What happened to the rebels of the financial revolution?
We’re starting this week with a quote from a piece by Ian Kar at Fintech Today:
In the first half of 2020, overhyped neobanks went from a contrarian opinion to a major industry talking point.
What was just recently a contrarian opinion, is now stated as fact.
Just a couple of years ago, neobanks were spearheading the ‘financial revolution’, armed with a seemingly bottomless flow of venture capital.
Today, they’re largely out of the mainstream news cycle.
This week, we’re diving into the world of consumer fintech: Why did neobanks suddenly become so boring? What drove the hype cycle? Where did it go?
From there, the harder question: with the initial boom out of the way, what’s the long game for these banks?
We have a bunch to cover, so best get started!
Cash Flows & Sleek Logos
Only about 2 years ago, every other week, news would break of a brand new neobank — seemingly out of nowhere — raising an 8 figure Series A, sending their CEO to speak at TechCrunch Disrupt to talk about their (very unique) company ‘values’, then hunkering down until it was Series B time.
Today, neobanks have reached almost meme status in tech and investing circles.
It quickly seemed like anyone and everyone could start a neobank. The space is extremely interesting. To get picky, almost none of the (US) neobanks are actual “banks” so to speak — they don’t store and insure client funds themselves, rather partnering with an FDIC licensed incumbent, serving as an intermediary.
The apparent relative ease to launch a neobank was an attractive sell for many new founders.
While launching a mobile bank — especially in the US — involves an immense roll of red tape, regulation, and high bars to entry, it is far less complicated than launching a “traditional” financial institution.
Rapidly looking to ride the trend, card issuers — namely Visa and Mastercard — scrambled to be first pick to serve these new banks in offering debit cards. In the US neobank space today, Visa fights to hold its lead.
As such, it quickly became a relatively smooth process to issue debit card services once your online bank was established. To add to that, several other fintech infrastructure companies quickly popped up to supplement the growth of the space.
These ranged from the complex field of compliance (eg. Alloy), interbank connections (eg. Plaid), and a bunch of under-the-hood services that were previously handled in-house by large banks, now being commoditized in the form of competing startups.
All of this came together to form a space perfectly ripe for creating new challenger banks with attractive brand values, all aimed at “making your finances more transparent”, “dethroning the big banks”, etc.
To go with the shiny mission statement, you need a shiny product — and neobanks nailed the mark.
Hype Cycles & Making Banking Cool
I’m a brand strategy guy at heart, so seeing Starling Bank’s announcement of one of the first-ever vertical debit cards was a masterclass in brand differentiation. It had been tried before, but nothing had quite reached the mainstream.
Once Starling Bank made it ‘cool’, the vertical debit card and minimalistic design became the representation of mobile banks, quickly adopted by Venmo, N26, Revolut, and so many more.
This widespread aesthetic adoption, though, did little to help with the copycat, meme status beginning to plague banking startups.
Business strategy aside, you have to admit they look sleek…
In a space not exactly known for its innovative creativity, neobanks brought a fresh coat of (bold, matte) paint, both through the physical product, and user experience.
Brick and mortar banks have immense resources to outperform on features and depth, but this comes at the expense of simplicity. From design to product experience, neobanks solidified simplicity and minimalism as a top priority, with a heavy sprinkle of customer experience.
Armed with a beautiful product, a mission to make a boring field exciting and accessible, and a target market of mobile-first digital natives, the next step was to ramp up marketing spend. This was the not-so-secret sauce in bringing hype to the banking space.
Tejas Raut Dessai put it best:
The menu is simple — a checking account, a debit card, and a few other adjacent services. The modus operandi is somewhat simpler too, raise a ton of cash, hit the gas on marketing, grow deposits, and leverage the spread on income to fuel more marketing.
Neobanks quickly took a page out of the DTC playbook and ran up paid social spend, with a focus balanced between brand building and user acquisition.
My Instagram Stories ads are the perfect proof of this, as is the London Underground.
If you’re a neobank, the hype train is now smoothly in motion.
User count is skyrocketing, all seems well. In fact, ARPU is even slowly rising as your neobank is slowly moving along the adoption cycle from early-adopters to the mainstream.
But now the problems are beginning to creep in.
Hypergrowth is brilliant, required, even, in the months fresh off a funding round. The issue, though, is that hypergrowth is seldom sustainable — especially when it’s largely tied to ad spend.
