Neobanks, the Future of Banking

As of February 2022, there are more than 250 neobanks worldwide. Almost all of them are working in a niche, targeting a specific product (loans, payments, wealth), customer segment (retail, business) or community (youth, temporary workers, immigrants). They are all trying to get a piece of the market.

Another thing they have in common is the declared intention to disrupt established banks and take them out of business. Therefore, banks must choose the technological architecture that allows them to offer a better customer experience and compete with neobanks.

In the era of digital transformation, the challenge for traditional financial institutions is to step up to meet the growing demands of new-age customers. Furthermore, the rapid rise of neobanks is giving tough competition to these banks, which still operate on legacy systems. In fact, neobanks, or digital-only banks, are eroding the market share of established banks.

For traditional banks to survive and remain competitive in this rapidly evolving digital age, the only way forward is to accelerate their digital transformation. The need is to take a digital-first approach by digitizing your core banking system and offering better customer engagement and a personalized experience.

What's so special about neobanks?

With a fully digital approach, neobanks provide seamless banking services to customers that can be accessed through a smartphone.

Rewards and gamification are some of the ways neobanks are attracting customer attention.

The neobanking industry is seeing new players every day. Most of them are creating a micro-niche like Nerve, a new neobank that aims to serve the unique needs of professional musicians. Verizon is entering the neobank space with an offering specifically for kids and teens called "Family Money."

While neobanks may focus their initial efforts on competing with established banks, they will soon find themselves surrounded by competition from big tech and consumer-facing brands that consume BaaS services to serve customers.

The future of neobanks

A discussion of the future of neobanks is incomplete without integrated finance and the kind of key it holds for the future. Embedded Finance is a fintech model where brands can leverage APIs to integrate banking and finance functions into their apps and ecosystem.

It opens up new opportunities for fintech and brands to create more customer-specific solutions. It reduces development and compliance costs, allowing neobanks to lease licenses and provide access to fintech- and brand-specific banking stacks.

Integrated financial services create room for improved efficiency, seamless integration, and intuitive flow by removing intrusions into a platform's customer journey.

In addition, the essential characteristics of these services are the affordability of credit and personalized and in-context financial offers. Recent EY research states that 63% of people would 'highly value' integrated finance and open banking solutions to create personalized experiences due to ease of use.

To understand better, we can have an example. Suppose an eCommerce brand has integration with an embedded finance solution. Most customers research products they wish to buy, make a list, and end up buying a small fraction of the list due to budget constraints. By analyzing the purchase pattern, transaction messages, and other factors, the brand decides the customer’s creditworthiness and extends a small loan or a buy now pay later (BNPL) offer to the customer. The customer will most likely buy most of the products on the list to pay later.

The example above is just the tip of the iceberg of what brands can achieve with integrated finance. There can be millions of use cases based on the brand, what they sell, their customers, and the customer journey.

Digital Transformation of Banks

For millennials, customer experience is a critical factor when choosing a bank. Therefore, the need of the hour is a seamless, instant and convenient banking experience. Banks are therefore aggressively investing in front-end channels (mobile, internet, handheld, etc.), thus improving the experience and increasing engagement.

Banks have a new responsibility: to integrate digital financial services into their systems. The goal is to meet the expectations of new and dynamically changing customers while improving their competitive positions.

So what strategies can banks adopt to enhance their digital transformation to compete with neobanks?

1. Progressive modernization: For this, customer journeys are reinvented from beginning to end, starting from scratch and leaving all existing notions aside. Modular microservices with shared utilities are introduced, iteratively creating the new business logic. To adopt this approach, the current core must be robust enough to last five to ten years.

2. Greenfield Tech Stack: This approach leverages cloud-native architecture. New customers are added to the new platform and existing ones are migrated. This approach is the passport to the fastest possible transformation and can potentially be implemented with the lowest investment.

In conclusion

Neobanks are entering the banking industry at a crucial time. As the industry repeatedly unbundles and bundles, it presents various opportunities for neobanks, tech giants, and other non-bank players.

The way to respond is to use first principles thinking and build a differentiated business model around getting customers' work done, to create and deliver unique customer value through better offerings, engaging experiences and partnerships with a purpose.

Simply put, technology will continue to play an essential role in "digital banking" by making banking and payment services more personalized and ubiquitous across devices.