The COVID-19 pandemic has catalyzed technology adoption and accelerated innovation even in the most static industries. Long-standing financial institutions in the Western world have not been immune to the changing tides. With home orders limiting mobility in society, people needed online bank accounts to meet their personal banking needs and turned to a growing cohort of newly formed tech companies that provide a digitized, user-driven iteration of services. traditional banking. What is this âneobanking revolutionâ and are they here to stay?
Contrary to what the etymology might suggest, neobanks are not actually chartered banks. In other words, instead of directly holding the funds passed through their products and earning income from interest income, these companies derive most, if not all of their income, from interchange fees on credit card transactions. debit. The neobank partners with regional chartered banks that take responsibility and store the deposits the fintech company receives from its users. In return, the smaller chartered bank gets a reduction in interchange fees and access to new business brought in by the neobank, especially from underbanked segments of the population.
There is a dominant narrative that traditional financial institutions are inefficient and intransigent to the point that they have alienated a significant portion of the population they are supposed to serve.
There is a dominant narrative that traditional financial institutions are inefficient and intransigent to the point that they have alienated a significant portion of the population they are supposed to serve. A 2018 Federal Reserve study claimed that 23% of Americans were underbanked or unbanked, with a disproportionate number of these low-credit individuals being visible minorities. By bypassing the difficult, time-consuming and expensive charter process, as well as the cost savings resulting from the abandonment of physical branches, neobanks typically run streamlined businesses that allow lending to borrowers outside of the risk appetite. traditional financial institutions. The resulting business model of a chartered bank, based on transaction fees, bodes well for its target demographic: People of lower socioeconomic status tend to save less and spend more. That being said, there is also a social rationale for accessing capital for underserved communities.
Many neobanks have articulated this noble cause in their business strategies with companies such as First Boulevard targeting the African American community, Jassby running financial education campaigns for children, and Dave helping their users find employment. While the growing prevalence of neobanking is by no means a catch-all solution to economic inequalities, it induces a gradual level of change by providing a clearer mechanism for escaping the cycle of poverty. In addition to those who have been left behind by the current system, a fintech solution to banking is also for people around the world who have seen their lives displaced and experienced extreme financial instability in the aftermath of the financial crisis. of 2008. In general, there is a deep-rooted mistrust of big banks among the population. The prospect of a banking platform without a hidden fee structure, better service and greater transparency is therefore naturally more attractive.
Largely out of necessity, neobanks have been one of the biggest winners from the pandemic.
Largely out of necessity, neobanks have been one of the biggest winners from the pandemic. During the first two quarters of 2020, the use of mobile banking services increased by 34% while banking operations at local branches decreased by 12%, which helped to increase the size of the global neobank market to $ 47.1 billion by the end of the year. According to the data company Apptopia, 20 million downloads of neobank apps in the first half of 2021 alone have contributed to a doubling of the number of active users since the second quarter of 2019. To highlight some specific players: Chime, the biggest American actor, announced in August this year that he had raised $ 750 million in a Series G funding round at a valuation of $ 25 billion, making it the 14th largest of all credit institutions in the United States. Revolut, the largest startup of any type in the UK, recently applied for a banking license in the United States to offer more traditional financial products. Neo Financial, a Calgary-based neobank backed by PayPal founder Peter Thiel, raised $ 64 million in a Series B round of funding last month.
We could see brick-and-mortar financial institutions making strategic neobank acquisitions to diversify their offerings and keep abreast of consumer preferences.
Navigating the changing landscape of financial services will be difficult for both neobanks and traditional banks. Big bank online banking services have been around for a while, but don’t offer the same level of innovation or focus on the underrepresented as their neo-counterparts. As a result, we may see some physical financial institutions making strategic neobank acquisitions to diversify their offerings and keep abreast of consumer preferences. On the other hand, neobanks will face regulatory headwinds and growth challenges. As legislation often lags behind innovation, we are starting to see increased regulatory scrutiny both on the data privacy front and on the labeling of these pseudo-financial institutions. For example, in May this year, the California Department of Financial Protection and Innovation ordered Chime to stop misleading its customers by calling itself a bank. In the long term, these companies should also consider getting into the lending business, as a topline based on interchange fees has thinner margins and requires a high and sustained volume of transactions. Due to the popular will for change, neobanks will undoubtedly play a role in our future ecosystem of financial services. The main question is whether they will integrate the current system as an add-on, or if they can really replace the giant brick-and-mortar institutions they were designed to challenge.