Innovating Industries: Neobanks

In the wake of Silicon Valley Bank’s collapse, account holders largely took their funds in two directions – either to established banks or neobanks. Why neobanks? They offer quick access to accounts - one can open accounts online, and transact quickly, which proved particularly beneficial for those seeking to move funds quickly from SVB. Several neobanks capitalized on the opportunity that arose, leading to an uptick in customer signups and deposits. One leading neobank reported adding 4,000 customers and over $2B in deposits in the week following SVB’s collapse alone¹. 

Given the uncertainty in the market, several neobanks also moved to increase their FDIC insurance to provide more certainty. Mercury, for example, launched its Vault product offering $3M in insurance for their accounts by spreading deposits across their two sponsor banks. American Banker noted, “[Neobanks] are scooping up new clients, promoting their abilities to safeguard funds above Federal Deposit Insurance Corp. limits, and touting their profitability and fast account opening prowess on Twitter.”²

Due to the online nature of neobanks and the seamless onboarding process, customers who were looking to diversify their banking partners had the opportunity to quickly transfer funds into neobanks. In doing so, neobanks gained a significant influx of new customers who now have access to the various other benefits of neobanks themselves. 

So what exactly are Neobanks?

Neobanks, also known as digital banks or challenger banks, are financial institutions that operate exclusively online without any physical branches.³ They offer most of the banking services that traditional banks offer, such as current and savings accounts, loans, credit cards, and money transfer services. Neobanks are usually accessible through mobile apps, allowing customers to manage their accounts, conduct transactions, and get customer support on the go. In an evermore digital-first world, they’ve grown in popularity amongst customers looking for tech-driven and convenient banking solutions.

There are two types of neobanks: retail and corporate. Retail neobanks offer banking services to individual customers, while corporate neobanks cater to small and medium-sized enterprises (SMEs) and larger corporations. Corporate neobanks also offer specialized services such as cash flow management, payroll processing, and expense management.

Another sub-group of neobanks is the ‘neo-lender’. These are financial institutions that offer loans and other credit facilities to individuals and SMEs, without the need for traditional bank intermediaries. Neo-lenders use technology-driven algorithms to assess creditworthiness and make loan decisions, and offer lower interest rates than traditional banks.

Neobanks broadly “are concentrating on creating services that can be easily integrated into business processes. With personalized insights, lower costs, user-friendly interfaces, predictive intelligence, easy accessibility and simplified processes, neobanks are challenging the universal banking model.”⁴ 

Think of the last time you walked into a physical bank. Probably not too recently, right? Neobanks' lack of physical presence allows them to offer higher interest rates and pass on savings to their customers, two key benefits that differentiate them from the large financial institutions they compete with. The influx of over $1 billion in deposits into Apple’s latest high yield savings accounts is reflective of the demand of such products. Per Forbes, “Banks have quickly responded to the Fed's interest rate hikes with higher mortgage and car loan rates, but savers have seen little to no increase in traditional bank deposits or savings accounts,” Richard Crone, CEO and founder of payments firm Crone Consulting, says. “There's an outflow to CDs, money market funds, and fintechs like Apple.”⁵ These same outflows are benefitting neobanks.

Investment Trends in the Neobank Industry

The neobank industry has been growing rapidly over the past few years, and this trend is expected to continue in the coming years. According to a report by Skyquest, “Neobanking market size was valued at USD 36.14 billion in 2021 and is poised to grow from USD 62 billion in 2022 to USD 2048.53 billion by 2030, growing at a CAGR of 54.8% in the forecast period.”⁶

Private market investors have taken note of this growth potential and have been pouring billions of dollars into neobanks - in fact, McKinsey highlighted, “investors have been drawn to the disruptive power of these banks, directing approximately $32 billion in estimated global venture capital funding to neobanks between 2017 and 2021.”⁷ 

That said, investments into fintech have slowed over the past year, due to the slowdown in the broader venture market. CBInsights recently reported that fintech funding dropped 33% in the second quarter of 2022 to $20.4 billion, a steeper drop than that of total venture funding.⁸ Despite the funding slowdown in fintech more broadly, neobanks still own a growing share of the financial services market. The reduction in the access to easy funding does however mean that the neobanks will be required to focus on highlighting their value proposition and reining in total expenses with an eye towards sustainable growth.

Neobanks are already finetuning their strategies to accommodate changing investor views on growth and profitability. Per Tech.eu, “after years of sacrificing profitability at the altar of growth, neobanks are now focusing on profitability, amid restless VC demands for positive numbers.” Bain and Company’s article highlighted that there are numerous other revenue drivers, including investing in subscriptions products, lending, partnerships and even increasing their focus on small and medium sized businesses, that neobanks can use to diversify their current revenue structure, which is typically based on interchange fees, and develop a stronger top line revenue model that can make them more attractive investments.

Private Neobank Companies to Watch

Several private neobanks have caught the attention of investors due to their innovative business models and impressive growth potential. Here are some of the top private neobank companies to keep a pulse on:

• Revolut is a UK-based neobank that specializes in mobile banking, card payments, money remittance, and foreign exchange. It includes a prepaid debit card, currency exchange, and peer-to-peer payments. The company claims it is on a mission to build a fair and frictionless platform to use and manage money around the world.
• Aspiration is an online financial firm that offers “Sustainability as a Service” products for consumers and companies. Its investment products and credit cards are designed to assist its customers in keeping their deposits away from fossil fuels and automatically planting trees with every purchase of a credit card, among other green initiatives.
• N26 is a young company based in Berlin that aims to revolutionize the traditional banking industry and how people spend, save and send money. It provides a free basic current account and a debit card, with overdraft and investment products and premium accounts available for a monthly fee.
• Monzo is a fully licensed U.K. digital bank. Monzo aims to build products that meet the financial needs of their customers including spending, saving, borrowing, and managing cash. In February 2022, Monzo officially launched in the United States and now allows U.S. clients to apply for a Monzo account.
• Foro is a commercial lending company that assists businesses in finding, evaluating, and selecting the best financial institution partner to meet their needs.

Neobanks are disrupting the traditional banking industry and are poised for significant growth in the coming years. Private market investors have taken notice of this growth potential and have been pouring a significant amount of capital into neobanks. However, increased competition and a tighter funding market pose challenges for neobanks, and only those with innovative business models and robust risk management frameworks will thrive in this competitive landscape.

Private market investors are keeping an eye on the neobank industry and the private companies that are leading the way in innovation and growth. Companies like Chime, Revolut, N26, Monzo, and Foro have captured the attention of private market investors and are well-positioned to drive growth in the neobank space in the coming years. Curious to see what neobanks are currently available to invest in on EquityZen’s platform? Check out our listings page.

Sources:

1. Fast Company, March 2023
2. American Banker, March 2023
3. Fortune, October 2022
4. Global News Wire, April 2023
5. Forbes, May 2023
6. Skyquest, November 2022
7. McKinsey, November 2022
8. Bain and Company, December 2022