January 7, 2020
Hong Kong’s ZA Bank has become the first of the eight virtual banks that won banking licenses in 2019 to launch services. In December 2019, it started the trial run within the HKMA’s FinTech Supervisory Sandbox. ZA Bank’s initial service offering allows around 2000 users to try its services that include remote account opening, multi-currency savings account, time deposits, local transfers, and e-statements. ZA Bank and seven other players have opted to go for licenses to become a neobank. However, that is not the only way to establish a neobank, and this is what we will discuss in this article.
When the first neobank Cashplus started in 2005, they didn’t know that later they would be classified/termed as a neobank. They had started from prepaid card offerings but moved to offer instant approval digital current accounts for consumers and SMEs, foreign currency cards, and business and employee expense solutions. For 12 years, Cashplus operated without a banking license; it finally applied for one in 2017. Fidor, Simple, N26, Revolut, Monzo, etc., are some of the better-known names in the neobanking history.
Neobanks offer services such as creating and operating a savings account, payment of bills or money transfers, loans to individuals and businesses, and other such services directly on their mobile phone or via any other digital platform. Unlike various traditional banks, these banks do not have any physical branches. These companies target largely younger generations who are willing to accept a bank that has no physical presence.
The neobanking landscape is an amalgamation of non-licensed, over-the-top banks, digital initiatives of traditional banks, and licensed neobanks.
One of these options is to obtain a virtual banking license from the government and start full-fledged banking services on a mobile app or via any other digital touchpoints without any physical branches. Examples of the same are Fidor, a German bank founded in 2009, which has been operating as a neobank in the UK since 2015, or Revolut and Monzo that were founded in 2015 in the UK. However, not many countries have defined their virtual banking policy, which means there has to be another way to do it.
Another model comprises of these companies partnering with existing banks and providing customer relationship services. They offer better user experience and develop various tools that can make the onboarding and transactional experience simpler for customers. As these companies work on a partnership model, the obligation to follow the regulatory requirements is on their partner banks. This is a risk-light model for OTT neobanks. E.g., in lending, the credit risk is borne by the partner banks. Also, partnering with the neobanks helps traditional banks in overcoming the loopholes of the current banking systems along with improvement in the quality of banking services. Another noteworthy and highly impactful benefit for traditional banks is the neobanks’ ability to augment the distribution network of incumbent banks. Traditional banks will also save in-house research costs for providing their customers a better experience, as they will have multiple FinTech companies to choose from for doing the same for them. Examples of these models include Open, Chime, Tide, and others.
Apart from these pureplay neobanks, there are digital-only initiatives by banks, such as digibank (by DBS) or Marcus by Goldman Sachs. These are stand-alone, digital-only banks created by traditional banks; they use cutting edge technology and innovative digital-centric products & services to service customers. These digital banks mostly use completely new technology platforms, thereby reducing dependencies on their parents’ legacy technology platforms and increasing agility and responsiveness in go-to-market. They are targeted at the niche segments as opposed to universal customer segments by traditional banks, as well as to provide best-in-class innovative banking services.
It is important to note that India does not have a virtual banking license policy yet. But the regulatory development in the area looks optimistic.
Founded in 2017, Open is Asia’s first neobanking platform for small and medium-scale businesses and startups. Open’s choice to go for partnership with bank is obvious – there is no other way, and it echoes in the words of Anish Achutan (CEO at Open), when he says, “Since getting a banking license is pretty hard in the Indian market, the only approach is to partner with a traditional bank.”
Open’s platform offers end-to-end business banking solutions, which include providing current account services, business payments, expenses management, and other similar services based on banking APIs. Open has ICICI Bank as its primary partner, along with 11 other banks. Commenting on Open’s partnerships, Anish said, “Being the first to offer an SME-focused neobanking platform in Asia, Open has been able to build the leadership in the segment (250,000 SMEs & 7 billion USD in annualized transaction processing) and was also able to build strategic alliances with 12 banks (ICICI being the primary banking partner) and VISA (card network).”
The main challenges that emerging neobanks face are targeting various consumer segments, arriving at the right product-market fit for addressable customer segments, making decisions relating to partnering with traditional banks, and adapting to regulatory requirements of the region to be followed. The ability to scale-up for different geographies and market segments poses a challenge in the growth stage if not planned in advance. Targeting a specific set of consumers is an extremely important decision, one which has to be taken after an intense research of the economy of the region. E.g., Brazil-based Nubank identified that despite credit card penetration, APRs were skyrocketing in the country, and a few banks who dominated the market were complacent towards customers’ agony. So Nubank targeted retail customers with their low-interest rate credit card offerings. In India, when Open was to decide on its addressable segment, the choice was obvious: the SMEs. Anish says, “We wanted to cater to the segments that banks had side-lined to date – SMEs & startups.”
In the cases where an emerging neobank decides to go for the partnership model or a combined model of license plus partnership, the decision of partnering with banks has to be taken after considering multiple factors. The research and development done by the neobank itself and partner bank’s digital & banking API capabilities need to be analyzed before getting into a partnership. When Open started to explore partnerships, technology limitations were the biggest challenge from the partners’ end. The core banking systems used by most banks did not meet some of the expectations for modern digital services. Hence most banks were not able to expose their banking APIs. The positive thing to note is that conditions have improved a lot, and Indian banks have worked on their capabilities to work with FinTech partners.
