What can Australian neobanks learn from the success of neobanks abroad?
In our previous articles we looked at the rise of neobanks and then took a deeper dive into the challenges that they are facing as they try to compete in an extremely difficult and competitive industry. For the third article in our series on neobanks we thought we’d take a deeper dive into one of the most interesting, but difficult markets, for new fintech businesses such as neobanks to operate, namely the Australian market!
The recent closure of Xinja, which was one of Australia’s most famous neobanks, has provoked a range of questions about the remaining players and whether neobanks realistically have any chance of surviving in Australia. Australia is one of the most difficult countries to launch a business in, let alone a fintech business, given the high costs of doing business, regulatory barriers and strong existing traditional banks.
Yet research by strategic insights consultancy Nature found that 82 per cent of Australians under the age of 55 were open to the idea of using a digital-only bank for at least one product so clearly there is an appetite for consumers to try something new. So what can Australian neobanks learn from the success (or failures) of neobanks internationally?
1. Supportive Legislation
While digital banks have operated for years in places such as the UK and Continental Europe, legislative restrictions in Australia have made it very difficult to start one until recently. It’s not easy to break into the Australian banking market with these new banks need to go through the process of obtaining a full Authorised Deposit-taking Institution (ADI) licence from the Australian Prudential Regulation Authority (APRA) before they’re allowed to call themselves a bank and take unlimited customer deposits.
APRA recently updated its requirements for companies hoping to obtain a banking license to include higher capital requirements and compulsory plans to develop revenue-generating products. These new regulations are designed to encourage new entrants to have a “greater focus on longer term sustainability, rather than the short-term ambition of receiving a licence”. APRA’s new regulations also dictate new entrants must develop advanced planning for a potential exit, that includes a blueprint for safely returning customer deposits.
In the UK their financial regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), have taken a different approach. They recently set up a ‘New Bank Start-up Unit’ (NBSU) as a joint initiative to give firms which are interested in, and/or currently applying for authorisation as a deposit-taker, the information and support they need to set up a bank in the UK. This hands-on and supportive approach with forward thinking legislation, which is far too detailed to go into detail in this article, provided a foundation for the acceleration of the neobanks in the UK leading it to become one of the fastest growing worldwide markets. Figure 1 highlights the growth in recent years of full banking licenses being awarded to neobanks, which has only helped to stimulate competition in the UK market.
Figure 1 – Recipients of banking licenses awarded in the UK
Source: FT Partners Fintech Industry Research, January 2020
The result of legislative challenges in Australia is that the market-place is seen as being just too difficult for neobanks to enter given the legislative barriers to entry. If the Australian government is serious about encouraging competition, which the public are crying out for, then they need to encourage new entrants and find a way to help them enter the market. Introducing increasingly difficult legislative challenges only serves to discourage innovation from new players in the banking sector given the risks and associated costs involved.
2. Open Banking Standards
The Open Banking regulation was introduced in January 2018 which released the financial data of consumers from the banks’ ownership and into the hands of consumers. Regulated banks in the UK are now required to let customers share their transaction data such as spending habits and regular payments with authorised third-party providers (TPPs) offering other services – as long as the customer has given permission. This is done in a secure manner through the use of Application Programming Interfaces (APIs), which provide TPPs with access to banking systems and customer databases. This had the impact of essentially dissolving banks’ monopoly on consumer financial data and stimulated significant innovation in the fintech industry. Indeed the introduction of open banking has played a major role in helping banks and fintech firms to collaborate as they provide a more comprehensive and standard way for banks and fintechs to collaborate.
The good news is that the Australian Government has seen the impact that this has had on stimulating innovation in the fintech industry and followed with its own version of Open Banking, the Consumer Data Right (CDR) which was introduced in July 2020 and is still in the process of being updated and further rolled out. It is hoped that this legislation will have a similar impact as the open banking regulations had in the UK and rest away the control held by Australia’s four largest banks with the introduction of open banking, which will make switching banks and accessing customer data easier. It should also help to further stimulate the fintech sector and encourage innovation.
3. Sufficient capital pool
When Xinja announced that it was exiting the market on 15 December 2020, one of the main reasons that it cited for its failure was the difficulties of raising funds, particularly during the COVID-19 pandemic. This wasn’t hugely surprising as Xinja had posted a A$36 million net loss in 2019 and a AU$433 million investment from Dubai’s World Investments, announced in March 2020, had not materialised. Nevertheless, the reality is that Xinja is not alone in funding it to be very challenging for neobanks to raise funds, at least compared to the US or European marketplaces.
As our article highlighted many neobanks have raised hundreds of millions of dollars of capital at valuations sometimes in the billions of dollars, although even in more developed markets this still pales in comparison to the money available to traditional banks. He reality is that the Australian marketplace is extremely difficult to raise substantial amounts of capital investment with Judo Bank’s closure of a A$230 million funding round in May 2020, which made it one of the first Aussie neobanks to climb above the coveted A$1 billion valuation, being an exception and not the norm.
