Neobanks vs. Traditional Banks

Նեոբանկերն ընդդեմ ավանդական բանկերի. Neo-banks against traditional banks

Neobanks vs. Traditional Banks: how  neobanks build the future of  financial system in the world

The rapid growth and development in technology have led to  a new digital era. Just as the quantum theory questioned stereotypical notions in physics and challenged common perceptions of the ideas of reality, neobanks, in their turn, revise the banking system. Digital banking is no longer a theory; it has evolved to become a part of our daily life [1].

In this context, the traditional banking system is getting new challenges from digital banks (the latters call themselves challenging banks) day by day as they recreate customer experience of using banking services, creating new possibilities. New or neo banks are modern interpretations of the banking system. In contrast to traditional banks which can also offer online services but rely on their physical branches as a rule, neobanks are digital financial structures only. Taking into account the increasing influence of  neobanks in the financial market, they are also assumed to  change consumers’ perceptions of financial services and will lead to important trends in the market, particularly to financial involvement, and increase of digital preference for branches. However, the market is quite competitive and contains many obstacles for neobanks, too.

The aim of this work is to find out whether the traditional banking system is strong enough to resist the competition with neobanks, which one of the them will dominate in future, whether having a completely digital banking system in the near future is realistic, as well as to find out the influence of the neobanks on the international financial system.

Neobanks vs. Traditional Banks

Fintech startups completely transform the existing products and services based upon the customer’s experience, the existing database, reduce operating costs and increase the efficiency of applied business models through advanced technology (Chappuis Halder, 2015) [2].

As fintech startups, neobanks offer banking services  at a completely different level with the logic of digital revolution. This means that anyone who wants to use their services does not need to visit a bank branch or fill out paper documents. Each process is 100% digitalized and everything can be done  through the bank’s website or  mobile application. This means that the investments in the physical branch are aimed at improving online services, artificial intelligence and its risk assessment tools.

Neobanks are presented in several forms:

  • Neobanks with a banking license. These types of neobanks acquire a license for banking activity from the Central Bank or the corresponding structure of the given country. Among them are “Atom” bank, “Revolut” in Great Britain and “N26” in Europe. These banks single out one to three main services  that can be offered to customers, putting stress on their quality and convenience. For example, Revolut mainly operates by issuing credit cards with interesting currency exchange offers [3].
  •  Neobanks collaborating with a licensed bank. This  is a relatively easy way and precedes the acquirement of a banking license as a rule. The British neobank Monese operates in a similar way, which, instead of a banking license, has a license to conduct transactions via electronic money and works with a number of European banks that keep customers’ funds, thus making banks partners and not competitors.
  • Neobanks created by traditional banks. Traditional banks that follow the pace of modern technologies and innovations are beginning to provide their services through neobanks. Kotak Mahindra Bank in India has launched its neobanking services as a new product in the form of 811 digital bank which is presented as a separate bank [4].

In the fight against traditional banks, neobanks try to take over the part of the financial market where other banks  failed or did not pay enough attention. Thus, the main target groups for neobanks, are the following:

  • First of all, the SMEs [5]. These enterprises have always had lack access to finance and the SME-centric services of neobanks have aroused great interest by them. In contrast to traditional banks, these banks offer loans with convenient rates for small businesses with a simpler and faster approach to the loan process.
  • Consumers which have not been served by banks yet, including the younger generation.
  • Migrants working in other countries․
  • Freelancers.

Here, it is important to mention that neobanks are taking special steps to increase  financial literacy and financial involvement. Taking into account the fact that the younger generation (up to 18 years old) is also a target for them and is considered as the main target group  for some  neobanks, they  post a lot of videos and useful materials on their platforms to increase the efficiency of using their services. Considering the circle of consumers, the above-mentioned two types of banks have many differences and similarities in terms of services, ways of delivery and other features, among which are:

[6] Neobank Traditional bank
Credit card Depending upon the type Yes
Maximum Deposit Medium High
Banking License   Depending upon the type Yes
Deposit Insured Depending upon the bank Yes
Branches No Yes
Face to Face Communication No Yes
Application Yes Depending upon the bank
Characteristics Agility Stability
Target Market SMEs, Younger Generation Institutions, Large Businesses, General Public

As we see from Table 1, neobanks largely provide the services provided by traditional banks, in some cases even with greater advantages. In order to thoroughly understand the differences of the latters, we will carry out SWOT analysis.

