Opportunities and Challenges for Neobanks Are Large in the U.S.

Over the past decade, traditional financial institutions have encountered new challengers what had been a relatively stable marketplace. These new entrants, referred to as “neobanks,” offer consumers free accounts to deposit their money, collect higher interest than from typical banks, and perform other assorted bank functions through their smartphones — no physical bank location required (or even available).

Some of the pioneering neobanks include the UK’s Revolut, Starling, Monzo, and Atom; Spain’s Next; Germany’s N26; Australia’s 86 400; Brazil’s Nubank; and South Korea’s KakaoBank. In the U.S., the biggest competitors are Varo, which recently received a banking license, Petal, SoFi, and Chime. Stock trading app Robinhood could also be considered a neobank.

To understand the appeal of these neobanks, as well as the challenges they face, Emily Voight of GLG’s Private Equity Content Team spoke with Sumeet Ahuja, founder of EVOKE Partners, who most recently was Director of Global Product Launch Management at PayPal. Below are a few select excerpts from our broader discussion.

What are the major themes within the neobanks space?

There are four key things. The first is their core value proposition and the leading message that they have in the market, which is around taking away pain points of traditional financial institutions (FIs) and helping consumers’ financial well-being. The second is around disruption. Neobanks are pushing innovative technologies, including machine learning, artificial intelligence, blockchain, and sophisticated APIs. The third aspect, which has become prominent in the past year, is their business plans. Are they striving for growth, or will they be profitable ventures?

Finally, in terms of their growth, it’s interesting that they’re tapping into both underbanked segments and the younger demographic. But at the same time, even the older population is taking to mobile platforms and neobanks. As we move forward, we’ll see an emerging theme of neobanks bringing net new segments into the banking space.

What’s the outlook for growth in the U.S., and what are the key drivers favoring that growth?

The U.S. has seen a slower rise compared with Europe. The next three to five years will be crucial for growth and adoption here. Data suggests that there are about 23 million neobank U.S. consumers, and that’ll grow to about 47 million to 50 million users by 2025. Worldwide, there are Bloomberg reports that say that the whole neobank economy could pass $720 billion by 2028. That’s a growth rate of about 50% annually from now until then.

The numbers are extremely promising, but what’s more important are the key drivers. Those are venture funding, which is still high, and changing demographics, including millennials and underbanked and underserved populations. There are about 2 billion people without access to financial systems across the world. That will play a big part in neobank adoption.

What are the main challenges that neobanks face when they enter the U.S.?

Neobanks will be challenged to adapt to or endorse the regulatory framework of the U.S. market, which is fairly complex. The second challenge is that U.S. consumers have typically been slow to adapt and adopt digital services compared with those in Europe. There’s only about 3% of millennials who have in the past 8 to 10 years opened an account with a neobank.

There are still a lot of embedded relationships with traditional FIs. The power of these institutions is immense. It’s difficult to dislodge a consumer from an existing relationship and move them over. There’s a lot of inertia. People have a fear of moving financial assets from one institution to another. So how do you make that mindset shift happen?

What are the biggest cost and revenue drivers for a neobank?

Unit economics are crucial for neobanks and increasingly so because investors are asking questions around the path for profitability. From a cost perspective, most money is spent on marketing. The cost of acquiring customers is extremely high. The other big part of their cost structure has just been the high growth — the high costs of headcount and office spaces. Talent is a huge expense. A typical neobank loses about $11 to $15 per consumer, so the economics are not favorable yet. What will become a higher cost for neobanks going forward as they try to get bank charters is the cost of compliance. Typically, a bank spends anywhere from 6% to 10% of its revenues on compliance.

From a revenue perspective, there are multiple channels. The first, and biggest one, is interchange fees from card usage. As we start seeing neobanks offering premium services such as high savings accounts or “metal” debit cards with loyalty programs, revenues will hopefully increase. I expect neobanks to increase the breadth and depth of their product portfolios, so we should start seeing more investment-related products and loans. The other thing to watch would be, for neobanks that don’t have bank charters and cannot move fast into higher-value services, will they offer referrals to the larger FIs for fees? Last but not least, how will neobanks use and monetize the data that they have?

What’s the outlook on M&A in this space?

I expect a steady amount of activity over the next few years. The whole space is extremely noisy and there’s a lot of fragmentation, meaning there are opportunities to be tapped into in various parts of the value chain of the financial ecosystem. M&A activity will come in many forms. Valuations are still extremely high for some of the unicorns, and with a focus on profitability, I expect that some of these larger neobanks will hold on as they strengthen profitability, justify their valuations, and build their consumer base.

In the meantime, I expect them to start seeking out and seeing what they can do in terms of sprucing up their product portfolio and relationships through acquisitions of smaller neobanks, including in other geographies where they don’t currently operate.

But we’ve got to keep in mind that the incumbents, the larger FIs, have resources and buying power, so I wouldn’t be surprised to see some unsolicited moves every now and then toward the smaller players or even some of the larger ones. I also anticipate some handshakes across the aisle in terms of neobanks collaborating. If they can’t offer particular product sets, there may be partnerships with another neobank.

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About Sumeet Ahuja

Sumeet Ahuja is Founder of EVOKE PARTNERS, delivering Product, Strategy and Business thought-leadership and execution planning for clients ranging from global large-cap brands to angel-funded startups. Prior to this, he served as Director – Global Product Launch Management with Paypal, where he served as the key leader of the core Product organization & “tribe”, and founding member of the Product Launch team & function that is regarded as a Center of Excellence.

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This financial industry article is adapted from the March 31, 2021 GLG Teleconference. If you would like access to this teleconference or would like to speak with financial industry expert Sumeet Ahuja, or any of our more than 900,000 industry experts, contact us.