Neobanks vs Traditional Banks: Is the War Already Over?

Technology has impacted almost every sector in the past two decades. In the financial services sector, the adoption of digital tools has changed the way people do banking forever. Nowadays, if you want to use just about any banking services, you do not need to go to a physical branch. Long gone are the days when the only way you could get a loan or a mortgage was by scheduling a meeting with the bank manager at your local bank.

Neobanks, also known as challenger banks and digital banks, have revolutionized the financial services sector by making the client onboarding process simple and cost-efficient.

The scale of neobanks is such that almost one billion people around the world are part of the digital banking ecosystem. However, less than 5% of neobanks are profitable. In 2020, Revolut, one of the most valuable neobanks in the world, posted an operating loss of £200.6 million.

Neobanks entered the financial system with the tag of 'challenger banks' because they challenged the complex infrastructure and client onboarding process of traditional banks. With struggling profits, many questions have emerged regarding the sustainability of neobanks in today’s financial ecosystem.

“For neobanks to win (against other neobanks and traditional banks), they have to outcompete in either marketing or feature (ideally both). For marketing, we're seeing verticalized neobanking offerings with marketing targets toward niche demos. For features, these might look like verticalized offerings targeted for the niche demo, like health or lifestyle benefits/discounts with lgbtq businesses, or accounting/tax features for freelancers,” Sunil Srivatsa, the CEO of Saddle.finance, told Finance Magnates.

Retail vs Institutional

Profitability is not only related to the number of retail clients. In fact, a recent report from Simon-Kutcher shows that most of the neobanks are losing as much as $140 per retail customer annually. On the other hand, traditional banking giants gain most of their profits from corporate and high-net-worth clients.

“In my opinion, traditional banks don't have much to worry about neobanks since their most important clientele are high net worth individuals, ultra-high net worth individuals and institutions, while neobanks are targeting newer retail customers who are just building up their wealth, so as long as traditional banks stay focused on serving their most important segments well (and investing in neobanks) they should be fine, at least, in the next 3-5 years,” Srivatsa explained.

Investing in Neobanks

Neobanks were supposed to be ‘challenger banks’, but that ‘challenge' is losing its intensity gradually as more and more traditional banks are taking huge stakes in neobanks. One such example is BBVA’s $300 million investment in Neon, one of the largest digital banks in Brazil, a country where almost 50% of the population is using at least one neobank.

Some of the leading financial services providers have already launched their dedicated neobanks. Last year, JPMorgan’s digital bank ‘Chase’ went live in the UK.

Sustainable Growth and Profitability

Despite nearly a billion customers, neobanks are struggling with profits. A large percentage of players in the neobanking ecosystem is still not as yet breaking even. A failure to achieve profitability within the next few years will make it difficult for most companies to even survive in this competitive market.

"It’s probably a good time for neobanks to shift focus from scale to profitability. Many of these founders are not bankers, and that’s why they focus a lot on user experience. But, very few of them actually have a deeper understanding of financial services, and where money is made. Out of the 400 or so neobanks, there are at least 300 that will not be around for too long,” Christoph Stegmeier, the Senior Partner at Simon Kucher & Partners, said in a recent report.

There are some bright spots in the neobanking ecosystem as well. For instance, Starling Bank, founded by Anne Boden who previously worked with financial giants like Royal Bank of Scotland and ABN AMRO, broke even in October 2020 and saw consistent growth in profits in the following months. For challenger banks, a shift of focus from scaling to profitability will change a lot of things.