Neobank Traditional Bank
Strengths – High speed

– Absence of expenses related to the maintenance of the bank’s branch network

– Low commissions (some neobanks do not have commissions)

– Simplicity and comfort

– Presence of new digital tools to manage your own finances wisely

– Ability to use the large network of ATMs without charge due to the cooperation with a large number of banks [7]

– 24/7 access via advanced chatbots

– Multichannel Cooperation with customers in offices and branches, as well as the use of digital tools (e-mail, SMS, application, website)

-Huge customer base (Philippon, 2016)

– Trustworthy relations with the customers [8]

– Variety of provided services and a big opportunity of choice

Weaknesses – Low level of trust

– Omnichannel Cooperation with customers with the use of digital tools

– High costs for IT and online customer service

– Narrow range of services (absence of car loans, mortgages, and other types of loans)[9]

 

–  High administrative costs

-Additional costs for customer service in offices and branches

– Length of making changes and taking decisions, and administration(bureaucracy)

Opportunity – Introduction of new technologies and innovations

– Geographical expansion of online sales

– Expansion of services through the involvement of new customers

– Introduction of new technologies and innovations

– Opening additional offices in different regions to provide greater access

Threat – Cyber risks

– Ease of the emergence of new neobanks, compared to traditional banks

– Threats as a result of being less regulated than traditional banks [8]

–  Profitability risk in the long run due to offering low costs for services to attract new customers [9]

– Loss of market position

– Reduction of the customer base

Table 2. Comparative SWOT analysis of neobanks and traditional banks

From the chart above, we can conclude that both sides have enough opportunities to get the ball rolling in their side in the market, but neobanks surpass traditional banks with their development speed and they do not have the problem of bureaucracy that prevents traditional banks. The existing weaknesses tend to be neutralised over time which can not be said about traditional banks  operating in the same system for many years and making changes at a relatively slow pace. The existing risks are more worrying from the point of view of neobanks because the long-term low profitability (in spite of a large number of customers, most neobanks are struggling for high profitability or generally normal economic profit) can push them out of the competition which can be partially prevented by increasing the customer base and thus expanding the existing threats of traditional banks. The low level of income can be explained by different factors. Firstly, digital banks offer only a subsystem of banking services which limits their profit potential. Then, despite their generally large customer base, most of them often use their accounts for transactions of secondary importance.

The role of neobanks in the financial system and their development trends

As neobanks are undergoing fundamental changes in the financial market, it is necessary to understand their influence and development dynamics which will distinctly show the image of the future financial system.

Chart 1. The number of neobanks in GB, USA and RF [12]

We can see in Chart 1 that the number of fully digital banks has grown over the years in the financial centres of the world (USA, GB). Although the number of neobanks operating in Russia has remained the same, the latters have strengthened their position in the market and expanded the number of their customers. It should be noted that during 6 years, the total number of neobanks has increased almost 18 times, changing from 9 to 161 [13]. Meanwhile, the total number of traditional banks in the world is decreasing: 96 banks have recently closed in the United Kingdom, [14] and in the United States, compared to 2016, the number of traditional banks has decreased by 394, [15] and  1720 banks have closed in Europe since 2008 [16]. The decline in the number of banks has several causes, among which are the financial crisis that began in the 1980s, the resulting mergers of banks, the subsequent decline [17], as well as technological advancements that, changing customer’s preferences and developing in form of credit and payment services [18], is leading to the structural changes of traditional banks.

It is interesting that the first neobanks were created in Great Britain. It became clear from Accenture’s Digital Banking Tracker in 2019 that the customer base of digital banks of GB had reached 20 million, compared to 7.7 million in 2018[19], while the customer base of traditional banks is 13 million. The deposit volume of neobanks for each customer is 280 pound sterlings, exceeding the volume of traditional banks. The latters’ average operating cost per customer  (£ 170) is  £ 120 higher than that of neobanks (£ 50). [20] Thus, taking most of the market, neobanks had their influence on deposits and loan interest rates, offering more comfortable rates to their target [21]. This process began in 2016 when the lending assets of neobanks grew by 31.5%, with the decline of the Big Five (Barclays, HSBC, Lloyds Bank, Royal Bank of Scotland and Santander) with 4.9%, according to data received from KPMG [22]. At the same period, the Big Five expanded the Interest Rate Differential on three-year bonds, although all banks offered lower interest rates in January 2016,  compared to the previous three years. This proves that neobanks have an influence also on the investment market, as they offer both banking and investment products in one place/platform, making the customer’s experience more favourable. In addition, in order to attract new customers, the latters spare no effort to offer products at the most convenient interest rates.

