The neobanking evolution

Neobanks are changing the financial landscape by offering consumers a digital banking experience that is often more accessible and streamlined than traditional banks.

In this article, we will explain what a neobank is and how it differs from traditional banks, explain the pros and cons, and set you on your journey to starting your neobank.

What is a neobank?

A neobank, sometimes referred to as 'challenger banks' in the UK, is a nimble financial institute that operates wholly online.

Unlike the traditional financial institution model, neobanks are primarily digital banking platforms that operate without physical branches, but they should not be mistaken for, what is commonly referred to as an "online bank." While online banks have a banking charter and offer a wider range of services, including loans, neobanks tend to focus on core online banking services that are delivered digitally.

The goal of these digital banks is to offer digital services and apps that streamline the banking experience for consumers, while often focussing on a specific area.

There are two types of neobanks:

Full-stack

Full-stack neobanks obtain their own banking license, allowing them to operate independently and offer a wider range of financial services directly. They have greater control over their operations, product development, and pricing strategies.

Front-end-focused

Front-end-focused neobanks partner with traditional banks to leverage their core banking infrastructure and services. They focus on developing a user-friendly interface and offering innovative features on top of the existing banking platform. Partnering with established banks allows for a quicker launch and avoids the complexities of obtaining a banking license.

Are neobanks FDIC insured?

It’s an important question to ask; if a consumer’s money isn’t safe then the company has already failed in one of its primary functions.

Just like traditional banks, neobanks are subject to regulatory requirements and must adhere to the same standards for security, privacy, and financial stability. This ensures that neobanks operate safely and securely, protecting the interests of their customers and the wider financial system.

Most neobanks partner with traditional banks holding bank charters, complying with regulations, and having Federal Deposit Insurance Corporation (FDIC) insurance. The eligibility of neobank account funds for FDIC insurance varies based on account opening methods and the location of the funds.

In contrast, some neobanks are chartered banks in their own right. The time-consuming process of acquiring a banking charter explains why many neobanks opt for partnerships with traditional banks, with the latter managing insurance and regulatory aspects, while neobanks focus on customer service and online operations.

Neobanks with FDIC coverage can lend, safeguard deposits, and offer standard financial services.

Why are neobanks popular?

The popularity of neobanks stems from several key factors. Firstly, their user-friendly interfaces make banking more accessible and intuitive for individuals of all backgrounds. This ease of use eliminates barriers and simplifies financial management for customers.

Moreover, neobanks are known for their cost-effective fee structures. By operating digitally and without the overhead expenses of physical branches - unlike the traditional financial services industry - neobanks can offer competitive fees or even fee-free services, saving customers money in the long run.

Neobanks also employ unique credit analysis methods that cater to underserved individuals. These alternative approaches allow neobanks to assess creditworthiness using non-traditional data points, enabling them to extend credit cards, checking accounts, and other financial services to individuals who may have otherwise been excluded from the traditional banking system.

How do neobanks make money?

Neobanks generate revenue through various channels, leveraging their cost-effective operations and expanding service offerings. Here's a breakdown of their revenue streams:

1. Interchange fees – Neobanks earn a portion of the interchange fees paid by merchants when customers use their debit or credit cards.

2. Interest on loans and credit cards – Some neobanks offer loans and credit cards, enabling them to earn interest on these products and diversify their revenue streams.

3. Transaction fees – While many neobanks avoid traditional account maintenance fees, they may charge small fees for specific transactions like international money transfers, ATM withdrawals outside their network, or expedited check processing.

4. Subscription fees – Neobanks may offer premium tiers with additional features and benefits, generating recurring revenue.

5. Partnerships and integrations – Neobanks establish strategic alliances with financial institutions or financial technology companies to provide integrated services within their platform. This can involve revenue-sharing agreements or referral fees for the partner bank.

Neobanks have diverse revenue models tailored to their target market, product offerings, and regulatory environment. Their lean operations allow them to achieve profitability with a smaller revenue stream compared to traditional banks.

How to charge fees for outgoing transfers?

How it works?

How to connect a digital wallet with a bank?

How it works?

What is an example of a neobank?

Here are a few examples of the various neobanks in the market:

Varo Bank

Founded in 2015, Varo Bank is an all-mobile neobank that offers checking and savings accounts. It obtained a full-service national banking charter from the Office of the Comptroller of the Currency (OCC) in 2020, effectively transforming it into a fully-fledged bank

Current

Current refers to itself as a "financial technology company," that was established to help American citizens who were underserved by the traditional banking system. Some of the services offered by Current Bank include mobile check deposits, peer-to-peer payments, and ATM fee reimbursements.

Revolut

This British-Lithuanian neobank that focuses on borderless transactions, savings options, retirement annuities, and more to consumers and businesses. One Revolut's core features is the issuing of physical and virtual Visa-backed cards that can be used in a wide range of companies, have set spending limits, etc.

Chime

Chime is one of the largest neobanks in the US and was founded in 2013. It provides various banking services such as checking and savings accounts, debit cards, and mobile banking features. Additionally, it offers an early direct deposit service that allows customers to receive their paycheck up to two days in advance and has no monthly fees, overdraft fees, or minimum balance requirements.

N26

N26 is a neobank headquartered in Germany that offers banking services like checking and savings accounts, debit cards, and mobile banking features in Europe and the United States. It is known for its transparent fee structure and security features such as two-factor authentication and real-time transaction notifications, providing customers with a secure and user-friendly banking experience.

How are neobanks different from traditional banks?

The primary distinction between neobanks and traditional banks lies in the delivery of services. Unlike traditional banks, neobanks prioritise digital platforms, offering services exclusively online.

Every single customer interaction and core banking service is handled online, simplifying interactions and removing bureaucratic and legacy hurdles that consumers often face.

In contrast, traditional banks provide both in-person and digital services, often through their mobile banking apps.

Why are neo-banks incorporating crypto-friendly solutions?

Neo-banks are embracing crypto-friendly solutions to cater to customers involved in the crypto space and to align with digital innovation in finance. By leveraging blockchain technology, they streamline transactions, reduce fees, and appeal to customers seeking faster, more efficient financial services.

Offering unique services like seamless crypto trading and crypto-backed loans, neo-banks differentiate themselves and enhance platform security, fostering trust with customers.

How to start a neobank?

Here are a few steps to guide you when starting a neobank:

1. Create a business plan – Like any company, you will need to develop a business plan. Who is the target market? What will be your revenue streams? Who are your competitors? How much will the operation cost to start and fund?
2. Obtain a licence – This is an incredibly expensive and time-consuming task that will require your organisation to comply with a variety of banking and financial regulations. Or, you can use an agency licence to get you there faster and without breaking the bank.
3. Compliance and risk - This involves compliance with industry standards such as AML, safeguarding customer funds, FCA reporting and more.
4. Your platform – You will need a substantial technology stack to launch a digital bank. And you'll need to decide between building it from scratch or using an infrastructure that is pre-built.
5. Create partnerships – Like most companies, neobanks can live or die by their relationships with other organisations. You'll need to establish partnerships with a wide array of third-party providers.
6. Launch and iterate – The beauty of a neobank is its app-driven structure. The offering can be launched to select customers, gain their feedback, and keep tweaking the offering before it is ready for the general public.

For more information on how Fintech infrastructure tech stack to compliment your business needs - contact one our team members.