Neobanks: Creating growth trajectories amid challenges

Despite their success, Neobanks face regulatory scrutiny, profitability challenges and stiff competition. How have these digital banks evolved to successfully challenge traditional financial institutions?

Digital banking has become mainstream, with digital-only banks - commonly called neobanks being widely accepted for their convenience and accessibility.

Neobanks have moved beyond niche status, becoming integral to the everyday financial lives of a diverse customer base. Their user-friendly interfaces, low fees, personalised financial solutions and seamless digital experiences are challenging their legacy counterparts.

The appeal of neobanks

The pandemic significantly accelerated the adoption of digital banking solutions as consumers and businesses sought contactless and remote banking options. This shift led to a substantial increase in user numbers for neobanks as the demand for digital-first banking services grew, drawing people away from traditional banks.

According to GlobalData’s Payment Instrument Analytics, digital payments accounted for 22% of all transactions in 2013 but have grown to 63% in 2023, indicating a widespread shift towards digital banking services. This steady increase in digital payments, now the majority of all transactions, underscores the rising adoption of digital banking, which has fueled the rapid growth and substantial investment in neobanks.

These digital-only banks are gaining popularity among all age groups, including older customers. GlobalData’s 2023 Financial Services Consumer Survey revealed that nearly 22% of 55-64-year-olds and 15.5% of those 65 and above prefer digital banks or payment apps for new accounts. This trend is promising for neobanks, as older customers are typically wealthier, and wealthy clients can generate more revenue for the banks by drawing on lines of credit and investment services.

Several key players, such as Brazil’s Nubank, UK-based Revolut, San Francisco–based Chime, and Germany’s N26, have been instrumental in this transformation. For instance, Nubank, a leading digital financial services platform, added 4.8 million customers in Q4 2023 alone, achieving a total of 93.9 million customers globally by December 2023—up from 54 million just two years prior.

Similarly, Revolut expanded its user base from around 10 million in early 2020 to over 25 million by mid-2023, demonstrating significant growth across countries like the UK, Romania, Poland, Spain and France.

Investors were attracted by this high growth potential and the ability of these digital banks to acquire customers, further fueling their expansion rapidly. Thus, venture capital funding for neobanks surged during this period. In the US, neobanks such as Chime and Current raised significant funds during the pandemic. Chime’s valuation soared to $14.5bn in 2020 after a $485m funding round, making it one of the highest-valued neobanks globally.

But amid all this success, the digital banking industry is not without its challenges.

Increasing regulatory scrutiny

As neobanks expanded, they also encountered heightened regulatory scrutiny, particularly concerning security, data privacy and compliance. A case in point is Australian neobank Xinja’s decision to return its banking licence and cease operations in 2020 due to difficulties in raising capital and meeting regulatory requirements imposed by the Australian Prudential Regulation Authority (APRA).

Like Xinja, N26 faced several challenges up until 2022. The bank was fined by German financial regulator BaFin in 2021 for inadequate antimoney laundering controls and again in 2022 for late filing of suspicious activity reports, leading to increased compliance costs and operational challenges. Additionally, the neobank withdrew from the UK market in 2020, citing Brexit and new regulations as the reason, and from the US in 2022 due to operational and regulatory difficulties, which impacted its growth ambitions in these markets.

Profitability challenges

Achieving profitability has been another significant challenge for neobanks. High customer acquisition costs and competitive pricing models put considerable pressure on margins.

Nubank’s stock price fluctuated due to investor scepticism about its profit margins and long-term sustainability. Although the neobank was founded in 2013, it was not until the third quarter of 2022 that Nubank finally reported a net profit of $7.8m, a first in its history.

Revolut also faced profitability challenges as it scaled, reporting substantial losses due to high operating costs and significant investments in product development and market entry. In 2021, Revolut reported a pre-tax loss of ￡207m despite doubling its revenue to ￡261m, highlighting the thin margins and high costs associated with its growth strategy.

