Thanks to the power of the internet and associated technologies, several companies accrued fortunes providing online alternatives to traditional business and commercial activities. However, finance has been slow to the digital revolution until recently with the development of the neobank.
As tech firms, neobanks offer financial services exclusively through the internet, bypassing the need for physical banks.
Similar to other digitized transitions, neobanks are consumer-friendly. Lacking physical overhead, they pass the cost savings onto their clients. In addition, neobanks help bridge financial access for the unbanked and underbanked, which is a growing problem because of the present recession.
Origin of Neobanks
Although the specific concept and term neobank is a fairly recent phenomenon, becoming mainstream around 2017, its origins began with the early days of the internet. According to a Banco Bilbao Vizcaya Argentaria (NYSE: BBVA) letter to the Federal Deposit Insurance Corporation, the financial industry witnessed the emergence of both the universal bank model and financial technology or fintech firms.
Later, when smartphones reached mass distribution, several traditional institutions offered online banking channels. Praised for its convenience and everyday access (unlike branch offices, which are usually only open Monday through Friday), bank customers gradually adopted digital services. This momentum picked up as cybersecurity protocols accrued end-user trust. Today, online banking is almost ubiquitous.
Despite the conveniences of digitalized banking services, though, fintech enterprises saw additional opportunity gaps to address. Primarily, the big banks and credit unions have massive overhead. By eliminating the brick-and-mortar banking model altogether, institutions that operate exclusively online can pass savings and superior products — such as higher interest-yielding accounts — to the client. Thus, the neobank was born.
It’s important to note that despite its name, neobanks are not actually banks. Rather, they are fintech organizations that provide bank-like services, often through partnerships with traditional banks. While this distinction may not appeal to everyone, the younger, tech-savvy demographic has gravitated toward neobanks over the years.
Plus, this burgeoning sector is generating traction with A-list celebrities. For example, Benzinga earlier this year reported that Robert Downey Jr.’s FootPrint Coalition Ventures Backs Neobank Aspiration. Focused on conscious consumerism, aspiration demonstrates the potential mobility of neobanks, not just as financial platforms but as instruments for meaningful social change.
Pros and Cons of a Neobank
Since we live in an increasingly digitalized and connected world, the neobank’s central concept — an accessible, convenient financial services platform — aligns with the ethos of modernity. Therefore, you can have reasonable assurances of sustained relevance. At the same time, nothing is without drawbacks. Here are key pros and cons to consider before using a neobank.
Convenience: If you’re like many “W2” employees, you’ve probably at least had the experience of rushing to your local bank or credit union to complete a financial transaction, only to find out that it’s a federal holiday and closed. With neobanks, you won’t have that problem because they’re technically always open.
Serving the underserved: According to FDIC data, a 2019 survey revealed that nearly 95% of U.S. households had either a bank or credit union account. Interestingly, this was the highest rate since the survey started in 2009. At the same time, this left 7.1 million households unbanked. Further, the COVID-19 pandemic will almost surely increase the number of both the unbanked and underbanked populations. Fortunately, neobanks can provide a solution, with many catering toward this underserved demographic.
Shaping the discourse: Neobanks find themselves in a unique position to be the change they want to see in the world. As cliché as that sounds, in this case, the concept resonates. Mainly, traditional banks are sometimes tied to controversial industries, such as fossil-fuel energy firms and firearms manufacturers. On the flipside, neobanks have more flexibility to craft a business model that aligns with their core principles, attracting customers who feel the same way.
Can’t offer full services and choices like banks: With society gradually decluttering most ties to the physical realm, neobanks are quite to the point where they can replace real banks. One of the biggest drawbacks for these fintechs is that they can’t offer full-spectrum services. Therefore, if you want to take out a loan for a car or house, you’re going to need a bank or credit union. This makes neobanks essentially superfluous for millions of potential users.
