The digital age is upon us, and financial institutions are no exception. Though financial institutions have adopted some online services, there is a class of banks that arose entirely on the internet. Neo-banks — as these online-only banks are sometimes called — represent a radical shift in the business of banking and are worthy of closer examination.
By placing a greater emphasis on convenience and user experience, online-only banks are gaining support faster than their traditional banking competitors. Whether this trend is sustainable, and to what extent this business model is profitable, remains in question.
What are neo-banks and why should we care about them?
A neo-bank is, quite simply, an online-only bank. Compared to traditional, brick-and-mortar financial institutions, online-only banks are a relatively new concept. While there are an estimated 60 million customers who currently bank with online-only financial institutions in North America and Europe, one report estimates that this will surpass 145 million customers by 2024. With such a sizable share of the market so close to their inception, neo-banks are attracting significant Venture Capital backing. Forbes notes that online-only banks attracted some $2.9 billion in VC funding in 2019, up from $2.3 billion the year prior.
Neo-banks offer a different approach to traditional banks, many of which have been in operation for hundreds of years, during which they have necessarily become tied to the banking systems in place and to a costly network of physical bank branches. Online-only banks emphasize that they are more cost-efficient and innovative than their big bank competitors. Neo-banks argue that their focus on maintaining low costs translates to lower interest rates and fewer fees for their customers.
What are the most common neo-banks in the U.S.?
In the US, some of the most buzzed-about neo-banks include Chime, Simple, Varo, N26, and Aspiration.
Founded in 2013 and publicly launched in 2014, Chime is now valued at $14.5 billion, making it the most highly valued fintech neo-bank in the US. Chime offers no-fee mobile banking accounts, debit cards, and ATM access, and focuses on the segment of Americans who earn between $30,000 and $75,000 annually. Chime’s CEO Chris Britt has noted that he thinks of the company as more a consumer software company than a bank.
Simple dates back to 2009, and was the first neo-bank in the US market. In 2014, Simple was acquired by BBVA for $117 million. In 2020, BBVA USA announced its intention to merge with PNC Financial Services Group, and as of January 7, 2021, chose to close Simple and transfer its customers to BBVA USA. Prior to its closing, Simple was popular amongst its customers for its built-in budgeting tools and its fee-free accounts.
While neo-banks tend to operate using partner banks or through a collection of state-specific charters, on July 31, 2020, Varo became the first consumer fintech to gain a national bank charter of its own. This marks an important shift in the company’s capacity to innovate across a range of financial products, and significantly reduces the burden of navigating sometimes incongruent state regulations. Launched in 2017, Varo now hosts nearly two million banking and savings accounts, with account growth up 60% in 2020.
Launched in Germany in 2013, N26 is one of the largest neo-banks in Europe and, as of 2019, expanded its operations to the US. N26’s accounts are free, with no monthly fee, no minimum balance, and no foreign transaction penalties. While N26 operates in Europe on its own banking license, it has partnered with Axos Bank in the US for FDIC-insured banking.
As its name suggests, Aspiration markets itself as an ethical and sustainable financial institution, with a mission of building a better world. Aspiration pledges to donate 10% of its profits to charity, and offers socially-conscious cash management and investment products. Aspiration’s business model has appealed to many, with more than 1.5 million customers and financial banking from celebrities, including Leonardo DiCaprio.
Why are neo-banks rising in popularity?
With their focus on low-cost banking, convenient budgeting tools, and intuitive technology solutions, neo-banks appeal to many customers weary of traditional banking. Though they lack the physical bank branches of large, national banks, neo-banks have created the perception of superior customer service and fewer hidden fees than their traditional competitors. As more people embrace digital banking, and as a new generation begins to generate income, online-only banks have attracted a massive following.
Following the 2008 global financial crisis and the resulting recession, confidence in the banking sector fell to historically low levels. Some cite these experiences as central to the rise of neo-banks, which seek to distance themselves from the powerful banks associated with the speculative investments and limited regulations that led to the loss of millions of jobs.
The neo-banking industry grew much more rapidly in the EU than in the US, due to less stringent governmental regulations and a market that supports open banking. While neo-banks in Europe could readily access national banking charters, those based in the US have struggled on this front, with Varo as the notable exception. Still, neo-banks have cropped up rapidly throughout the world, with Exton reporting an increase from 100 active neo-banks globally in 2017 to almost 300 in 2020.
Are neo-banks safe?
Neo-banks are as safe as any other bank, using their partner banks’ charters to obtain FDIC insurance for their customers’ deposits. While there have been reports of fraud and suspect transactions from Monzo and Revolut, neo-banks devote significant resources to their cyber-security.
As neo-banks exist for their customers in an online-only format, there is the risk of technical challenges that arise from internet or power outages. In October 2019, Chime experienced an outage caused by issues with a third-party payment processor. Some Chime customers had trouble accessing their account in the app and on the web, but Chime worked swiftly to resolve these issues.
What does the future hold for neo-banks?
It’s difficult to say for sure what the future holds for neo-banks. While they have significant financial backing and a sizable share of the market, their pathway to profitability remains unclear. Online-only banks have seen their number of customers skyrocket due in large part to their lack of fees. Though they’re managed to garner significant financial backing, they are far less profitable than their traditional bank competitors. What follows are three possible strategies available to neo-banks on a journey towards profitability.
Three potential pathways towards profitability:
- Pivoting towards lending and collecting interest.
- Introducing fees, with the hope that the user experience and available products are sufficient to maintain most of their customer base.
- Continued growth of customer base with an eye to sell.
Pivoting towards lending and collecting interest.
Currently, neo-banks tend to offer a much more limited range of products and services than traditional banks. Most online-only banks maintain checking accounts and offer debit products, but relatively few have transitioned towards credit and lending services. This may be due to the challenge associated with not holding a banking charter directly, or to a lack of available capital. In any case, as neo-banks continue to grow their customer base and acknowledge their need for profit, they may begin to pursue this path.
Introducing fees, with the hope that the user experience and available products are sufficient to maintain most of their customer base.
Alternatively or in conjunction with the previous approach, neo-banks may consider introducing fees to their customer base. This move would prove risky — after all, the promise of no-fees is how many neo-banks attract customers in the first place. When done very gradually, and with a simultaneous investment in UX design and customer service, neo-banks could pursue this approach to profitability without losing too much of their customer base, provided that they hold a large segment of the market.
Continued growth of customer base with an eye to sell.
This final approach appears to be the one most commonly pursued by neo-banks today. Rather than revise their business model, neo-banks seek to maximize their number of accounts, garnering financial backing to pursue innovative solutions and banking services to their customers. When satisfied with their valuation, neo-banks allow themselves to be bought out by a larger entity with deep pockets, with a profitability strategy of their own.