the Banking sector employed more than 280,000 Canadians.
• Banks made purchases from outside suppliers totaling about $21.8 billion in 2019. Suppliers to the banks, including businesses of all sizes, all over Canada and the world.
• A 2021 article, shows 52% of bank revenue earned is net interest income, whereas Non-interest income accounts for 43% of bank revenues.
• Canada has one of the most accessible banking systems in the world — more than 99% of Canadian adults have an account with a financial institution.
• As of this writing, there are a total of 81 banks operating in Canada including 35 domestic banks (Schedule I banks), 15 foreign banks, 27 foreign bank branches — full service, (Schedule II and III banks), and 4 lending branches of foreign banks (source: Office of the Superintendent of Financial Institutions)
• Full list of CDIC members

The image below — Oct 2023, Source: Canadian Bankers Association, Banking Basics — Focus: Banks and the Economy

Source: Canadian Bankers Association, Banking Basics — Focus: Banks and the Economy

Credit Unions -

• Credit unions are full-service financial co-operatives that provide their customers — known as members — with similar services as large banks, including savings and chequing accounts, mortgages, investments, and insurance. Credit Unions operate on a not-for-profit basis and distribute any profits or dividends back to members.
• In Canada (excluding Desjardins), as of the second quarter of 2023, there were 197 credit unions and caisses populaires (francophone jurisdictions). They collectively reported deposits of $254.8 billion and over 6 million Canadians were reported as members (source: Canadian Credit Union Association-CCUA, National System Results 2023 Q2).
• When combined with Desjardins (the largest federation of credit unions), credit unions & caisses populaires, close to 11 million Canadians trust their local credit unions for day-to-day banking (source: Canada’s Credit Unions and National System Results 2023 Q2).
• There are 70 independent credit unions in Ontario (source: Central 1 Credit Union).

Check 1 — We already have a multitude of financial institutions and banks based on our economic output and the size of the population.

Comparing Canada to other countries:

When discussing Canada’s banking landscape, fintech founders often compare our nation to counterparts like the United States, the United Kingdom, or Australia. They argue that our policies are lagging, hindering the innovation and competition they believe is necessary. I believe, due to many socioeconomic factors, it is more realistic and relevant to compare us based on our economic health, i.e. GDP and the size of our population.

A closer look at the data below shows the State of New York generated a similar GDP to Canada’s but with almost 50% less population (no wonder OECD published articles on Canada’s weak recovery and TD economists reported Canada’s lagging living standards). Now, this perspective reshapes the conversation around the level of our economic activity and the abundance of banks, credit unions, and neobanks in our country.

According to the World Bank report, Canada’s Gross Domestic Product (GDP) in 2022 was US$ 2.14 Trillion (source). Hence, we cannot compare ourselves with the U.S. as we are less than 10% the size of their GDP and we are approx. $1 Trillion short of what the United Kingdom generates as a Country.

Comparing Canada and New York State — 2022, GDP and Population

Canada —

• GDP = 2.14 Trillion
• Population = 38.9 million
• 81 Banks and 197 Credit Unions (as reported above)

New York State —

• GDP = 2.05 Trillion
• Population = 19.6 million
• 120–125 Banks in New York State, including National Banks, Regional Banks, Community Banks, Online Banks, and Private Banks — (Source 1 Forbes article and Source 2 — FDIC Search)

Other Countries for reference —

• Australia — GDP = 1.68 Trillion, Population = 25.9 million
• United Kingdom — GPD = 3.07 Trillion, Population = 66.9 million
• United States — GDP = 25.46 Trillion, Population = 333.2 million

Chart source —The World Bank, GDP 2022 chart and data and USA Facts, 2022 GDP New York

Source — The World Bank and USA Facts

Chart source — The World Bank, Total Population chart and data and USA Facts

Source — The World Bank and USA Facts

Check 2 — Learn but localize, Canada is not like the United States.

Drawing insights from the information above, it is beneficial to look towards our neighbors, compare fintech valuations, raise venture funding, and learn from their innovations. However, founders and investors focusing on fintech ventures in Canada inspired by the U.S. neobanks must develop a realistic understanding of growth projections and eventual market returns.

For instance, the success of Chime, a fintech company founded in 2012 that used paycheck advances as a wedge to acquire over 14.5 million bank account holders, does not automatically imply that replicating that tactic in Canada would lead to similar growth. Recognizing that no single country in the Western world can match the vast global reach or generate unparalleled scale and growth achieved by U.S. companies and their markets is essential.

The unprecedented value added to the world economy by the U.S. still surpasses even that of China or India, despite their substantial populations.

