Traditional banking has been just that for decades now -- traditional. Although much of the world around them has grown and changed at a rapid pace thanks to several emerging technologies, experienced investor Daniel Calugar says many financial institutions have remained stagnant.
Recently, though, a new type of bank has emerged that is challenging and disrupting traditional banking models. They're called neobanks -- digital-only banks that operate online and provide all of their banking services to customers through websites and mobile apps.
Some of the main draws of these new banks are the user-friendly interface to their digital offerings, along with innovative products and low fees -- all of which are quite attractive to many people today. As a result, these new financial institutions are challenging the dominance that traditional banks used to have over the financial industry.
Below, Dan Calugar will discuss the emergence of these neobanks, the business models they operate on, and the advantages they provide over traditional banks. Additionally, he'll explore the potential opportunities and challenges for customers and the financial industry as a whole.
What Are Neobanks?
Neobanks are, quite literally, a new form of bank. After all, the prefix "neo" means new in Latin.
But neobanks aren't just new banks that have hit the market in recent years. Instead, they're an entirely different type of bank that is working hard to disrupt the market. As such, they are often referred to as challenger banks.
In many ways, neobanks are financial technology -- or fintech -- companies more so than they are traditional financial institutions, as Daniel Calugar explains. The main draw of these banks is the technology tools they offer customers, including the ease of signing up for accounts and using them online. In stark contrast, digital tools are one of the weaknesses of traditional banks.
Rather than trying to be an all-encompassing financial institution like many traditional banks, neobanks will usually focus on a few common services, such as savings and checking accounts.
How Neobanks Operate
There are two ways that neobanks can operate. First, they can function as "full-stack" companies. This means that they obtain a full banking license to operate and, as such, are fully insured by the Federal Deposit Insurance Corporation. This insurance can give consumers the confidence they need to feel comfortable depositing their money into accounts.
The other option is for neobanks to operate as "front-end" companies. In this scenario, the companies will partner with other existing banks. The traditional bank will provide the back-end operations -- such as the FDIC insurance, the financial products, and the brand name -- while the neobank will offer the front-end operations, such as the user interface, mobile apps and more.
It's rare that a neobank will operate as a hybrid of the two -- partnering with an existing bank while also getting a full-fledged banking license of its own.
Neobanks are focused on the online services they provide- specifically, the banking and financial transactions that can be done via mobile apps. Dan Calugar says that while most neobanks will provide services such as account access on a website, their distinguishing factors are in the mobile apps they provide. Having said that, some neobanks still offer some traditional banking services, such as physical debit cards.
The Growth of Neobanks
Neobanks only really hit the market about ten years ago. In 2014, there were just eight neobanks that were trying to disrupt the monumental traditional banking industry by providing an experience that was not just digital-focused but digital-only.
Their target market was people who were 18 to 34 years old -- a generation of consumers who grew up with not just advanced technology but technology in the palm of their hands. In other words, Daniel Calugar says this segment of the population isn't just used to working with mobile phones; they prefer it.
The concept certainly caught on, as neobanks have become a legitimate niche in the financial services market. As of 2022, more than 400 neobanks were operating around the world, serving roughly one billion customers. And about 20 percent of those neobanks were in the United States, with over 100 million active accounts.
The main reason for neobanks' explosion in popularity is the 18-to-34-year-old segment of the population, who desire more tech-forward financial services.
Advantages of Neobanks
There are many advantages that neobanks provide over traditional financial institutions. If there weren't, there's no way that the industry would have grown the way it has since 2014.
There's no singular reason for neobanks' success at making inroads in an industry with some genuinely huge players. Below, Daniel Calugar discusses some of the main reasons consumers are opting for neobanks over traditional banks.
The biggest claim to fame of neobanks is the access they provide. It's the separating factor between them and traditional banks.
While all banks today offer some form of online banking -- and just about all offer mobile apps -- their services are typically clunky compared to that of neobanks. There's a major reason for this, of course.
Traditional banks were built on a brick-and-mortar business model, where branches are the hub of operations. Neobanks, by contrast, don't have any physical locations, so all of their efforts have been poured into offering top-of-the-line tech tools.
The leading neobanks' apps rank very highly in mobile app stores, which brings in new customers who can appreciate all they have to offer.
Neobanks also offer quicker applications and approvals for their accounts. All offer a completely digital application process, including the entry of basic information and uploading of verification documents.
While many traditional banks today offer the ability to fill out application forms online, some still require consumers to print those forms out and bring them to a branch, where they can show photo ID to verify themselves. This is a major disadvantage of traditional banks compared to neobanks.
What's more, neobanks that offer loan services typically offer quicker turnaround times on funding decisions. Then, once approved, consumers will have their money made available to them in short order.
Because neobanks don't have any physical locations to deal with, they are able to save money on overhead, and some of these companies pass those savings on to their customers.
Many neobanks offer checking and savings accounts with no monthly fees and minimum balance amount requirements. If a traditional bank charges $10 per month for their checking accounts, this is a savings of $120 per year.
In addition, Dan Calugar says that neobanks offer competitive interest rates as well for the same reason. They might offer a 3% interest rate on savings accounts, for instance, compared to many traditional banks, which offer interest rates lower than 1%.
The same thinking also applies to any loans they might offer. The interest rates on those products are usually lower with neobanks than they are with traditional banks.
Disadvantages of Neobanks
While neobanks are certainly disrupting the financial industry, there are plenty of reasons why consumers still prefer to do business with larger traditional banks. Below, Daniel Calugar lays out some of the biggest disadvantages of neobanks.
