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02. 23. 2018

Digital-only banks: Traditional players copy challengers

Digital-only banking: Incumbents copy challengers
New banks with no physical infrastructure are wowing customers with their easy-to-use digital services and low fees. Their business model might be far from perfect but some of the biggest traditional banks have still decided to take a leaf out of their book. And with good reason.

The financial services sector saw yet another shift when digital-only banks, aka neobanks, entered the picture as disruptors and began to gain momentum in the market. But who are these new kids on the block and what sets them apart from their competitors? Let’s start with a definition: a digital-only bank provides banking services exclusively through digital platforms like mobiles, tablets and the internet. It offers basic services in the most simplified form, relying on electronic documentation, real-time data and automated processes.

The most well-known players include Monzo, Revolut, Atom and Starling in the UK, Fidor and N26 in Germany and Simple in the US. Digital-only banks have been especially popular in the UK, where about 27% of customers have already switched to an online or mobile bank, and 26% are considering a similar move. Revolut, founded only in 2014, reached an important milestone last November when it hit one million customers. And it’s out to widen its footprint in Europe. Similarly, German rival N26 is planning to branch out into the US and UK banking market this year.

Digital-only: a response 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. As many as 46% of consumers now interact with their banks in the digital space only, skipping physical channels altogether, PwC found in a survey. And this is a huge jump from 27% in 2012. Smartphones have played a huge part in this change: 81% of consumers now have a smartphone, and 60% of these customers now use mobile banking, up from 36% in 2012.

But it’s not only Gen X and Gen Z customers who have a soft spot for digital-only banks. As the industry keeps growing, along with consumer comfort and trust, digital banking promises to become a go-to banking solution for a variety of demographics, Romexsoft says. 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 mobile but no access to traditional banks.

Financial institutions have been focusing on omni-channel customers, who visit branches but also use mobile or online banking and call contact centres. But demand for omni-channel use is shrinking, with more and more customers becoming omni-digital instead. What does this mean? They only use digital channels and ditch physical ones like branches altogether. And they more and more compare their digital experience to that offered by big online retailers and tech giants like Amazon, Google, Facebook and Alibaba. In other words, the bar’s been set rather high.

Here’s why customers love neobanks

So why are digital-only banks that attractive? There are lots of reasons. First of all, they make the most of new technologies, offering geolocation-based real-time alerts and biometrics-based services. Atom, for example, offers biometric security and account opening features through their app. Revolut, which started out as a currency exchange app, launched cryptocurrency support last December. Customers can now buy and sell Bitcoin, Ethereum or Litecoin, and even transfer them to other Revolut accounts for free.

And neobank services are also very easy 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. Monzo, for example, bagged a full UK banking licence last year and is now introducing an upgraded account that offers customers bank transfers to other banks, overdrafts and the option to receive their salaries or pay rent from their Monzo account. Another challenger, N26 now grants loans in France and has introduced Apple Pay to its customers in several countries in Europe.

Digital-only disruptors also provide services to track expenses and send push notifications to, say, alert customers when a purchase seems to be over their budget. Such personalized money management and budgeting tools can boost customer loyalty, and are becoming a major selling point when compared to traditional banks.

Take Simple in the US, for example, which has recently shared an inspiring story about how one customer used its money management tools to pay off $24,000 in debt in just a few months. This neobank often promotes its services with testimonials from customers, including digital nomads travelling the world.

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. Why? Mainly because they don’t carry the burden of costly legacy IT platforms, and use a cloud-based infrastructure instead of an on-premise one, Infosys points out.

Teaming up with partners help digital-only banks to roll out new customer solutions faster. Fidor, for instance, has already adopted application programming interfaces (APIs) and opened its application to third parties. It has also joined forces with Bitcoin exchanges and integrated the Ripple block chain payments protocol.

Others work together with banking-as-a-platform financial organizations 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 late last year.

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 have limited offerings, which puts a brake on customer growth, Infosys believes.

Whether or not these risks will actually jeopardize 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 the latest among leading banks to launch a mobile-only subsidiary, buddybank, in February. The “buddy” aspect of the service is a 24/7 concierge service using both artificial intelligence and real people to help with everyday tasks.

Building digital-only units with their own brand has become a trend among established banks, according to Finextra. JPMorgan Chase has recently unveiled its service, Finn, 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 regarding digital-only banks may not hurt traditional banks that much after all.

In the meantime, Monzo and other neobanks have largely steered clear of the loans and hefty fees for overdrafts or 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 could eat into the retail banking profits of large banks big time.

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Digital sales: 12 strategies for banks to win in the digital world war