NEO Banks – Pre-Paid Cards Masquerading as Banks

UK’s Neo banks are big on promises

Will Revolut get a banking licence? 

Neo Banks the darlings of the UK Fintech sector and are front in centre in a fight for credibility with Revolut seeking a full banking licence and Starling seeking to buy a ‘lender’ - you would think lending is a core skill for any bank?

While 2020 saw a number of Neo Banks close – Simple, Moven in US; C-zam close by Carrefour, Anytime sold to Orange, Atom Bank seeks more support from BBVA, Xinja closed in Australia while N26 cut back substantially the UK Neo Banks remain fully committed to high growth at all costs. Others in the graphic - Fidor closed in 2019 and BNP Paribas acquired Nickle - showing nothing stays the same on Neo Bankland - expect more changes in 2021 with over 400 global Neo Banks.

The full 2020 UK numbers will be released soon – it’s well worth reviewing the previous period numbers just to refresh how small these banks really are. They are basically pre-paid cards with revenue from FX fees and surcharges as well as using the pre-paid float to fund their businesses – hardly a secure revenue source during Covid-19. 

Inside Revolut’s bid to become a bank

SIFTED ISABEL WOODFORD 18 JANUARY 2021

In a packed conference hall in central London, Revolut chief executive Nikolay Storonsky took the stage.

This was 2018, and Storonsky had been invited to share the vision of his fast-growing financial app to private sector hotshots.

The stakes were even higher though — senior officials from the Bank of England, the gatekeepers of the UK bank regime, were also present, listening carefully.

The chief executive certainly left an impression, but perhaps not the kind he expected.

According to two people present, at one point Storonsky was asked about the rigour of Revolut’s anti-money laundering systems, and the executive answered: “Just above average.”

Storosnky’s trademark monosyllabic answer raised eyebrows, and — according to one — left Revolut’s reputation at the UK’s top financial institution “tarnished.”

“There was always this impression that he [Storonsky] favoured growth over resilience,” one former employee of the Bank of England told Sifted.

“Cavalier is a bit too strong…but he was always in an extraordinary hurry to build out the business,” raising well-documented questions about the firm’s compliance systems.

This had previously led to clashes between Revolut and the Financial Conduct Authority (FCA), its principal regulator.

“[Our] reputation with regulators was not strong in 2017/2018…There were some chilly first meetings,” said one source inside Revolut’s regulatory team.

By 2019 then, when Revolut formally began proceedings to get a bank licence with the Bank of England (BofE), it was on shaky ground.

Turned a corner

Nearly two years later however, relations between Revolut and the regulators seem to have thawed.

Last week, Revolut announced it had been “invited” to apply for a licence, which is no small feat.

Official data shows that between 2013 and 2019, just 31 companies out of 110 candidates were given the green light to apply for bank licences. That already puts Revolut in the top two-thirds of applicants (note: while the BofE cannot “deny” companies from applying, those deemed inappropriate are strongly discouraged, or put in a “holding pattern”).

Revolut’s progress is no coincidence; the fintech has put in some intense grafting since Storonsky’s faux pas.

“You can’t underestimate how much work Revolut has done on governance, risk, and compliance over the last 18 months,” said the Revolut insider.

“It’s not perfect but there’s broad recognition from regulators that they’ve come a hell of a long way.”

This has involved months of “pre-application” meetings, big hires, trawling through red-tape, and a seismic change in attitude, as outlined by the FT.

But Storonsky did try an alternative strategy first.

According to two venture capitalists with direct involvement, Revolut looked into acquiring Zopa for its UK licence in 2019, hoping to speed up the process.

“They tried to buy a licence through the back-door,” one investor told Sifted.

Revolut made a firm offer on Zopa, and informed the regulator of its plan.

However, the BofE warned Revolut the acquisition would take time to approve, meaning there would be no “shortcut,” the two investors recall.

Both companies declined to comment, as did the Bank of England.

The path to success

So what happens now?

For all its progress, Revolut still has a long road ahead before it clinches the licence, which will allow it to house, guarantee, and lend out British users’ deposits.

Approval is set to take up to 2 years, assuming it’s successful at all (over 50% of applicants are).

The next stage will involve scrupulous interviews with key executives, due-diligence of its main investors, and stress-tests of its controls and complaints procedures.

The Prudential Regulatory Authority (PRA), which oversees the licence process at the Bank of England, will also examine the ‘viability’ of Revolut’s business model, having gotten tougher on prospective banks in recent years.

The typical timeline for a bank application. Revolut is now early on in the “Application” stage. Source: The Bank of England.

