Neobanks are online-only financial institutions that are similar to banks. The offerings of a neobank are usually limited compared to those of traditional banks. Sometimes these services are nothing more than a simple checking and savings account. The simple model of these institutions often allows neobank clients to enjoy lower fees and higher-than-average interest rates.
Learn how neobanks work, what they offer, and if they might be right for you.
Table of Contents
What is a Neobank?
Neobanks are financial technology or fintech firms that offer financial services only online and do not have physical branches. These entities appeal to tech-savvy consumers who don’t mind managing most of their money through a mobile app.
Neobanks do not integrate new technology just because they are avant-garde. By ditching physical branches and moving everything online, neobanks often save on banking costs, allowing them to lower fees and expand services to the unbanked.
Neobanks are not identical in their offerings or structure, but they generally differ from credit unions and traditional banks (including online banks) in that:
1. They are not licensed by state or federal regulators as banks.
2. They provide a streamlined process designed primarily for mobile devices.
3. Partner with traditional banks to federally insure customer deposits
4. They don’t always extend credit (like overdrafts)
How do neobanks work?
From the customer’s perspective, a neobank might be nothing more than an app you use to manage your money and make decisions. For those comfortable with technology, neobank accounts are easy to set up quickly. They can often establish a relationship with a neobank and start using their services without signing any physical paperwork; simply by signing up for an account and downloading the app.
Neobanks do not replace traditional banks for all customers. Some neobanks allow you to link your traditional bank accounts to the neobank so you can get the best of both worlds. An example of this in Colombia is the Nequi service, which is associated with its parent bank, Bancolombia, which provides much of Bancolombia’s savings benefits to its online subscribers.
Neobank offerings are similar to traditional banks and credit unions, albeit more limited. They generally include:
1. Checking and savings accounts
2. Payment and money transfer services by telephone number or agreement numbers.
3. Financial education tools, including budgeting aids.
Most neobanks offer limited or no credit to limit your risk, which helps them keep costs down. However, some neobanks offer loans to individuals and businesses through partner banks and credit unions. Others, like SoFi, were lenders before offering neobank features, and thus may offer both loans and deposit accounts.
Some neobanks are startups that go through the hassle of becoming chartered banks, but they represent a minority of neobanks. It’s a major undertaking to become a chartered bank, which is why many neobanks form alliances with existing banks, allowing them to offer FDIC (Federal Deposit Insurance Commission) insurance on the money you hold with the service. For example, Chime is a neobank that partners with The Bancorp Bank and Stride Bank to insure customer deposits.
Neobanks are just as safe as traditional banks and credit unions, but customers should check to see if they are federally insured (at least in the US). If your neobank doesn’t offer federally insured deposit accounts, it presents an unnecessary risk to your deposited cash. In Latin America, the clients of the neobanks must verify the permanence time of one of these entities in the market. Some of the best-known neobanks in the region are Nubank, Bnext and Brubank.
The big banks have recognized the demand for neo-banking products and have begun to implement similar offerings to compete. These products are intended to appeal to a mobile and tech-savvy consumer base, as well as underbanked populations. Bank of America, for example, offers an AI-powered virtual financial assistant called “Erica” on its mobile app. In Colombia, Davivienda offers its clients the Daviplata service, with which clients can access a deposit account to save money, pay utility bills and make transfers to other banks and other clients of the service.
How neobanks make money
Despite the fact that many of the services of neobanks are free, these institutions have managed to be profitable through multiple innovative strategies from which they take advantage and with which they position themselves at an advantage over traditional banks.
According to statistics and studies published in SDK.finance, citing Research And Markets, the global neobank market is projected to reach $334.5 billion by 2026, with an annual growth rate of 47.1%. The big question in the face of all this financial growth is how do these entities manage to be profitable if most of the services they provide are free.
The first thing to say is that neobanks operate a business model that is different from conventional banking. A large percentage of their profits is the result of interchange fees that businesses pay when their customers, debit and credit card holders, make purchases.
For example, Chime, a popular neobank in the United States, has a base of about 12 million debit card customers. When a user makes a purchase with their Visa card, a fee of 1.5% is charged by Visa and for its part Visa pays a fraction of this commission to the Chime neobank.
Another important characteristic of neobanks is that they also generate profits from the interchange fees and the interest that is generated in the use of credit cards. One part of this business model is the one that Nubank has explored. They offer credit card services and charge a fee for each transaction made by the user. They also earn interest rates on their customers’ credit balances.
What’s more, neobanks also benefit from lower interest rates on deposits and account openings. They also make profit from ATM fees.
Likewise, neobanks can charge fees for re-issuance of cards, even if they do not charge for the first issue of the card.
