Fintechs – bigtechs – neobanks. Challenges facing banks.

The history of fintechs can be broken down into three stages. The 1990s saw the emergence of online banking and direct banks, i.e. those that did not have branches. The competition was basically only between them. Fintechs were established only in the second phase of market development, using technology to provide financial services. However, they dealt with a narrow scope of such services, or even only part of the value chain. The third phase brought about blurring of the differences between niche fintechs and banks, the emergence of digital service platforms featuring a wide range of services and different providers. In this phase, fintechs often become banks (Fidor, Holvi) or enter into long-term, loyal cooperation with a particular bank (N26). As a result of market success, some fintechs are listed on the stock exchange and their market value is growing rapidly (e.g. the value of German Wirecard AG is comparable to that of Deutsche Bank!).

So far, progress has often consisted in introducing a different way of providing a service, i.e. making it simpler, cheaper, faster or more personalised. New business models, including crowdfunding, social lending, mobile payments and robo-advisors, have developed. Banks, initially reluctant to respond to new rivals (e.g. the famous battle in Germany concerning the Sofort system), quickly adopted an optimal cooperation strategy, but did not cease to compete. This was when some interesting and significant expressions were used, including coopetition (cooperation + competition), fintegration (finance + integration) or frenemy (friend + enemy), i.e. a fintech in relation to a bank, i.e. both a partner and a competitor. There are various ways to pursue development. Banks develop as technology platforms for fintechs, most often the bank being the dominant entity controlling the platform. Banks invest in fintechs. Banks develop their own services typical of fintech, i.e. they essentially become fintechs themselves. Banks cooperate with fintechs on an equal footing and integrate the services offered by fintechs into their own business models, while each of the partners uses their key competences (e.g. banks’ capital strength and risk management and fintechs’ innovative approach to technology and customer experience, e.g. on the payment services market).

The concept of a neobank reflects the evolutionary nature of alternative finance; it performs the functions of banking in business transactions, i.e. primarily deposits and investments, loans and credits and payments (clearing), including advisory functions, but the difference lies in alternative approaches to solutions applied by banks and non-bank providers, ensuring, among other things, consumer protection and limitation of systemic risk. The business model of a neobank is based on complete digitalization of all banking services and a simplified organizational structure, usually without its own network of local branches, which translates into low costs of banking operations. There are three fundamental reasons behind the emergence and development of neobanks on the financial services market.

Firstly, it is pressure from non-banking fintech customers who expressed their willingness to use their services, but at the same time they were concerned about the level of security and reliability of financial transactions performed by such fintech. A banking licence obtained by a fintech should be treated as a certificate, which is not only a gateway to full integration with the financial services market, but also to offering a full range of banking services.

Secondly, the introduction of open banking resulting from PSD2 is of key importance. Traditional banks are obliged to make their customers’ financial data available to other financial institutions in a secure manner provided that the customer has given their consent. These regulations have contributed to the introduction of innovations in the financial services sector and new opportunities for non-banking institutions to enter the banking services market.

Thirdly, customers can enjoy savings made by banking institutions. In addition to lower prices, banking services provided by neobanks are more transparent and often cover a wider spectrum (e.g. alert and notification services or customer flow forecasts can be added) which does not entail additional charges.

The question arises as to what neobanks can offer to consumers that traditional banks cannot?

  1. Fees – neobanks require minimum overheads (maintenance of the website), which means that they can be more competitive than traditional banks.
  2. Functionality – mobile banking applications developed by traditional banks are constantly criticised for not being user-friendly. They often break down and raise security concerns. Neobanks offers an elegant, safe and easy to use service. Neobanks can offer a good quality service as they focus on protecting data using technology and quickly react to new threats. Traditional banks are less technology-oriented and, as a result, much slower to adapt to change.
  3. Wider customer base – since barriers to entry for neobanks are much lower than in the case of traditional banks, they can afford to accept customers with worse credit ratings than traditional banks.
  4. Easy configuration – neobanks offer a simplified and paperless registration process, much unlike the process of opening an account in a bank. For example, the N26 paperless registration process takes up to eight minutes and can be completed entirely from a smartphone.
  5. Special features – many neobanks offer embedded tools for planning household budget and savings. For example, the Monzo target feature allows users to create budgets, categorize expenses and keep track of spending. 

Neobanks, in the narrower sense of the word, do not have their own banking licences, but use their partners to offer services reserved for banks. Applications that facilitate the administration of accounts and payment cards are typical neobanks – they rely on customers with an account in a bank with a corresponding banking license, but offer a more user-friendly interface. The extent to which customers are aware of the relationship between the bank and the neobank may vary. The examples include: Yolt (newly launched ING on the UK retail banking market), Lunarway, Webank (Tencent associated with WeChat, China’s most popular social media platform), Moven. Another category of challenger banks includes players that are not connected with traditional banking licenses but fulfil the conditions necessary to provide financial services in a different way than traditional, e.g. as a payment institution or other “third party” within the meaning of PSD2. Monese, whose offer on an e-money licence, being one of the examples. Non-banking companies are new fintech companies that operate independently of existing banks and can significantly disrupt traditional banking.

Customer acquisition is the biggest problems that neobanks are currently facing. Due to the tradition of trust in banks as entities subject to state supervision, open banking (PSD2), changing consumer habits remain difficult, particularly on a market that is rapidly becoming saturated. Profitability is another major problem. This raises the question of whether, in order to be profitable, neobanks simply need to attract more customers, or maybe they need to fundamentally change their business model. Lack of capital is the last issue they face. Although neobanks attract significant investment, this is still less than the money available to traditional banks. As long as neobanks do not succeed in attracting much more investment or in creating a truly unique product, it is doubtful whether they will be able to effectively compete in the long term.

If neobanks manage to create a more attractive business model and if traditional banks continue to postpone technological development, the landscape may change. Just look at the success of fintechs on the Chinese market to appreciate the potential impact that fintech companies can have, with Ant Financial and Tencent completely disrupting the Chinese financial system. The difference is that they offered a different service than neobanks, providing a combined social networking, e-commerce and payment system, similar to Paypal, and offering the largest money market fund in the world that invests in debt instruments.

Cooperation with incumbent operators often becomes a matter of survival of startups. This remark does not apply to bigtechs (techfins), which are capital-strong, have a recognisable brand and operate globally. Bigtech corporations such as Amazon, Facebook and Google pose a greater threat to the basic business models of banks than small startups – fintechs. When traditional banking institutions are only just beginning to exploit the potential of cooperation with fintech companies, organizations such as Google, Amazon, Facebook and Apple (GAFA) may disrupt the entire banking ecosystem.

Prof. dr hab. Włodzimierz Szpringer, Collegium of Business Administration, SGH Warsaw School of Economics, Faculty of Management, University of Warsaw

Last Updated on October 28, 2020 by Łukasz