What Are Neobanks?

Customers increasingly seek digital banking solutions as the digital revolution reshapes the finance sector. Traditional banks and Fintech companies are working on upgrading their systems to cater to these evolving needs, while neobanks are generating digital bridges to provide comprehensive financial services, particularly in underserved regions.

However, key questions arise: What are neobanks? What unique features do they offer? What are the advantages and disadvantages of utilizing neobank services? Stay tuned as we address these fundamental questions about neobanks.

What Are Neobanks?

Essentially, it’s a type of fintech company that operates exclusively through mobile apps or websites, offering various financial services like savings and checking accounts, budgeting tools, and cash advances. Neobanks are particularly attractive to customers seeking flexibility, convenience, and transparency in their banking experience.

One key advantage of neobanks is their cost structure. Without the burden of maintaining physical branches, they can afford to offer lower fees and higher interest rates on savings accounts. Moreover, their apps and websites are often designed with user-friendly interfaces, providing a smoother customer experience.

Source: Fortune Business Insights

It’s worth noting that most neobanks aren’t technically classified as banks themselves, as they lack the official charter from regulatory bodies like the Office of the Comptroller of the Currency. Instead, they partner with chartered banks to facilitate the delivery of their services and ensure that deposits are insured by the Federal Deposit Insurance Corporation (FDIC).

How Do Neobanks Work?

While neobanks work fundamentally differently from traditional banks, they provide a similar variety of financial services. Typically, these digital banks collaborate with well-established, chartered banks that offer essential banking functions, such as loan issuance, deposit management, and regulatory compliance.

With this basic framework in place, neobanks create a digital platform through websites and mobile apps, enabling them to offer banking services only online. Customers no longer need to use physical branches because they may open accounts straight through the Neobank website or app.

The neobank oversees the user interface and customer service functions, while a partner bank handles the underlying banking operations. Customers can access services such as checking accounts, savings accounts, debit cards, loans, and ATM access through Neobank’s platform. The partner bank’s systems process transactions, including deposits, withdrawals, and transfers initiated via the app.

Neobanks operate digitally and have fewer overhead costs, so they can offer advantages such as cheaper fees, greater interest rates, budgeting tools, and rapid access to services. In a standard neobank arrangement, the neobank and its partner bank split income from interest, interchange fees, and other sources.

How Are Neobanks Different from Traditional Banks?

Neobanks and traditional banks represent two distinct types of financial institutions, each with its own features and approaches to banking services. Neobanks, also known as digital or challenger banks, are entirely digital entities that operate primarily through mobile apps and online platforms. They are technology-driven and offer services such as checking and savings accounts, loans, and debit cards, all accessible digitally.

Traditional banks, on the other hand, are well-established institutions with physical branches. They have a long history of serving customers in person and offer a wide range of services, from checking and savings accounts to loans, investment products, and financial advice. Many traditional banks have also embraced digital transformation by offering online and mobile banking services.

It’s also worth noting that neobanks often partner with traditional banks to utilize their established infrastructure and ensure regulatory compliance. This partnership enables neobanks to focus on their digital platforms and customer service while the traditional banks handle backend operations.

Types of Neobanks

Front-end Neobank:

A front-end neobank doesn’t have its own banking license. Instead, it partners with a traditional financial institution, leveraging their balance sheets to operate. This setup allows it to offer banking services to its customers despite lacking a standalone banking license.

Digital Banking Units:

These are digital entities affiliated with established banks. Operating as an independent digital bank requires a virtual banking license. Once a digital bank accumulates enough capital to secure its investors’ deposits, it can apply for a full banking license.

Full-stack Digital Banks (Licensed):

Full-stack digital banks hold regulatory approval and provide a comprehensive range of services. They issue deposits, offer loans, and manage their balance sheets and brand. These banks operate increasingly digitally, avoiding the costs associated with physical branch networks.

Benefits of Neobanks

• Quick Loan Processing:

Opening an account with a neobank is akin to signing up for any website. Neobanks that offer loans do so with minimal paperwork. They circumvent the rigid structures found in traditional banks, instead verifying your credit score from multiple data sources. This enables quick loan approval, showing you the amount and interest rate within minutes.

• Convenience:

A key advantage of neobanks is the ease of getting started. It’s as simple as downloading an app and signing up. They often leverage AI-assisted tools for online verification, utilizing data from partner banks to streamline customer onboarding. This digitized process greatly simplifies getting started with a neobank.

Additionally, neobanks integrate seamlessly with smart devices. They support payments through wearables and smartwatches and are compatible with Samsung Pay, Google Pay, Apple Pay, and others.

• Money Transfer Services

Neobanks provides money transfer services, allowing users to send and receive funds domestically and internationally conveniently. These services encompass peer-to-peer (P2P) transfers, wire transfers, and foreign remittances, offering users flexibility in managing their finances across borders.