Despite being an advocate of neobanks and fintech innovations in general, I have to state that neobanks have risks of losing their position and yielding in the fight with traditional banks in the future which should not be ignored. First of all, there is the issue of profitability, that was discussed above; how long can neobanks provide services with their own funds or through fundraising, especially when in 2020,  as a result of the epidemic, there is a decline in interest rates on deposits [23]? Will the growing interest in them turn into trust and will customers completely switch to these banks, saying goodbye to their traditional bank accounts? A number of similar questions can be clarified only over time, although the forecasts and data analysis (also taking into account the current trends) are of a positive nature.

As a result, we came to the conclusion that since the establishment of neobanks, the growth trend is continuous and the unprecedented progress will not stop in the near future. Nevertheless, there are many threats in the long run that can be prevented by taking steps now; these steps should be aimed at increasing the customer’s trust and turning the letters’ base into a profit.

However, the influence of neobanks on the banking system is undeniable because they have activated the market, expanded the financial involvement of the population, increased competition, challenged traditional banks which has led to the introduction of new structure and business models of banks to the customer.

[1] Neobanking 2.0: Global Deep Dive 2020 – Report By MEDICI

https://gomedici.com/neobanking-2-0-global-deep-dive-2020-report-by-medici

[2]  Chappuis Halder (2015). “How can FinTechs and Financial Institutions work together?” Chappuis Halder, Co.

[3]  https://www.revolut.com/en-LT/credit-cards

[4] https://teknospire.com/neo-banking-exclusive-digital-bank/

[5] https://psm7.com/mobilnye-banki/neobanki-i-klassicheskie-banki-bitva-titanov-ili-david-protiv-goliafa.html

[6] https://www.calendata.com/2019/05/ewallet-vs-neobank-vs-digitalbank.html

[7] https://www.fintechfactory.eu/post/disrupting-banking-how-neobanks-are-changing-the-financial-industry

[8] https://repositorio.ucp.pt/bitstream/10400.14/25884/1/Thesis_Sara_Santos_152416071.pdf

[9] https://www.pwc.in/consulting/financial-services/fintech/fintech-insights/neobanks-and-the-next-banking-revolution.html

[10] https://www.thebalance.com/what-is-a-neobank-and-should-you-try-one-4186468#:~:text=Neobanks%20are%20financial%20technology%20firms,sake%20of%20being%20cutting%2Dedge

[11] https://medium.com/datadriveninvestor/neobanking-is-the-future-of-banking-here-469148216d15

[12] The data was obtained from https://neobanks.app/  website, as well as from the websites of one and all neobanks․

[13] https://gomedici.com/neobanking-2-0-global-deep-dive-2020-report-by-medici

[14] List of Banks in the United Kingdom, https://thebanks.eu/banks-by-country/United-Kingdom

[15] https://www.statista.com/statistics/184536/number-of-fdic-insured-us-commercial-bank-institutions/?fbclid=IwAR1QeV4TVXQYdRiBJhr_su-4xSHk5VfAVhXwaJC4qbKTQtEcnIvPjaQTC2Q

[16] https://ec.europa.eu/eurostat/cache/digpub/european_economy/bloc-3d.html

[17]https://www.richmondfed.org/~/media/richmondfedorg/publications/research/economic_brief/2015/pdf/eb_15-03.pdf

[18] https://www.stlouisfed.org/on-the-economy/2018/february/why-banks-shuttering-branches

[19] https://www.uktech.news/news/uk-neobanks-near-20-million-customers-but-customer-and-deposit-growth-rates-slow-20200224

[20] https://newsroom.accenture.com/news/uk-digital-only-banks-on-track-to-triple-customers-to-35-million-in-the-next-12-months-finds-new-research-from-accenture.htm

[21] https://www.theadviser.com.au/breaking-news/40134-neobank-makes-second-home-loan-rate-cut

[22]  https://assets.kpmg/content/dam/kpmg/pdf/2016/05/challenger-banking-report-2016.PDF

[23] https://www.forbes.com/sites/madhvimavadiya/2020/05/11/is-covid-19-being-used-a-scapegoat-for-neobanks-recent-sluggish-growth/#27d722121dbe

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Author: Hermine Fanyan © All rights reserved.

Translator: Mariam Antikian.