Are Neobanks going to survive the VC winter?

Every Christmas, Financial Times runs a story on Revolut, Europe’s  biggest and most funded B2C neobanks, and it’s always a juicy read. The audience of fintech investors, with significant exposure to past London’s fintech boom, fret with expectations: Will they publish the revenues and what does the bottom line look like? The question of whether Revolut gets to keep its $33bn valuation based on the raise in 2021 never fails to draw attention. Stories on N26, Monzo follow closely in size of reader audiences and so far have offered both confirmation of the bubble in this fintech subsegment, as well as its propensity to toxic work cultures and compliance shortfalls.  

But what about African neobanks? Given African VC investment in 2023 39% drop YoY, which models are better equipped to survive the prolonged VC winter?

The African Context

The proliferation of commercial banks in sub-Saharan Africa has been growing steady over the last decade. However Commercial bank branches per 10,000 adults in Africa continues to lag behind other emerging economies. This has given scope for digital banks to capture piece of the market. Digital banks have seen rapid increase in the last 5 years, particularly 2019 onwards. 

With over 60% individuals excluded and underserved by existing financial service players opportunities in Africa remain. A recent report by BCG and QED proclaim Africa to be the fastest growing Fintech region in the world and estimate fintech revenues to grow by a staggering 13X by 2030.

Neobank models in Africa, or “Where is the money Lebowski? “

Neobanks in Africa employ various business models to generate revenue, including:

Payment / Card Based

Most African neobanks, especially digital banks, offer debit cards to their customers. Their partnerships with financial service corporations such as Visa and Mastercard allow them to get paid an amount from the processing fees that merchants are charged.  Most of them also offer their debit cards to their users free of charge, and many also provide discounts and offers from partner businesses to promote their use. 

Credit Based  

Some neobanks are set up specifically to provide credit through digital lending to individuals and micro, small and medium-sized enterprises (MSMEs).  They make revenue from the interest rates applied to those loans. 

Investment / Behaviour led

This model prioritizes offering investments and digital trading services, such as stock brokerage, crypto trading, saving in gold and long-term savings with high interest rates 

Ecosystem Based

This model creates a unified platform such as a marketplace or superapp that integrates solutions for several financial needs. These can include bill payments, remittances, investments and short-term lending.  

All above mentioned models struggle with common challenges, some of them similar to those in Europe. However, in Africa, regulatory fragmentation, lower purchasing power and data scarcity present serious additional challenges for neobanks to scale. Key challenges for neobanks we see in the market:

-        Building effective CAC and acquisition funnels

-        Managing identity fraud and money laundering

-        Monetization ceiling, set by the size of middle-class segment and purchasing power

-        Delayed break-even points due to capital intensity needed for customer acquisition and retention in the African context

-        Loyalty in face of competition

-        Data scarcity

If we were to chose two key challenges to B2C neobanking Africa, it would probably be safe to focus on two:

1)     Limited monetization potential and

2)     Data scarcity

First Circle view

When investing Africa, many global investors bring useful learning from other markets. However, we believe that applying a “cookiecutter” approach in Africa requires significant modification for the local context. When it comes to B2C models, and especially B2C neobanks, we cannot ignore the local offline reality, data scarcity, regulatory fragmentation and limited monetization potential due to middle class segment size and lower purchasing power. As VC funding slows, and investors' preference for capital-intense, low margin models vanes, we anticipate that payment-led neobank models will be more at risk and consolidation- prone in 2024. On the other hand, our preference goes for credit-led and remittance led neobanks, who can grow prudently, securing access to local debt and USD in 2024, who have a higher chance of survival in the VC winter.

In the coming months, we see a high potential for mergers and acquisitions in the neobank segment, as investors behind larger players will seek to merge capabilities and customer segments, and create efficiencies. In addition, smaller traditional banks and fintech startups are increasingly converging to become challengers to incumbent banks.

While the competition in the neobanking industry is intense, the opportunity to serve African customers better and digitize financial services in the region is substantial. Neobanks that can differentiate themselves, are able to achieve attractive unit economics and offer valuable solutions to the unmet needs of African consumers have the potential for success.