Innovation & Consolidation in Neobanks/challenger banks- 2022 Recap

Though this is a recap of 2022 happenings in the Neobank industry, 2023 started off with news from Neobanks in Africa, Europe and Australia worth mentioning.

The State Bank of Pakistan announced on January 13, 2023, that it issued a no objection certificates (NOCs) to five companies including KT Bank to establish digital banks in Pakistan. KT Bank is a partnership between Nigeria’s neobank Kuda bank (registered as Kuda Technologies Ltd), Fatima Fertilizer Ltd., and City School Pvt. Ltd. Ruuky, a German neobank announced it has filed for bankruptcy in January 2023 due to its inability to secure fresh funding from either new or existing investors. Ruuky’s operation lasted less than three years. In Australia, AMP ?Bank bought a mortgage focused neobank?Nano Digital Home Loans ?and its $400 million mortgage book in February 2023.

Why is Nigeria’s Kuda expanding to Pakistan? Yes, Nigeria and Pakistan share similarities in socio-economic development but that isn't all there is. Why didn't Ruuky strive for profitability so it can be self sustaining? Why was Nano Digital Home Loan acquired by an incumbent?

Neobanks are devising strategies to keep afloat amid a tighter funding environment driven by volatile markets, widespread uncertainty, and recessionary pressures. These include acquiring banking charters, adopting mergers and acquisitions, forging partnerships, entering new markets, and expanding their products portfolio. This article discussess the rise of Neobanks globally, the crowding into neobanks by fintechs, big techs, and traditional banks, explains what a Neobank is, address the refunded funding and market exits as well as the survival strategies adopted by Neobanks.

The rise of neobanks globally

The growth of neobanks is driven by their low-cost service model and rising demand for convenience among retail customers – mostly individuals and MSMEs. ?There is also the rise in banking-as-a-service and the aggregation of business services such as accounting, budgeting, taxation, analytics for MSMEs at fractional costs. Neobanks are estimated to be between 250 to 400 globally.

Some Neobanks are fintech companies that offer streamlined mobile and online banking, while others have a banking charter that enables them to operate as full banks. In many cases, regulation requires that the fintech Neobanks partner with traditional banks as a compliance requirement for deposit accountability. While most Neobanks started by specializing in specific financial products, such as checking and savings accounts, embedded finance has enabled them to diversify their services to specific target markets, subject to meeting relevant regulatory requirements.

The Crowding into the Neobank Market

Neobanks may have challenged the incumbent banks and acquired some of their customers, but a wave of competition from incumbents, big fintechs, and non-financial brands is slicing up their market. For example, incumbents such as JPMorgan Chase & Co , Goldman Sach , etc., have launched digital banks. In addition, many fintech acquirers, such as Stripe, Square, etc., have embedded financial products such as savings/business accounts, card products, and credit, and some retailers such as Walgreens offer a bank account and debit card .

?Understanding Neobanks

Translated literary neobank means the new bank or a revived form of banking. Contextually, it means new-age banks that are different from traditional banks. Sometimes they are referred to as "challenger banks" because they are transforming the banking sector as Uber and Airbnb revolutionized the transportation and hospitality industries, respectively. A significant difference between a neobank and a traditional bank is that while traditional banks have physical branches alongside their digital banking products, neobanks operate via mobile and online channels.

Survival Strategies adopted by Neobanks

For Neobanks still open for business, remaining in business for the foreseeable future necessitates adopting new strategies or amending existing ones. Thankfully, Open banking policies give them access to customer data with incumbents, allowing them to sell their services to new customers faster. Revenue growth beyond the expense card business model, increased cross-selling products, leveraging existing user bases, and partnerships to reduce the cost of acquisition (CAC) are some of the strategies adopted by the Neobanks to keep afloat. I tracked the activities of Neobanks between 2021 and 2022 and found these recurring themes.

●?????Acquiring banking charters

A banking license widens the services Neobanks can offer consumers. Three U.K. challenger banks with charters and loan offerings - Redwood Bank, Starling Bank, and Zopa - reported attaining profitability between 2021 and 2022. On the other hand, Revolut broke even in November 2020 with revenue from crypto and stock trading, alongside insurance products and monthly membership subscription. Revolut holds a U.K. e-money license and a European banking license.

That said, acquiring a banking charter can be time-consuming and expensive. For example, it took Varo bank three years (and cost $100 million), while Atom, Tandem, and Starling waited up to 2 years to receive banking charters. In addition to the time and money spent ?during the process, they were not able to launch their products before receiving their charters.

Meanwhile, according to CBS Insights , the fastest-growing challenger banks — Revolut, Monzo, and N26 — rapidly acquired customers through viral growth strategies without a bank charter. These 3 banks had a combined customer base of over 34M users as of November 2022, while Atom, Tandem, and Starling had a combined 3.6M users. A banking charter allows the banks to offer diversified products to users. However, the data shows that faster go-to-market strategies, product testing, and iteration should be the priority in a race for high-speed user growth. Revolut applied to secure a U.S. charter in 2020, while Monzo withdrew its U.S. banking license application in October 2021 after it was told by regulators it was unlikely to be approved.

It is important to note that despite high customer base, Revolut is yet to post a profit. Monzo could be closer to achieving annual profitability by the end of 2023. N26 is yet to post a profit.