Less to no personal service: Because several neobanks partner with traditional financial institutions, they provide basic services and protections, such as account insurance in case a neobank goes bankrupt. However, this is a new sector so you must perform due diligence before joining. Also, because everything is online, you will probably not have access to robust customer service networks. Thus, the process of finding the right neobank is more complicated or time-consuming than opening a bank account.
No physical storage options: An aphorism that has a murky provenance states, “the palest ink is better than the most retentive memory.” A modern take may be a paper record is better than a digital file that has been corrupted. Yes, digitalization delivered untold conveniences to us. But some documents — the title to your house or your last will and testament — need safekeeping. As in physical safekeeping. A neobank can’t do that for you.
How Does a Neobank Work?
To best answer the question of what is a neobank and how does it work, it helps to consider the innovation not as a bank but rather as a platform. Partnering with regular banks, neobanks provide many core functions, such as opening checking, savings and investment accounts.
However, because the platform is online, it’s streamlined and usually optimized for mobile use. As a result, neobanks work best for basic services but many currently lack the bandwidth or backing for more intensive needs.
Neobanks for Personal or Business Use
Primarily, neobanks feature optimization for tech-savvy individuals, usually from the millennial and Generation Z demographic. For one thing, a neobank platform caters to the everyday conveniences associated with digital channels. As well, the rapid adoption of cryptocurrencies and blockchain-based platforms reflects enormous trust among young people toward digitalized and decentralized transactional networks.
On the other end, neobanks also offer compelling conveniences for businesses. Enterprises that interact exclusively through digital channels have sought digital-only services from their banking providers. Here, challenger institutions like neobanks are making a dent.
Still, comprehensive business adoptions of neobanks may be years away due to several companies using cash-based exchanges. One aspect to keep in mind, though, is that the COVID-19 pandemic may change this narrative favorably for neobanks.
Differences Between Regular Banking and Neobanks
Principally, regular banking usually involves deeply rooted establishments offering a full spectrum of financial, investment and lending services. And, banking as you know it offers diverse consumer-level choices. Today, the major institutions provide robust “analog” and digital channels.
Yet the fundamental difference between regular banking and neobanks is that while the former’s services are indeed comprehensive and robust, the consumer pays for that overhead. Moreover, several major banks are publicly traded, which means they are also beholden to their shareholders. This, too, subtly takes away from the consumer-first approach for which neobanks are popular.
Again, by removing the costs associated with a physical front, neobanks provide cost savings that support more attractive products such as higher-yielding savings accounts. Also, neobanks can implement positive social change that reflects their values.
Last year, Benzinga reported that “Next-gen Neobank Douugh Debuts on ASX,” narrating the development of neobanks crafting their architecture to support initiatives such as financial literacy and education on personal budgeting.
Because of their open-source nature, you can find neobanks originating from all parts of the globe. In addition, several domestic neobanks facilitate international transactions, in some cases free of charge. It’s also worth noting that neobanks provide an alternative outlet to non-U.S. residents who may undergo more scrutiny due to the Patriot Act.
Work in Progress to Financial Digitalization
As an online provider of financial services, neobanks represent the evolution of financial technology, from providing access more conveniently to gradually connecting communities that traditional institutions historically underserved. In addition, neobanks can shape our culture for the better, bolstering businesses that are environmentally and socially responsible. At the same time, neobanks lack full-spectrum service capacity so they have yet to reach their zenith.
Frequently Asked Questions
Q. Are neobanks safe?
Neobanks are among the safest financial institutions as they exclusively function online. Therefore, you don’t have to worry about physical incidents such as strongarm robberies or fires. Additionally, neobanks often partner with traditional banks, offering account insurance as a result. Still, you must do your homework with every neobank to understand what is covered and more importantly, what is not.
Q. What is the future of neobanks?
Perhaps the best evidence for the neobank’s bright future is the blockchain and cryptocurrencies. Principally, what the two sectors share is the open sourcing of financial tools from traditional hierarchies to digital frictionless ecosystems. Potentially, neobanks can open financial connectivity to underserved communities, bolstering overall economic activity.