Episode 5: Neobanking Revolution

Transcription:

Hello, and welcome to Speed Talks, the podcast about everything tech in the financial industry.

In this episode, I will take a closer look at the phenomenon of neobanking. I’ll explain what neobanks really are. What are the key factors and market drivers contributing to their growth? Who are the key players in the industry? What actually sets them apart? Why is it so that everyone spotlights them, not the traditional banks? So what’s the fuss all about? And I’ll focus on the other side of the coin, like what challenges do neobanks face? We have recently published a report on how legacy banks compete with neobanks on mobile apps. In this podcast, I’m continuing the topic that sparked a lot of conversations. So, if you have not downloaded the report yet, you will find a link in the description of this episode.
Again, just a disclaimer: this is not about reinventing the wheel here. It’s more about providing you with an easy-to-digest overview of the neobanks market. So, enjoy the episode.

What are neobanks?

Let’s start with the basics first: what neobanks really are. So, neobanks are often referred to as challenging banks. The word neobank is used more in the US, and the challenger bank is a more popular phrase in the UK. At the end of the day, they are all fintech firms that offer apps, software, or any other technology that streamlines mobile and online banking, specifically in the retail context. So, that’s a high-level Forbes definition.

Key Players

So, I would say they see themselves more as a tech company operating in the banking space rather than a bank. And if you look at key examples of players, you could list the likes of Revolut here, the N26, Monzo, Monese, Starling Bank, Lunar, Chime, Varo Bank, Atom Bank, Bunq from the Netherlands or Brazilian Nubank. I would see the key milestones in the development of neobanking include the early Pioneers’ launches like Simple or Muvin in the US and Monzo and Revolut in the UK and broader EU context. If you look at Revolut, for example, the most popular European digital banking app at the moment since it was launched in 2015. It has more than 26,000,000 app downloads, currently available in over 200 countries, offering quite a wide range of services. And yet again, Despite that scale, Revolut is not, I would say, commonly perceived as a bank but rather a fintech app that makes dealing with certain aspects of financial situations more efficient and smooth.

How neobanks differ from traditional banks?

So, how does neobanking differ from traditional banks? Naturally, they’re different in many ways, which greatly impacts how they offer banking services to their customers. I’d list some key differences here.

Business Model

So, if you look at the business model first, neobanks are entirely online. They operate online without physical branches. They focus on low operational costs and offer services through apps, be it mobile, web, or just over the Internet. Whereas traditional banks have physical branches, brick and mortar, where customers usually handle their affairs in person. They also offer a wide range of financial products and services targeting various market segments.

Operational Costs

This business model very much impacts operational costs. Where neobanks have no physical branches and, therefore, fewer employees, they have lower operational costs, allowing them to offer lower fees for banking services as a result. Compared to traditional banks, which are huge organisations often, they have high costs associated with keeping the lights on and maintaining branches and stuff. This often results in higher fees for customers. So, no physical branches equals lower operating costs. And if you look at the overall trends since 2008, European banks closed more than 41% of physical branches, which means that there’s a huge advantage here for the neobanks, definitely.

Technology and Innovation

The other aspect is technology and innovation. So, if you look at neobanking, it relies heavily on modern technology, not only AI or big data. These are all still, again, overhyped buzzwords. But, being user-friendly, focusing on customer experience and digital interfaces, and having this technology-driven approach – in that mindset, there’s more space for innovation, change, and being agile. Whereas traditional banks often use existing legacy heritage IT systems, these are less flexible and harder to modernise, often restricting the range of ways moving forward for a bank.

Service Availability

Another aspect that differentiates neobanks from traditional banks is the service availabilities. Naturally, with neobanking being available 24/7 via apps and online, it is quite a natural thing. Processes are more automated; nonetheless, they are huge on personalisation, with AI-supported services helping them scale their services and offerings. Whereas traditional banks offer access through branches during specific hours and online via apps and portals they use. So again, 24/7 here and on top of that, physical branches that do provide more personalised service because, at the end of the day, you sit face to face with an expert advising you on what to do.

Product Offerings

Regarding product offerings, neobanks instead focus on simple, more basic banking products or product lines like personal accounts, cards, transfers, savings, and currency exchanges. That’s what made Revolut so famous. In comparison, traditional banks offer a wide range of products, both retail and B2B. There are a lot of things neobanks usually don’t touch, like mortgages, deposits, investments, insurance, and specialised products for the business. So, neobanking is expanding here more and more. But the space is saturated with traditional banks, and it’s just wider when it comes to offering.

Regulations and Licenses

Last but not least, there are significant differences with regulations and licences. Neobanks often operate under a fintech licence or use the licence of a banking partner to leverage banking as a service model, for example. They must compete with regulations but are often more flexible. Whereas traditional banks hold full banking licences, meaning they are subject to super strict financial regulations and oversight.

Summing up, neobanks can provide more cost-effective and convenient online banking solutions. At the same time, traditional banks offer a wider range of products and services online and physically in branches, often with a different touch. And that results in neobanks not enjoying as much trust as traditional banks. I think they seem less secure to customers. I don’t think I would personally consider going for Revolut when I would, I don’t know, buy a mortgage. But Revolut would be my go-to for travelling abroad and using ATMs there, for example. I would say a different type of crowd compared to traditional is being targeted here. Specifically, if you compare it to incumbent tier-one banks. So, to some extent, the neobanks and traditional banks cannibalise each other. To some extent, they can also naturally supplement each other.

