The challenges faced by neobanks
In our previous article we looked at the rise of neobanks and the impact that we can already see them having on the retail banking industry. Whilst we have seen a considerable increase in the number of neobanks, there are a number of difficulties and challenges that they face which are likely to threaten their very survival.
The first and undoubtedly main challenge is one of customer acquisition. The traditional incumbent banks benefit from long established and trusted brand names, extensive retail branch networks and diversified commercial and retail banking operations that give them sufficient capital to properly market new products and to ride out any potential downturns. In comparison neobanks have a range of difficulties in acquiring customers and in scaling their operations. Neobanks are, to all intents and purposes, startups which need to raise significant capital to get commercial traction. They also lack the broad support network needed to establish themselves in the minds of potential customers. The recent demise of Xinja, one of the first neobanks in Australia, is one of the most recent neobanks to fail and is not likely to be the last.
A question of trust
A second difficulty that the neobanks face is one of trust. Whilst the public are tired of the low quality of service and poor value for money offered by traditional banks, they do trust them to keep their money safe. In comparison many people have misgivings about neobanks and perceive them to be untrustworthy. A recent survey of British people by Accenture found that just 45% of Brits believe that neobanks will exist in 12 months’ time. As long as these trust issues persist then neobanks will struggle to get customers to switch to them permanently.
Another big concern is profitability. Whilst many neobanks, such as Revolut, Monzo, Chime and N26, have valuations of billions of dollars, very few of them are expected to be profitable in the coming years and even less are already profitable today. Accenture recently found that UK neobank’s lose, on average, $11 per user every year. Indeed of the hundreds of neobanks globally Starling and more recently Revolut are the only neobank’s to have shown significant profitability. If neobanks are going to have any chance to compete in the long run they need to find a way to monetize their service effectively while remaining an attractive alternative. This leads to a range of strategic and operational decisions that they need to take in order to survive, namely whether to try to market to a wider audience, which’ll require significantly more capital or to change their business model.
The recent decision by Monzo to launch a premium account, complete with a metal payment card for £15 per month and both N26 and Revolut introducing low- and mid-tier subscription plans for €4.99 and £2.99 per month, respectively shows the strategic change of direction taking place by many neobanks.
A question of scale
One of the most difficult challenges faced by neobanks is trying to change long-running consumer habits and in over-turning entrenched traditional banks. Whilst the UK has one of the highest concentrations of neobanks, with three of the largest ones (Revolut, Monzo and Starling) having approximately a combined 10 million or so customers between them, the UK’s largest traditional bank (Lloyds), has over 30 million customers on its own. The neobanks need to achieve sufficient scale otherwise they run the risk of being unable to compete and bull-dozed by the banks on the long-term basis.
Whilst neobanks embrace of digital technology has enabled them to grow rapidly and to be remarkably nimble and responsive, it also makes them more vulnerable to the growing cyber security threats. Whilst neobanks create innovative web and mobile applications built on scalable third-party code IT infrastructure it also leaves a significant portion of their code not under their direct control and more open to external threats. This creates considerable issues in trying to convince consumers that the move to a digital-only platform won’t compromise safety and security.
Lack of capital
The final issue that neobanks face is the lack of relative capital, especially when compared to traditional banks. Figure 1 highlights that whilst many neobanks have raised hundreds of millions of dollars of capital at valuations sometimes in the billions this still pales in comparison to the money available to traditional banks.
Figure 1 – Capital Raised by neobanks
Source: FT Partners Fintech Industry Research, January 2020
Unless Neobanks can either attract far more investment or create a truly unique product, it is questionable whether they will be able to effectively compete in the long-run when traditional banks have so much more capital to invest.
Clearly neobanks have a number of challenges that they need to overcome if they are to survive and prosper over the coming years. We anticipate seeing significant changes in many of their business models as they move away from a relentless loss-making focus of growing their customer base to instead focus on developing a sustainable and profit driven approach. We also anticipate seeing considerable consolidation in the industry and that a number of neobanks shall be acquired by traditional banks who are keen to benefit from the know-how and lean and agile thinking of neobanks.
Proto Innovation is focussed on working with neobanks to understand and overcome these challenges and to explore ways in which they can continue to grow whilst aiming to become profitable. Only by doing so shall they have a long-term future in the retail banking space.