The BofE also has to deal with the fact Revolut is already “systemic” (in other words, at scale); having used its e-money licence to grow to over 13m customers worldwide.

Some commentators say this will make the process trickier than for Starling and Monzo, who were in their infancy when they applied for licences.

“This application is far more complicated… Revolut is a company with a whole load of volume, and a whole load of history, and a whole lot of customers [to migrate],” said a former executive at a digital bank which recently secured its licence.

“While Starling and Monzo were selling hope, Revolut is selling reality.”

Still, Revolut’s pathway isn’t entirely unprecedented; overseas banks face a similar prospect when they arrive in the UK. London’s Cashplus is also over a decade old and only now going through the licence process.

Meanwhile, Revolut has the advantage of having raised $580m last summer, which should at least put capital concerns to bed.

The company has also now bolstered its global compliance division to over 600 people.

Nonetheless, Revolut may still need to put on a “charm offensive” to shake off its early reputation (it previously mowed through four heads of compliance in five years).

The fintech could even be asked to shut its crypto-trading product in the UK to satisfy both the FCA and the PRA, who co-manage the bank licence process.

The ‘Nik question’

Compliance systems aside, Revolut’s personnel — including its enigmatic chief executive — will also be under scrutiny.

Many within the London fintech scene tell Sifted they consider Nik Storonsky a “genius”. Yet the pace of his ambition and his unconventional demeanour has raised questions at the highest ranks about control, careful execution, and team retention.

One investor said they passed on an earlier funding round precisely because of the ‘Nik question.’

“We felt he’d never get the licence if he was in charge. He’s marmite. You either love him or hate him.”

They added that “Nikolay is a much stronger character” than most, and the BofE will be wary of attempts to “bulldoze the board.”

To address the issue, Revolut is hiring a separate and experienced team to lead the UK bank (as it has done elsewhere across the world).

Ex-Standard Chartered chief Richard Holmes has been nominated as Revolut’s UK bank chairman, alongside a shadow board of bigwigs like James Radford, Ian Wilson, and Kitty Ussher.

The UK bank CEO will also report into Holmes, not Storonsky.

In practice then, Storonsky is “quite divorced from the bank”, the Revolut insider assures Sifted.

Storonsky is also now prepared to play second fiddle to the regulator, they added.

“It’ll be an adjustment for him, going from an EMI [e-money institution] to a bank..but he’s been through an adjustment already in 2019. He got whacked up pretty hard [by the FCA], and he responded to that. He’s a very adaptable guy. He learns by evidence.”

Still, while Storonsky won’t be the UK bank chief in name, the regulator will be testing the UK bank’s independence.

“The PRA won’t want the UK bank to be just a subsidiary of the parent… They’ll be asking: Has the UK bank got enough ‘management’ and ‘mind’ to run the bank themselves, or are they looking to the parent every 5 minutes,” said the afore-mentioned former digital bank exec.

A change of tune: A real neo-bank

Becoming a full-stack UK bank is a far cry from the money-transfer, hypergrowth business that Revolut began as in 2015.

So why has Revolut spent years battling for a UK licence?

This could simply be a natural progression of Revolut’s ambition. Arguably, having a reputable bank licence is essential to becoming a global leader.

But Tom Merry, a managing director at Accenture, says it’s an admission that fintechs’ vision of a ‘new model of banking’ has fallen short.

“5 years ago…a lot of people were forecasting a different business model. They were saying ‘We can do it differently and at low cost.’ That’s not necessarily what’s playing out,” he told Sifted.

“[Revolut] are seeing they need lending to make enough money. It’s not sustainable otherwise.”

Despite healthy revenues, Revolut is currently operating at a ￡107m loss, according to its 2019 accounts. It also has the smallest average deposit rate per user at ￡252, while Monzo’s users store ￡357 each and Starling’s is ￡999.

If Revolut gets a UK licence, one executive estimates its new lending facility could “easily” eventually generate a third of the fintech’s total revenues.

Still, it’s worth remembering that lending runs its own risks, taking time to do responsibly. Revolut has also actually been authorised to lend in the EU since late 2018, when it attained a Lithuanian bank licence.

To seek a second licence exclusively for UK users therefore suggests the fintech may be in need of fresh ammunition in its home market, Accenture’s Merry argues.

“Revolut is obviously making a bigger commitment to the UK,” he suggested.

Indeed, the UK licence will only benefit Revolut domestically in the wake of Brexit.

For its part, a Revolut spokesperson commented: “Our ambition is to offer customers across the world a financial superapp …Banking is a central pillar of that ambition.”

