One of the hottest new concepts in fintech is the neobank. Essentially, a neobank is defined as an online-only bank that offers a lot of convenience to many finance-related services but isn’t quite a bank (we’ll explain this more below).
Nebanks of course have a few advantages as well as some disadvantages over the traditional banking model.
In this article we’ll explore what exactly is a neobank and how it differs from challenger banks (another emerging concept) as well as the old brick-and-mortar with security guards and safe deposit box model we all know and love.
What is a Neobank?
“Neo” is Latin for “new” and a neobank is indeed a new form of banking that exists only in digital form.
Neobanks make their money by offering customers a variety of convenient digital services like checking accounts, spending advice, and sometimes even payroll; startups have liked using neobanks for this perk alone.
Since they have no physical presence that requires paying rent or mortgages and things like teller or security guard salaries, they can charge much lower fees.
Neobanks are also known for being very easy to use, with cute names like Monzo or Starling, and a great UX on mobile or web.
However, there is a small catch: a neobank may not actually be a licensed bank. Unless they partner with a traditional bank or are a challenger bank (see below) they can not offer credit, loans, or even FDIC insurance for deposits.
Neobanks vs. Challenger Banks Vs. Traditional Banks
As mentioned above, another type of “newfangled” bank is called a challenger bank.
A challenger bank is actually a licensed banking entity; however, they only have a very few physical locations.
It has become popular recently in some countries for neobanks to become challenger banks by opening with one branch; they can then offer a full range of digital banking options for the rest of the nation.
- Challenger banks may be considered the “best of both worlds” between neo and traditional
- They tout easier consumer access, lower rates, plus loans and credit like a regular bank
- Every challenger bank is a neobank, but not all neobanks are challenger banks
Traditional banks of course are established entities that offer perhaps the greatest security and trust of them all.
However, many of these banks are perceived to be behind the times in terms of services and ease-of-access.
- Traditional banks tend to charge higher fees
- They also tend to be more conservative in their lending practices
Many traditional banks are seeking inroads to neobanking by partnering with them to expand their offerings. It can be a “win win” for everyone.
Neobank Business Model
Currently, the most popular neobanks business model is to grow fast, regardless of the costs involved. It’s been reported that the average neobank loses $11 per user.
However, these bright young neobanks are willing to lose money in order to gain traction and more accounts.
In spite of having no physical location, many neobanks are seeking to build their own digital community, offering products and services that meet real-world needs.
In this way, they hope that when they can expand their offerings they have a large database of existing clientele.
Using their satisfied customers as evangelists, they can then spread the gospel through their social networks.
Neobanks Poised for Growth in US, EU, UK
Neobanks have technically been around since at least 2010 but have had a surge in popularity since the term was first coined in 2017.
The EU market was the first to be receptive to the concept with Germany’s N26 and UK’s Revolut leading the pack.
The surge in the US market is due to the recent trends toward innovation in the sector and a signal by regulators who seem to be more receptive to granting banking licenses to neobanks.
A rise in consumer confidence in neobanks along moves by traditional banks into digital services has also stoked the flames.
Another milestone is the introduction of Open Banking in 2018, which required banks to share data to other financial institutions (with customer approval).
- Customers can now have a more complete picture of all their financials in one application
- This is arguably one of the most important developments in the neobank industry
- As they lead the tech charge, they can offer new products that integrate and manage the data
According to Grand View Research, the US neobanking industry is expected to expand to almost $723 billion and a CAGR of 47.7% by the year 2028.
Disadvantages of Neobanks
As with everything in life, there are upsides and downsides. This is also true with neobanking.
- No physical bank branches to speak to someone in person
- Neobanks that aren’t challenger banks don’t have federal deposit insurance
- Requires at least a bit of tech savviness from users
There have also been recent setbacks in the fledgeling industry as some neobanks have withdrawn from certain markets and profitability is always an issue with investors.
Still, with COVID-19 still making in-person banking less viable, the downsides are quickly being mitigated.
Neobank Regulation
In spite of being uninsured and part of the blossoming “wild west” of the tech sector, neobanks still have to follow a host of regulations much like a traditional bank would.
For example, there are the general “know your customer” (KYC) regulations that exist in most countries that require physical IDs for every new account. New technology has enabled neobanks to meet this requirement digitally.
