Why do neobanks have to reinvent themselves? 🤔

The pandemic has not slowed the momentum. New banks are still being created. According to a survey by Exton Consulting, a specialty firm, more than 70 new digital banks were created around the world last year. That’s as many as in 2019. France has not escaped the trend, as is evident by recent launches by Memo Bank and Helios. In total, across the globe, nearly 320 neobanks have a presence on the web, a third of them in Europe.

Not having a banking license can be problematic

While the above exuberance is an apparent sign of good health for the sector, it’s masking a different reality. Indeed, while some new neobanks are launching, several players have been forced to shut down, like Morning and Ditto in France, the RBS subsidiary Bo, as well as Xinja in Australia. In addition, some high-profile neobanks have seen their capitalization shrink in recent months, like Monzo (-40%), while others have had to lay off employees in order to cope with declining revenues, as was the case with Revolut. It is true that with the reduction in travel and the drop in consumption seen during lockdown, commissions that neobanks charge for card payments, in particular, have plummeted. In addition, neobanks that catered to professional clients suffered from something else: since almost all had no banking license, they were unable to provide financing (cash lines, government-guaranteed loans, etc.), which was problematic because, at the time, businesses were seeking to maintain positive cash flow and most neobanks had nothing to offer. 

However, the pandemic does not explain everything. More often than not, neobanks are struggling to stand out from the competition in terms of how they portray their offerings (bank accounts, free credit cards, interest-bearing savings accounts, and so on). As a result, they do not achieve the new customer acquisition rate they were hoping for, even after several years in business. And this is true despite the financial benefits they receive (remittances, increased rates, etc.) Consider the recent Wirecard scandal, where a German fintech company—which had become a leading player in the payments industry—was exposed for having engaged in fraudulent accounting activities over several years. This did not exactly boost confidence in the industry!

Business activities that are typically unprofitable 💳

To make matters worse, the relatively limited number of products offered by neobanks leads to minimal customer activity, or perhaps no activity at all. As noted in a study on French banks conducted by the French Prudential Supervision and Resolution Authority (Autorité de contrôle prudentiel et de résolution - ACPR), most neobanks’ banking income is derived from only 20% of their customers! This can have a negative impact on profitability. According to the ACPR, each customer generated a median loss of 20 euros in 2019 for their neobank. This situation is far from being limited to France. Business Insider Intelligence estimates the loss to be $US 11 per user worldwide, which is clearly unsustainable in the long run.

Many neobanks will have no choice but to rethink their business model in order to survive. One option could be to obtain a banking license and challenge traditional institutions head-on for the credit business. But having that license would increase regulatory oversight, which would increase operating costs, which would, in turn, weaken their low-cost distribution of services business model. Other alternatives, however, might be more plausible. One would be to broaden their scope of offerings, for example, by including non-financial services. Accordingly, neobanks might be inspired by the Singaporean banking institution DBS’s initiative whereby it launched a marketplace for customers to purchase cars or book a trip. Another solution might be to become just a service provider for banks, with the banks white labeling the neobank’s technology and using it to benefit their own customers.

A sector in flux. Is consolidation on the horizon?  👀

With the above in mind, capital mergers with players that have reached critical size might finally become more common in the future. This could be banks, similar to Société Générale’s acquisition of a stake in Shine last year, but it could also be Big Tech. Consider that the Chinese giant Tencent, owner of WeChat, the payment solution, has already mentioned that it hopes to do business outside its borders by becoming a shareholder in European fintech companies or neobanks, including Lydia, N26, Viva Wallet, and Qonto. All this activity taken together suggests that the neobanking market will eventually consolidate.