There was a time when we had to visit a bank to move even a penny from one account to another. Remember the long queues to just update your passbook or the 3-day waiting period for a cheque from a different bank to get cleared and money credited to the account. The advent of Neobanks made sure that all of these problems became a thing of the past. A Neobank is a virtual bank that exists solely online, without any physical branches providing a wide range of financial services including payments and money transfers, money lending, and more.
Neobanks are becoming very popular very fast. Imagine this, the global Neobank market, which was worth US$ 18.6 billion in 2018 and is expected to accelerate at a compounded annual growth rate (CAGR) of around 46.5%, generating around US$ 394.6 billion by 2026. Neobanks also saw a surge of interest during the lockdown.
Why is the Neobank market growing so fast?
In recent years, we’ve seen a massive drift in the finance industry. Customers are moving away from physical banks and physical cash, and more towards online banking and digital payments. Neobanks provide the customer experience that traditional banks don’t. The explosion of mobile technology has enabled Neobanks to provide a complete digital banking experience through mobile applications with the main aim of providing a seamless customer experience.
The extraordinary growth potential of Neobanks is driven by their low-cost model for end customers with no or very low monthly fees on banking services resulting in widespread adoption by millennials, Gen Z, and micro, small and medium enterprises (MSMEs).
The main objective of Neo Banks is to offer a seamless customer experience that is better than what traditional banks offer at a much faster pace and cheaper rate. Here, we look at 5 ways that enable Neobanks to serve customers at around 1/3rd of the cost of traditional banks.
- Leaner Business Models – Neobanks have considerably leaner business models and superior technologies at their disposal compared to traditional banks. They do not obtain a banking license or obtain a partial license. Obtaining a full banking license is costly and time-consuming. Instead, they partner with small regional lenders, who hold and insure the customers’ deposits. Neobanks can thus, provide faster and cheaper services, such as seamless account creation, round-the-clock customer service, and near real-time cross-border payments.
- No Brick & Mortar Branches – Neobanks don’t have a physical location and are completely online, unlike traditional banks. This substantially reduces the costs of physical infrastructure required. This reduced cost of infrastructure allows Neobanks to slash the customer fees by a significant amount.
- Automated Services – Apart from providing primary banking services, Neobanks offer automated and near real-time accounting and reconciliation services for bookkeeping, balance sheets, profit and loss statements and taxation services. Automating several of these services, allow Neobanks to employ fewer manpower as compared to traditional banks. This means the personnel costs endured by Neobanks are much lower as compared to Traditional Banks.
- Lower IT Spend – Traditional banks still operate their siloed legacy systems that consume a large chunk of IT spend. Studies have shown that a mid-sized bank spends over two-thirds of its IT budget on maintaining legacy systems alone. Legacy systems have accumulated layers of complexity leading to fragmented and manual operational processes keeping costs higher than necessary. Neobanks on the other hand, have benefited by adopting newer technologies like Cloud, AI, and RPA resulting in lower costs.
- Interchange-fee Models – The interchange fee is what debit and credit card issuers charge the business when the business processes card payments. For example, if you use a debit card issued by XYZ Bank at the local grocery shop, a small percentage of your payment will go to XYZ Bank. This is called the interchange fee. Any merchant that accepts debit or credit card payments from customers has to pay interchange fees to the bank that issued the card. Neobanks make money by collecting interchange fees from the merchants where their customers shopped and not from the customers themselves. On the other hand, the strategy of making money from interchange-fee did not work for traditional banks because of the introduction of the Durbin amendment in 2010. The Durbin amendment put a ceiling on the interchange fees that large banks could charge businesses. However, this interchange ceiling did not apply to small banks. So, fintech companies or Neobanks partnered with small banks to issue debit or credit cards, and were able to charge merchants higher interchange fees compared to large traditional banks. Neobanks built infrastructure on top of community and regional banks and were able to generate significant revenue through interchange fees while offering free or low-cost offerings to their customers.
Neobanks are the perfect example of how convenient banking can be attractive to the modern customers. Traditional banks too are expected to invest more in enabling technologies and solutions for customer-facing operations to improve their customer experience. However, the influence of Neobanks on the banking system is tremendous because they have expanded the financial involvement of the population, introducing customers to new structures, business models and services. This competition between traditional banks and Neobanks will be one of the most interesting battles in the banking industry in the coming years.
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