What are Neobanks

Digital technology has transformed the conventional ways of doing business across industries – and banking is no exception. Traditional banks have been slow to adapt, but they haven’t yet lost too much of their business. However, this scenario is changing rapidly as neobanks across geographies are disrupting the banking industry. Due to their disruptive capabilities and innovative solutions, neo-banks have attracted investors across the globe, as reflected in their high valuations. While Nubank (Brazil) was IPO’d last year at a $52B valuation, Chime (USA) is in talks to IPO at a $40B valuation, and Revolut (UK) was recently valued at $33B. The global neobanking sector is expected to grow at a CAGR of 47% and is expected to become a $330 billion market by 2026. Following the global trend, in India as well, the future of banking will be digital, and we will see a fundamental shift in how banking services are offered by digital-first banks, aka neobanks. But really, what are neobanks?  

Neobanks are 100% digital banks with no physical branches. They are mobile-only fintech firms that heavily leverage technology to offer personalized banking experiences that traditional banks cannot. As per the current RBI regulations, in India, neobanks do not have a banking license. Hence, they have partnered with licensed banks such as Federal, ICICI, Kotak to receive deposits, provide loans and perform other banking transactions. Neobanks control customers’ front-end digital banking interface and use APIs to connect customers to banking services offered by licensed banks.   

Why do we need neobanks now?  

New-age consumer apps have accustomed us to having a seamless digital experience while using any app. However, this expectation has not been fulfilled by the sub-optimum banking apps developed by traditional banks. Moreover, due to the complications of the conventional banking system, TAT on banking services is very high, which is a huge pain point for customers. To solve these problems, neobanks have come up to revolutionize the banking industry.  

Why are traditional banks partnering with neobanks?  

Traditional banks have CACs of ~₹3,000 and an annual recurring cost of ~₹2,500 to keep the customer active, which at scale is a considerable margin eater. Partnering with neobanks helps them reduce their CACs significantly to ₹800 – ₹1,500 and also allows them to cross-sell other financial products.  

Whom do these neobanks cater to?  

We can broadly segment neobanks based on their target segment – B2B and B2C. B2B neobanks provide payroll management, working capital credit lines, and expense management, whereas B2C neobanks help individuals (typically between 15-45 years) better understand their finances through savings and investment products while granting easier access to loans.  

How do neobanks generate revenue?  

Currently, neobanks earn an account activation fee from their partner banks (typically one of the traditional banks they have partnered with to offer accounts, e.g., ICICI Bank, Federal Bank, IDFC First Bank, etc.). They also earn share float income on idle balances, commissions from loan referrals, interchange fees, FX charges, and premium subscriptions for exclusive features. It has been observed that growth vs profitability is a dilemma for neobanks to solve in India as UPI payments are not revenue-generating, and underwriting models will gradually evolve for lending to these millennial customers. This leaves them with cross-selling financial products as one of the primary revenue-generating sources.     

It is still early days for neobanking in India, with most startups just going live and their business models and offerings being refined each day. In the long term, their success will depend on how innovative they will be in creating new revenue streams and acquiring users with high lifetime value. In the last two years, Indian neobanks have raised over $400 million, with Jupiter recently being valued at $710M, Open at $500M, and EpiFi at $315M. While there is early traction, neobanks must acquire a large user base with sustainable revenue streams in an economical and time-efficient manner for long-term success. Only such neobanks will stand a chance to get a digital or a universal bank license and will therefore emerge as winners in this space.