Neo Upstarts: Virtual Banks in the Real World

An overview and a brief history of digital banking, by Vlad Lounegov, CEO of Mbanq

Think back to years past: do you remember how bank branch visits were a regular thing for almost every household? Fun at times, but mostly tedious, it seemed as though the paperwork would never end.

However, in recent years, we’ve seen an increase in smartphone usage. What’s more, access to the internet grew rapidly for the global population and created a vast new customer base for digital banking – this led to the digitization of other segments in the FinTech ecosystem, including payments, lending, and insurance. Against this background, we’re witnessing the emergence of neobanks as contenders to traditional banking solutions.

A quick overview: neobanks are digital-only banks that deliver financial services primarily through the internet or other digital channels. They are standalone entities that have no physical branches.

Neobanking startups have been growing steadily over the last few years. Before 2010, there were eight such startups; by 2014, the number rose to 26, and since then, it has increased to 79.

Funding figures tell a similar story: in March 2018, neobanks were ranked second in terms of FinTech segments with the highest funding, having raised $586.7 million in five high-value deals across the world.

The recent growth of neobanks is impressive, but their origin, rather surprisingly, dates back further. An early iteration of a digital bank can be traced back to over 35 years ago. In the UK, Nottingham pioneered internet banking with its launch of HomeLink in 1983. Though nascent in its development and not offering many services, it set a precedent and was followed by several American and European banks that went on to establish online service units in the 1990s and 2000s.

Subsequently, other banks saw the opportunity to develop subsidiaries of their own. In 2000, Singapore allowed existing banks to develop internet-only banks, as long as they operated within the traditional banking system. Similar trends cropped up in other regions as well. Jibun Bank was Japan’s first digital bank, which was established jointly by KDDI and Mitsubishi UFJ Bank in 2008. Although traditional banks may have been the first to jump onto the bandwagon with their digital offerings, FinTechs have taken the game ahead.

Today, neobanks have proliferated across the globe – about 40% of neobanks are in Europe; the US has about 27%; while Asia, LATAM, and Africa remain key emerging markets.

Global legislation that regulates neobanking is not far behind. Australia has established itself in the regulatory space by providing restricted deposit-taking institution licenses to neobanks such as Volt Bank and Xinja in 2018. Volt went on to obtain a full-banking license early this year. Similarly, Europe is providing neobanks with full banking licenses, with several FinTechs taking the lead, including Revolut. Moreover, the Monetary Authority of Singapore (MAS) recently announced 5 digital-only banking licenses, in addition to those held by existing banks. Hong Kong has also issued 8 licenses from 29 applications.

Certainly, neobanks are a growing phenomenon, but what makes them so popular?

Legacy systems and a lack of innovation culture have made it difficult for traditional banks to satisfy new consumer needs. Neobanks, in contrast, offer newer features straight out of the gate, even from the first customer interaction, customer onboarding. And they are not slowing down with services or ideas.

Moreover, neobanks have managed to tap into segments that were previously underserved or for people who found it cumbersome to engage with traditional banks. These include customers who don’t have access to a bank branch, migrants without sufficient paperwork, SMEs that face difficulty in receiving credit, and young people or freelancers in the gig economy who prefer to have their accounts accessible at their convenience.

While neobanks continue to innovate, it is unlikely they will eradicate the traditional banking model. Cash is still used by many across the world, and smartphone penetration, while increasing, hasn’t reached 100%, and neither has internet access. Although millennials are increasingly dissatisfied with their present banking experiences, they also tend to keep their options open. Most importantly, trust in traditional banks is difficult to replace.

Despite this, one thing is certain – the opportunities presented by neobanks are very real. FinTechs and banks will continue to improve their digital-banking offerings, and traditional banks find themselves in a digital innovation arms race, competing with neo upstarts who have entered the real world of banking.