The Rise of Neobanking

Let’s look at the phenomenon of neobanks in the 1st place. How did they rise, and where did they come from in the 1st place? So, I think the emergence can be traced back to the aftermath of the 2008 financial crisis with Lehman Brothers, etcetera. I believe it wore out trust in traditional banks. It created a lot of opportunities for new players to enter the market. The phrase neobanks first appeared in 2016 only in Digital Economy Outlook. And then, the trend for digitally accessible, transparent services was even further accelerated by the COVID pandemic. And now, the neobanking market continues to grow and expand worldwide. There’s a forecast that by 2027, there will be almost 125 million users of digital-only banks.

I think a few trends drive this phenomenon, and I’ll expand on that in a bit. However, more and more users prefer to use banking services via phone or computer rather than visiting a branch (and the branches are very much associated with traditional banking). According to EY, 27% of global consumers currently maintain relationships currently with neobanks, and this number is increasing annually. Europe was the brightest spot for the neobanks for the best part of the last decade, and I think just the growing demand for frictionless customer experience driven, for example by part in by millennials and the, let’s say, the first wave of Gen Z coming of age. I think the industry will see the continued rise of neobanks 100% digital low-cost geared towards mobile. And the shift is staggering. While the neobank customer base across Europe is constantly growing, traditional retail banks have seen a decrease in the number of customers. And let’s try to understand why that is.

Market drivers

If you look at the market drivers, there’s a level of increased frustration with legacy banks combined with an increased appetite for digital that has accelerated the shift to digital-only banking. Initially, neobanks started as niche players targeting tech-savvy customers and individuals unsatisfied with traditional banking services. But, over time, the overall appeal is broadening, driven by demand. For example, in product fields, customer payment preference continues to move towards digital methods. But there are more reasons; there are more benefits that neobanks bring to the table than just that.

Benefits of Neobanking

There’s convenience; there’s accessibility related to being digital-first, there’s cost-effectiveness, there’s transparency with pricing. There’s this opinion that it is cheaper and more cost-effective. They don’t have the stigma that traditional banks often deal with and struggle with. They challenge the status quo and are, therefore, liked and more popular being disruptors.

A huge impact is definitely driven by the quick adoption of technology, adapting to changes in the market and often pioneering new services, even creating new markets. I’ll expand on that later on. And I’ll say the overall disruption of the market full of rusty incumbents was just a very, let’s say, a good ecosystem to steer. So, even though neobanks typically offer a more limited range of products than traditional banks, what they lack in range they make up in depth. They have excellent experience, intuitiveness, and ease of use of their apps because if you look at the core features, it’s almost always what a typical bank would offer, too. It’s just the customer experience and the ease of doing stuff that helps them excel, and often, they are the first to introduce a particular feature, and then that feature is adopted broadly.

Technological edge

And if you look at why that is happening, what is the edge that gives them the ability to be first, pioneering, and spearheading the market? I would say that one of the most significant advantages of neobanks is their technological edge, and I’m very happy with that. Because, being a tech freak myself, the neobanking space is a very good example of how technology actually gives you this competitive edge. Because they can quickly leverage technology to offer innovative solutions. And I’m not talking about AI-driven customer support, but more like real-time transaction tracking and advanced security features like biometric authentication. But any feature you can think of, the adoption of it is faster if you don’t have the legacy holding you back tech-wise. And that allows you to have this continuous innovation-driving approach.

For example, neobanks are positioning themselves as a financial go-to app and introducing new features. Say, only recently, Revolut’s introduction of commission-free stock trading, cryptocurrency offering, being a financial super app. It’s hard to chase someone running that fast if you have some, you know, a level of heritage holding you back again. And not having that does not stop them from innovating. So, a new feature with a challenger bank that will take them just a few sprints for a big bank can be a no-go due to certain limitations of their internal IT ecosystem.

Cost-effectiveness

I would say the other driver would be related to effectiveness. No physical branches mean savings you can pass on to the customers in the form of lower fees and better interest rates. So, I guess being an incumbent comes with pros and cons. But again, being a challenger bank also has cons because it’s not a bed of roses.

Neobanking challenges

Neobanks do face a lot of challenges. There’s fierce competition from traditional brick-and-mortar banks and new neobanks disrupting the industry. Plenty of Gen Z customers still prefer to make the most important financial decisions in the presence of a physical expert because the subject matter of this decision is super heavy.

There are issues with customers’ trust and security. Having no physical branches can be challenging and does not support building trust and security. Because if you are a remote-only app, you’re less tangible than a traditional bank.

There are a lot of hurdles with regulatory compliance because you don’t have your own license more often than not. And you know, getting that licence is a pain in the back. There are challenges related to the limited offering, and again, coming back to the example of mortgages, at least in my local Polish market, there are just traditional banks offering mortgages, and naturally, it’s just a very, very good financial product that neobanks cannot tap into.

The overall changes in trends according to geographies or space where the neobanks operate also contribute to unequal development across countries. So, some countries are more open to adopting neobanking, like Brazil, and countries where it’s just less sexy.

Summary

Wrapping it all up, neobanking has definitely seen tremendous growth and innovation over the past few years. They offer a fresh, innovative approach to banking, specifically in contrast to traditional banks. And even though they face challenges like regulatory compliance and huge competition, the future looks quite bright, with continued growth and innovation on the horizon.

More on neobanks and how traditional banks can compete with them is in our report on how legacy banks can compete with neobanks, specifically in the mobile app context. Again, neobanks have gained popularity due to their innovative features, customer-centric approach, and ability to provide convenience and cost-effectiveness. But will it continue? I think it will.
How to compete? You can you can find some tips in the report. Thank you and see you again soon. That was Speedtalks.