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.

Will Neobanks Reward Investors?

Venture capital firms have been flocking to invest in neobanks, and they must be hoping that they will see big rewards. Expectations are high, but it appears that some questions are being asked about whether or not the hype around fintech will yield the financial returns that everyone hopes for.

It is true that the neobanks are attracting plenty of customers; N26 and Revolut being two good examples of customer growth. According to Accenture, UK-based digital banks could add 35 million customers over the next year, and they have around 13 million at present. Its data also shows that in the first six months of 2019, the UK neobanks added five million customers, indicating that the sector is picking up momentum this year.

However, there are some challenges remaining. First, the traditional banks still occupy the biggest slice of the market, and then there are the financial regulators like the FCA, which are extremely averse to any finance related institution cutting corners. Plus, as John Detrixhe points out, we have seen that companies in other ‘disrupting’ sectors, Uber and WeWork, have demonstrated that big valuations and intense customer growth are not sure signs of success. He also says that the fintechs need to ask themselves if they will continue to be seen as a niche product, or will customers eventually see them as a one-stop financial service.

Hence, there seems to be some changes happening in fintech investment, with investors looking at fintech tools beyond neobanks that will prove to provide bigger gains. This move is based on the idea that digital banks will never really disrupt the traditional banks.

So, they are looking at fintech software, such as cloud-hosted software and systems that make it easier to sign up for a new account. In other words, there is a belief circulating that the incumbent banks can fend off the newcomers by adopting new technology that allows them to offer the same benefits as their digital competitors.

These fintech tools are not as sexy an investment as Revolut say, but they could perform better in the long term, because if the incumbent banks can provide the same service as Revolut, then why would customers switch?

The situation in Europe is different to that in other regions where there are millions of people who are unbanked. Europeans have fewer problems with banking access, but perhaps don’t always have a great customer experience. So there is still plenty of investor enthusiasm in the West. Detrixhe says, “Eighteen of Europe’s biggest fintechs are now valued at more than $1 billion, according to Richard Diffenthal, a partner at Hogan Lovells. Investors are lining up to give them even more money.”

The one advantage that neobanks have over the traditional banks is that the incumbents can’t just rip up their legacy and start afresh. They are having to implement change one small step at a time, and that will take time. The neobanks need to use this opportunity, i.e. the incumbent banks slow-moving change, to accelerate their position as a trustworthy alternative to the banks that have been trading for hundreds of years. Then they will provide the returns that make investors happy.

A New Fashion In Fintech Investment

Investment follows fashion in a sense. In the last few years venture capitalists have been pouring money into neobank startups thus creating a trend for other VCs to follow. However, John Detrixhe says,

“Questions are being raised about whether this fintech craze is another quixotic quest for market share that burns cash but doesn’t generate much profit in return.”

The most ambitious neobanks, namely N26 and Revolut, want, he suggests, to be the Amazon of finance, and they are proving to be very successful at picking up new customers. According to Accenture, digital-only banks operating in the U.K. could amass a total of 35 million customers globally within the next 12 months — up from 13 million today — based on current growth rates. The report also says, “Digital-only banks are also reaping the rewards of improving the customer experience as they gain an average Net Promoter Score of 62 compared to just 19 for traditional banks.”

Naturally, they are having to face the incumbent banks, which can’t offer the same service. But, we should be wary. As Detrixhe says, if you look at Uber and WeWork, for example, “these have shown that rapid growth and high valuations are far from a sure sign of success.” Furthermore, it is impossible to say if customers will continue to use them as niche providers of peer-to-peer payments or travel spending or fully embrace them as a one-stop-shop for financial services.

Some investors are now looking beyond the neobank buzz and are moving onto another fintech sector. For example, on hedge fund founder, Steve Cohen, thinks traditional banks won’t be disrupted by the unicorns. But, he does think the banks will have to learn some new tricks. He suggests “Older lenders need things like cloud-hosted software and systems that make it easier to sign up for a new account.”

And that is where the new investment opportunity lies; in software for digital account openings and machine learning systems to make recommendations to customers. It’s not quite as sexy as investing in a startup neobank, but these software startups could help traditional banks leap into the 21st century, and in that respect they could serve as neobank killers.

What do banking innovators have in common?

There have been many studies, blogs, book,s newspaper articles, etc on the qualities entrepreneurs have in common. Now the Digital Banking Report’s “Innovation in Retail Banking” gives us a view of how innovative leaders in banking perform.

According to The Financial Brand, these banking leaders share three important characteristics: they generate greater profits, they leverage new technologies, and those of advanced analytics. As a result they achieve higher satisfaction scores.

Why is this important? The simple answer is, because the financial institutions need to embrace innovation and join the digital revolution. That requires strong leadership and a certain amount of fearlessness. Those leaders will need to challenge the current system, as well as push the limits of the available technology. But, perhaps most importantly, the banks need to put the spotlight on the customer, and they need innovators who understand this.

Complacency is the banks’ biggest enemy, and it is something they are finding it tricky to get around. After all, they have been around for hundreds of years in some cases, and have a sense of entitlement. If their shareholders seem content, and the majority of their customers happy, then why do anything to move with the times? This attitude is what is helping the digital challengers.

The neobanks have discovered ways to deliver a more keenly price service and a better customer experience. As the Financial Brand says, “Unlike the iterative innovations from the past, a premium is now being placed on “big ideas,” agility, and real-time application of data for personalized contextual experiences.”

What the banks need to do

For the banks to embrace innovation, they need to think in terms of interdepartmental co-operation, as well as being prepared to break up their legacy systems and rethink them. They also need to look outside their own world and find more opportunities to collaborate with fintechs and look at a range of more up-to-date solutions. They should be incorporating AI, robotic process automation, blockchain and the Internet of Things amongst others into their thinking.

There is also a pressing need to retrain employees. The Financial Brand points out that we are facing a skills shortage, so the banks not only need to embrace retraining of existing workers, they also need to rethink their hiring strategy and bring in more of those people who have been immersed in digital technology since their early years.

The leaders in banking who will win this game are those who are able to embrace these challenges and take their organisations into a new future. The banks without leaders having these qualities will surely get left behind.