Then there are strict security protocols as outlined by the International Money Fund to detect and prevent fraud or money-laundering activities.
These include both robust authentication and perimeter security to stop hackers from accessing accounts as well as alerts within the system to detect large or unusual transactions.
Neobanks must also separately ensure their mobile app is secure and compliant. Additionally they need to protect the privacy rights of their individual account holders and comply with laws like the EU’s GDPR.
That’s without even mentioning the regulations that come with the Open Banking initiative.
Are Neobanks Safe?
Which brings us to perhaps the most important question: are neobanks safe to use?
The answer, in a nutshell, is yes. As you can see, there are many safeguards that prevent anyone from simply building an app and saying “I’m a neobank!”
That said, it’s important to perform due diligence with any so-called neobank.
Before downloading, search online and read the reviews. It probably wouldn’t be a bad idea to understand the terms and conditions so you know exactly what you are getting yourself into.
Then, by all means, set up an account and enjoy the exciting new conveniences of being a neobank customer.
Neobanks: Regulatory and Legal Framework
How are neobanks regulated in different countries? First, neobanking is not directly regulated, as neobanks do not have a bank charter that dictates operational guidelines. That’s why neobanks usually partner with larger charter banks, which are also called their quasi-regulators that operate under banking licenses.
Before onboarding a neobank, established banks thoroughly check the neoban’s documentation and operating rules. Neobanks should adhere to the following AML regulations and requirements.
Banking Licenses
- Full Banking License
Sometimes, neobanks partner with national regulators and obtain a full banking license that gives them a full range of banking services, such as accepting deposits and providing loans.
- E-Money License
An e-money license allows banks to provide their customers with digital wallets and different payment services but without some regular banking services like loans.
- Special Purpose License
If neobank requires some special services, they can get a special purpose license adjusted to their needs.
Anti-Money Laundering and Know Your Customer regulations
AML regulations involve various operations to prevent fraud and terrorist financing. These include monitoring financial operations and tracking any suspicious activity.
KYC is part of anti-money laundering standards neobanks should compy with. During the KYC process, a system identifies the client's identity and checks if that person is actually who they claim to be. KYC requirements include checking driver’s license, passport, and financial operations history.
Data Protection and Privacy Laws
Neobanks in EU should follow GDPR rules - the strongest set of data protection rules to give customers full control over the personal data they want to share.
- Other Jurisdictions
If neobanks operate in other countries, they must follow data protection rules in that region, for example, CCPA in the United States.
Payment Services Regulations
In the EU, PSD2 controls payment services and electronic payments, monitoring transparency and enhancing their security.
Cybersecurity Regulations
Neobanks should verify customers' identities to prevent fraud and illegal financial operations. To become a member of the new bank, users need to provide personal details such as proof of residence, government ID, full name, registered address, and take a photo for facial recognition.
The EDD process includes a set of different measures for checking and monitoring high-risk or high-net-worth customers and their high-volume transactions. It usually consists of steps such as collecting customer information, identifying the beneficial owner, and defining business relationships with a higher risk level. The main purpose of this obligation is to detect risks that can’t be identified by customer due diligence.
How To Start a Neobank
If the concept of a neobank intrigues you, now may be the time to start your own online-only neobank. The demand is increasing every day and the possibilities are nearly limitless.
The first thing you need, however, is a proven partner in fintech. That would be us: S-PRO! We have more than 250 full-time employees and a very strong track record in the fintech world.
In our short five years of existence, we’ve completed over 120 different projects from start to finish. We also won over a dozen awards for our software as well as our leadership.
We’re also extremely bullish about the idea of neobanks and are eager for our clients to succeed.
- We understand all the regulatory issues around the neobank requirements
- We can help you create a new app from scratch or develop an existing one
- We understand UX and UI banking issues and can help build your brand through a slick yet functional interface
- Our experience with AI and Blockchain ensure you are getting the very latest technology
At S-PRO, security is the framework of everything we do.
Our DevSecOps protocols integrate security in every phase of the continuous improvement cycle as we continue to roll out features and upgrade even after launch.
Ready to begin the steps towards opening a neobank?
Talk to S-PRO today about what we can do to help you get going. We have partners in finance, blockchain, and startups. All you have to do is come up with the catchy name.
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