The number of neobanks has grown tremendously in the last two years, but only a few of them are profitable, according to a new report from Simon-Kucher, a global consultancy which had looked in detail at the profitability of neobanks around the world.
Neobanks hold one billion accounts around the world, including 100 million in the U.S. In Brazil, half the population has an account with a neobank.
“Neobanks have seen super high-speed growth, but at the same time we expect that less than 5% are profitable,” said Christoph Stegmeier, a senior partner. “Neobanks are almost a decade old in Europe and almost none has reached breakeven. That’s what everybody has been saying, but we have put the numbers behind it.”
So how would he invest in a neobank? Stegmeier said he would look for a startup that aims to breakeven in two to three years with a strategy of carefully selecting markets and products.
“I’d take Starling over other better known brands focusing mostly on scale,” he said. “Starling (based in the UK) has moved to a Banking as a Service model, one of the more profitable areas in banking. It started three years ago and has about 30 fintech clients while the other neobanks are caught up with accounts and cards and transactions. With Starling, the customer experience is up to the fintech, so for Starling the business is a constant revenue stream.”
Simon-Kucher’s numbers are stark.
“Of the 400 neobanks in the world, less than 5% are breaking even. Less than a handful of the 85 neobanks in the U.S. are breaking even; several are in the cash-burn zone losing as much as $140 per customer annually.”
Competition has recently risen from a new quarter — big banks entering, or attacking — the successful neo space with highly digital offerings. The report calls this “disrupting the disruptors” and says one in three new neobanks are “innovation speedboats” launched by large financial services groups. The report cited JP Morgan’s European neobank, Chase, and Marcus at Goldman Sachs.
“But many other large retail and universal banks have remained hesitant. Those banks need to act now if they want to participate in this accelerating trend or simply to defend their market share.”
They can build, using many of the plug and play applications on the market, “but they require enormous ambition, focus, and a clear vision.” Or they could do an acquisition which could probably be expensive, but could provide a way for late entrants to catch up.
Simon-Kucher notes that a gap is opening between successful neobanks in the U.S. and their less successful colleagues.
“As of early 2022, eight banks have already reached a client base of 5 million users or more, gaining them significant scale benefits for bolder strategic plays. On the other side, we’ve observed an ongoing inflow of new providers, counting a staggering 19 new banks entering the market in the last 12 months alone.”
The report also mentioned neobanks targeting niches:
Mercury serves startups, Cheese targets the Asian-American community, and Dailight is built for the LGBTQ+ community.
Will such tight niches provide the scale that neobanks require to survive, or will a large incumbent acquire a niche provider?
“For neobanks focusing on smaller segments it is absolutely critical that they identify a pain point within that niche for which that segment has a high willingness to pay. Just a Me Too offer combined with the lack of scale will indeed mean they are doomed from the beginning, he said.
“Examples for a monetizable pain point would be challenge to get access to affordable accounting and tax services for smaller startups or the high costs of remittance services for immigrants.”
Looking at the European market, he said Brexit hasn’t seemed to hurt the UK neobanks, but it has sharply curtailed interaction between the UK and Europe neobanks.
“The UK fintech and banking ecosystem is almost as strong as the rest of Europe,” said Stegmeier. “We have two centers, EU and the UK. If you look at the neobanks, the UK has 50 neos and Europe has about 80. What has happened is the exchange between UK fintechs and coming to Europe and going back and forth has slowed down a lot. When European neos think about expansion, they don’t think UK because of the regulatory regime.”
Meanwhile the UK and European fintechs and neobanks are looking to the U.S., but they are apt to be disappointed, said Stegmeier. The top three contenders are Revolut, Monzo and N26.
“N26 launched and withdrew after a couple of months —a good decision because overwhelmed by complexity, Monzo tried to get a license for three years and have launched with Sutton Bank, so their the deposits are insured by a partner.”
Revolut is live in the U.S. but the last he heard they had 300,000 customers while 13 other American neobanks had two million or more customers. (One of the challenges fo European banks is they come in offering great FX rates and travel insurance, but as an executive at Varo told me: “My customers rarely leave California, much less the United States.”)
In accounts of neobanks and other innovations in banking, “financial inclusion” is almost always present, as a vague goal, a nice-to-have, or simply a buzzword. But in several countries regulators are making it a requirement for a digital banking license.
“Regulators say if you want to get a license you have to make sure you are dealing with the unbanked and the underbanked in our country. So they’re using neobanks as a way of pursuing financial inclusion. It’s in the complex procedure. The the applicants have to show their business case by by including the underbanked in their services. So essentially the banks have come back to us and said ‘Lok we have to do that, 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 money?’ Because in practicing financial inclusion you can make some money, but not a whole lot.”
One bank that has been successful at financial inclusion is Nickel, in France, which was acquired by BNP Paribas. And they did it with low tech indeed.
“Their distribution model relies on using newsstands and tobacco stores for gaining their clients, and they charge a small fee for the account. They are probably the first profitable neobank in Europe. They use some digital, but it mostly relies on human distribution.”
The consultancy has developed a playbook for neobanks, or aspiring neobanks and it calls for critical thinking, discipline and a focus from the beginning on profitability at the core of all decisions rather than fast growth with no defined date for moving beyond breakeven.
It starts with identifying pain points and identifying those where customers will pay for a solution. And presumably, where customers are able to pay for a solution.
Under innovation and trendspotting it suggests moving beyond user experience and hook products to detect profitable product trends and expand product range accordingly A startup can’t live on debit card interchange fees forever. Support growth with low cost digital marketing and then apply modern pricing strategies and develop a monetization playbook.