Market Capitalization Comparision — The top 10 U.S. technology companies have a combined market capitalization of the entire stock markets of Canada, UK, France, and Germany —

Source URL — https://x.com/FareedZakaria/status/1744072849575301313?s=20

US GDP and the slowdown of China —

• China’s GDP declining as a percent of US GDP (image below)
• Full report on China’s Contribution to the Global Economy — by December 2023 — China’s Troubles in Historical Perspective

CNN charts above were sourced from the following videos -

Video 1 — The U.S. still dominates the world as an economic powerhouse

Source URL — https://x.com/FareedZakaria/status/1744072849575301313?s=20

Video 2 — Global economy and China’s charade of fake growth —

Source URL — https://x.com/FareedZakaria/status/1744078108381037045?s=20

Check 3 — We already have the healthy competition that venture-funded neobanks keep demanding to better serve the Canadian customer.

Let’s start by acknowledging that, based on the size of the population and GDP, almost all the countries mentioned above (the U.S. top 10 or the U.K. top 5) have a financial sector in which the top 5–10 institutions hold the majority of the market share due to the breadth of financial services they cover. Canada is no different with its top 5 banks.

In the dynamic landscape of modern banking, numerous neobanks have emerged to reshape the way we manage our everyday spending. These digital-first institutions prioritize user experience and offer customer rewards, particularly with pre-paid credit cards. As a Canadian consumer, exploring how these neobanks bring their products to the market can be insightful.

Within the fintech landscape, it’s common for these neobanks to form partnerships with other financial institutions for the backend administration of financial products. This collaborative approach should not be viewed negatively; rather, it enables neobanks to promptly bring regulated products to market without violating any applicable Canadian laws.

Note — The list of institutions and related information below was captured during December 2023.

Notable Neobanks with large Venture Funding —

1. Wealthsimple — I have covered Wealthsimple (🤩 ⭐ ️) in my articles and LinkedIn posts many times as one of the few fintech companies with deep technical expertise in simplifying complex financial products. They have introduced many new product offerings within wealth management that were built from the ground up and were not easily accessible before by retail investors in Canada. Based on the information reported by Wealthsimple on LinkedIn and other sources like the Globe and Mail, they exhibit a robust wealth management business. However, it is challenging to validate how many customers are using Wealthsimple as their primary bank and the amount of cash deposits they manage in spending accounts.

• Number of customers — approx. 3m, three million clients, and $30 billion in assets under management (source: Globe & Mail)
• Founded — 2014, Company Size — 501–1,000 employees (source: LinkedIn).
• Funding — Total venture funding amount — $1.1b (source: Crunchbase).
• Wealthsimple Mastercard® Prepaid card is issued by KOHO Financial Inc.
• Alternative Investing Products — Private credit yield in partnership with Sagard, Private equity investing in partnership with LGT Capital Partners

2. Neo Financial — Kudos 👏 on establishing partnership programs like Hudson’s Bay Mastercard® powered by Neo and the Tims Credit Card by Tims Financial (a financial services division of Tim Hortons).

• Number of customers — unable to find a reliable source
• Founded — 2019, Company Size — 750+ employees (source: About Us).
• Funding — Total venture funding amount — $235.8M (source: Crunchbase).
• The Neo Money™ card is a prepaid Mastercard® issued by Equitable Bank under license by Mastercard International Incorporated.
• The Neo Money™ card is powered by the Neo Money™ account, which is provided by Concentra Bank (Concentra is an Equitable Bank company).
• The Neo Money™ account is provided by Concentra Bank (Concentra is an Equitable Bank company).
• The Neo High-Interest Savings account is provided by Peoples Bank of Canada.
• Neo Credit and Neo Secured Credit cards are issued by ATB Financial under license by Mastercard International Incorporated.
• Neo Invest™ — Portfolio management services provided by OneVest.
• Neo Rewards™ — Neo is solely responsible for the Program. Neo’s banking providers, including Peoples Bank of Canada, ATB Financial, Concentra Bank, and Equitable Bank have no responsibility for the Program.
• Neo Mortgageᵀᴹ — offered by Neo Mortgage Services Inc., but was unclear to me who the mortgage underwriter/provider is as the website shows that their ‘advisors’ are licensed mortgage professionals.
• New offerings — https://jacanada.org/ & Neo Card — https://card.neofinancial.com/JA

3. Koho Financial — Kudos 👏 on creating technology that facilitates programs like Koho Affiliate, Koho Business, and Koho Partner Program.