This was a common theme among many neobanks that faced the challenge of balancing rapid growth with sustainable profitability.

Neobank setbacks

The market’s saturation with numerous players led to intense competition among neobanks and the challenge of convincing consumers to switch providers. Neobanks needed to effectively market themselves to customers who are most likely to switch or, in general, give consumers a good reason to move providers.

GlobalData research indicates that while 36.9% of consumers say they might switch their main account provider in the next 12 months, the actual number who do so is much lower.

However, customer acquisition is just one part of the process, and an expensive one. Offering fee-free accounts or attractive savings rates incurs costs without generating revenue. Much can be learned from Australian neobank Xinja and France’s Orange Bank.

Xinja’s failure stemmed from prioritising growth over a sustainable business model. Its sole product, a high-interest account, generated no income. Plans for a home loan product never materialised, and regulatory delays in pledged capital further strained the bank. Without a revenuegenerating product at launch, Xinja couldn’t sustain its operations and had to close in December 2020.

In contrast, Orange Bank’s demise was ultimately driven by the lack of a clear market differentiator compared to existing online competitors. This hampered its ability to drive the customer acquisition numbers needed to fuel its revenue growth and push the bank towards improving its bottom line. After incurring $1.1bn in losses since its inception, the bank entered negotiations to sell its retail banking division to BNP Paribas in June 2023.

To be sustainable and attract further investment, neobanks must eventually turn a profit. In order to achieve this, they must also have a revenuegenerating product at launch (or shortly after) to offset their costs. Without a revenue stream, a neobank may have to close.

A turning point

Fortunately for the industry, 2023 marked a turning point characterised by market rationalisation, increased regulatory scrutiny, a shift towards profitability and ongoing innovation in technology and products.

Several factors contributed to this shift. The influx of venture capital slowed down in 2023 due to economic uncertainties and a focus on sustainable growth over rapid expansion. Additionally, some neobanks faced valuation corrections as investors became more cautious and focused on profitability and clear business models

Regulators introduced stricter rules and guidelines to ensure the stability and security of digital banking operations. Compliance costs increased, impacting the operational models of neobanks. As a result, neobanks started prioritising costcutting measures and operational efficiency and focused on sustainable business practices.

There was also a strategic shift towards diversifying revenue streams. Neobanks expanded their offerings beyond basic banking services to include loans, insurance and investment products, striving to create comprehensive financial ecosystems. They also explored fee-based services, premium accounts and business banking solutions. In the US, for example, where monthly account fees are standard, neobanks such as Chime have attracted low-income customers by offering fee-free accounts.

The diversification of product offerings helped improve their performance aided by rising interest rates. GlobalData analysis highlights that higher lending margins boosted by higher rates helped neobanks obtain greater profits from their lending solutions, and that many digital providers, who were previously loss-making, achieved full-year profits in 2023. For example, Londonbased online bank Monzo achieved profitability for the first time in 2023, reporting its first monthly profits in January and February.

Despite challenges in previous years, Monzo reached 9 million personal and 400,000 business customers, launched new products, and closed a ￡489.5m capital raise in FY2024, reporting its first year of profitability. Monzo’s success is primarily attributed to its vastly increased lending portfolio, driven by an increase in the use of its buy now pay later (Monzo Flex), overdraft and loan products.

Outlook

While neobanks have gained popularity and a significant customer base, their path to profitability has been challenging. Despite this, some neobanks, including Monzo and Nubank have begun to show promising signs of profitability. This indicates neobanks have the potential to achieve sustainable profitability over the long term.

With the global neobanking market projected to grow at a compound annual growth rate (CAGR) of 54.8% from 2023 to 2030, as per Grand View Research, neobanks are faced with a mix of challenges and opportunities. Their growth will be driven by clear differentiation strategies, higher demand for digital banking, product diversification and advancements in fintech infrastructure.

As in the past, the ability of neobanks to innovate and adapt to the changing market dynamics will be crucial for their survival and profitability.