Although they do not charge interbank fees, these entities benefit from the fact that all their operations are done online and due to this they do not have to pay the maintenance costs of commercial banks or retail banks. Another great feature is that by not having physical establishments or in-person service, since many of their procedures are automated through chatbots, artificial intelligence and user interfaces, neobanks avoid maintaining a large staff, which saves them a lot of money.
Some neobanks or neobank entities, such as DaviPlata in Colombia, have reached agreements with multiple companies to pay employee payroll using digital applications. These deals can be tied to paying small fees on each transaction or deposit that is also profitable for neobanks.
Advantages and disadvantages of neobanks
Advantage:
Low costs.
Convenient and easy to use.
Fast processing time.
Disadvantages:
Requires knowledge in the use of technology.
Less regulated than traditional banks.
No physical bank branches.
Advantages explained:
Low costs: Fewer regulations and the absence of credit risk allow neobanks to keep their costs low. The products are usually inexpensive and do not have monthly maintenance fees. By not having a physical branch, neobanks can also eliminate traditional banking expenses such as those associated with maintaining a physical plant floor and full-time employees.
Convenient: Neobanks allow you to do most (if not all) of your banking through a smartphone app. In addition to basic banking tasks, you should be able to manage your finances and predict activity in your accounts to avoid problems.
Fast Processing Time: These tech-savvy institutions allow customers to set up accounts and process applications quickly. Neobanks that offer loans can skip the rigid and time-consuming loan application, changing their processes in favor of innovative strategies to assess your credit and streamline the process. For example, SoFi allows you to pre-qualify for a loan and see your interest rates in minutes.
Easy SEPA transfers (In the case of European neobanks):
Some neobanks such as N26 and Revolut have become cross-border entities and can be used by clients from different countries around the world. In the case of N26, customers from Italy, Spain, Portugal and other European Union countries can access this German neobank and benefit from its low rates.
Because European neobanks operate with the SEPA (Single Euro Payments Area) identification model and this system is easily recognized by major cryptocurrency exchanges, such as Binance or Kraken, users of these banks can easily trade and access to the crypto market at low fees.
Disadvantages explained:
Requires tech savvy: If you don’t like keeping up with tech trends, you may want to avoid banking with cutting-edge institutions like neobanks. You won’t be able to take full advantage of offers if you’re not comfortable tapping and swiping through new apps. Some people enjoy exploring new technology, but if not, neobanks may not be right for you.
Less regulated than traditional banks: Since neobanks are not legally considered banks, you may not have any legal recourse or well-defined processes to follow if there is a problem with an unregulated third-party application, service, or service provider. There may be confusion about who will be responsible for possible fraud and errors. Customers are also concerned about making sure their neobank offers some form of deposit insurance, such as through the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Stock Insurance Fund (NCUSIF).
Limitations on international transfers: Many neobanks do not have international transfers or operate with the SWIFT code of traditional banking. For example, if you have a Google Adsense account and you want to have money deposited in a bank account in Latin America, you will not be able to receive the money in a neobank, since to do so you will need the SWIFT payment processor and its respective code in each entity. banking. Only large conventional banks have a SWIFT code. In the same way, if you want to receive international transfers from an institution, you will not be able to do so because for this you will need your bank to process the transaction with the SWIFT code.
No physical bank branches: It‘s getting easier to do everything online, and neobanks often have partnerships with ATM networks, but some people want the ability to visit a branch and bank in person. This is especially true when it comes to complex transactions. While many neobanks offer robust customer service tools, some customers may prefer to ask questions in person.
Disrupting Traditional Banking
In November 2019, Forbes magazine detailed in an exclusive report by Jeff Kauflin, how new financial institutions, or neobanks, are cornering traditional banking, offering services that make traditional banking have to rethink its commercial and product strategies. if you want to keep up with the new demand for services. Forbes highlighted the MoneyLion experience and how this new fintech has become a benchmark in the new technology-based banking industry. Diwakar Choubey founded MoneyLion in 2013 and since then the company has seen explosive growth. This is what Forbes had to say about the rise of MoneyLion:
Choubey, 38, is taking a midday constitutional exam at MoneyLion’s packed offices in the Flatiron district, where 65 people are working to reinvent retail banking for the app generation. He points to a couple of businesses he admires, ones that have fundamentally changed the way money flows around the world, highlighting his ambitions for his six-year-old startup. “PayPal,” he says. “Square” Two companies with a combined value of USD 150 billion.
“MoneyLion’s promise is to be the wealth manager, the private bank for families earning $50,000 a year,” says Choubey.
At last count, the MoneyLion app had 5.7 million users (2019), up from 3 million a year ago, and one million of them are paying customers. Those folks, many from places like Texas and Ohio, shell out more than $20 a month to maintain a MoneyLion checking account, check their credit score or take out a small, low-interest loan.