Lack of Customer Service
The bread-and-butter of traditional banks is the customer service they provide. As a result, Bank branches have often been seen as focal points of communities, and for good reason.
Aside from branches, traditional banks usually invest a significant amount of time, effort, and money in building up extensive customer service offerings, from telephone support to live chat online.
While neobanks certainly don't ignore the customer experience altogether, it's not their primary focus. You'd be hard-pressed to find a neobank that doesn't offer phone or live chat support, but sometimes, that's simply not enough. Consumers have grown accustomed to being able to head to a branch if they have a major issue with their bank account, and neobanks don't provide that option.
Another calling card of traditional banks is that they are often a one-stop shop for financial services. For example, at the same bank where you open a checking and savings account, you can also get a safety deposit box for valuables; obtain a credit card, personal loan, auto loan, mortgage, and other forms of credit; and even take advantage of free services such as getting documents notarized.
Neobanks simply don't offer that many products. As mentioned before, they are hyper-focused on a few mainstay products that most consumers want, such as checking and savings accounts. But, if one of their customers needs a loan or wants to open an investment account, they're going to have to look elsewhere.
In addition, traditional bank branches do provide one major advantage over neobanks on even the accounts that they do offer -- the ability to handle cash. And while many financial transactions today are going all-digital, people still do deal with cash.
Not only is it nearly impossible to deposit cash into a neobank account, but most neobanks don't even offer a direct way for customers to obtain cash from their account at an ATM.
Lack of History and Trust
Comparatively speaking, neobanks are babies in the financial services industry. Traditional banks have been around for hundreds of years. However, even the longest-tenured neobanks have only been around for just over 10.
That lack of track record may not scare everyone away, but it certainly will give some people pause.
Dan Calugar points out that people are often very careful about what they do with their money -- at least in terms of where they store it. And the lack of history often goes hand-in-hand with a lack of trust.
A lot of consumers out there still view neobanks as startups rather than financial companies with solid foundations, and many startups fail in the first few years of operation. As such, those who are hesitant about making the switch to neobanks might wonder what would happen to their hard-earned money should the company they choose fail.
While this shouldn't be much of a concern -- since almost all neobanks are either FDIC insured or partner with a traditional bank that is -- it's still a fear that many people have. Even if recovering their money isn't the concern, dealing with the process of reclaiming the money and then switching their accounts to a new bank is certainly a hassle.
Other Factors Affecting the Industry's Growth Potential
While there is a lot of confidence in the future of the banking industry's neobank sector, certain factors could affect the growth potential.
Daniel Calugar points out some of the internal and external factors that could affect the growth potential of neobanks.
Internally, all financial services companies -- fintech or not -- face challenges related to fundraising and capital. As was seen with the overnight collapse of Silicon Valley Bank, having enough capital to cover deposits -- and keeping depositor confidence high -- is essential to success.
If neobanks aren't capitalized adequately from the beginning, they are bound to fail. And that's if they're able to make a mark in the industry at all. Additionally, as they grow, they will similarly fail if they can't keep pace with increasing deposits and products.
Since neobanks have to be viewed as typical startup companies, it's no surprise that capital would be a significant concern. After all, the primary reason most businesses fail in their first few years is they don't have enough money to continue operating.
Perhaps the biggest external challenge to neobanks over the next few years will be the big banks themselves. While these large companies would never consider themselves tech-forward, they have enough resources at their disposal to become that if they so desire.
If a major banking institution were to decide that it was tired of losing customers to neobanks and didn't want to partner with a neobank to offer tech services, it could simply decide to invest heavily in tech tools of its own. If large established banks were to do this, they would likely be successful since they already have built-in consumer confidence.
Because neobanks are rising in popularity, the sector will likely see new companies enter the fray over the next few years. At first glance, this added competition may seem only a potential threat to individual neobanks rather than the industry as a whole. However, Dan Calugar says that it's possible that a plethora of neobanks on the market could dilute the product and cloud their benefits.
It's likely that a majority of the neobanks that launch over the next few years will, frankly, not be that good. This is not to say that there won't be shining stars; it's simply a number game when it comes to startups.
The problem for the sector is that when a neobank fails, it looks bad on the entire sector -- whether or not their failures are at all related to how successfully neobanks, overall, are operating. If this were to happen, it would allow traditional banks to jump on these failures and use them to engender more confidence in consumers to stick with them.
The Future of Regulations
Another crucial external factor in the growth potential for neobanks is potential changes to banking regulations. If banking regulations were to tighten, for instance, it's possible that neobanks could be adversely affected overnight.
While other financial institutions would likely be affected in similar ways by the same regulations, Daniel Calugar says that neobanks may be more affected than larger traditional banks. This is because traditional banks have more products they can rely on if one specific portion of their business is affected, while neobanks tend to offer only a few.
Right now, neobanks aren't facing specific regulatory standards from any one agency. Instead, the products they offer are regulated. That's serving as a key positive for the sector right now, but it's possible that could change in the future -- especially if the industry were to keep exploding.
No matter what the additional regulations are or where they come from, they serve as a potential threat to the future growth potential of neobanks.
About Daniel Calugar
Daniel Calugar is a versatile and experienced investor with a computer science, business, and law background. While working as a pension lawyer, he developed a passion for investing and leveraged his technical capabilities to write computer programs that helped him identify more profitable investment strategies. When Dan Calugar is not working, he enjoys working out, being with friends and family, and volunteering with Angel Flight.