That’s not to say that sustainable growth can’t be built on paid channels, rather that it’s a much more expensive and risky long-term play, relative to building out alternative, less expensive, and organic acquisition channels.
Neobanks have begun to fall out of the Silicon Valley spotlight as they now begin to build out more sustainable paths to growth — or profitability.
It’s the end of the beginning. Next step, prepare for the future.
The Long Game
The rise of the neobank in the US has been a relatively recent one, compared to the rest of the western world.
That doesn’t come as a huge surprise though. America has long lagged Europe in terms of consumer financial infrastructure and product innovation. Corporate finance knows no better land, but consumer tech has fallen by the wayside.
While the rest of the world quickly adopted chip and pin, contactless payments, and instantaneous bank transfers, the US kept mailing cheques, swiping magnetic strips, and waiting 3-4 days for transfers.
This failure (refusal?) to modernize is largely why, until recently, almost all top neobanks were Europe-based.
US entrants are finally changing that, though. Chime, Varo, and SoFi are among the most recognizable neobank leaders today in the US, and quickly caught VC attention in the Bay Area.
Fast forward a couple of years to today, the widespread hype in tech and VC circles for neobanking is much more subdued.
This doesn’t mean neobanking itself has slowed down, though.
Beyond offering checking accounts and debit card services, fintech companies and neobanks are making moves up, and across the value chain.
As we touched on earlier, until very recently, there have been no US-based neobanks that hold an actual banking license, with regards to FDIC coverage. This means that no neobank had been approved to have client deposits insured by the US government.
For this reason, as we saw before, neobanks, upon launching, partner with a sponsor banking institution, one that does hold an FDIC license, and operates via their services.
This all changed when US-based neobank Varo, recently announced approval by the US government to be the first mobile bank to be granted FDIC approval. This marks a watershed moment in the fintech space, allowing the company to decouple from their sponsor bank (Bancorp) and vertically integrate a significant part of their value chain.
In offering independence from a partner institution, Varo will be able to bring all customer data in-house, and regain control over the cut of profits the partner bank would have otherwise claimed.
Though license integration is nothing new for neobanks on the international scene (lead competitors such as N26, Monzo, or Revolut all already hold EU-wide banking licenses), the move up the value chain is exciting news for US-based neobanks.
This brings me to a prediction: within the next 2 years, we’ll have seen the first US neobank IPO.
Through this lens, a bank charter is an attractive line item in an S-1.
Integrating operations away from a partner bank to in-house, though, brings with it a need for significant resource allocation to regulatory compliance. This is the expensive downside of integration, representing costs to the tune of 6-10% of revenue.
For the many neobanks already hemorrhaging money, engaged in a vicious race to the bottom, working hard to avoid death by a thousand Instagram mid-rolls, the extra costs vertical integration brings makes little financial sense.
So, instead of looking up the value chain, as in the Varo example, many neobanks are exploring lateral moves.
We saw earlier how most of today’s neobanks began as online checking accounts. They then expanded to offering debit card services. Now, many players are looking further afield.
This takes both the form of geographical expansion and product expansion.
Many established companies are now looking to expand operations horizontally to lending, insurance, and robo-advisory roles.
Upgrade is a leading example of this, bundling a credit-focused service with a card service all at once. To the difference of ‘traditional’ neobanks, credit-focused mobile banks operate on a revenue model built primarily on transaction fees, and interest.
Meanwhile, companies such as SoFi are deepening the focus on robo-advisory products and expanding quickly.
Already offering debit card, checking account, and loan services, the company is now moving further into the investment space, both with brokerage access, and a hands-off automated financial advisory service which sets goals, auto-rebalances and diversifies investments.
Many of the top established neobanks, now comfortable with stabilized CAC/LTV ratios, streamlined checking/debit card services, and sustained growth, are setting sails for foreign lands.
Revolut, already established in 30+ countries, announced the success of a $500M funding round to fuel a global hiring spree, aiming to grow from 1,800 employees to 5,000 by the end of 2020.
The story for competitor N26 is a similar one, already in 30+ markets, with eyes set abroad.
Both companies are making rapid moves to dominate the US market share while the competition is so fragmented.
It’s this same fragmentation that today makes the space anything but boring.