In all, MoneyLion offers seven financial products, including unexpected ones like paycheck advances and, soon, brokerage services. Choubey expects revenue of $90 million this year, triple the $30 million from last year. Its last round of funding, when it raised $100 million from investors including Princeton, New Jersey-based Edison Partners and McLean, Virginia-based Capital One, who valued the company at nearly $700 million. By mid-2020, he predicts, MoneyLion will break even. An FDIC-insured high-yield savings account will be rolled out soon, while credit cards are slated for later in 2020. To retain customers, he says, “we have to be a product factory.”
Like most other entrepreneurs, Choubey believes his company’s potential is essentially limitless. But having spent a decade as a traveling investment banker at Citi, Goldman Sachs, Citadel and Barclays, he’s also a guy who knows how far a horizon can realistically stretch. And he is far from alone in seeing the opportunity for new digital-only banks, so-called neobanks, to transform retail banking and create a new generation of Morgans and Mellons. “I just heard a rumor that Chime is getting another round at a $5bn valuation,” he says.
Leading the neobank industry
In 20 years, these Private Equity-backed startups could dominate consumer banking, but they will face a lot of competition. Fintech companies that originally offered investments are rushing to add banking services.
Globally, a vast army of neobanks target all kinds of consumer and small business niches, from millennial investors to dentists and franchise owners. McKinsey estimates that there are 5,000 startups worldwide offering new and traditional financial services, up from 2,000 just three years ago. In the first nine months of 2019, venture capitalists invested $2.9 billion in neobanks, compared to $2.3 billion in all of 2018, CB Insights reports.
Behind this explosion is a new infrastructure that makes starting a neobank cheap and easy, plus a rising generation that prefers to do everything from their phones. While it can take years and millions in legal and other costs to launch an actual bank, new plug-and-play apps allow a startup to plug into traditional bank-supplied products and launch them with as little as $500,000 in capital.
“Now you can get your [fintech] company off the ground in a matter of a few months instead of a few years,” says Angela Strange, a general partner at Andreessen Horowitz, who sits on the board of directors of Synapse, a San Francisco-based company. Francisco, a startup whose technology makes it easy for other startups to offer banking products.
Using these intermediary platforms, small neobanks can offer products from big banks: FDIC-insured savings accounts, checking accounts with debit cards, ATM access, credit cards, foreign exchange transactions, and even paper checks. That frees up fintech entrepreneurs to focus on cultivating their niche, no matter how small or quirky.
Let’s take Dave as an example. Dave (yes, that’s his real name) is a little app that rescues people from the pain of chronic bank overdraft fees. Created by a 34-year-old serial entrepreneur named Jason Wilk who had no previous financial services experience, Dave charges his users $1 a month and, if it seems likely he can cause them to overdraw, instantly deposits up to $75 as a deposit. A nice little deal, but nothing to make Bank of America nervous.
And this was what Forbes had just in 2019, as these services become more popular or complex, it will soon be possible to access more sophisticated services. Returning to the case of Colombia, where fintechs have found fertile ground, the Tyba service has recently become popular there, an application for novice investors that allows its clients to invest in the stock market through managed funds, so that the client only has to deposit the money and wait for the returns. Thus, as Netflix and Amazon Prime revolutionized the television industry, we will soon see how the financial industry is revolutionary. Will the floor banks be prepared to compete and undertake the transformations necessary to remain current? It will certainly be an interesting event to follow.
Neobanks and their importance for financial inclusion
According to PAConsulting, neobanks are becoming more common around the world, so much so that current conventional banks are also creating digital brands to enter the market and thus compete with new financial institutions.
The fact that these new financial institutions have started from scratch has helped them to be more flexible and inclusive than traditional banks, allowing themselves to reach the most vulnerable sectors, underserved and forgotten by the banks. The British company Monese, for example, provides its services to migrant workers who had not been taken into account by traditional banks.
Neobanks, as well as other financial technologies, are also bringing more segmentation to the finance and banking market.
The focus initially was to provide customers with a single product or service, usually transactional accounts, but these services have been expanding over time.
Neobanks can today outperform banks in customer service, products, or margin to bring their offering to market. Some good examples of these are Habito for mortgages and Revolut and TransferWise for international transfers.
The mistake that traditional banks have made to date is not worrying about the arrival of new entrants to the market, being complacent with their size or range of products. But banks could soon find themselves in a tough spot if neobanks start taking customers away from them in areas where they generate their revenue.