●?????Mergers and acquisitions

Acquisitions increase the purchasing company's market reach and customer base, which can improve revenue. Neobanks are acquiring other companies to expand their technology, product suite, or/and market reach. For example, in March 2022, Danish neobank Lunar announced plans to buy Norway-based Instabank . Instabank operates in Finland, Germany, Sweden, and Norway and offers savings accounts and loans. In South Africa, TymeBank, a neobank, acquired Retail Capital , a credit provider to SMEs, in 2022. Starling Bank, in 2021, acquired specialist buy-to-let mortgage lender Fleet Mortgages. To expand to green energy lending products and mortgages, home improvement loans, and auto loans, Tandem, a U.K. green-focused neobank, acquired Allium in August 2020 and Oslo in January 2022. In March 2022, Oxbury, a UK-based farmer-focused challenger bank, and Chetwood Financial, a UK-based digital bank, acquired their core banking providers, Yobota and Naqoda, respectively. The mergers will enable the Neobanks to offer more comprehensive financial products and services.

●?????Partnerships

Acquisitions and partnership can achieve similar objectives. Neobanks adopt a partnership model to increase the resources available to make better products and reach a greater audience. Most partnerships are with other financial institutions. Spanish neobank Plazo signed a strategic partnership with Mambu in June 2022 to grow its lending portfolio. In addition, Monzo, a U.K. neobank, partnered with Funding Xchange , a lending aggregator that offers businesses a range of lending options. Brazil's Nubank leveraged partnerships to break into cryptocurrencies.

In May 2022, Nubank partnered with blockchain infrastructure firm Paxos to allow its customers to trade bitcoin and ether through its mobile app. The crypto offering gained Nubank one million users in just one month . Monzo currently partners with US-based Sutton Bank to serve the U.S. market. Revolut, in April 2022, partnered with Cross River Bank , a US-based technology infrastructure provider that offers embedded financial solutions. The partnership opens consumer personal loans for Revolut customers in the U.S., leveraging Cross River's technology and regulatory infrastructure.

Sometimes, regulation forces fintechs offering digital saving or account products to partner with incumbents/banks for compliance purposes- Chime partners with the Bancorp Bank, N.A., and Stride Bank to provide its banking service. Although Monzo has a bank license in the U.K., it partners with Ohio-based Sutton Bank to provide its U.S. accounts. Sutton holds user deposits and protects them with FDIC insurance.

In Taiwan's case, neobank partnerships are regulation induced. Its Financial Supervisory Commission (FSC) encourage?BigTech, telcos, and fintech startup interested in offering account products to team up with incumbent financial services firms. Thus, Line Bank, and Rakuten Bank both neobanks launched in 2021 allied with Fubon Bank and IBF International Holdings respectively.

Hong Kong’s virtual bank Z.A partnered with Wise in November 2022 to launch international transfers in Hong Kong. In January 2022, Z.A. received a license from the Securities and Futures Commission (SFC) in Hong Kong for Type 1 regulated activity, allowing it to deal with securities. Up, an Australian Neobank launched in October 2018 in partnership with Adelaide Bank and Bendigo Bank, allowing it to circumvent bank license requirements.

●?????Cross-border expansion

Neobanks are digital and not beholden to physical branches creating an advantage for global expansion. To tap into the growth potential in new markets, asset diversification, economies of scale, and increased competitive advantage, some Neobanks are expanding globally. For example, N26, a Berlin-based startup, has used the European passport to expand its service to over 20 European Economic Area ( EEA ) countries. In 2019, N26's launched its first market outside of Europe in the United States. However, in November 2021, N26 announced its exit from the U.S. market to sharpen the Group's focus on Europe. Revolut also expanded to the U.S. and, in November 2022, announced plans to launch in Brazil, India, and New Zealand . In 2021, Revolut pulled out of Canada — a year and a half after launching in beta there.

●?????New product offerings

As Buy Now Pay Later (BNPL) gains popularity, Neobanks are implementing BNPL features to provide more flexible payment options to existing customers,?attract new customers and grow new revenue streams. Monzo and Curve launched BNPL products in September 2021, and more challenger banks are following suit. Zopa (U.K.) announced launching a BNPL in June 2022, while?Revolut announced in June 2022 that it would unveil its BNPL product called Pay Later in Ireland, Poland, and Romania toward the end of 2022. Plato's partnership with Mambu in June 2022 also entails offering?Mambu’s BNPL, fractional payments, and salary advance s products.

Revolut, in August 2021, added an on-demand pay service , an earned wage access (EWA)?product, to its offering.

Going Forward

While these development patterns are spurred by the need to become profitable or remain a going concern, the proliferation of neobank is intensifying competition. As a result, we expect more neobanks in 2023 to fall back to these patterns as they navigate the macroeconomic conditions.

***About: Ifunanya is a Senior Consultant at KoreFusion. Based in Hong Kong, Ifunanya built her career working in Nigeria across retail, commercial, and corporate banking.?More recently, her experience includes being a pioneer employee in Africa's fintech sector and working in Hong Kong’s fintech scene. If you've enjoyed this piece, don't hesitate to like, leave a comment and share the article with others.

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