They continued: “There is a huge opportunity for innovation and modernisation in UK banking services and a bank licence allows us to get that innovation underway.”

So now, Revolut’s fate lies in the hands of the regulator.

Nobody can predict how long — or if — Revolut will succeed. The regulator will ultimately be balancing its duty to protect consumers with its desire for fresh competition.

But if the détente between the two continues, Revolut’s odds of securing a licence look reasonable.

Just above average, some might say.

 Starling Bank wants the buy a lender 

SIFTED RYAN WEEKS 13 JANUARY 2021

Starling Bank, the digital bank steered by founder-turned-author Anne Boden, is hunting for acquisition targets in the lending market in a deal that could trigger a neobank-led wave of consolidation in the fintech sector. 

Speaking exclusively to Sifted, Boden said the company is now actively searching “for lending businesses to buy”, with Europe’s non-bank lenders (including P2P firms) squarely in its sights. 

A deal makes sense for Starling because the bank, more so than any other fintech business, has capitalised on the emergency lending schemes designed by the UK government to prop up struggling businesses during the pandemic’s early lockdowns.

Between October 2019 and October 2020, the startup’s gross lending ballooned from ￡37m to ￡1.5bn — driven primarily by its work dishing out 100% taxpayer-guaranteed Bounce Back Loans to small businesses.

A decent portion of that money has been distributed through partnerships with P2P lenders like Funding Circle and Zopa, and executives at Starling have already admitted to having looked at acquisition opportunities.

But Boden, in an interview with Sifted, went a step further. She said the company is now actively searching for a lending business to acquire. 

“Because we have a European strategy, we’re also keen on looking for lending businesses to buy,” she said.  

Asked again to clarify if that means that Starling is actively on the lookout for a lender to buy, she said: “Yes”.

Boden explained Starling would continue to dish out loans under the government’s emergency funding schemes, but added that “there are other sorts of lending that we’re currently working on to replace that”.

Part of the rationale is that while emergency lending has been a boon to the business, helping it to break even in the month of October, Boden acknowledges that — even with the UK once again locked down — the schemes will not last forever.

That means Starling has to look for other ways to sustain its beefed-up lending operations.

Boden also provided a potential clue as to which pools Starling is fishing in for acquisitions by pointing out that the retail investors who have historically powered P2P platforms have for the most part been replaced by institutional funding, which are costly when compared with the retail deposits.

The union of Starling, which has a pile of cheap cash in the form of retail deposits, and a lender with solid distribution, could be a lucrative one. 

 Boden added that P2P lenders and non-banks are under pressure at the moment as the government has effectively capped the amount of interest they can charge on their loans.

“The Coronavirus Business Interruption Loan Scheme (CBILS) loans are capped at 15% [interest]. So those sorts of businesses are going to be under strain because what the government-backed lending has done is really put a ceiling on the interest rates that people can charge SMEs. And if you have a business model based on lending above this, you’re really locked out of this market,” said Boden.

There is no detail yet as to which lending business Starling might be eyeing, but there really aren’t that many sizeable non-bank lenders in Europe to choose from. The big P2P lenders in Europe include the likes of Funding Circle, which is listed on the London Stock Exchange, and October in France.

Here are a few other eye-catching quotes from our interview with the ever-energetic Boden.

On customers

·       Starling customers have been relatively unaffected by the lockdown: “Our demographic is less likely to have been impacted by the lockdown [than other fintechs]. Our demographic is slightly older, slightly more affluent. So [our users are] more likely to have just gone home to work and are continuing to spend on the family shop and going to Sainsbury’s and Tesco’s and whatever.”

·       They were never big on using the bank for travel: “We’re less impacted by [the big dip in] international travel. We’ve got only something like 15% of our transactions that were international travel, and therefore interchange wasn’t really impacted.”

·       Forget Freetrade, Starling customers invest old school: “One of our most popular merchants is Hargreaves Lansdown. Starling customers tend to be investors.”

On open banking

·       Acquisitions in this space are a risk: “Visa buying Plaid and Mastercard buying Vocalink is all a way of maintaining what is basically a duopoly.”

·       So much for a third card scheme: “Especially in Europe, there’s been a lot of push for a third card scheme or some alternative and generally the introduction of an API through an open banking mechanism could have been a third way of making those payments. And therefore it’s a very, very interesting space for the owners of the existing rails to play in.”

On crypto

·       Starling customers don’t care about crypto: “We have lots of people coming to us to ask us if we would process crypto or whatever… But the people who come forward and ask for it, in the context of having two million customers, is hardly anything. People do ask for it, but we don’t think it’s going to be what our customers really need.”