The great beneficiaries of this entire process are naturally the financial consumers, who see how the barriers to access to banking are knocked down and can begin to access low-cost or even free services. This also means that the most vulnerable sectors, and that generally lacked financial education, will soon begin to have more powerful incentives to save, ask for credits and be able to access new consumer services that were previously prohibited to them, such as online purchases or investments in the stock markets and more complex financial products.
In this sense, by reaching the most vulnerable and neglected sectors by traditional banking, neobanks can become drivers of economic growth by putting more money into the economy and by helping the poorest with the management of their money at a lower cost. competitive.
Examples of neobanks
Let’s take a look at some of the most popular neobanks in the US and around the world.
Varo (USA)
Varo offers a checking account, savings account and financial services so customers can improve their credit scores. With Varo customers can instantly have a credit advance of up to 100 dollars for a month. Clients have to pay a $20 fee, but there is no additional interest as long as the deposit is paid within 30 days. Here are some other features of Varo:
No credit history required for cash advances,
No minimum savings amount required , No
monthly handling or administration fees,
No hidden fees,
Credit and debit cards can be used at more than 55,000 ATMs free.
N26 (Germany; European Union)
Any citizen of the European Union can create an N26 account in a matter of minutes, and also receive an associated debit card for payments and ATM withdrawals. N26 accounts also offer savings tools, cash back on card purchases, and smart tools to analyze and build a better budget. N26 cards are compatible with Google Pay and Apple Pay for easy mobile payments. Here are other additional features.
No minimum fees, Non
-existent monthly fees , No
hidden fees or expenses,
No fees on international transactions,
Free withdrawals at more than 55,000 ATMs.
Associated SEPA account for easy international transfers and withdrawals.
Chime (United States)
Chime has spending accounts and savings accounts, as well as a credit builder account, which also comes with strategies to help customers easily build their credit history. Customers can choose to save more by rounding up purchase costs and by having extra money added to their savings account, they can also choose to have a pre-allocated amount to transfer each month to their Chime account.
Chime cards are easily accepted at any Visa payment location, and the cards are also compatible with Apple Pay and Google Pay.
Monzo (UK)
Monzo is a UK based company and is currently one of the biggest challengers for banks. Having been founded in 2015, its products range from savings accounts, credit cards, and credit advances. Like the above companies, no minimum account balance required, no monthly maintenance fees, no credit advance fees.
Additionally, no commissions are charged for conversion to foreign currency.
The Monzo card can be used at more than 38,000 ATMs completely free of charge. +
Nubank (Brazil and Colombia)
Nubank, founded in Brazil by Colombian businessman David Vélez, is one of the largest neobanks in the world. Its shares are currently listed on the New York Stock Exchange and have generated great expectations by revolutionizing the way credit is allocated among financial consumers.
The company provides the credit card service of the Mastercard franchise. It is necessary to have a good credit score and be able to demonstrate income to access your credit card. However, the company does not charge handling fees for its card and interest rates remain affordable for most consumers. The company charges a 2% conversion fee for foreign currency purchases, as well as fees on credit advances.
International purchases with the Nubank credit card are deferred to 24 installments or more if they exceed a certain limit, so consumers should be cautious with this type of service.
Lulo Bank (Colombia)
Lulo Bank is a neobank of Colombian origin founded by the Gilinski family. It aims to offer all traditional banking services completely online. Its main products are savings accounts, credits, bank interest, debit card free to use in the allied network of Servibanca, no management fees or hidden fees are charged. On international purchases the bank charges a 1% currency conversion fee.
Uala (Argentina)
Ualá is a neobank of a limited nature, since it does not offer all the services of traditional banking. Savings accounts with this entity cannot exceed a certain amount.
The company offers credits, installment deferred purchases, partnership promotions with various online business entities, no bank transfers, no handling fees, and no hidden fees.
Ualá additionally offers the dataphone service for businesses with a standard commission of 4.4% for credit cards and 2.9% for debit cards.
Should you opt for a neobank?
Neobanks are a great option for customers looking for simple account services, online mobile access, and low fees.
Many customers could rely entirely on neobanks, without having to resort to traditional banking. Others, for their part, could access some of the specific services of these entities without leaving the services of conventional banking.
Before considering switching to a neobank-type entity, clients should consider what their financial needs are. Although for many clients, the services of the neobanks could be sufficient due to the limited and low use of financial resources, others could be forced to continue using traditional banking for large transactions or to receive and send international transfers in those jurisdictions where the neobanks They do not yet provide these services.
In any case, it would be advisable to combine the services of these two types of entities and vary between them depending on the costs and needs of each user.
key takeaways
Neobanks are online-only financial institutions.
Neobanks typically offer fewer products and services than traditional banks, which helps them reduce both institutional risk and customer costs.
While some neobanks are chartered banks themselves, many neobanks partner with larger chartered financial institutions to secure deposit accounts.