The neobank sector is perfectly ripe for consolidation. The established top-dogs in the space, primarily Revolut, N26, Monzo, and Monese have all seen YoY user growth rates upwards of 150% in the last 24 months.
|Neobank||2018 no. of Customers||2019 no. of Customers||% Increase|
Currently, though, the majority of the top neobanks do little in the way of product or brand differentiation.
To call back to what we saw earlier, the neobank playbook has been to offer checking, then debit cards, then expand to brokerage services, with a sprinkling of robo-advisor features.
Over the coming years, the primary differentiator in the neobank space will be the ability to overcome regulatory hurdles and rapidly expand to new markets.
Through this lens, Varo zigged while the others zagged.
The move to focus on FDIC/banking charter approval relatively early on slowed down front-row product innovation, but now positions the company extremely strongly on the US market, relative to other home-grown opponents, and more pressingly, the incoming foreign threat by the British and German incumbents.
Within the coming years, I believe we’ll begin to see the first rounds of neobank M&A deals as EU-based neobanks set their sights on the New World.
The moves would serve the EU-based players well, largely circumventing the regulatory nightmares of acquiring banking charters in the US as a foreign entity, and integrating an existing client base, partially forgoing the need for a shiny Instagram ads bidding war to drive user growth.
Opposition Far and Near
While “normal” neobanks launch from the ground up, competition is slowly coming out of the woodwork in the form of the tech giants.
Google Pay and Apple Pay are nothing new.
For a few years now we’ve been able to digitize our existing debit and credit cards and use them via our phones.
Apple went one step further last year, launching its first physical finance product: the Apple Card. Sponsored by Goldman Sachs, Apple, similar to the neobank strategy we’ve talked about, looked to integrate the physical payments interaction.
Already used by more than 3M+ Americans, the majority of whom use it as their primary credit card, the strategy has been a strong opening for Apple’s financial ambitions.
But they’re soon going to have company.
In April this year, TechCrunch broke the news that Google has been exploring possibilities in launching a card of their own.
Google Pay was Google’s first entry into the finance space, already on track to hit over 100M users in 2020.
For both Apple and Google, though, the core ambition within their finance verticals is — at least for now — very different to that of full-fledged neobanks.
While “traditional” neobanks seek a path to dethroning the incumbent brick and mortar banking institutions, Google and Apple look at banking as a means to an — unrelated — end.
For Google, this takes the form of advertising data. The transaction data granted to Google through using a Google Card makes their existing colossal ad network even more powerful by “closing the loop”.
Advertising attribution is an impressively tricky field. If you’ve been shown 7 ads for the same brand/product on Google, but you end up buying the product physically in-store, Google has very little knowledge that the ads it served you worked.
The Google Card changes that.
In closing the loop, gaining visibility into the offline purchase journey is a goldmine of advertising data for Google (all while claiming their x% of transaction fees).
For Apple, this takes the form of ecosystem empowerment.
Apple’s fundamental product strategy has always been one focused on interconnected, inter-device, seamless experiences.
If you own a MacBook as your daily driver, there’s a strong chance you also own an iPhone. If you own an iPhone, there’s a strong chance you own Apple EarPods, or better yet, AirPods.
Now, when you next look to upgrade your laptop or phone, each individual Apple device you own acts as a weight on your decision, pushing you towards not straying from their walled garden.
The Apple Card is no different — and it does an even better job of extending the ecosystem beyond “attractive” consumer tech, into moments of daily life that would otherwise have very little connection to Apple.
Apple Card fights off other phone brands. Google Card fights off other ad networks. Neobank cards fight off other neobanks.
Neither of the two is likely to make huge ripples in vertical integration in the finance space anytime soon. That said, the immense resources available to both companies and their enormous existing userbase does pose a significant threat — by platform power alone — to neobank entrants, local, and incoming.
In this view, neobanks, our rebels of the financial revolution, are fighting a battle they’re racing to finance, fighting on a landscape they’re racing to expand, and fighting a range of opponents growing faster than ever.
We watched as the first act of the neobank tale unfolded, a chapter ripe with VC cash, sleek logos, and extraordinary advertising budgets.
Today, competition is growing on all sides, free flows of venture capital are growing harder to come by, but the need for hypergrowth at all costs has never been more pressing.
The neobank story never became boring, it’s just gearing up for the second act.