Over the years, legacy systems or Core Banking Solutions (CBS) have undergone cycles of change, to meet a wide range of requirements. This has presented financial institutions with multiple challenges with respect to updating their existing systems. For instance, ‘knowledge transfer,’ ‘undocumented logic,’ ‘technical debt,’ and a ‘skills/desire gap’ are among the factors that come as obstacles to making CBS more versatile. It’s not just a matter of knowing how to do this; CBS comes with a great degree of complexity, and as a consequence, changing over to newer, better systems isn’t a very simple task, which is why banks aren’t often keen on getting this done. Today’s systems are more modular, componentized, and, therefore, adaptive and agile to the fast pace of changes demanded by the digital world. Investments are being made by most banks to move into a microservices-driven architecture supplemented by the power of the cloud. This is in sharp contrast to legacy monolithic architectures, where changing one part of the larger system could have an adverse impact on other parts. This, in turn, necessitates lengthy impact assessments and testing, which would incur significant expense. The bottom line is, switching over to agile systems is far from easy and risk-laden for incumbent financial institutions that already house millions of customers.
In the case of a partnership model, the neobanks partners are bound to work with outdated core-banking systems. Hence, the ambition of neobanks adds the scope to provide optimum technology-driven solutions for partner banks, along with banking services for end consumers.
Starting and operating a neobank in a region where the regulatory environment is restrictive & rigid would be very inconvenient. Europe, in this matter, has easier regulatory mechanisms, and its regulatory support in the form of Payment Services Directive Law has helped in the emergence of multiple Neobanks in Europe. Now a number of countries in Asia are considered to be a prospective environment for Neobanks. On account of the presence of a huge population underserved by banking facilities and lenient regulatory requirements, China, by 2025, is expected to become one of the biggest players in the Neobank market. Hong Kong, Taiwan, Singapore, Malaysia, and Indonesia are already pro-neobanking, and India is only going to follow the suite. Regulatory sandbox initiatives such as ones by central banks in the UK, India aims to promote innovation, and trials of such models are a step in the right direction.
The RBI, in the past, has raised numerous concerns over cryptocurrency transactions and neobanking services, which has resulted in stricter regulations to be followed by neobanks. The RBI regulations even deny the lawfulness or authenticity of stand-alone digital-only banking institutions. Hong Kong and Taiwan are the first ones to grant stand-alone neobanking licenses in Asia in the year 2019. The same was done on account of the huge demand for neobanking facilities from SMEs. The same is the scenario in India as well. There is a huge demand from MSME businesses for neobanking facilities in India as well. Hence, considering such demand, RBI may relax the restrictions in the future.
Technology and regulatory challenges may appear to be the biggest hurdle; however, overcoming operational governance hurdles to bring everyone in a partner bank on the same page is actually the biggest challenge. There are very few banks who have set up a one-stop-shop for neobanks or FinTech partners to work with them. These one-stop-shops make it easy to bring people from various departments such as business, security, legal, IT, and others on the same page. In the absence of it, neobank partners feel like being engaged in a never-ending ‘temple-run’ between various departments.
With the changing regulatory and market landscape, there is an increasing pressure on banks to reassess their strategies, increase their tech spending, and bring down their costs at the same time. While there are a number of challenges associated with it, such as legacy issues, upgradation costs, and battle with inefficiencies, the benefits of ‘digital’ significantly outnumber the challenges.
If we look from the neobanks’ perspective, the opportunity is huge. As per MEDICI’s Neobanking Report, in 2018, the neobank market accounted for about $18,604 million, which is expected to see a herculean growth with a CAGR of 46.5% in the coming years. The global neobank market size is expected to grow up to $3,94,648 million by 2026. A good part of this market opportunity is within the underserved market segments, such as SMEs, startups, Gig-economy, unbanked population, and thin-file or new-to-credit customers. Open has identified the SME and startup segment to deliver the impact. Commenting on the segment strategy used by Open, Anish says, “SMEs face a lot of difficulties tracking and forecasting cash-flows, effectively managing account receivables & payables. They need to deal with multiple interfaces for accounting, expenses, payment gateway, and payroll. And there is a lack of online tools that help them plan their day-to-day activities. For example, till now, SMEs used various services to cater to their needs, like collecting online payments via a payment gateway like PayU or Razorpay, current account from banks like ICICI Bank/Kotak, accounting from Tally/Zoho, and various tools for invoicing. Open’s services come pre-integrated with payment gateway, current account, automated accounting, and APIs that can help integrate banking into business workflows. Using Open, SME business owners are able to save at least 2–4 hours a day where they do not need to track payments using UTR numbers.”
If you ask a neobank founder about how difficult it is to get a banking license, many of them would answer with, “Very hard!” And “Harder than it sounds.” However, a partnership model is a win-win for the ecosystem for the time being. Open has cracked it and sets an example for other players in the region to learn from.