Neobanks and challengers are here. But they’re not here to play. Forecasts say that the size of the global neo and challenger bank market will reach a whopping $356 million by 2025, from a modest $17 million in 2017. That’s a handsome CAGR of 45.8% in eight short years. And if you think traditional banking is yet another thing millennials are ruining, along with soap bars and cereals, think again.

“While you could argue that millennials are a core audience for neobanks, and they make up 41% of our audience, nevertheless 36% of our audience is over 45, and 9% over 65. We believe it is just as much a question of mindset as generation. People are expecting a lot more than just ‘digital’ banks — digital is a given these days — what they are looking for is something that delivers an easy, frictionless and engaging experience, similar to those they have found in other next generation companies from other industries,” Eric Wilson, CEO of Australian neobank Xinja has explained.

Traditional banks must act right about now if they don’t want to lose more customers – and bigger and bigger chunks of their revenue to neobanks. But where to start? As a first step, it might be a good idea to have a closer look at the strategies digital-only challengers follow to see how they woo more and more users. And while they’re at it, learn what incumbents with limited digital prowess can adopt in their own strategies.

So how do they do it?

There are some common strategic moves digital-only challengers seem to swear by in securing growth. These are the factors that have traditionally given them a significant advantage over their traditional counterparts:

Lower operation costs: With no branches or extensive legacy IT systems to maintain, digital-only startups can run wild with relatively low operation costs. They automate functions and use cloud-based infrastructure instead of on-premise systems, which means lower servicing costs. And by low we mean 40-70% lower than the expenses of mainstream banks.

Lower fees, higher rates: Neobanks usually charge their customers low or no fees while providing higher-than-average interest rates on savings, thanks to said lower operation costs. Getting better rates and free transactions abroad are among the top five reasons why people switch to digital-only players (according to 31% and 22% of customers, respectively).

Faster product launches: Digital-only players have been largely relying on partnerships and teaming up with third-party players to roll out products and customer solutions at the speed of light. These partnerships, often developed into entire digital ecosystems or marketplaces, help neobanks save time and money, and respond to changing customer demands more rapidly.

Leveraging technology: The biggest snag holding back many traditional banks from following tried-and-tested neobank strategies is that they still operate sluggish, decades-old legacy systems. Banks spend about 70% of their IT budgets on traditional IT services, like maintaining core systems, and only about 30% on innovative solutions related to digital transformation, such as cloud or data analytics.

Neobanks, however, rely heavily on these technologies, plus a bunch of other cutting-edge solutions like artificial intelligence, robo-advisors or biometrics, and make the most of the latest technologies to enhance customer experience. Revolut, for example, has begun offering cryptocurrency support. Monzo and Starling are the only UK banks that let you switch accounts within their apps. Meaning customers can ditch their main current account provider at a tap of the finger, moving all incoming and outgoing payments from one provider to another.

In another stroke of genius, Revolut, Starling and Monzo have all rolled out ‘pay people nearby’ functions, a P2P payment method using Bluetooth to identify and pay other users. In June 2018, Monzo became the first bank to join forces with IFTTT, the world’s biggest automation platform, to allow customers to connect their accounts to more than 500 services, including Twitter, Spotify and Instagram.

Lower risk aversion: Incumbents tend to play it safe when it comes to launching innovative digital services and are often held back by their own conservative approaches. Neobanks, by contrast, are more adventurous and less afraid of experimenting and learning from their failures. They are not stalled by lengthy bureaucratic procedures and are more likely to talk to their customers about their needs before launching any new products or offers.

Better user experience: Digital-only challengers have certainly raised the bar in satisfying customer needs by offering fast, seamless and personalised services. They listen to feedback and add features users love, like real-time balance, transaction alerts, budgeting tools and personal finance solutions. Putting a bigger focus on user experience also explains why neobanks’ satisfaction ratings (76%) exceed that of the top 50 global banks (69%) in the UK, the US (83% vs 67%) and Germany (82% vs 60%).

Cut the lag in app functionality

Current differences between neobanks and incumbents are best reflected by the speed and diversity of services available in their mobile banking apps. By November 2018, the average log-in time had fallen to 7.5 seconds from 8.1 seconds within just six months, with startups remaining twice as quick as incumbent banks. On average, non-traditional current account providers have 42% more features in their mobile apps than established players, and they’re coming up with a larger number of new features than traditional banks.

The most striking difference remains in money management, where newcomers offer 9.6 features on average, compared to only four provided by incumbents. Not to mention that those four features (search, view balances, view transactions and customise notifications) only provide basic insights for users. This is an area where traditional banks really need to up their game, especially with sophisticated digital advisory services becoming more and more important to customers.

Real-time balances are only supported fully by 32% of the reviewed apps and instant updates to the main balance are exclusively provided by digital-only challengers. Neobanks also tend to send smarter notifications to their users. Starling alerts customers if their direct debit payment is due the following day, and Monzo sends messages about upcoming direct debits as well as travel insights.

Enquiries and interaction is another category of app features where neobanks have a clear lead over traditional banks. For instance, Starling and Monzo both added joint accounts in late 2018, and the latter also launched a feature allowing users to dispute certain transactions entirely within the app.

How to train your digital bank

In recent years, several incumbents have embarked on launching stand-alone digital-only banking units under separate brands to tackle competition from neobanks and satisfy demand from digitally active customers. Digital banks can help cut operations costs, up to 70% lower than traditional banks, while generating returns on equity of more than 15%. On the down side, they can take three to four years to break even and require heavy investment in marketing.

Adding higher-margin credit products to account and payment services is essential to boost income. What led to Zuno’s failure was the lack of loans: even though the direct banking unit of Austria’s Raiffeisen Bank, set up in 2010, acquired 255,000 customers, it was shut down in 2017. Former Zuno CEO Oyvind Oanes reportedly said that the only mistake they had made was that they hadn’t started building a credit portfolio from the get-go, which eventually led to their inability to generate revenues.

Acquiring up-and-running neobanks can also turn out to be a bumpy road. French incumbent BPCE bought German digital-only player Fidor in 2016 and, only two years later, it is reportedly seeking to sell it because of a “clash of cultures”. In another example, US neobank Simple had struggled with moving customer accounts to a new platform after its purchase by Spanish incumbent BBVA in 2014. The buyer also took hefty write-downs for Simple after its $117 million acquisition.

All in all, traditional banks setting up a neobank might be better off building a new infrastructure for the “parallel bank” and using it as a sandbox to learn how to run a truly digital organisation. Rushing into merging the new and old units rarely pays off because it leaves no room for experimentation. Also, building a neobank shouldn’t become a hurdle for the mother organisation in carrying out its own digital transformation.



Download W.UP's white paper and find out what traditional players and neobanks can teach each other and discover ways to outrun the likes of Amazon and Apple in the digital banking race.

Download now

Let’s keep in touch

Stay in the loop about the latest digital banking news and expert analysis.