WILL NEOBANKS SURVIVE?

Retail Banking is about credit risk and margins – will 'swish' marketing win the day?

‘Neobank’ is the new label given to digital banks that launched a decade ago.

Digital banks delivered primarily via the internet while Neobanks deliver via a smart phone app.

The ‘Neobank’ term rules out subsidiary app-based banks launched by bigger banks that operate using the existing bank’s legacy banking system.

A review of all digital banks in 2005 shows only two are still in business.

Will neobanks go the same way digital banks did?

Neobank founders love to talk about how dissatisfied consumers are with the big banks. Someone needs to tell the consumers.

While the neobanks made gains in primary bank status during the first half of 2020, they’ve done so predominantly at the expense of community banks and credit unions.

For example, among US consumers who opened a cheque (checking) account during Covid-19, 18% did so with a digital bank - up from the 6%.

Yet scale is still lacking as the following USA chart shows - the first neobank is Chime.

Structural issues are now the main issue

The UK’s Monzo was forced to raise capital at half its valuation and the offer was not fully subscribed, demonstrating the head winds.

Volt, one of Australia’s ‘hot’ new regulated neobanks was forced to raise funds at a half-price discount because of the Covid-19. The cut-price raising from cash-hungry Volt also came with inbuilt insurance to protect investors from any subsequent cheaper capital raisings.

 The most high profile neobanks are in the UK and USA.

The Sad Demise Of Europe’s Neobanks

David Dawkins Forbes Staff

Europe’s biggest neobanks – Revolut, N26, Monzo and Starling – promised to make banking better. Here was a fresh, new set of distinctly European tech startups sitting in the wallets of millions of genuine users – the familiar flash of neon colored cards in pubs, cafes and shops had sparked wildfire word-out-mouth marketing across the U.K. in particular.

From 2014 onwards, the challenger banks offered something simple, better, entirely online and free of the stodgy lineage of century-old banking brands for whom current account banking had become a largely loveless and loss-making exercise.

But the pandemic and the subsequent ‘new normal’ across Europe has pushed neobanks to the edge. With not a penny of profit yet between them, the pandemic was an opportunity for the startups to strengthen their relationship with users, and come out of the lockdown having proved their value over the big banks they sought to disrupt.

This simply didn’t happen. Instead the prospects of the European neobank withered, unused and unloved in the wallets of their users. For years, no one has had reason to question the claim that the bank of the future would be a neobank, but as revenues dwindle, regulatory obligations sap energy and long-serving staff wave goodbye, the basic promise of Europe’s neobanks to deliver on this is fading fast.

Dark Clouds

The first warning came in June when the U.K.’s shining star neobank, Monzo, saw its valuation drop from $2.6 billion in June 2019 to $1.6 billion. The darker clouds of fintech foreboding gathered later in July as poor financial results exposed what they described as “material uncertainties.” While having grown to 4 million accounts, the regulatory responsibilities of running a bank cost time and money, and the pandemic smashed Monzo’s tiny trickle of revenue as the few pence pocketed with every coffee paid for simply dried up at a time when spenders have stayed in, and stayed safe.

Monzo’s founders are fleeing – challenger bank poster boy Tom Blomfield stepped down as CEO in June, while in January this year co-founder Paul Rippon announced on Linkedin that he was stepping down to concentrate on farming his “300 alpacas” with his wife in Northumberland.

Meanwhile Revolut, the only neobank to mint a Forbes billionaire in founder Nikolay Storonsky, is certainly better at putting money in the till than its coral-colored card rival with revenues tripling in a year from $75 million in 2018 to $211 million in 2019 from its wider offering that includes crypto and gold. 

But Revolut has a cash burning problem. Staff numbers rising from 633 at the end of 2018 to 2,261 by 2019 is extreme. Its 13 million open accounts puts it miles out front in terms of users, but with costs of $352 million, up from $120 million the year previous, Revolut has simply trebled the size of a loss-making business.

Revolut itself knows this. In a slide from its April Town Hall, Revolut announced to staff that it had lost “operating leverage,” getting “fat and weak” in the process. That same month Revolut launched a company wide voluntary temporary salary sacrifice scheme to retake control. A spokesperson for Revolut told Forbes, “Like many businesses, as revenue reduced, we needed to reduce costs across the business.” While the arrival of $500 million in February in a deal led by California-based TCV, certainly helps, injecting cash straight into the main vein won’t last forever. 

Over in mainland Europe, N26 the German neobank with five million customers, revenue of $50 million and operating losses of $86 million is now licking its wounds over a chaotic row with its staff over soft unionisation (in the form of a more collaborative, workers board) late last week. Reports from Berlin of police being called, and a restraining order filed suggests all is not well.

Founder Valentin Stalf apologized for how the “debate” had “escalated,” after attempting to stop a meeting at a Berlin bar where staff were planning to vote on a Works Council, citing pandemic related health and safety concerns. A staffer told Forbes that this was less about covid expertise and more about union busting having recently claimed that “trust and confidence” in N26 management was “at an all time low.” Stalf denies this, claiming on LinkedIn, N26 was not “trying to stop the formation of a Works Council” and that N26 “fully support” efforts towards stronger representation. A statement described by the staffer as “external PR.”

