The end of the era of neobanks
FINTECH SNARK TANK COMMENTS
In some ways, 2021 has been a good year for neobanks – also called challenger banks, digital banks or online banks – like Chime, Varo and Current.
The top 10 neobanks in the United States grew by just over 10 million accounts in 2021, from 23.3 million to 33.5 million, according to Cornerstone Advisors.
However, the appearance – or in this case, the growth – can be deceiving. Despite the positive growth figures, recent news from neobanks is not encouraging:
- Dave – a fintech, not some random dude –said that capital constraints limited its ability to invest in the second half of last year.
- MoneyLion faces investor skepticism as it burns cash, according to the Financial Times.
- Varo Bank could run out of money by the end of the year. According to Fintech Business Daily“With $32 million in salaries and $38 million in marketing expenses in the first quarter, costs continue to far exceed non-interest revenue.”
- In May, Chime confirmed reports that it would delay its planned IPO in light of falling fintech stock valuations.
The case against neobanks
It would be easy to attribute the negative neobanking press to the general fintech funk that pervades the industry at the moment. But there are market factors impacting neobanks that close the door to the arrival of new neobanks on the market:
1) Megafintechs have better economic and business models
Cornerstone research found that only about half of the top 10 neobank customers, or 17.6 million consumers, call their account with these fintechs their primary checking (or spending) account.
In contrast, more than 15 million consumers call PayPal or Square Cash App their primary provider of checking or spending accounts. This is only a small percentage of the approximately 272 million accounts that Americans have with these “megafintechs”.
Do the math: neobanks need to acquire two customers to get a primary spending account customer.
Fintech Business Weekly reported that Varo’s customer acquisition cost is $45. This means that it costs Varo $90 to acquire a primary (i.e. engaged) customer.
Megafintechs, on the other hand, already count nearly all U.S. adults under 55 with smartphones as account holders. Their cost of increasing engagement should be less than $90 per existing customer.
A key point here is that neobanks aren’t just competing with incumbent banks, they’re competing with megafintechs, whose platform business models give them scale and revenue diversity.
2) Interchange is not a reliable source of income
Speaking of income diversity (or lack thereof)…
I don’t know who said relying on the exchange to generate revenue was a good idea, but in every argument I’ve had with a neobank supporter where I’ve brought up the flaws of a model trading dependent on the exchange, the response has generally been, “they will expand into other revenue streams at some point.”
We have passed “a certain point”.
Relying on exchanges runs counter to consumer behavior trends regarding:
- Merchant mobile apps. In any given week, Americans have about 10 billion in merchant mobile apps waiting to be used. And when it’s used, that’s one less transaction a neobank (or a traditional bank, for that matter) generates interchange revenue for.
- Buy now, pay later. BNPL may be at the top of the list of things that ruin civilization, but it continues to eat away at the exchange revenues of banks – traditional and neo-. Square (via Afterpay) and PayPal have heavily promoted BNPL, and now Apple has announced plans to offer the service.
- Integrated banking services. A survey by Cornerstone Advisors asked consumers about their involvement and interest in obtaining financial services from non-financial brands. The results show a strong pattern of interest in product categories like gaming, electronics, home fitness, fashion, pharmaceutical, home improvement, automotive, and online retail. general.
I wrote that Chime should expand beyond financial services and sell other digitally deliverable products and services – e.g. cell phone damage protection, subscription management, phone theft protection. identity – to diversify its sources of income.
The Fintech brain food newsletter echoes this call for income diversification, suggesting things like tips, real-time payments, subscriptions and loans.
So what are the neobanks waiting for?
3) The niche affinity game is played
I have been a proponent of the niche affinity approach to neobanks where community fintechs like Kinly, Daylight, and Panacea Financial cater to the unique financial needs of specific consumer segments. This approach forces neobanks to:
- Identify the unique financial needs of a segment. Easier said than done. Witness the rise and fall at the beginning of this century of online banking for women. None have been able to define women unique financial needs, largely because “women” is not a marketable, definable segment (it is the aggregation of a number of segments).
- Be the dominant affinity. Claims by neobanks about the size of their affinity groups are misleading because most of us belong to more than one affinity group. If you’re an African-American gay doctor, do you rely on Kinly, Daylight, or Panacea?
The end of the era of neobanks
I don’t know when the term “neobank” became popular. In January 2013, I published a blog post titled NeoChecking Accountsand I know the term was not used at the time.
Whatever its introduction, 2022 marks the end of the era of neobanks.
Today’s neobanks aren’t going away, just yet.
They may have won the first battle with the incumbent banks, but a new wave of competition is coming from megafintechs and non-financial brands.
It’s hard to imagine that venture capitalists will continue to fund an endless list of neo-banking startups planning to tackle smaller and smaller market segments with exchange-dependent revenue models.
The loan is not a panacea. Neobank’s customers are mainly subprime borrowers who are not the best candidates to lend to.
This may change over time, but do neobanks have time?
The pioneers of the neobank era – Simple, Moven, Monzo, etc. – deserve to be celebrated. But the days of a general-purpose, digital-first, retail-bank-like fintech — which doesn’t lend and doesn’t have a charter — are over.