For a long time, banking meant a drive to the nearest branch. Money mostly moved as paper bills and paper checks. This only really started to change in the 1960s, as credit cards became widely adopted.
Obviously, a lot has changed since then. More and more of our daily life moves online, and many banks and credit unions have taken their financial services into the digital space with online banking and mobile banking.
In recent years, traditional financial institutions have faced hot competition from a new type of challenger: the so-called neobank.
Neobanks — which have no branches, and typically aren’t actual “banks” in the legal sense — are disrupting the banking industry, leveraging emerging technology to lower costs and attract a younger cohort of consumers.
Here's what you need to know about what neobanks are, how they’ve taken shape, and where they may take consumers in the future.
Neobanks are financial technology (fintech) companies that offer digital banking services. Unlike traditional banks, they have no physical branches. They operate entirely online. In the UK, neobanks are also called challenger banks, because they compete with established banks for business.
Compared to traditional financial institutions, neobanks offer fewer, but more specialized, services.
They typically focus on the basics, like opening a checking or savings account, transferring money to individuals or businesses, and receiving direct deposit or mobile check deposit.
Many neobanks offer tools that help consumers with specific goals, like budgeting and saving. Most offer limited-to-no credit services. Some neobanks offer loans to individuals and businesses, but they do so through partnerships with other financial institutions. They can’t lend money themselves, because as mentioned, most neobanks are not actually banks, legally speaking.
Despite their more limited offerings, these new challengers in the neobanking industry are increasing in popularity. One reason for this is they're making banking more accessible and convenient. An entirely online banking experience means that consumers don't need to travel to their nearest physical branch or worry about operating hours. Many neobanks specifically target niche groups, like young people just starting out with personal finance who have a native preference for doing almost everything on their phone.
Neobanks operate on the Banking as a Service (BaaS) model, and fall into one of three categories:
A non-licensed entity that partners with a traditional bank, enabling Federal Deposit Insurance Corporation (FDIC) protection, like Chime®,
A digital-only initiative by a traditional financial institution that’s a subsidiary of that institution, like Marcus® by Goldman Sachs, or
A neobank with a digital banking license, like Varo®.
There are currently very few neobanks that fall into the third category. Most partner with existing banks to offer their core banking services. That partnership can also enable additional banking service offerings, like loans and credit cards.
While a traditional bank earns most of its income from interest and banking fees on credit cards, checking accounts, and savings accounts, a neobank makes most of its revenue from the interchange fees that merchants pay when customers use their debit cards to make a purchase.
Due to a smaller footprint and lower overhead, neobanks can charge interchange fees (transaction fees that merchants pay when customers swipe or tap their cards) up to seven times higher than traditional financial institutions. Their ATM withdrawal fees may be higher, too. Some also use freemium or subscription pricing strategies, which involve charging higher prices for additional benefits or services.
An entirely online or mobile banking experience comes with a few perks:
Lower fees. Without physical locations, neobanks don't have the same operating and overhead costs as traditional banks and credit unions. As such, their fees are typically much lower or non-existent.
Convenience. Customers can access their bank account at any time from any location. They can open a bank account, check their balances, and manage their finances from their phone
Ease of use. Neobanks tend to focus on creating smooth, seamless digital banking experiences. Fintechs design their systems to be user-friendly and intuitive while also ensuring they can cater to the complex needs of each customer
Faster processing times. Consumers can open a checking or savings account with minimal effort and provide the necessary documentation digitally
Unlike many other industries, the banking sector has been held back from adapting to the digital world by strict regulations, legacy technology, and diverse customer needs. That delay created a need, and fintech companies answered the call.
The use of established and emerging technologies like AI, cloud computing, and blockchain have been combined in different ways by different neobanks to boost functionality, enable faster transaction processing, and decrease operational costs.
The flexible nature of neobanks puts them in a position to capture niche markets that traditional banks can't reach. One such market is gig workers. The products and services traditional banks offer don't typically meet the needs of freelancers and contractors. By making it easier to open banking accounts, offering instant digital payment solutions, and using alternative methods for assessing creditworthiness, neobanks give gig workers what they need to succeed.
Other niches that neobanks cater to include new-to credit customers like recent high school graduates and college students, thin-file customers with fewer than five credit accounts on their credit reports, small and medium-sized enterprises that might not have the same access to essential services at larger financial institutions, and unbanked individuals that lack access to the products and services traditional banks provide, including underprivileged individuals and those in underserved communities.
Neobanks aren't only shaking up traditional financial institutions: They're also disrupting mobile banking.
With the advent of smartphones and tablets, mobile banking has become a service that an increasing number of banks or other financial institutions provide, and that younger consumers increasingly demand. It enables customers to perform a variety of financial transactions remotely, typically with a mobile banking app. Customers can manage their banking needs from their phones rather than visiting a physical branch in person.
Neobanks have been able to create better online mobile banking experiences because they’re building new technology, not trying to work around the limitations of existing software.
Common drawbacks of mobile banking from legacy banks include security concerns, lag time in being able to access deposited funds, the inability to complete loan applications entirely online, and caps on the number of transactions and a cap on the number of transactions a customer can perform in a given time period.
Neobanks tend to put a lot of thought into their design and their technological stack, so they may seem to have the advantage when it comes to digital savvy. But that doesn't mean traditional banks aren’t keeping pace.
Traditional banks and credit unions with a competitive suite of digital services — like mobile check deposit, bill pay, and online loan approvals — are finding ways to compete against the relatively lean and agile neobanks. Many have a robust mobile app, which is an increasingly important feature, or old-school but reliable online banking features.
That said, a lot of small banks and credit unions simply can’t devote the resources to regularly upgrading their technology. Some are partnering with neobanks or other digital-only fintechs. Local, community-based financial institutions in particular are compelled to partner with tech-forward companies in order to compete against the bottomless pockets of megabanks.
A partnership between a traditional financial institution and a fintech or neobank could prove beneficial for both parties. Traditional banks could reach more customers, and neobanks could offer a wider suite of services and products. But could is a key word here: Some fintechs partner with small banks and credit unions just to subtly erode their customer base, wounding the community financial institutions in the long run.
While neobanks might be skipping ahead of the traditional banking industry in some respects, they haven't taken over — at least not yet. They might be popular, but they're still new, their offerings are limited, and they are relatively unproven in an industry dominated by old, entrenched laws and institutions.
That said, neobanks have identified some inefficiencies in traditional banking, and are innovating technological approaches to solve them. They're targeting the young and unbanked, and for that reason alone are a phenomenon that we’re likely to see stick around for a while.