Neobanks across Europe are simply struggling to adapt to the regulatory and business pressure that comes with their size and ambition, only over in Germany staff feel they’re now the punch-bag pressure release for N26’s banking struggles.

The Starling Darling

As N26, Monzo and Revolut have shared the headlines, Starling Bank, founded by experienced banking chief Anne Boden in January 2014, very much remains the darling of the U.K.’s challenger banks amongst analysts. Sending a clear message to her rivals, Boden wrote last week, “Growth is one thing … we’ve always kept costs under control,” adding that Starling could “break even” by the end of 2020.

The U.K. Government sees something in Starling and its mature, business-like approach to consumers and (revenue generating) business accounts alike saw Starling take on the government’s two lending schemes to support businesses during the pandemic. Starling can claim (in a small way) to be like Dyson and Palantir, a working part of the entrepreneurial infrastructure the U.K. government called on at a time of crisis.

However, despite its prestige, Starling has just 1.25 million customers – a number by itself unlikely to strike fear in the heart of execs at the U.K.’s high street banks. Hard, fast and painful disruption comes when a challenger arrives seemingly overnight offering something cheaper, better and bundled with energy. But having taken six years to hit a million accounts, the incumbent banks across Europe can see Starling slowly lumbering towards them, and presumably have the best part of a decade to reinvent themselves.

Analysis – Bank, Or Lifestyle Choice?

In just six months the tone from analysts and commentators has shifted.

For the experts at Pitchbook, the direction of travel here is clear. Emerging technology analyst Robert Le warns that if a neobank’s sole asset is their “millions” of customers, then they’re only really attractive to a “larger incumbent financial institution” better able to employ the parts of their business that make money. Le predicts a big bank buyout of a neobank in the “near- to mid-term,” sending at least one neobank back under the aegis of the big banks they sought to disrupt.

Accenture’s neobank expert Tom Merry says there’s still a “trust factor” at play here. Six years in and neobanks are really still more a banking bolt-on for millennial pocket money, with deposit amounts in the low hundreds, not thousands of dollars. Whilst the neobanks may hold the key to the customer’s heart through “experience,” Merry says, many customers still see incumbent banks as safer and more secure. Accenture’s Digital Banking Tracker found that the average deposit balance at Neobanks operating in the U.K. dropped by 25%, from $460 (￡350) to $340 (￡260) per customer across the second half of 2019. Again, the direction of travel here is clear.

With normality slowly returning, the coronavirus pandemic deepened our relationship with the businesses and technology which we came to rely on most.

But lockdown shows the consumer relationship with neobanks is simply not deepening. Standing balance losses aside, if all neobanks disappeared tomorrow, would anyone really miss them?

Starling, Revolut and Monzo’s annual results compared

Analysts weigh in on why digital banks are still heavily loss-making, and where their latest financial results leave them

By Isabel Woodford SIFTED by FT

The UK’s top three digital banking apps have all now released their financial results for 2019.

By most accounts, it was a surly reality check for the sector, which has attracted millions of consumer users but seem to be struggling to control costs. Digital banks also still seem to be grappling with how to seriously monetise current accounts — often dubbed the “low hanging fruit” of banking — and it remains to be seen whether their business models can confidently ride out the coronavirus.

Still, beyond these shared trends, it’s worth comparing how the three fintechs — Monzo, Revolut and Starling — performed in relation to one another.

Sifted also asked analysts and venture capitalists to share their top takeaways from the annual results.

The breakdown

 Each of the fintech’s annual results can be read in isolation at their corresponding websites or, in Revolut’s case, on Companies House.

It’s worth bearing in mind that each company follows slightly different reporting practices, and that these results are over 6 months old for the most part.

Revolut is also a slightly older company than the rest, launching in July 2015 in the UK, followed by Monzo in early 2016 and finally Starling in mid-2017.

Still, for ease, we have aggregated the core areas from each set of results below.

To reiterate, different accounting methods means there are deviations, especially in the revenues reported. Starling, for instance, does not include deferred income in its final revenues while others do. Meanwhile, Monzo’s total reported revenues included a sum of ￡10m in interchange fees that is handed back to third parties.

Starling has the most diversified revenue stream

Card transaction fees (known as interchange) still made up an important part of all three business models last year.

As noted above, 63% of Revolut’s revenues came from interchange while 55% of Monzo’s did.

But last year, Starling was the only one to have less than half (45%) of its revenues come from interchange, showing reduced dependence on a piecemeal income source that is ultimately pegged to how much people spend.

Instead, it also collected fees from its 80,000 business accounts, as well as having a handful of banking as a service (BaaS) customers, and from interest fees from lending and holding balances at the central bank.

Lourens Ruigrok, an investor at Finch Capital, praised Starling for having the most “sustainable” and least “fragile” revenue-model of the three fintechs. He also noted it was “more core to their customers.”

However, Starling’s marketplace model seems to have had disappointing results, bringing in just ￡72,000 in commission from connecting users to third party apps.

