A New Era in Banking
Following the 2007-08 financial crisis, a general mistrust of large banks combined with the increase in digitally based business ushered in a new era of banking. This new era of banking is characterized by the emergence of neobanks, financial technology firms that attempt to simplify mobile and online financial services through apps and digital tools. While the new era of banking may not lead to a significant shift in the industry’s major players, it already has changed and will continue to change the focus of the industry. Banking services will continue to be streamlined, as large banks are forced to make changes in order to prevent losing current customers to simpler and feeless neobanks.
Neobanks are typically all-online platforms with bank-like services; however, they are not the same as traditional banks. Unlike a traditional bank which offers online banking, neobanks have no physical locations, relying solely on mobile banking and offering all of their support virtually. Not having physical locations means neobanks are much less expensive to operate than traditional banks with offices across the country, resulting in the neobanks needing less income to stay profitable and being able to minimize fees. Another significant difference between a neobank and a traditional bank is that neobanks lack a banking charter, meaning they are much less regulated. Instead of having a banking charter, neobanks partner with existing banks with a banking charter and FDIC insurance. This enables neobanks to be much more agile and to adapt quickly to changing economic conditions. A neobank therefore aims to provide you with the same insurance and security given to you by an established bank, but with fewer fees and a better customer experience.
Neobanks emerged worldwide in the wake of the 2007-08 financial crisis. Their major selling point was their transparency and ease of use compared to a traditional bank. While neobanks span the globe, the most prominent ones are in the US, UK, and Brazil. Many of these neobanks have targeted niches they believe are underrepresented in the financial services industry. For example, Cheese is a neobank that targets Asian Americans and intends to support Asian American communities, Mercury targets startups, and Daylight is built for the LGBTQ+ community. By targeting specific niches, neobanks are able to present customers with a sense of connection and personal service that the large established banks often cannot provide. This allows for greater engagement for the neobanks, while also drawing customers away from the established banks.
The emergence of neobanks has resulted in an unprecedented industry disruption that likens respective sector changes that companies like Uber and AirBNB have imposed. Since it was founded in 2013, Chime has grown to be the largest neobank in the United States, with 12 million users in 2021 (Business of Apps). Of those 12 million users, about 7 million use Chime as their primary bank. As of 2021, Chase Bank, the largest bank in the United States, has nearly 58 million digitally active users (Chase Media). As much as Chime has been growing in the past decade, they still are far off from the nation's leading banks in terms of mobile users.
An additional example of industry disruption can be seen with Walmart’s potential entrance to the industry. Walmart, the country's largest private employer, plans to start offering digital checking accounts, primarily for their employees, through the acquisition of One and Even (Bloomberg). One is a neobank offering debit cards, as well as checking and savings accounts. Even offers an app to help workers get paid early, save automatically, and budget their money better (Even). Walmart aims to combine the two companies, creating a neobank which can target their vast community of employees and consistent shoppers. Walmart’s move demonstrates how easily a powerful company can enter financial services and further disrupt the status quo.
As we look towards the future, the financial services industry can expect to see neobanks continue to grow and assert themselves as forces in the sector. This will come as funding continues to grow for many new firms. An example of this is Daylight, which describes itself as “a banking app designed for the LGBTQ+ community, by the LGBTQ+ community” (Silicon Republic). In June of 2021, Daylight announced that it raised $5 million in seed funding (Silicon Republic). To put that number into perspective, another neobank called Dave raised just $3 million in their initial seed funding in 2017, but to date has raised almost $500 million in funding (CrunchBase). This shows the potential for new neobanks such as Daylight as they enter the industry and secure early funding. The huge funding available will provide them with the opportunity to compete with each other and with traditional banks for the customers who wish for a more personalized and fee-free banking experience.
With the huge growth of neobanks in the past decade, traditional banks have been forced to respond. Capital One created Capital One 360, a 24/7 mobile banking app with no fees and an extensive network of ATMs (CapitalOne). Marcus by Goldman Sachs is a similar initiative, a savings account with no fees or minimum deposit, and an easy to use app (Marcus). Neobanks recent success and growth has been the catalyst for many of these banks releasing or improving their online services, as they attempt to reduce the amount of customers they may lose.
The largest issue neobanks will face in the future is a simple one: they struggle to make enough money. Chime’s largest selling point is fee-free banking, which, while great for the consumer, stands in the way of them making as much money as a normal bank would. Coupled with their lack of significant fees, many neobanks also suffer from low customer retention and low average deposits (Forbes). This means that even if they grow incredibly quickly and rack up large amounts of users, they still have to find a more effective way of keeping those customers, and making sure they are actively using their accounts. This becomes increasingly important because many neobanks rely heavily on interchange fees to make the majority of their revenue. Interchange fees are fees charged by payment processing companies (like Mastercard or Visa) every time a card is used. For Visa the interchange fee rate typically is between 1.4% - 2.5%, and the bank issuing a card using Visa will take a portion of that interchange fee. As a result, neobanks are reliant almost entirely on interchange fees that they take a portion of. Interchange fees, while in theory are profitable on a large scale, are not nearly as profitable when many of the bank's customers use their accounts infrequently.
Another issue some neobanks face is growth limitation. For many neobanks, their business model relies on high customer usage and a large quantity of customers. However, neobanks such as Daylight and Cheese, who target specific groups within the population may find that they struggle to continue significant growth and maintain the volume necessary to succeed. If neobanks want to become profitable and be able to compete with the large traditional banks in the United States, their biggest issue will be consistently growing at the rate they have been, but also maintaining high customer satisfaction and ensuring they will be a customers primary bank.
In the era of financial services which has seen neobanks surface in great numbers, existing banks have had to respond with new or improved services of their own. Neobanks have the ability to maneuver and adapt to a changing climate much easier than traditional banks can, but they also face some challenges which make it hard to grow to quite the same standing. As a result, the vast majority of neobanks will likely never be able to truly challenge the major banks, but their rapid growth and threat has had incredible effects for customers of many banks. We see these positive effects with programs such as Capital One 360 and Marcus by Goldman Sachs, which offer customers simpler solutions to banking and lower fees. While this era in financial services may not last or see any major changes to the main actors in the industry, it has certainly had a massive impact on the world of banking, and changes will continue to be made to streamline and simplify the industry.
References
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