Why has Australia fallen in love with neobanking?

Neobanks, or digital banks, arrived in Australia in 2018, dues to a change in legislation, and since then there has been a flurry of activity. Some might even call it a tsunami of neobanks, and this has led to a high level of competition in the country’s banking sector, something that hasn’t occurred for decades.

The neobanks are app-based banks accessed mostly from a smartphone. They don’t have physical branches and they promise clients a ‘touch of the button’ 24/7 service, and most of them have much lower charges than the traditional banks.

Neobanks have been growing in popularity outside Australia for some time, with Europe being a leader, especially the UK. As Jack Derwin points out, the fact that they are doing so well in the UK, and a number of them are registered there, such as Starling, Revolut and Monzo, is a good sign for Australia.

The digital banks are a more recent addition to the Australian banking scene, because until legislation changed in 2017/18, it was extremely difficult to start a neobank. Whilst the previous legislation was intended to protect the consumer, it was perhaps too restrictive, and anti-competition.

In 2017, Scott Morrison, who then headed the Treasury, dramatically simplified the application process to enter the banking sector. As a result, within months neobanks were lining up to enter the market.

Still, entering the banking sector is never easy. Neobanks need a banking licence, a core banking system and a substantial fund of money: one neobank founder told Business Insider Australia that $100 million was the figure needed to start up.

It takes time to raise that kind of money, and to get a banking licence, which can take up to 12 months, as the newcomer must convince the financial regulator to trust the product.

So, what is the advantage to using a neobank? Unlike traditional banks, they are more cost efficient. They don’t have a network of offices and the fact they have lower overheads, means they can pass the cost saving onto the client. Also neobanks have access to the best tech and can therefore optimise their product. It only takes minutes to set up an account, compared with all the paperwork needed for a bank. So, the consumer appeal is there, combined with free accounts and lower charges.

As Derwin says, “From recognising higher than usual bills, notifying you of unused subscriptions, and even helping you switch to a cheaper energy provider, neobanks say they can do banking better.”

That might not be hard to achieve in Australia, where the traditional banks have admitted to extorting fees for non-existent services, to the point they were even charging dead people. They also admitted to lying to the regulators, holding forged documents, failed to verify customers’ expenses when approving loans, and sold insurance to people who couldn’t afford it. And as Derwin says, with four banks controlling 80% of Australia’s business, there was no incentive for them to do better.

All this adds up to a reason for Australians to love neobanking. They now have around five to choose from, including Volt and Xinja, and the UK’s Revolut is testing the market. This is definitely a geographical space to watch for anyone interested in neobanks.

PayPal doubles down on P2P payments

For rather a long time, PayPal has been inextricably wedded to eBay, the mammoth auction site. However, that relationship is in a state of flux, and this has prompted PayPal to look to new partnerships that may take its service in a different direction.

To start with it has paid $4 billion to buy Honey, a shopping rewards platform, and now it is looking at Venmo, a peer-to-peer mobile payments service. Essentially the company offers a digital wallet that allows you to make and share payments with friends. For example, you can easily split a restaurant bill or a cab fare using the Venmo app.

Venmo is distinctly different to PayPal, and yet it complements it, which is no doubt why PayPal’s board considered it such an attractive proposition. By having one partner that covers day-to-day purchases, whilst PayPal covers payments for larger goods, or payments for freelance work, and other types of transfers, it means that together, they more or less have a large swathe of the market covered.

The Venmo app has been showing considerable growth as well. According to its fourth quarter results, published at the end of January, “Venmo processed $29 billion in volume for the quarter, growing 56%. And for the year, volume increased to $102 billion,” PayPal’s CEO, Dan Schulman reported. He also said that it ended the year with 52 million active accounts and revenue in excess of $450 million.

It has grown significantly since its third-quarter figures, which showed it had 40 million active accounts. By the end of 2019 it also, according to PayPal, exceeded a projected $100 billion in payment volume.

How has this happened? Well, PayPal points to Venmo’s deal with Synchrony Bank, which has allowed it to add a credit card to its offering. Plus, Visa will be Venmo’s exclusive network partner for the Venmo credit card, Schulman has revealed.

Future plans for Venmo, that it is predicted will boost growth, include Venmo Rewards, a loyalty program it will run with selected merchants. Schulman told Donna Fuscaldo at Forbes magazine: “Last year, we saw brands like Netflix, Pepsi and Chipotle use Venmo payouts to reward their customers and pay them via Venmo. We are excited to introduce new monetizable value-added services to our Venmo platform over the course of 2020.”

What we can conclude from this is that PayPal’s new direction is heavily skewed towards the peer-to-peer (P2P) payment market, where Venmo is the market leader. That makes sense, and it’s surprising it hasn’t moved this way sooner. Here’s why. According to eMarketer, P2P mobile transactions will reach $396.48 billion this year, up 27.9% from $309.95 billion in 2019. Moreover, it is expected that will be 73.8 million P2P payment users by the end of 2020. And by 2030, who knows how big that user base will be!

