New digital entrants are disrupting virtually every sector of the global economy. This includes financial services, where neobanks have emerged as an attractive new sector within the banking industry. Featuring cloud-native and customer-centric financial solutions, these banks are a compelling choice for both consumers and businesses seeking greater control and transparency with their finances.
Now, Insider Intelligence predicts U.S. neobank account holders will grow by 46.4% from 2022 to 2026. To understand what’s driving this growth, it’s important to define neobanks and understand the factors contributing to their rise. This article explores those growth factors, identifies neobanks’ key advantages and disadvantages, and provides guidance on how both traditional and new financial organizations can embrace digital transformation and stay competitive in the era of neobanking.
Neobanks are digital-only banks that provide banking services via mobile apps and web-based platforms. They do not have a physical commercial presence; they rely on technology to facilitate their banking operations instead. Even so, these digital banks may partner with traditional financial institutions to access the infrastructure they need to offer core banking products such as debit cards, savings accounts, and loans.
There are two types of neobanks in operation today:
Both types may offer a wide range of digital banking services, such as mobile payments, money transfers, budgeting tools, and automated savings plans. Notably, “neobanks” and “challenger banks” are often used interchangeably, but challenger banks are more often characterized by having at least some physical commercial locations.
In 2019, roughly 5% of U.S. consumers had digital-only bank accounts, Insider Intelligence reports. By the end of 2021, 15.5 million adult consumers had opened a digital-only bank account—66% growth compared to 2019. By 2022, Boston Consulting Group reported more than 200% growth in the number of neobanks across several global regions compared to 2015 numbers.
There are a variety of elements driving the growth in neobanks; for example, greater sophistication in consumer mobile devices and greater digital capabilities among financial groups and their partners. Here is a closer look at these and other factors driving the emergence and adoption of neobanks:
Despite these opportunities, most Neobanks are yet to turn a profit, Insider Intelligence reports. But as neobanks expand their services and advantages for both consumers and businesses—often beyond what’s possible with traditional financial institutions—the performance of neobanks may improve over time.
Now, “these fintechs are transforming the banking sector in a similar way as Airbnb revolutionized the hospitality industry or Uber and Lyft overhauled transportation,” Forbes describes in their June 2021 article. It is digital natives in particular that are driving their acceptance. These customers—Millennials and Gen Z consumers and professionals—are often more comfortable with digital banking than previous generations and are especially attracted to the convenience, transparency, and innovative financial products that neobanks offer.
THis is putting pressure on their business models. As neobanks continue to introduce new services at reduced costs, traditional banks have to adapt by investing in their cloud-based capabilities and embracing digital transformation.
Starling bank, a digital-only entrant in the United Kingdom, has already acquired 2.4% of all retail bank accounts and 9.4% of small and midsize enterprise bank accounts in the country, McKinsey reports. Meanwhile, the largest traditional competitors have at most 10% to 25% of retail banking accounts. Now, Starling is working to partner with legacy institutions to bring its digital advantages to their customers.
The following characteristics are advantages that stand out for neobanks over traditional approaches to banking:
However, there are some drawbacks to consider when it comes to neobanks. These include:
As we dive deeper into the universe of neobanking, it is crucial to understand the potential roadmap to success for these emerging entities. Navigating the digital finance landscape is no small feat; a unique combination of factors and strategic decisions can pave the way for growth and profitability. This section delineates five crucial success factors that prospective neobanks should consider to thrive in the competitive banking industry.
“Most banks aim to be customer-focused, but winning neobanks go a step further in ensuring customer delight by rapidly launching and reworking new products and propositions,” McKinsey observes. To set themselves apart from the competition, neobanks should focus on developing unique value propositions and products that target specific customer segments.
Digital banks may find success homing in on a particular domain within financial services and streamlining their offerings for customers in that area. Tide, one of the first neobanks for small businesses, “gives businesses the ability to open and set up a bank account in minutes,” says Forrester. “Once onboarded, the customer can view categorized income and spending, track invoices, upload receipts, and easily sync with accounting software.”
Neobanks can provide seamless, hyper-personalized experiences for customers beyond what’s possible at legacy financial institutions. They should use customer data to understand their needs and preferences, tailor services accordingly, and deliver real-time insights that add value to their relationships. Many of these functions can be automated, such as financial product recommendations based on customer data or savings advice based on spending habits. Neobanks may provide customers with self-service capabilities, such as setting up reminders or selecting criteria.
Partnerships with traditional financial institutions, including banks, insurers, and asset managers give neobanks access to their existing infrastructure and products. These digital banks may also partner with technology companies or fintech startups that can offer a range of services, as well as access to unique markets. “Leading [neobanks] can increase new-product sales within the partner ecosystem by around 50% to 70%,” according to estimates from McKinsey.
As entrants into an industry dominated by legacy institutions, many full-stack neobanks must start from the ground up to become compliant with all relevant regulations. Additionally, they must invest heavily in cybersecurity to protect customer data from fraud or misuse. Fortunately, many cloud solution providers support both managed security and regulatory compliance functions for new neobanks as part of their services, helping neobanks with their entry, Forbes reported in 2022.
Generative AI (GenAI) query and customer support functions are ideal for neobanks, which can help customers manage their money more efficiently. Additionally, neobanks can take advantage of open banking APIs to access customer data from other financial institutions, giving customers a richer and more comprehensive view of their finances. These features will help differentiate neobanks from traditional banks as they strive to capture market share in the digital finance space.
As consumer connectivity increases and cloud-native capabilities grow more sophisticated, neobanks will become more prominent. But the competitive landscape will also grow as a result. Neobanks that both specialize in unique markets and capabilities and differentiate themselves through sophistication and personalization will realize lasting financial success.
Neobanks and other financial institutions partner with Semifly for managed security and other cloud-native capabilities. Semifly supports solutions compliant with all regulatory requirements for financial institutions as well. Contact us directly to discuss opportunities for your organization.
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