Digital-only banks with no physical infrastructure have been wowing customers with their easy-to-use, customer-friendly digital services and transparent, low fees. Their business model might be far from perfect but more and more traditional banks are choosing to take a leaf out of their book and focus their attention on customer needs. And with good reason.

The financial services sector saw yet another shift when digital-only banks, often called neobanks, entered the picture and began to gain momentum in the market. But who are they and what sets them apart from their competitors? Pretty much what’s said on the tin: they provide banking services exclusively online, without physical branches, through a browser or an app. They offer basic services in the most simplified form possible, relying on electronic documentation, real-time data and automated processes. Just think Monzo, Revolut and Starling in the UK, N26 in Germany or Simple in the US.

Digital-only: the answer to new expectations?

Neobanks were started in response to changing customer expectations and the rising demand for simple, quick and hassle-free services, especially among new generations of young, tech-savvy clients. A recent survey shows that about 9% of British adults, about 4.5 million people, have already opened an account with a digital-only bank and another 16%, an estimated 8.5 million people, plan to do so within the next five years. This proportion is considerably higher among younger age groups, with 15% of Gen Z (born after 1996) already having a digital account, compared to only 6% of baby boomers (54–73 year olds).

But it’s not only millennials and Gen Z customers who may develop a soft spot for digital-only banks. As the industry keeps growing, along with consumer trust, digital banking promises to become a go-to banking solution for a variety of demographics, Romexsoft predicts. These include busy professionals on the go, digital nomads looking for a versatile bank, small business owners seeking new sources of credit, and people in developing countries who have a smartphone but no access to traditional banks.

Omni-digital instead of omni-channel

Financial institutions have largely focused on omni-channel customers, who visit branches but also use mobile or online banking and call contact centres. But demand for omni-channel use seems to be shrinking, with more and more customers becoming omni-digital instead, only using digital channels and ditching physical ones like branches altogether. According to PwC’s 2018 Digital Banking Survey, 20% of banking customers are now online/PC dominant (down from 25% in 2017), 15% are mobile dominant (up from 10%) and 14% use both channels regularly. “To a growing number of consumers, banking just is a mobile activity. In fact, when developing strategy, we encourage banks to think mobile-first, or else,” the report suggests. And the bar’s been set rather high, as customers more and more compare their digital experience to that offered by large online retailers and tech giants like Amazon, Google, Facebook and Alibaba.

Interestingly, PwC also found that there are certain, more complicated transaction types that remain “branch dominant”, such as applying for a loan (59%) or a new checking or savings account (58%), opening a new brokerage/ investment account (43%) and using financial advisory services (37%). As physical branches are the most costly channel of all, banks should really look into why customers still walk into their local branches for these types of activities.

Why customers love neobanks

So what makes digital-only banks so attractive? For starters, they make the most of new technologies, offering geolocation-based real-time alerts and biometrics-based services. Atom, for example, has been offering biometric security and account opening features through their app since 2015. Revolut, having started out as a currency exchange app, launched cryptocurrency exchange and now even offers cryptocurrency cashback to premium customers.

Neobank services are also a breeze to use. As Infosys puts it, “all banking-related hassles tend to vanish with the advent of digital-only banks, where consumers can simply click and upload their documents in a bank’s soft locker, open bank accounts and transact right from their homes”. And that’s only the beginning.

Because the thing is, disruptors don’t seem to stop for a breath. The UK, in particular, has been a hotbed for neobanks. Revolut, founded in 2015, reported over two million customers in July 2018 and a few months later, became the first London-based fintech to obtain a European banking licence and is preparing to offer full current accounts, personal loans and overdrafts in the near future. Monzo, a fully-fledged bank in the UK since 2017, offers bank transfers, direct debits and standing orders, just like any of its traditional counterparts. It also managed to raise over £100 million in a funding round late last year, and besides having over 1.5 million private customers, has recently started beta-testing its new business accounts. Similarly, Starling Bank has just obtained £75 million in investment and is eyeing European expansion.

