Why have Neobanks failed to unseat the incumbents?

A decade ago, neobanks like Monzo, Starling and Revolut emerged as fintech trailblazers, aiming to disrupt the dominance of traditional banks.

They promised a seamless digital experience, transparency, and innovative features like bill-splitting and real-time payment notifications. While they have succeeded in setting new standards for digital banking, their journey highlights both their triumphs and challenges.

Neobanks have excelled in delivering mobile-first banking solutions.

Their intuitive interfaces, real-time updates, and clever tools for managing personal finances have attracted millions of younger customers. Features such as the ability to freeze cards instantly, split bills, and manage multiple currencies have become staples of modern banking, forcing legacy institutions to invest heavily in their own digital platforms.

In fact, the advent of neobanks has driven a significant digital shift in the banking sector.

The proportion of UK adults using mobile banking apps has soared to 60% in 2023 from just 33% in 2015, according to UK Finance.

Traditional banks have emulated the digital-first approach of neobanks, incorporating features like instant notifications and simplified interfaces to stay competitive.

Growing Pains: Profitability and Fraud Prevention

Despite their success in customer engagement, neobanks face mounting challenges in achieving profitability.

Higher interest rates and reduced venture capital funding have forced these fintechs to abandon the “growth at all costs” mindset and focus on sustainable revenue generation.

For now, only Starling has turned a profit, posting a £195 million pre-tax profit for the year ending March 2023.

Monzo and Revolut expect profitability in their next financial statements.

However, the path to profitability has highlighted shortcomings in their business models.

Unlike traditional banks, which generate income from loans and upselling products, neobanks rely heavily on transaction fees and interest on central bank deposits.

Efforts to diversify into areas like mortgages and passive investment are still in their infancy, leaving them vulnerable in a competitive market.

Fraud prevention has also been a pain point.

Rapid customer acquisition outpaced their ability to scale anti-financial crime measures, leading to some of the highest fraud rates in the industry.

In 2022, Monzo reimbursed only 6% of fraud claims, compared to 44% at Starling and 91% at Nationwide.

Regulatory scrutiny, including investigations by the Financial Conduct Authority (FCA), has further underscored the need for more robust compliance measures.

The Battle for Primary Accounts

While neobanks have successfully attracted millions of users, many still rely on traditional banks for receiving salaries and managing larger transactions.

The FCA estimates that UK neobanks hold an 8% share of personal current accounts, but only a fraction are “primary accounts.”

This results in lower transaction volumes and overdraft usage, limiting funding and fee income opportunities.

Revolut’s head of growth, Antoine Le Nel, counters this by pointing to the significant funds users transfer to their Revolut accounts monthly, suggesting active engagement.

Similarly, Monzo touts its high “net promoter score,” indicating strong customer satisfaction and organic growth.

To thrive in a challenging environment, neobanks are exploring alternative revenue streams.

Starling is licensing its technology to other businesses, while Monzo is expanding into the US, and Revolut is diversifying into areas like advertising and cryptocurrency.

However, these strategies require significant investment and regulatory navigation.

Competition is also intensifying.

Chase UK, backed by JPMorgan, has attracted over 2 million customers since 2021 by offering market-leading cashback and savings rates, coupled with a slick digital experience.

Chase’s hybrid model combines fintech innovation with the security of a traditional bank, posing a formidable challenge to existing neobanks.

Collaboration Over Disruption?

As traditional banks enhance their digital offerings, analysts suggest collaboration between incumbents and fintechs may yield the most benefits.

By combining fintech agility with the scale and expertise of established banks, both can address evolving customer needs.

However, some argue that neobanks’ primary impact has been pushing traditional institutions to innovate.

“It’s silly to suggest that neobanks have materially challenged the hegemony of traditional institutions,” says Alex Barkley of Lancero Capital. “Their lasting impact is pushing big banks to improve their digital platforms.”

However, their journey from disruptors to profitable enterprises is far from over.

To sustain their relevance, they must refine their business models, enhance fraud prevention measures, and continue innovating in an increasingly crowded market.

Their ability to balance growth with regulatory compliance and profitability will determine whether they remain an evolution or become a revolution in banking.

Image by Freepik

 

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