• Number of customers — approx. 1m users signed up for Koho (source: Dec 23, latest funding announcement)
• Founded — 2014, Company Size — 201–500 employees (source: LinkedIn).
• Funding — Total venture funding amount — $407.1M (source: Crunchbase).
• The KOHO Mastercard® Prepaid card is issued by KOHO Financial Inc. under license by Mastercard International Incorporated.
• Financial products — Koho partnered with Mastercard® and Peoples Trust to bring the financial product offering to the market.

Direct banks (with no branches like the neobanks) launched as wholly-owned subsidiaries of a regulated incumbent Bank or a Credit Union —

Here are a few direct banks (with no branches like the neobanks) that are directly challenging the venture-funded neobanks with similar product offerings —

1. Alterna Bank — is a Canadian direct bank and a wholly owned subsidiary of the Ontario-based credit union Alterna Savings.
2. EQ Bank — is a trade name of Equitable Bank (founded over 50 years ago), offering no fees on everyday bank and investment accounts directly. EQ Bank is one of Canada’s oldest Challenger Bank™. It is a wholly owned subsidiary of EQB Inc., which trades on the Toronto Stock Exchange (TSX: EQB) (TSX: EQB.PR.C) and serves more than 370,000 customers across Canada. Equitable manages more than $67.9B in assets and has grown to become the country’s 7th largest independent Schedule I bank (source). Similar to other neobanks, EQ Bank has established partnerships with other financial institutions, including: a) Mortgage Marketplace — EQ Bank partnered with the digital-first mortgage broker Nesto, offering access to over 2,000 mortgage products. b) The EQ Bank Card is a prepaid reloadable Mastercard® issued by Equitable Bank under a license from Mastercard International Incorporated. c) International Money Transfers with EQ Bank, powered by Wise. They are also supporting the fintech community through EQ Bank’s Card infrastructure — EQ Bank serves as a BIN sponsor for Berkeley Payment prepaid card programs. This partnership allows Berkeley clients to issue cards using EQ’s relationship with Mastercard. Additionally, Equitable Bank’s wholly-owned subsidiary, Concentra Bank is the issuer for Neo Financial, which competes with Berkeley Payment in some ways. Concentra Bank also supports credit unions across Canada serving more than 5 million members. Between EQ Bank and Concentra Bank, they have over $100 billion in combined assets under management and administration. EQ Bank platform (eqbank.ca) has been named the top Schedule I Bank in Canada on the Forbes World’s Best Banks 2023, 2022, and 2021 lists (source).
3. Manulife Bank — according to their website, Canada’s first branchless bank, was launched more than 30 years ago in 1993. Manulife Bank is a wholly-owned subsidiary of The Manufacturers Life Insurance Company and was the first federally regulated bank opened by an insurance company in Canada. They offer products like Manulife All-in Banking Package™ that encourage consumers to save to get rebates on monthly fees. Manulife Bank products also include savings, mortgages, investments, loans, and insurance.
4. Motive Financial — is a trade name of Canadian Western Bank
5. Simplii Financial — with 2 million+ customers, a no-fee chequing account, and full-service banking products, is a Canadian direct bank and the digital banking division of the Canadian Imperial Bank of Commerce (CIBC).
6. Tangerine Bank (was ING DIRECT) — with 2 million+ customers, $0 daily banking fees, and full-fledged banking products from savings, spending, investing, and borrowing. They may have internal financial applications powering consumer products and experiences but all of their offerings are managed by Tangerine Bank which is a wholly-owned subsidiary of The Bank of Nova Scotia.

Other financial institutions with consumer-facing products —

1. ATB Financial (Alberta only) —a crown corporation that started in 1938 and has since grown from one small Treasury Branch to the largest Alberta-based financial institution, with assets of $60.9 billion. Only available to the residents of Alberta, ATB Financial has over 280 locations and offers full-fledged consumer banking products such as deposit accounts, investments, loans, insurance, mortgages, etc. I listed ATB Financial here as they are actively providing banking infrastructure and backend services to other fintechs who offer financial products to consumers across Canada.
2. Canadian Tire Bank (CTB) — a financial services arm of Canadian Tire Corporation, Ltd. offering products like credit card and deposit accounts (Savings, GICs, etc). Over time, they have made subsequent changes to their name and in 1995, Canadian Tire Financial Services Limited (CTFSL) became the first non-deposit-taking, financial institution worldwide to launch a Mastercard called the Options Mastercard. Today, they have grown their Mastercard portfolio (Triangle® credit cards) to 4 million card members (source).
3. PC Financial — President’s Choice Financial is a part of Loblaw Companies Limited. They offer a no monthly fee spending account (PC Money™ Account) and a no annual fee credit card (PC® Mastercard). President’s Choice Financial Mastercard is provided by President’s Choice Bank. PC Optimum program is provided by President’s Choice Services Inc.
4. Peoples Bank of Canada (PBC) — BC and the PBC logo are trademarks, service marks, and trade names owned or licensed by Peoples Group. They offer accounts with no monthly fees or minimum deposits savings accounts, GICs, mortgages, etc.
5. Rogers Bank — part of Rogers Communications Inc., they offer Rogers Bank Mastercard® and a spending management account (web and mobile app).