How neobanks are modernising banking

 

Banking is going through some changes thanks to the arrival of neobanks. The traditional banks continue to work at their own pace, and are still largely bound by legacy systems that go back decades. Change is not a simple process for them: it is similar to trying to change the direction of a massive oil tanker at speed on the high seas. In other words it is something that takes a while.

The arrival of the neobanks, which are the digital-only challenger banks, (there are challenger banks that don’t fit in the neobank niche because they are more like traditional banks) has caused an upset in the banking sector, but what is the real difference between a neobank account and the type of bank account that most of us already have?

The first, and most basic difference is that they are technology driven. And they don’t have physical branches. That can be off-putting to customers who feel more secure by having a branch that they can go to and talk to someone. In this way, neobanks have a greater appeal to younger sections of the population who are used to operating their existing bank account through an app and online.

Often neobanks don’t have a full banking licence, but they can still offer the range of services offered by traditional banks. They can do this because they have an alternative type of financial services licence, such as an e-money licence, or they have partnerships with financial service providers that hold an appropriate licence.

Opening a neobank account is extremely simple and can be done via a smartphone, or a computer in minutes. There’s no wait while all your documents are assessed by head office. This has a huge appeal for many customers, especially those people who may be dismissed by traditional banks, because they don’t have a large enough income to make them a ‘worthwhile’ customer. Some banks now insist that customers keep the balance in their account at a certain level, and this means many people are excluded from holding an account, or find that their account is suddenly closed.

And we all know that traditional banks often charge exorbitant fees. The neobanks offer free accounts, as well as a range of accounts with a monthly fee, but even these are much lower than an established bank would charge for the same service. Chime, for example, is a neobank in the US that offers debit cards and fee-free overdrafts.

Neobanks are also cutting out a sector for themselves with small businesses and freelancers, which is a sector that the traditional banks don’t serve very well. For example, UK neobank Coconut focuses on serving freelancers. They’ve developed specific accounting features, including VAT and invoicing that cater to the day-to-day needs of the self-employed. For example, a freelancer who needs to request payment from a client can use Coconut to send invoices directly from the app.

Overall, neobanks are changing the entire banking experience. It will take some more time to grow this new financial sector, but it seems to me that every day one meets yet another person who has added a digital-only banking service to the tools they use to manage their money, and that is progress.

Do we need credit card rewards?

This topic may resonate more with North American readers than with Europeans, the latter being not quite so obsessed with credit card rewards. I came across an article in Forbes by Alan McIntyre on this topic, which made me pause to think about the future of cards and rewards, and whether this rather old-fashioned system will survive in a more fintech-led financial system.

For some time Americans have been receiving bonuses for spending on their cards. They have come to expect these ‘gifts’. Of course all this comes at a cost to the credit card companies. According to new research from Accenture, rewards spending by the top five credit card issuers grew to $31 billion in 2018, up from $11 billion in 2015.

McIntyre suggests that the cash-back Apple card might be “the peak of card rewards” and that this entire system is on its way out. As he also mentions, card companies are having to figure out how to deal “with a less attractive volume-value trade-off.”

At the moment the payments industry is still on the winning side with the trade-off, as its revenue has grown by $50 over the last three years. It’s worth somewhere around $300 billion and it is expected to grow 4% by 2025.

However, the American payments industry is lagging a bit behind the rest of the world in this respect. In Europe and Asia, the consumer payments sector is moving to “high-volume, low-margin payments,” and “many of those are moving over account-to-account payment rails rather than over the card networks.” Here’s why it’s changing. In Asia, for example, it costs a merchant only 0.5% on average to accept an Alipay payment, while credit card payments in the U.S. can still be over 2% for many merchants.

The pressure on the North American payments industry to shift over to this model will come from the merchants. The consumer is less likely to change, because they love getting those rewards when they spend with their card. But that significant percentage difference in cost to the merchant is a big deal.

McIntyre says that recent research shows, “We are already seeing merchants begin to favoor debit over credit as a lower-cost payment mechanism, and favouring their own loyalty schemes rather than relying on those run by the card-issuing banks.”

And he says there are two other factors that will end rewards: “The first is the belated development of real-time payments in the U.S. and the opportunity it provides for merchants to have lower-cost payments that will be even cheaper than debit transactions.”

The second major driver of change will be “the continued internalization of payments by major retailers to avoid having to pay merchant acceptance fees at all.” Starbucks, Walmart, Uber and Amazon are the frontrunners in this system.

It seems unlikely to me, thinking over all this, that the old North American credit card rewards model will last for much longer. But I do think that whilst the merchants may be the driving force of this change, there will also be a need for consumer education, so that they understand why their rewards have been taken away.