Can the popularity of neobanks survive the pandemic?

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“WHAT DO YOU think we are, a bank? mocks an advertisement for Current, a neobank, in the New York subway. He continues to paint bank branches, poor customer service and overdraft fees as relics. The company is one of a hundred “neobanks” vying to shake up retail banking in America, and which have exploded in size and number over the past year. On August 13, Chime, the country’s largest neobank, raised $ 25 billion in fundraising, about as much as America’s 13th publicly traded bank.

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As the ad suggests, most neobanks are not technically banks. They offer debit cards and online banking through stylish apps. But instead of getting an expensive, expensive and time-consuming banking charter, they often negotiate partnerships with small regional lenders, who hold and insure customer deposits. Startups pride themselves on their speed: they typically deposit paychecks a few days faster than big banks, and with simpler identity checks, open accounts in minutes, even for clients with bad backgrounds. credit.

Unlike conventional banks, which also make money on overdrafts and other fees, neobanks get most, if not all of their money, from interchange fees on debit card transactions. Regulators allow small banks to charge at least double the interchange fees that large ones make; the profit is passed on to the fintechs that cling to it. In return, partner banks increase the pool of deposits on which they lend.

The pandemic partly explains the success of neobanks. The lockdowns have prompted customers to open online bank accounts from their homes. The fact that neobanks quickly cashed stimulus checks probably also helped. According to Apptopia, a data provider, the number of monthly active users of neobank apps doubled between July 2019 and June 2021, while those of traditional banking apps fell a bit. Top neobanks saw almost 20 million downloads in the first half of this year alone.

The underlying drivers of the boom, however, are long standing. Many customers have been poorly served by the financial system, if not completely excluded. (The Federal Reserve estimates that one in five adults was unbanked or underbanked in 2018.) Biggest neobanks aspire to help those who live paycheck to paycheck; others target specific underserved groups such as migrants. Social focus aside, it makes business sense: These clients tend to save little and spend often, which suits the interchange fee industry, says Max Flötotto of McKinsey, a consultancy firm. . Jarad Fisher of Dave, another neobank, hopes that once in the system, customers will “switch” to using more profitable services. To this end, his company helps consumers find work.

Optimists say incumbent banks will find it difficult to compete with neobanks, given the difficulty of modernizing technology and customer service, and the risk of cannibalizing their paid businesses. Bank shareholders may also be less inclined to innovate than venture capitalists, says Scott Galloway of New York University.

But the challengers also face obstacles. A business based on interchange fees is only viable if costs are contained and volumes are high. All neobanks have to bleed money to build trust with the hesitant underbanked and attract the already banked with freebies, but life is especially difficult for the little ones who pursue narrow customer segments. Carillon aside, few companies are making a profit. Polls suggest that a small fraction of bank customers view fintechs as their primary bank. Meanwhile, giants like Google and Walmart are starting to branch out into digital finance.

Many neobanks have realized that if they want to achieve sustainable profitability, they must get into credit, says Jeff Tijssen of Bain, another consulting firm. A few companies are launching credit cards and other loan products, venturing further into the realm of conventional banks. Some could be swallowed up by the incumbents. Others might even possibly seek their own charters.

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This article appeared in the Finance & Economics section of the print edition under the title “New Tips”

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