Check 4— There is a lack of technical innovation across the entire financial sector in Canada.

I will start by reiterating that a $0 or no-fee chequing account, real-time payments (also referred to as real-time rails, RTR), and Open Banking alone will NOT grow our consumers’ financial net worth in Canada. The entire financial sector in Canada needs to innovate ‘now,’ developing actual financial products and focusing on building the technological foundations to take advantage of such banking sector changes in the future.

Fintech Innovation — X.com, circa 2000

Fintechs need to stop complaining and start building new financial products with deeper consumer value. Founders like Peter Thiel or Elon Musk did not wait for the incumbents or the Government to bring fintech innovation to market. For more, review the “opportunities” section in part 2 of this article.

Within retail banking, the last innovation that was ahead of its time and had to overcome deep technical challenges was launched by Elon Musk and Peter Thiel circa 2000. Their vision was to remove all friction from money movement, and retail banking by having an online bank that he called X.com. He raised venture funding, launched the MVP, and then ended up merging with PayPal and morphed into just a money transfer application (it is a long story on why X.com didn’t survive because of founder egos, board member support for Peter Theil, Elon Musk ousted, etc.).

Elon Musk and Peter Thiel showing X.com Visa Cards

The Neobanks' main offerings, pre-paid debit cards and spending accounts, lack true innovation —

The associated spending accounts require loading money from a primary financial institution, limiting their novelty. Cashback or rewards, often promoted by neobanks, originate from higher interchange fees on Visa and Mastercard, essentially funded by customers. Free transactions come with limitations on the retail product, already covered in the interchange fees of prepaid cards. Merchant rewards, a common feature in both neobanks and incumbents, are primarily sustained by interchange fees. Additionally, neobanks face constraints on money movement and spending, including limitations on pre-paid card spending amounts, restrictions on funds transfer from other banks in a single transaction, and occasional delays in fund availability for immediate spending.

In the past few years, the only notable and relevant innovation I have encountered in Canada was the launch of Canadian Depositary Receipts™ (CDRs) by CIBC Capital Markets. I invested in some of the top U.S. equities using CDRs and made solid returns (between 10%-150%), as it is an inclusive financial tool that also helps avoid FOMO (fear of missing out). I covered CDRs in my 2022 article — Canadian Depositary Receipts- CIBC’s innovative stock trading product for 🇨🇦 Canadian investors.

What could Neobanks do to add economic value?

Canadian consumers actively seek financial products that contribute to achieving their life goals by growing their financial net worth. However, in the realm of fintech, we predominantly observe apps encouraging increased spending, trading, and offering low-value rewards — with hidden fees ultimately funded by the same consumer spending. At the fundamental level, neobanks and challenger banks can start with the following:

• Boost financial net worth — Instead of contributing to consumer debt, neobanks can focus on developing financial products that actively contribute to growing consumers’ net worth. This can be achieved through simpler, low-cost, long-term focused investment products and tools (e.g., CDRs, ETFs, CAD hedged S&P 500 Index Funds) beyond just building credit scores and mutual funds.
• Revisit unit economics and diversify — Avoid relying solely on interchange fees to fuel financial growth. Introduce reward programs that derive value from the core product offering. For instance, the Starbucks Loyalty Rewards program, launched during the financial crisis, didn’t hinge on pushing credit cards to customers for funding.
• Remove friction with technology — Tackle friction within financial systems by leveraging innovative technology and alternative data across the financial rails. For example, Wealthsimple continues to enhance its technology by successfully collaborating with institutions like Payments Canada, Bank of Canada, and others.
• Revisit strategic partnerships — The current partnerships place neobanks on the periphery of the financial system, resulting in high customer acquisition costs. Once neobanks have compelling unit economics for an incumbent partner (banks or credit unions), they can play a more central role within the financial system, potentially lowering customer acquisition costs. Forge partnerships with incumbent institutions to reduce friction across various financial products such as business banking, personalized mortgages, instant loans, low-cost money movement, and pay-as-you-use insurance to grow the economic pie.

In part 2 of this article, I will potentially cover areas such as —

• Why are we witnessing limitations in the growth of neobanks or direct banks in Canada?
• Would a Canadian consumer ever leave an incumbent as their primary bank?
• New opportunities for all types of Banks in Canada.