Ongoing economic uncertainty and inflated valuations are having a dramatic impact on the fintech funding cycle. Last year’s numbers paint a bleak picture – according to CB Insights, fintech companies raised $20.4 billion in Q2 2022, almost half the amount raised in the quarter. 2 years in 2021.

With fintech valuations and start-up capital plummeting in 2022, combined with the threat of a recession looming, this begs the question: can neobanks, which have grown during the COVID-19 pandemic, have Are they facing a decisive moment?

The COVID-19 outbreak has called for immediate changes across the financial services industry, including new and urgent demand for contactless online services. According to Statista, almost one in five banks (18%) have launched contactless payment methods in response to digital services. As branchless banking begins to take the lead, a new generation of banks – digital-only players – are well positioned to rapidly accelerate the digitization of financial services. But with the number of neobanks around the world exploding since 2019, neobank newcomers are facing new challenges to secure their future.

Neobanks face economic pressure

Despite its high valuation, it is currently estimated that only 5% of neobanks break even, let alone make a profit. Neobanks depend on high levels of investment, but with an impending recession, investors are writing fewer and fewer checks. Indeed, global fintech funding fell 37% quarter-on-quarter in Q3 2022.

With less capital flowing into the sector – and especially as fintech have yet to prove their capital effectiveness – neobanks face a tough road. Meanwhile, rising costs of living could prompt people to retreat to their “first” bank accounts to weather the recession. The allure of convenience means that many people have a “secondary” neobank account, but some may be willing to forego it to play it safe with fully licensed, traditional banks when thinking about it. the economic recession began.

Both of these factors are weighing on financial services firms, with costs rising and profits falling.

Unsustainable business model

Neobanks’ underlying business models are under strain. As a cash-intensive business, it relies on consistently high levels of funding, but its revenue model remains vulnerable, with the costs of acquiring and retaining customers also rising as competition grows. competition is getting fiercer.

Most new banks offer two things: a mobile app and a debit card (powered by Visa or Mastercard). Because they are so focused on growth and staying ahead of their competitors, they rely on low card fees and low exchange turnover to attract users and thus miss out on conversion card fees, monthly fees, transactions, etc. Instead, their business model is based on incentivizing customers to upgrade to a premium account that offers additional benefits – and a monthly fee. In addition, they can provide customers with services such as insurance, cryptocurrencies, and loans.

The challenge is that only a small group of customers will upgrade to premium accounts while selling more services proves difficult as all the new banks are competing on basic paid services. alike. Assuming that new banks rely on these premium services for revenue generation, the nature of adding these expensive products and services to their offerings presents a dual effect on the establishment and their cost structure, hindering their path to profitability. Neobanks with their own banking license will naturally be more protected from future contractions. Meanwhile, those who rely on a traditional bank to process transactions like a world-class F1 race car builder have to rely on competitors for tires, steering wheels and even people. drive. Relying on third parties for core components naturally leaves neobanks vulnerable to external factors.

Compliance issues for neobanks

Today, anchor banks also face increasing scrutiny over their compliance systems. Amid the cost of living crisis and the rise of financial scams, regulators are probing new banks to ensure they have proper fraud and compliance systems in place.

Many new banks face an uphill battle to evolve their compliance programs to accommodate the new products they offer. Early-stage fintech often lacks the resources of a traditional financial institution to staff and operate internal compliance systems, with the C-suite often focused on rapidly bringing in new products to the market.

However, as regulation catches up with digital innovation across the industry, new banks need to invest in teams that can manage these processes, build greater trust in their services, and promote better customer journeys. If new banks want to put themselves on par with their physical counterparts, they need to make compliance the importance they deserve and strengthen their defenses against financial crime.

Goliath’s revenge on the card?

Competitive threats to neobanks from existing providers are also increasing, as traditional banks and fintech giants begin to step on neobanks.

Chase UK, the new bank equivalent of J.P. Morgan, has attracted over £8 billion in deposits and reached half a million UK customers in just eight months of its launch. Meanwhile, fintech giants like PayPal aim to be a full-blown finance app, offering a competitive array of features to those considering moving their finances to neobanks. As competition from established players increases, differentiation will become essential for new banks looking to strengthen their position. Larger companies will naturally have access to a larger set of customers, which means new banks will do a good job of targeting a specific niche that traditional providers have. does not meet the. This could mean meeting the needs of the financially disadvantaged, self-employed or young people.

Another option is to stand out through a digital experience. While the established banks are entering the new banking space offering features and rewards, the USP of the new bank lies in its ability to provide an engaging and personalized user interface. The products offered may be the same, but customers will naturally turn to solutions that can meet their needs and are simple and intuitive to use.

The advantages of neobanks are many. First, they have minimal costs and are therefore able to maintain lower rates than traditional banks. Second, technology is part of their cultural DNA, which means they can react more quickly to threats or opportunities. It also means they can offer a more streamlined referral and KYC experience, as well as innovative features like a budget visualizer. And third, they have access to a broader customer base, with lower barriers to entry for customers with lower credit scores or who cannot meet traditional requirements. To survive, new banks must hone these advantages and outperform their incumbent counterparts.

However, both sides now face the threat of integrated finance, which is redefining the banking space. Non-banking brands are increasingly offering their customers financial functions, which raises questions about how relevant traditional banks, or even new ones, are when it comes to banking. customers can access credit and other banking products directly from their favorite brands.

Where does that leave neobanks?

The era of “cheap” finance is over and providing services below cost is no longer feasible. The way new banks are set up doesn’t provide a quick enough path to profitability, and the relative amount of capital means they need to think carefully about their next move. Indeed, even the biggest fundraisers pale in comparison to the financial resources of traditional banks.

Innovation and differentiation are essential to the survival of neobanks. Ant Financial is a prime example of a new bank that has rocked the Chinese financial space, currently valued at 50% more than Goldman Sachs. This has been made possible by the uniqueness of its value proposition:
combines social media, e-commerce, and payments. Ant is the largest money market fund in the world, and what’s interesting is that it profits from excess funds, meaning consumers move money from their checking accounts to their Alipay wallets.

More than ever, anchor banks’ chances of survival will depend on experience and commitment to their clients. As the “architect of choice” of potential changes in our financial services habits, neobanks will always have the opportunity to deliver real disruption – or risk to others. seize the opportunity. As new banks ponder the future, expect to see the rise of technology-driven companies that leverage integrated finance and provide their vast user base with a seamless service experience. simulated financial services. Going back to the Chinese FS market, we can imagine social media companies taking bold steps and adding an FS experience layer to their offerings. Could Twitter be the next big bank disruptor? Let’s see what the future holds for us.