What Factors Affect The Development Of Neobanks?

In the past few years, neobanks have disrupted the banking industry. Although the adoption rate of new digital banking services varies per country, it’s as high as 43% in some countries like Brazil.

Due to their swift growth, traditional banks have started respecting neobanks and are beginning to compete against them with innovative features of their own. But despite the current success of neobanks and challenger banks, like in any other industry, there might be unexpected hiccups along the way to sustainable growth.

Types Of Neobanks

Before understanding the factors that might affect the development and growth of neobanks, defining the various stages a neobank might be in is crucial. On a general note, a white-label neobank is a digital banking platform that operates entirely online, offering financial products and services without a physical location.

Depending on the execution, neobanks can be divided into three groups. There are full-stack neobanks, front-end neobanks and hybrids. Neobanks shouldn’t be confused with challenger banks, which are banks with few physical locations that focus on digitizing their services.

Full-stack neobanks, in contrast to front-end ones, operate with a full banking license. Front-end neobanks, on the other hand, need to partner up with a traditional bank to offer financial services. These neobanks mainly focus on developing the “front-end” technical and user interface side of their applications, and their partnering banks deal with regulations and legal requirements. Rarely does a neobank offer a hybrid approach. Hybrid neobanks incorporate DeFi (decentralized finance) into their operations, by which all transactions of its end users go peer-to-peer instead of through intermediaries.

Factors Affecting Growth

The more innovative services neobanks offer, the more customers trust them, and transactional value continues to rise. If the trend continues, it’s expected that transactional value in the form of digital transactions in the neobanking segment will reach nearly $9 trillion by 2027, with a CAGR of 22%.

The success of neobanks is mainly owed to the ever-expanding customer base of tech-savvy users. With typically lower fees, quick online verification and customer-centric applications, digital-only banks also appeal particularly to those 18 to 34 years old who have grown up in a technology-based world.

Internal Factors: Internal factors like business planning and funding/raising capital are substantial reasons for growth or a decline within most fintech companies and neobanks. To foresee similar factors that might affect growth in a negative way, we must pay close attention to the failed neobanks and what factors drove them out of the game.

One of the most common reasons for closed neobanks is the inability to secure funding to the expected and needed levels. Such an example is Moven, which closed in 2020 after nine years of being in business. Alternatively, inadequate business planning was what drove Xinja, an Australian neobank, off the market. The company increased interest rates to attract more deposits while failing to secure demand for loans, resulting in a negative balance sheet.

External Factors: Internal factors are mainly wrong decisions and the inability to foresee certain demands. But there are many external factors to consider — one of the most prominent being competition. In the banking industry, both traditional brick-and-mortar banks and neobanks are constantly stepping up their game, offering more and more innovative features to satisfy consumers. But despite the high speed of customer acquisition and interest, neobanks have a very long way ahead of them before they reach the number of customers traditional banking institutions are sporting.

Initially, consumer trust was one of the biggest external factors that stopped people from signing up for fintech and neobank accounts. However, just after the Covid-19 pandemic hit, according to McKinsey research results, more than 40% of household financial decision makers in the U.S. had a fintech account. This number continues to grow each year.

Changes in regulations according to geographical locations and the operation of neobanks can also contribute to unequal development across countries. If tighter regulations arise within certain regions, traditional banks can remain in the lead there, regardless of the innovative features of white-label digital banks. Moreover, the differences between regulations in various areas can also impede expansion in certain markets. Good examples of that are the expansions of Revolut and Monzo into the U.S. market. Adapting to U.S. regulations has proven not only difficult but also expensive for both neobanks.

The difficulty of obtaining a banking license in the U.S. has forced giant neobanks like Chime, with over 25 million users, to operate without a license with the help of partnering banks in the region. However, some banking-as-a-service (BaaS) and SaaS solutions provide regulations for newly formed neobanks as a bundle with the service to help make entry easier.

Final Words

The main growth factors concerning neobanks — mainly related to regulatory frameworks, customer preferences and competition — will undoubtedly continue to exist during the next few decades. Some of these factors might contribute to growth, whereas others might limit it. The future is unknown, yet one thing remains clear: Neobanks are here to stay, and more people adopt them into their daily lives each day.

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