It’s been a few years since the UK’s first neobanks appeared, and now we’re seeing incumbent banks create ‘flanker’ brands to enter the market. So, it felt like an appropriate time to ask some questions about the sector’s evolution to date – and what that means for its future.
A neobank is 100 per cent digital and uses apps and online platforms to support their customers, rather than traditional physical branches.
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Most believe that the secret to the fast growth of Monzo, Starling and others lies in them initially launching beta products with an e-Money license (a license authorised by the FCA that ringfences customer deposits so they can’t be used to generate profit, for example by lending them out). Yet ongoing success sees many neobanks evolve. Some have applied for full banking licenses with the FCA (for example Starling and Monzo), while others have acquired fully-licensed banks (for example Tandem taking on Harrods Bank) to develop their products and services.
Some incumbents have started to develop their own digital-only brands (for example RBS has Bó). Although most use their parent bank’s existing license, these new digital brands are separate, including operating on new systems rather than cumbersome legacy platforms. This will let them compete more easily with new entrants, but there are still questions:
Only time will tell.
Incumbents have many advantages over neobanks, such as funding and customer trust. But with legacy systems weighing them down, they’ve found it tough to develop innovative user experiences.
While neobanks don’t have the money or customer-base to overthrow traditional banking overnight, they can launch features and develop partnerships that people want much faster.
This mix of strengths and weaknesses is creating interesting knowledge transfer. In some instances, neobanks have pushed incumbents to better serve and support their customers. For example, Barclays quickly followed Monzo in letting people block certain types of spending on their account, like gambling.
Starting from nothing has helped neobanks be more flexible and inclusive than incumbents, letting them reach vulnerable or underserved customer segments. Monese, for example, is delivering services that migrant workers value.
Neobanks, along with other FinTechs, are also driving further segmentation in the market. Most initially focus on providing customers with one product or service. They can outperform banks on customer service, products and margin to bring the offering to market. Good examples of these are Habito for mortgages and Revolut and TransferWise for international transfers. The mistake that incumbents have made to date is being unconcerned about new entrants, satisfied that they can complete with their size or range of products. But they could start to struggle if new entrants continue to pull customers away from these revenue-generating areas.
Even with the FCA encouraging more competition, generating profit is tough and margins are slim. There isn’t room for everyone and we’ve already seen some challengers winding up. In the future, we’re likely to see more M&A activity as the sector matures.
Business banking for small- and medium-sized businesses is a big growth area for neobanks. Many feel the sector is under-developed and customers are poorly served. So, we expect to see others follow Starling and Tide into this space.
Overall, this is just the beginning for neobanks. We’re expecting to see a lot more changes following the introduction of PSD2.