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Traditional Versus NeoBanks – Who’s the Champion and Who’s the Challenger?

Sep 01, 2021

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Sep 01, 2021

COVID forced banks to develop new low-touch ways of serving clients. Meanwhile many traditional banks have lost millennial clients accustomed to running their lives on mobile/digital devices who are more willing to trust Neobanks with their finances.

Traditional Versus NeoBanks – Who’s the Champion and Who’s the Challenger?

In recent years, many stories and articles have been published about the coming demise of brick-and-mortar banking. Each pointing to different market developments as evidence, all reaching the same conclusion: branch banking is part of the past, and mobile banking is the future. Some articles declaring banking would see dramatic transformation seemed to be a bit hyperbolic but were not too far off given what has transpired over the past 18 months. Shifts driven from COVID restrictions which forced banks to figure out new low or no-touch ways of serving clients were answered by fintech’s relentless pursuit of new and better digital offerings. Alongside these changes was the demographic profile of traditional banks, institutions who have lost millennial clients accustomed to running their lives on mobile/digital devices and have been more willing to trust Neobanks with their finances.  

Neobanks, often referred to as “challenger banks,” are fintech firms which develop, and offer software, apps and other technologies to reduce friction within mobile and online banking. They tend to be more nimble than large traditional providers by effectively using transactional data to guide product development. Where large online banking and mobile providers offer their services to a multitude of clients with different core processors, Neobanks align themselves with one financial institution and focus their energies on digital service innovation, and cost reduction. These challenger banks, operating in a fully digital environment, offer market ready products and services through a perceived approach of “fee-free bank.”  

For decades, generating fee income from services provided and interest on loans have served as the primary business model.  Banks must not only establish a secure placement in a customer’s “wallet” but also ensure enough enticing product diversification is provided and more importantly used to generate revenue from the relationship. This model has been in place for decades because it has worked. But just as Amazon, Uber, and Airbnb have disrupted their verticals, so have Neobanks. Where Amazon does not own or manufacture the products it sells, Uber does not own the vehicles, or Airbnb the properties it rents, Neobanks partner with providers who offer services and simply share the revenue. An example is Chime. Since its inception in 2013, Chime has attracted over 12 million checking accounts, making it the 7th largest provider of banking services in the U.S. in relation to primary bank customers, per Cornerstone Advisors.  Chime and other digital-only organizations have been successful because they offer specific services which appeal to younger banking clients:  

  • Early, rapid access to funds and money transfers 
  • Few fees and none for overdrafts
  • Products designed to improve credit scores

Chime is not alone but has been a huge success story thus far. The top 5 digital-only banks, in aggregate, have more accounts than Wells Fargo and should surpass all credit unions in the next 18-24 months with a growth rate of 7% annually versus 4.1% for all other financial institutions per Forbes.  

Banks have faced competition from outside players before, from monoline credit card issuers to consumer finance companies.  Some fintechs have been absorbed into banks becoming the backbones for expanded technology stacks and functionality. The use of technology and the speed of deployment is the driving difference today. The advent of same-day payment rails, QR code payments, and card-not-present ATM withdrawals are just a few features often reserved for the bigger financial institutions and digital-only banks.  

With the digital explosion, the ability to retain customers is a constant tug.  Banks of all sizes are not immune from the onslaught of account migration. Forbes reported Bank of America had seen a 9% decrease in customer checking accounts between the ages of 26-40 in the last 18-months, while community banks reported a net loss of 1.5 million accounts.  Meanwhile, PayPal, Current, Dave, and Square Cash have experienced double-digit growth.  The shift seems to have less to do with mobile banking than with product design and innovation and perception of fewer account-related fees. 

In a recent interview with CB Insight, Chime’s CEO Chris Britt shared Chime’s goal is to keep banking “simple” and allow customers to tell them what they want and need. He said they look at Net Promoter Scores and customer feedback to develop their product set. But what drives most of their business is the data they obtain from customer transactions and mobile usage. These two elements allow them to decide which direction and path they should take regarding innovation. Digital only ‘banks’ use the consumers’ behavior to get ahead of their wants and needs, allowing for trust to be built into the relationship through unique product offerings and slick app technology.  

Introduction of new products, such as Chime’s Credit-Builder card provided the means for customers to determine an amount to have drafted from their checking account into a Credit Builder card to be used for purchases and paid off monthly.  This in turn helps cardholders improve their credit scores by reporting to the bureaus and, in a recent article from American Banker, was said to be one of the top requests from their customers according to one of the Chime executives  

The amalgamation of data, in a clear, comprehensive format allows for patterns to be visualized and decisions to be made, serving as the starting block for innovation. What digital has done for customers is allow them to have a single channel of entry into their financial institution, but what innovation has accomplished is arming the channel with features and functionality to manage their financial life in one place. Mobile users can complete almost any transaction via their device, easily and quickly from applying for a mortgage to getting renters insurance for a college bound child. As the information age continues to dominate the 21st century, personalization of the user experience and user interface will only become more pronounced. Companies that focus on the user experience and allow for personalization will provide greater adoption rates within those FIs. 

The first chartered bank in the US was founded in 1791. Its goal was to provide savings and access to customers' money, that goal has not changed, only the way it is done.  

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