Neobanks are numerous but rarely profitable
The number of neobanks has increased dramatically over the past two years, but only a few of them are profitable, according to a new report from Simon-Kucher, a global consulting firm that had examined in detail the profitability of neobanks in the world.
Neobanks hold a billion accounts worldwide, including 100 million in the United States In Brazil, half of the population has an account in a neobank.
“Neobanks have grown at very high speed, but at the same time we expect less than 5% to be profitable,” said Christoph Stegmeier, a senior partner. “Neobanks are almost ten years old in Europe and almost none have reached the break-even point. That’s what everyone said, but we put the numbers behind it.
So how would he invest in a neobank? Stegmeier said he would look for a startup that aims to break even in two to three years with a careful market and product selection strategy.
“I would take Starling over other more well-known brands focusing primarily on scale,” he said. “Starling (based in the UK) has moved to a banking-as-a-service model, one of the most profitable areas of banking. It started three years ago and has around 30 fintech clients while the other neobanks are caught up in accounts and cards and transactions. With Starling, the customer experience depends on fintech, so for Starling, the business is a constant revenue stream.
Simon-Kucher’s figures are striking.
“Of the 400 neobanks in the world, less than 5% break even. Fewer than a handful of the 85 neobanks in the United States break even; many are in the cash burn zone and are losing up to $140 per customer per year.
Competition has recently shifted from a new quarter – major banks entering or attacking – the thriving neo-space with highly digital offerings. The report calls it “disrupting the disruptors” and says one in three new neobanks is an “innovation speedboat” launched by large financial services groups. The report cites the European neobank of JP Morgan, Chase, and Marcus at Goldman Sachs.
“But many other large retail and universal banks remained hesitant. These banks must act now if they want to participate in this accelerating trend or simply defend their market share.
They can build, using many plug-and-play apps on the market, “but they require enormous ambition, focus and clear vision.” Or they could make an acquisition that could probably be expensive, but could provide a way for late entrants to catch up.
Simon-Kucher notes that a rift is growing between successful neobanks in the United States and their less successful colleagues.
“By early 2022, eight banks had already reached a customer base of 5 million or more users, giving them significant advantages of scale for bolder strategic actions. On the other hand, we have seen a steady influx of new providers, with a staggering 19 new banks entering the market in the last 12 months alone.
The report also mentions neobanks targeting niches:
Mercury serves startups, Cheese targets the Asian-American community, and Dailight is designed for the LGBTQ+ community.
Will such narrow niches provide the scale neobanks need to survive, or will a large incumbent acquire a niche provider?
“For neobanks that focus on smaller segments, it’s absolutely critical that they identify a pain point within that niche where that segment has a strong willingness to pay. Just a Me Too offer combined with the lack of scale will indeed mean they are doomed from the start, he said.
“Examples of monetizable pain points would be the challenge of accessing affordable accounting and tax services for small startups or the high costs of remittance services for immigrants.”
Regarding the European market, he said that Brexit did not seem to hurt UK neobanks, but it did greatly reduce the interaction between UK and European neobanks.
“The UK fintech and banking ecosystem is almost as strong as the rest of Europe,” Stegmeier said. “We have two centres, the EU and the UK. If you look at neobanks, the UK has 50 and Europe has about 80. What’s happened is that UK fintech trading and coming to Europe and going back and forth has a lot slow motion. When new Europeans think of expansion, they don’t think of the UK because of the regulatory regime.
Meanwhile, British and European fintechs and neobanks are looking to the US, but they may be disappointed, Stegmeier said. The three main contenders are Revolut, Monzo and N26.
“N26 launched and pulled out after a few months – good move as overwhelmed by complexity Monzo tried to get a license for three years and launched with Sutton Bank so their deposits are insured by a partner.”
Revolut is live in the US, but last he heard they had 300,000 customers while 13 other US neobanks had two million or more customers. (One of the challenges for European banks is that they offer great exchange rates and travel insurance, but as one Varo executive told me, “My clients rarely leave California, let alone the United States. United.”)
In stories of neobanks and other banking innovations, “financial inclusion” is almost always there, as a vague goal, a feel-good factor, or just a buzzword. But in several countries, regulators are making it a requirement for a digital banking license.
“Regulators say if you want to get licensed, you have to make sure you’re dealing with unbanked and underbanked people in our country. So they use neobanks as a way to pursue financial inclusion. It is in complex procedure. Applicants must show their business case by including the underbanked in their services. So basically the banks came back to us and said, “Okay, we have to do this, but we have to find that balance between financial inclusion and profits. What part of our business is going to do financial inclusion and where do we actually make a lot of money? Because by practicing financial inclusion, you can make money, but not a lot.
One bank that has been successful in financial inclusion is Nickel, in France, which was acquired by BNP Paribas. And they did it with low technology indeed.
“Their distribution model is based on using newsstands and tobacco shops to win over their customers, and they charge a small fee for the account. They are probably the first profitable neobank in Europe. They use some of the digital , but that relies primarily on human distribution.”
The consultancy firm has developed a playbook for neobanks or aspiring neobanks and it calls for critical thinking, discipline and an early focus on profitability at the heart of all decisions rather than growth fast with no set date to break even.
It starts with identifying pain points and identifying where customers will pay for a solution. And presumably, where customers are able to pay for a solution.
As part of innovation and trend spotting, he suggests going beyond user experience and hooking products to spot profitable product trends and expanding the product line accordingly. A startup can’t live forever on debit card interchange fees. Support growth with low-cost digital marketing, then apply modern pricing strategies and develop a monetization playbook.