Revolut earns the most revenue per customer

By dividing revenue by the average number of customers in the year, you can get a rough estimate for how much each user generated in 2019.

In this area, Revolut led the pack, making ￡24 per customer per annum. It was followed by Starling with ￡21 and Monzo with ￡20.

This is partly because Revolut has the most customers, meaning it benefits from economies of scale, and also because it is most active in non-European markets where interchange fees are higher.

Fintech analyst Lex Sokolin says Revolut’s revenues put it confidently in the lead. Speaking on the Rebank podcast, he said: “￡160m in revenue… that number feels quite large and it does feel to some extent like a victory of building a large scalable business.”

He added: “There is definitely a big performance difference that we’re seeing between Monzo and Revolut, with Revolut pulling away quite significantly, ￡100m in revenue difference on the same burn number. And I think that’s going to be tough for Monzo.”

Revolut’s ability to pull in paid users via its subscription service also shows that its users see value in them.

Sokolin also referenced Revolut’s strength in pushing out new products quickly. He also estimates that Revolut squeezed out $5m–$10m in profit from their crypto-trading.

One investor, who questioned Revolut’s valuation earlier this year, also said they were more bullish on the company after comparing its latest figures to that of its peers.

Still, to clarify, all three fintechs’ revenues were burdened by losses involved in running and growing the businesses.

Moreover, in Revolut’s case, the direct cost of running each account is still larger than the revenue each customer generates — meaning it still has a negative gross margin. That could force it to think about scaling back existing growth projects.

Meanwhile, Monzo has now lost one of its key revenue sources, after regulators stepped in to stop them charging a steep 50p daily fee for unplanned overdrafts.

One positive for Monzo is its revenues are rising faster than costs.

Monzo’s revenue grew by 241% year-on-year, while its cost-base increased by only 159%. To put it another way, for every ￡1 spent in 2019, Monzo generated 37p; up from 28p in 2018.

Monzo’s unit-economics has improved such that each account now generates ￡4 in profit a year on average, when accounting exclusively for client servicing costs (rather than total costs, which include everything from salaries to marketing). This is a vast improvement from the net loss per account of ￡15 they recorded in 2018.

In contrast, Revolut’s cost-efficiency actually dropped. In 2018, it generated 64p per ￡1 spent, but in 2019 it dropped to 61p.

Starling holds the most deposits per customer

Collectively, the three challenger banks held ￡4.8bn in customer deposits at the last count.

That still makes them very small. By comparison, Virgin Money, one of the previous crop of “challenger” banks, has around ￡64bn in customer deposits; and Metro Bank has customer deposits of ￡14.5bn.

Still, one important point of comparison for Starling, Monzo and Revolut is how much money users deposit on average.

Starling leads here, pulling in ￡999 per user at the last count; largely due to its headstart in business banking, where deposits tend to be larger.

Monzo is now in second place, increasing its average user deposit rate to ￡357 from ￡142 in 2018.

Meanwhile, Revolut has dropped from having an average deposit of ￡252 per user in 2018, to ￡236.

Starling is also technically acquiring customers the fastest in the UK, when adjusting for its age, as shown in the graph below. This reflects the fintechs’ pace of growth in their home markets from their launch date.

Last data point from Dec 2019

Note, this does not illustrate the rate of active customers or the churn rate for each fintech; data which is difficult to access.

Nobody won on lending

Both Monzo and Starling began lending last year (Revolut is not a UK bank so cannot lend off its own balance sheet).

Yet Marc Rubinstein, a former hedge fund analyst calculated that “lending is hurting” the banks, with predicted losses outweighing the interest they earnt from loans last year.

For instance, Starling recorded ￡2.1m in interest income from customers but has ￡2.2m in provisions for bad loans.

As a result, Rubinstein concludes that Starling and Monzo would “have been better off not lending a penny” in 2019; particularly Monzo, who he shows below has a much riskier loan book than Starling.

Moreover, Finch’s Lourens Ruigrok told Sifted that digital banks will now have to resist pressure to grow their loan books at all costs.

“Lending seems to be the most obvious opportunity to monetise but has its challenges. Strong knowledge of how to effectively lend money and run a healthy loan book are key and loan books don’t scale like VCs want them to.”

Still, Starling says its lending book has already grown rapidly in the financial year of 2020, thanks to its role in deploying government-backed loans.

Note; the reports do not make clear how much the banks actually had in realised losses from loan defaults.

Worth their valuations?

Analyst Lex Sokolin argues none of the fintechs’ unit economics are particularly compelling relative to their valuations.

“If you look at the unicorn valuations of these companies, they are pricing on a per user basis valuation somewhere like $1,000…in enterprise value per user. So you take the 5 billion [dollar valuation] divided by the number of customers,” he noted, speaking on the Rebank podcast.

“The reality is all of these companies are making 20 to 30 bucks a year per customer. And so for me that’s the core existential question; how do you go from 30 bucks a year per customer in revenue probably at a loss to 1,000 bucks per customer in enterprise value?”

He concluded:

“Are these banks at all or are they media companies with financial services monetisation?”

Unfortunately for Monzo, given its burn rate and the size of its recent fundraise, it will be the first to put this question to investors again.