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Are "Neobank" Startups a Threat to Big Banks? Not Yet.

Monday, March 04, 2019

While mobile banking startups might be perceived as a threat to larger banks, they still have yet to show they can make a profit.

In the United States, a second wave of mobile-based banking startups dubbed "neobanks" (also known as "challenger banks") has flooded the market in recent years. Operators such as Chime, Varo Money and BankMobile have all had successful first phases in terms of signing up customers, and collectively these banking upstarts have added millions of accounts.

Like the first phase of the neobanks — Simple and Moven — these newer players have forged partnerships with financial institutions for compliance reasons. Their marketing pitch generally follows Simple's playbook of fee-free accounts and personal financial management, with debit cards supplying them with interchange as a revenue stream.

More scale, more problems

Yet with that type of model, adding more accounts might only increase losses for now. "You can basically go to the poorhouse on scale," says Dickson Chu, executive chairman of Simple, a mobile bank owned by BBVA Compass Bancshares Inc. "Fundamentally the math won't work."

No doubt, mobile banking is a tough business in which to go it alone. Simple debuted in 2009 and Moven in 2011. While both still have customers, they've gone through major shifts. BBVA bought Simple for $117 million in 2014, and later wrote down its value by roughly $90 million in early 2017. Moven shifted its main strategy to offering white-label services to bank clients, rather than rely on consumers for profits.

These firms have shown it's easy to find customers with a nice interface, a financial management tool and savings accounts. But the trick is holding onto those users, all the while generating a profit.

A chart showing the differences between Homogenous vs. Differentiated banks.

Neobanks globally

On the one hand, neobanks in the United States and United Kingdom offer better interfaces than traditional banks, but it's not enough, says Sarah Kocianski, a principal research analyst at 11:FS, a consulting firm based in London. "They are not offering a great deal of differentiating functionality," Kocianski says. "Their feature sets are very similar."

For mobile operators, good "old-fashioned" banking might be the route into the black. "The long-term business model for a lot of these startups is questionable if they are not going to get into lending," says Ron Shevlin, director of research at Cornerstone Advisors, a consulting firm based in Scottsdale, Ariz. "That's where the money is."

In fact, lending has been a starting point of many new fintech entrants. Goldman Sachs has taken that approach last year, launching Marcus, an online lending product, with a savings account option that pays a generous interest rate. SoFi, which makes personal loans, launched a similar product last year: SoFi Money is a savings account option with a debit card. MoneyLion, which has built its business on small-dollar loans and investing, now offers a checking account.

Challengers' path forward

Meanwhile, a few challenger banks themselves have added lending options. Atom Bank, a U.K. startup with a banking charter, offers mortgages, where customers can track and approve applications in-app. Simple recently struck a deal with Prosper to offer a credit option, and also plans to originate its own loans through Compass later this year, Chu says.

As neobanks add services, other successful fintech operators have muscled their way into the checking and savings market, taking share. Acorn, a startup that automates and simplifies investing for its users, recently offered a debit card to allow them to spend their balances. In the first four days after the product's debut, Acorn received 100,000 orders among its 4 million users.

These fintech upstarts have given their customers a reason to stay. But neobanks must do the same, and that could come from analytics and artificial intelligence, with the harvesting of transaction information.

"The real value is all about what [data] you get from the behaviors … to truly be an advisor," Chu says.

Paying for premium service

And if that data is valuable enough, people will pay for it. For example, Simple is working on adding a machine-learning AI underneath its bill-pay services. The technology could be used to predict a customer's cash flow, offering advice on how to improve it by delaying certain payments. Another option is offering a look at consumers' cell phone bill payments to present better offers from competitors. "All of that comes out of observing the data," Chu says. "This is where value-add comes from."

One question, Chu adds, is whether banks can reset expectations for a premium-services model in banking, using the software-as-a-service (SaaS) approach of charging monthly. "You need to get away from transactions and think of it as value-added software, and charge for it like any other SaaS business," Chu says.

Acorn has done it. Acorn charges $3 a month for debit cardholders, who also benefit from its investing platform. So whether it's analytics, investing or lending, people have shown they'll pay for services, if warranted. That could bode well for today's neobanks.