Ambitious challenger banks

In other parts of  the world, challenger banks are no less ambitious. Berlin-based N26, one of the fastest-growing banks in Europe, has gained over 2.3 million customers and is now moving into the US market. Australia’s Volt Bank has recently partnered with digital wealth platform Spitfire to distribute its deposit platform, seeking to cement its position as a “one stop shop” for investors. It will also roll out savings accounts in March, transaction cards in May, personal loans by the middle of this year, and home loans towards the end of 2019.

Other perks digital-only disruptors offer to customers include money management services that help users track expenses, like sending push notifications alerting them when a purchase seems to be over their budget and offering tips on where they could cut back on expenses. Such personalised money management and budgeting tools can boost customer loyalty, and are becoming a major selling point over traditional banks.

Take Simple in the US, for example, which regularly publishes testimonials from customers, including digital nomads travelling the world. The American neobank’s inspiring stories include a customer who used its money management tools to pay off $24,000 in debt in just a few months as well as a couple who hit the road in a trailer thanks to a rigorous savings plan.

Lower operating costs mean lower fees

One of the most attractive features of digital banks is that they charge low or no fees at all, and provide higher-than-average interest rates on savings. Of course they do: their operating costs are way lower than that of traditional banks and they don’t carry the burden of costly legacy IT platforms but use a cloud-based infrastructure instead of an on-premise one, Infosys points out.

Teaming up with partners help digital-only banks roll out new customer solutions faster. Starling, for example, has joined forces with digital wealth management startup Moneybox, to allow customers round up their everyday purchases and invest their spare change in companies from all over the world through tracker funds. Moneybox uses Starling’s API to connect accounts with its system. N26 also partners with several other fintechs, including Transferwise for P2P money transfers, Raisin for savings, Vaamo for investments and Clark for insurance.

Others work together with banking-as-a-platform financial organisations or other banks to provide fast access to services, instead of holding a banking licence of their own. Berlin-based Penta, which targets German small and medium-sized businesses, partnered with SolarisBank to launch its accounts in 2017. American Chime, offering a slick mobile banking and money management app, has joined up with the The Bancorp Bank.

Traditional banks hop on the bandwagon

But the picture is not all rosy for digital-only players, at least according to some experts. Infosys warns of concerns, “which if not addressed soon, can hinder their acceptance in the future”.

Security is one of them: the risk of fraud and malpractices is “understandably magnified” with the emergence of digital-only institutions. Not to mention that zero physical presence can alienate some customers, making them shift to traditional banking. And digital banks also tend to have limited offerings, which puts a brake on customer growth.

Whether or not these risks will actually jeopardise their future remains to be seen. But one thing is for sure: their business model is getting more and more attractive to traditional banks. Italy’s Unicredit was one of the many leading banks to launch a mobile-only subsidiary, buddybank, in early 2018. The “buddy” aspect of the service is a 24/7 concierge service using both artificial intelligence and real people to help out customers whenever and wherever they need it.

Digital-only banks may not hurt traditional ones

Building digital-only units with their own distinct brand has become something of a trend among established banks, according to Finextra. JPMorgan Chase rolled out its digital-only challenger bank, Finn in the summer of 2018, joining the likes of Santander’s Openbank and Bank Leumi’s Pepper. It’s quite telling that the Financial Brand lists some of these banking ventures among the 25 most important digital-only banks to watch in the future. Most of the above concerns about digital-only banks may not hurt traditional banks that much after all.

In the meantime, neobanks have largely steered clear of high-interest loans, hefty fees for overdrafts and foreign exchange that have been so lucrative for other banks – but which the newcomers see as ripping off consumers, Reuters says. The upstarts plan to make money from a new model, which uses customers’ data to sell them other financial services for a commission. And if they succeed, they will seriously eat into the retail banking profits of large banks.

This post was originally published on 23 February 2018 and has been updated to include recent developments.


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