Neobanks – The Creative Destruction of Financial Services as We Know It

Thirty years ago, there were no cellphones and, whilst the internet age had started, access to the information superhighway could only be facilitated via your telephone landline. Netscape became the first commercially viable web company, and their boffins created the first usable website browser – Netscape Navigator. Good ideas never really go away, but standing still is not an option. Internet Explorer, Mozilla Firefox, Yahoo, and Google simply ousted Netscape from an apparently unassailable position, where the company had at one time commanded no less than 80% of the internet-browser market. Although market domination by one major player has never been an issue in the banking industry, the need for innovation and disruption is clearly evident. In contrast, many of the major legacy lenders are not sufficiently nimble to make the necessary adaption. Beyond ‘new’… The really important aspect of creative destruction is that it has zero respect for convention and tradition. The history of modern-day banking, as we know it, can be traced right back to the year 2000 BC. Back then, basic banking fulfilled the same role as today in providing a lien of credit to traders. But, these banks were ‘counting houses’….no notes, no digital exchange, just coins, such as the ancient Roman denarius. There is no precise definition for the term ‘neo’. But it encompasses the concepts of new, recent, modified, and, most importantly of all, revitalized. Neobanks are tech-first, new-age financial services providers, free from physical locations and traditional overheads. They are innovating much more rapidly than their conventional counterparts and offer their customers faster response times, lower costs, and mobile-first financial solutions. Being 100% digital and often accessed solely through an app, neobanks have exponential scope for growth, as illustrated in the chart below. Exponential scope for growth

The typical pattern for Neobanks so far has been to launch with a few “signature” features – such as low-cost foreign exchange (FX) and international money transfers, fee-free credit cards), business accounts – and progressively evolve the proposition to include a broader range of services. The aim is ultimately to create a multi-country, full-service digital bank encompassing current accounts, lending, insurance, and investments. However, this is a goal that only the strongest participants can aspire to. This strategy faces many potential obstacles. Retail banking, like many consumer markets, is very culturally specific – what works in one country may not work in neighboring jurisdictions. Regulation of areas such as deposit-taking and payments varies between countries and regions, making established business models less transferrable. Many European markets, including France, Spain and Italy. are significantly overbanked, posing huge hurdles in the path of new entrants, yet there is always scope for true innovation. Barriers to entry help to explain why only the best neo-innovators have been able to establish a firm foothold. But their sizeable advantage over previous incumbents is tangible. Legacy banks are typically slow to respond, seismically expensive, and technologically inadequate. Although we have seen substantial growth in the Fintech space over the last decade, the catch-up potential remains breathtaking. Legacy banks and financial services providers still account for the vast majority of market capitalization across the broader industry. Yet, legacy IT systems are extremely expensive to maintain and this is one more justification for a major pendulum swing. Breathtaking speed… The neobank concept has gained significant traction in the aftermath of the COVID-19 pandemic, with growing numbers of enterprises migrating to the virtual space, integrating such advancements as IoT (the ‘internet of things’), machine learning, cloud computing, electronic record keeping, and big data analytics. Neobanks are focusing on providing 24-7 customer service, a previously unimaginable concept, by integrating the very latest technology into their offering. As we have already seen in the preceding chart, the exponential growth opportunity provided by ‘instant banking’ is massive with a double-digit compound annual growth rate CAGR of 53.4% anticipated in the US during the period 2022-2030 (Source: Grandview Research). Few developments within financial services have occurred with such breathtaking speed as the evolution of Neobanks. Less than 10 years after the first next gen mobile banks entered the market, these digital disruptors have developed into a global standalone industry segment, and their influence will continue to strengthen in the years ahead. Upgrade, a rapidly growing US-based credit-led Neobank and leading consumer lending fintech platform, is a good example of an industry player that is particularly well-placed to benefit from the brisk expansion of this segment.