• Easy International Payments:

Traditional bank debit cards typically have restrictions on international payments, necessitating an upgrade or special request to enable this feature. Neobanks, however, make international transactions seamless. They allow easy foreign currency purchases and may offer no international transaction fees. Additionally, many neobanks allow holding accounts in multiple currencies.

• Low Costs:

Neobanks offer cost-effective solutions, with many services being free of charge. They eliminate fees for services like debit cards, ATM usage, and text message alerts and often don’t charge monthly fees for maintaining an account.

• Excellent User Experience:

Neobanks replace clunky Internet banking websites with modern, responsive apps. These apps provide a familiar Internet user experience, making banking straightforward.

Neobanks also enable instant transactions and allow users to view all account and transaction details in one place. Some even provide spending insights and allow users to set up savings goals, improving financial management. Personalization options also add flexibility, offering a more tailored experience compared to traditional banking apps.

• Budgeting Tools

Neobanks commonly integrate budgeting and savings tools directly into their mobile apps or online platforms. These tools empower users to track expenses, categorize spending, set financial goals, and establish targeted savings plans.

How Exactly Does Neobanks Make Money?

Despite their relatively short existence and lack of physical infrastructure, neobanks have managed to carve out a sizable market share and are poised for significant growth in the coming years. Reports suggest the global neobanking market was valued at over $98 billion in 2023. It is projected to grow significantly, reaching $143.29 billion in 2024 and soaring to $3,406.47 billion by 2032.

Neobanks operate on a distinct business model compared to traditional banks. A significant portion of their revenue comes from interchange fees, which businesses pay each time a customer purchases using the neobank’s debit card. Take Chime, for example, a leading neobank in the US with over 38 million users. Whenever a Chime user swipes their Visa debit card, Visa charges a transaction fee, of which Chime receives a portion.

In addition to interchange fees, neobanks also generate income through other avenues:

• Subscription Fees: Certain neobanks, including Revolut and Chime, charge a monthly subscription fee for their premium services.
• Interest from Loans: Many neobanks provide loans and credit cards, accruing interest on these financial products to bolster their revenue stream.

It’s important to note that revenue models can vary among neobanks, leading to differences in charges. However, due to their streamlined operations and reduced overhead costs, neobanks typically require less revenue to sustain profitability compared to traditional banks.

Are Neobanks Safe?

In general, neobanks are considered to be as safe as traditional banks, provided they partner with licensed banks that offer FDIC insurance on their customers’ deposits. Since neobanks typically aren’t licensed or chartered as traditional banks, they cannot directly access FDIC insurance. To determine if funds deposited in a neobank’s checking or savings account are federally insured, check the neobank’s website for information on their banking partners and FDIC coverage.

Neobanks often collaborate with larger financial institutions, allowing them access to deposit services and the protection of the partner bank’s umbrella. While neobanks are fintech companies and not traditional banks, this partnership provides them with a level of safety comparable to other financial institutions.

This collaboration also enables neobanks to insure their products with FDIC coverage, extending protection to your funds held by the neobank at the partner institution. This coverage insures deposits up to $250,000 per depositor, per institution, per ownership category, similar to traditional “big name” banks.

What Are Some Popular Neobanks?

Here are some well-known neobanks and what they offer:

• Chime: It offers no monthly fees and does not charge overdraft fees for purchases made with debit cards up to $200. In addition, Chime provides a secured credit card and a high-yield savings account for credit building.
• Aspiration: Gives cash back for purchases made at eco-friendly businesses and monthly savings after $500 in eligible debit card purchases. Together with the option to plant a tree with each card swipe, it reimburses users for one out-of-network expense.
• Revolut: Offers three plans, including free standard and paid premium options. The free account connects users with discounts and cash-back offers from favorite brands.
• Current: Like other neobanks, Current does not charge annual fees or impose minimum balance requirements, and it offers early access to direct deposit payments. Current partners with Choice Financial Group and Cross River Bank to ensure its deposits are FDIC-insured.
• Varo: As the first self-chartered neobank, Varo Bank seeks to ease financial burdens and offer first-rate banking services to all. Initially established as Varo Money in 2015, it was the first neobank to be granted a national bank charter in 2020. Checking accounts, high-yield savings accounts, and free cash advances of up to $100 are all provided by Varo. Further advantages include No credit check, minimum balance requirement, and overdraft fees.

Conclusion

Neobanks epitomize the modernization of banking, offering digital-first solutions tailored to today’s consumers. With streamlined operations and innovative mobile platforms, they provide convenience, lower fees, and higher interest rates than traditional banks. Neobanks generate revenue through interchange fees, subscription models, and interest from loans, ensuring sustainability.

Partnering with licensed banks ensures FDIC insurance on deposits, guaranteeing the safety of customers’ funds. As they continue to redefine banking norms, neobanks are poised for continued growth, reshaping the financial landscape with their tech-driven, customer-centric approach.

Frequently Asked Questions