If neobanks are to succeed in Australia they need to have access to a wider pool of capital in order to fund their expensive early days of customer acquisition and to build the scalable infrastructure needed. We foresee international neobanks, such as Monzo, Starling and N26 following Revolut’s footsteps in entering the Australian marketplace once they have succeeded in their ‘home’ territories.
4. Team experience
Interestingly, Judo Bank’s recent success in raising a funding round of A$230 million in May 2020 was no doubt due partly to the market’s perception that the neobank had a very experienced management team Its co-founder David Hornery had previously worked at NAB, ANZ and Macquarie Bank while co-founder Joseph Healy held executive positions at NAB and ANZ.
It’s crucial for Australian neobanks to be led by an experienced team in order to be taken seriously by the market. Proto Innovation recommends that management consists of a careful ‘blend’ of experienced banking executives and more agile and innovative executives with a tried and tested track record of successful innovation in other industries. This blend would provide the neobank with the industry experienced required whilst also providing it with innovative ‘DNA’. Too much existing banking experience is likely to lead to it not being innovative enough.
5. Wider product offering
Successful neobanks will need a well-funded balance sheet, broader product suite and a strong brand to compete as the Big Four traditional banks begin to focus increasingly on digital services.
In the UK, Starling has become the first retail digital challenger bank to break even and is on its course to become profitable. Starling has around 80,000 of its 1 million users are enterprises. They are making a significant amount of their money from net interest income – using customer deposits to lend to other customers as overdrafts and loans. Starling and other neobanks internationally are increasingly offering a wider range of services and providing more innovative features, process simplifications, and offerings that are different from traditional banks, including fast account opening, free debit cards, instant payments, cryptocurrencies, lower costs, mobile deposits, P2P payments, mobile budgeting tools, user-friendly interfaces, and more. Some of the top innovations happening in neobanking space, which Australian banks could follow include:
- Digital Onboarding/Account Opening: Neobanks offer simple and fast online account opening processes compared to traditional banks.
- International Payments/ Remittances: Neobanks offer the usage of their debit card in foreign countries for no fees and at live exchange rates.
- Money Tracking/Account Aggregation: Neobanks can simplify money tracking and account aggregation.
- Lending/Credit Products: Neobanks can provide credit products at lower charges and interest rates than traditional banks.
Figure 2 highlights the increasingly wider range of product offering from leading international neobanks, which Australian neobanks could look to provide in the domestic market.
Figure 2 – Product Offerings from Leading International Neobanks
6. Appeal to younger or niche audiences
Younger audiences are likely to be a crucial target market and segment that Australian neobanks need to focus on. Neobanks could differentiate themselves from traditional banks by targeting younger customers who are more open to adopt digital services. A recent survey by GlobalData showed that 68% of millennials in Australia would prefer to open a new transaction account via mobile or a personal computer, which shows that they are clearly a crucial segment for neobanks to focus on.
Figure 3 highlights the age distribution of users between three of the UK’s largest traditional banks (Barclays, Lloyds and NatWest) and two of the UK’s largest neobanks (Monzo and Revolut), which are increasingly focussing on younger audiences, especially in the 25 to 34 age range.
Figure 3 UK Banking Apps – Age Distribution
7. Move into business banking
Many international neobanks are now turning their attention to focus on business banking, which is perceived to be more profitable and ripe for innovation. In the UK Revolut launched a web-based business offering in 2017, designed to allow small and medium-sized enterprises (SMEs) to manage their finances easier and faster, and is leading the pack with close to 600K page views to its business account pages from April to September 2019 (an increase of 23%). Monzo, which introduced its business offering in February, is already closing the gap with 191K page views in the same timeframe.
Figure 4 highlights the rapid growth of business accounts over just two years with all three of the UK’s largest neobanks seeing explosive growth. Given the lack of choice for who Australian businesses can bank with we believe that this market is extremely lucrative for Australian neobanks as Australian businesses have put up with poor and often not very innovative banking services from traditional banks for far too long.
Figure 4 Business Account View Pages per Neobank in the UK in 2018 and 2019
Clearly some of the international neobanks must be doing well as in Europe digital-only banks are growing and taking considerable market share from traditional banks. A 2019 report by AT Kearney stated that European neobanks gained more than 15 million customers between 2011 and 2019; by 2023, neobanks are projected to have up to 85 million customers – equivalent to 20 per cent of Europe’s entire population.
Consequently, Proto Innovation believes that Australian neobanks would benefit greatly from being ‘inspired’ by these international neobanks for the Australian domestic market as we feel that the market is still ripe for further disruption. The recent exit of Xinja and the acquisition of 86400 by NAB highlights the challenges faced by Australian neobanks in operating in what many consider to be a very tough market. Clearly, new entrants will need to be more innovative and generate enough revenue to survive. Providing a wider range of innovative products and targeting specific younger or business markets is likely to lead to not only faster growth but also a more productive business.