OBSERVATIONS FROM THE FINTECH SNARK TANK
In some respects, 2021 was a good year for neobanks—also called challenger banks, digital banks, or online banks—like Chime, Varo, and Current.
The 10 leading neobanks in the US grew by a little more than 10 million accounts in 2021, from 23.3 million to 33.5 million, according to Cornerstone Advisors.
Looks—or in this case, growth—can be deceiving, however. Despite the positive growth numbers, recent neobank news has not been encouraging:
- Dave—a fintech, not some random guy—said that capital constraints have limited its ability to invest in the second half of last year.
- MoneyLion faces investor skepticism as it burns cash, according to the Financial Times.
- Varo Bank could run out of money by the end of the year. According to the Fintech Business Daily, “with $32 million in salaries and $38 million in marketing spend in Q1, costs continue to far outweigh non-interest income.”
- In May, Chime confirmed reports that it’s delaying its planned IPO in light of the decline in fintech stock valuations.
The Case Against Neobanks
It would be easy to attribute the negative neobank press to the overall fintech funk permeating the industry right now. But there are market factors impacting neobanks that are closing the door to new neobanks coming into the market:
1) The megafintechs have better economics and business models
Cornerstone’s research found that only about half of the top 10 neobanks’ customers—17.6 million consumers—call their account with those fintechs their primary checking (or spending) account.
In contrast, more than 15 million consumers call PayPal or Square Cash App their primary checking or spending account provider. That’s just a small percentage of the roughly 272 million accounts Americans have with these “megafintechs.”
Do the math: Neobanks have to acquire two customers to get one primary spending account customer.
Fintech Business Weekly reported that Varo’s cost of customer acquisition is $45. That means it costs Varo $90 to acquire a primary (i.e., engaged) customer.
The megafintechs, on the other hand, already count nearly every smartphone-carrying American adult under the age of 55 as an account holder. Their cost of increasing engagement has got to be less than $90 per existing customer.
A key point here is that the neobanks don’t just compete with incumbent banks—they compete with the megafintechs, whose platform business models give them scale and revenue diversity.
2) Interchange isn’t a reliable revenue source
Speaking of revenue diversity (or lack thereof)…
I don’t know who said relying on interchange for revenue was a good idea, but in every argument I’ve had with a neobank supporter where I’ve brought up the shortcomings of an interchange-reliant business model, the response has typically been, “they’ll expand into other revenue sources at some point.”
We’re past “some point.”
Relying on interchange runs against consumer behavior trends regarding:
- Merchants’ mobile apps. In any given week, Americans have roughly $10 billion sitting in merchants’ mobile apps waiting to be used. And when it does get used, it’s one less transaction that a neobank (or traditional bank, for that matter) generates interchange revenue for.
- Buy now, pay later. BNPL may be at the top of the list things ruining civilization, but it continues to eat into banks’—traditional and neo—interchange revenue. Square (via Afterpay) and PayPal have been promoting BNPL heavily, and now Apple has announced its plans to offer the service.
- Embedded banking. A survey from Cornerstone Advisors asked consumers about their involvement and interest in getting financial services from non-financial brands. The results show a strong pattern of interest across product categories like gaming, electronics, home fitness, fashion, pharmacy, home improvement, automotive, and general retail.
I wrote that Chime should expand beyond financial services and sell other digitally-deliverable products and services—e.g., cell phone damage protection, subscription management, identity theft protection—to diversify its revenue sources.
The Fintech Brain Food newsletter echoes this call for revenue diversification, suggesting things like tips, real-time payments, subscriptions, and lending.
So what are the neobanks waiting for?
3) The Niche Affinity Play is Played Out
I’ve been a supporter of the niche affinity approach to neobanks where community fintechs like Kinly, Daylight, and Panacea Financial serve the unique financial needs of specific consumer segments. This approach requires neobanks to:
- Identify a segment’s unique financial needs. Easier said than done. Witness the coming and going earlier in this century of online banks for women. None were able to define women’s unique financial needs—in no small part because “women” is not a marketable, definable segment (it’s the aggregation of a number of segments).
- Be the dominant affinity. Neobanks’ claims of how big their affinity groups are are misleading because most of us belong to multiple affinity groups. If you’re a gay African-American doctor, do you bank with Kinly, Daylight, or Panacea?
The End of the Neobank Era
I’m not sure when the term “neobank” became popular. In January 2013 I published a blog post titled NeoChecking Accounts, and I know the term wasn’t being used then.
Whenever it was introduced, 2022 marks the end of the neobank era.
Today’s neobanks aren’t going away—just yet.
They may have won the first battle with incumbent banks, but a new wave of competition is coming from megafintechs and non-financial brands.
It’s hard to imagine that venture capitalists will continue to fund an infinite list of neobank startups planning to go after increasingly smaller market segments with interchange-reliant revenue models.
Lending isn’t a panacea. Neobank customers are predominantly sub-prime borrowers who aren’t the best candidates to lend to.
That may change over time, but do the neobanks have the time?
The pioneers of the neobank era—Simple, Moven, PerkStreet Financial, Monzo, etc.—should be celebrated. But the days of a general purpose, digital-first, retail bank-like fintech—that doesn’t lend and has no charter—is over.
This news is republished from another source. You can check the original article here