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Is the Neo Bank Bubble About to Burst?

Sarah Grotta by Sarah Grotta
June 23, 2022
in Analysts Coverage, Challenger Banks
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Is the Neo Bank Bubble About to Burst?

Is the Neo Bank Bubble About to Burst?

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With looming indicators that the economy is in for a prolonged downturn, concerns have been raised about the ability of neo banks and challenger banks to survive, particularly those that are solely or highly dependent on interchange income. Investors who are supporting all the free services that these neo banks are giving away are getting restless and looking for a plan that will pivot towards a profitable business model. 

I don’t think that these tech-forward, digital banks will disappear. And I think that they have had a positive impact on the industry; they challenge traditional financial institutions to up their digital app experience and I credit these banks for achieving the lowest level of unbanked individuals in the U.S. since the FDIC has been tracking this population. I do worry, however, about the outcome if one or several of these non-bank banks fail. I trust that their sponsoring chartered financial institutions will make account holders whole, but it could be very messy and disruptive for these individuals. 

Here are some excerpts from American Banker article, Warning signs emerge for neobanks: ‘Doomed to not survive’.

A recent study by consulting firm Simon Kucher found that of the 400 neobanks in the world, less than 5% are breaking even. U.S. challenger banks Chime and Varo have hit bumps in the road, Chime because it closed customer accounts due to suspected fraud, Varo because it has suffered steep losses and burned through investors’ cash. The CFPB is examining the bank partnerships, also known as rent-a-bank or rent-a-charter programs, that many challenger banks rely on for legal legitimacy and FDIC insurance.

And challenger banks, like many other types of fintechs, have seen their equity overvalued. All of this is likely to give neobanks’ backers pause as the economy tightens.

Three hundred of the 400 challenger banks that exist today will not exist in five years, predicts Christoph Stegmeier, senior partner at Simon Kucher

In the U.S., Stegmeier predicts some challenger banks will go out of business, but others will merge and reduce their cash burn and funding needs, out of necessity. 

Overview by Sarah Grotta, Director, Debit and Alternative Products Advisory Service at Mercator Advisory Group

Tags: Challenger BanksChimeDigital BankingDigital BanksEconomic recessioninterchangeNeo BankingNeobanksUnbankedUnderbankedVaro
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