Neobanks vs traditional banks: who has the advantage?
Digital banks will continue to have an impact on the banking sector in 2020. But is their long-term future bright, and what do they need to do to continue their growth?
Neobanks, or digital-only banks, continue to make a significant impact on the financial landscape. One reason they have grown so quickly in the past few years is that they often provide consumers with innovative services at very attractive fees and rates. But is this business model viable in the long run?
To answer that we first have to consider where neobanks are on the adoption curve, and it is clear that they’re already beyond early adopters. According to Business Insider Intelligence global neobanks count 39 million users today, and they expect that number to surge to 98 million by 2024, with the actual number of accounts being roughly twice the number the users.
Accenture research estimates that the average UK neobank loses $11 per user annually. Which should be of concern; significant activity but little value creation is the same situation that preceded the .com bubble bursting.
But that doesn’t tell the full picture. Research indicates digital only banks have much lower acquisition costs, perhaps as low as one tenth of the acquisition cost of a traditional high street bank. And operating costs per customer are much lower as well; in the same paper Accenture estimates the average yearly operating cost per customer of a neobank in the UK at $25 to $63, compared to over $210 for a traditional bank. Essentially, digitally only banks’ operating costs are between one eighth and one third of that of the high street incumbents.
So neobanks may have a significant enough cost advantage to become profitable in the months and years to come, by introducing some fees (still much lower than traditional bank fees) lowering the interest paid on balances (still much higher than interest paid by traditional banks). This would begin to combine scale with profitability.
Incumbents still have some advantages
With all that being said, incumbents do have a number of strong advantages over digital only banks. The first is their brand value and specifically the amount of consumer trust this brand possesses. As second is the finance at their disposal. But they will need to move swiftly and aggressively to lower their cost structure, while at the same time, upgrading technology through a total digital transformation from front to back-office; this will will no doubt require extensive investment of capital. Most of these banks are already fighting tooth-and-nail to retain their large and profitable user bases.
A role for digital cash
A further disadvantage of digital only banks is that, by their nature, they don’t offer the full range of banking experiences that a high street branch can offer. In some countries this may not matter; in the UK for example 72% of consumers do the majority of their banking online. However, whilst this remains the case there is an argument that neobanks will remain only a second banking option, and not the primary banking services provider for the majority of consumers.
And nowhere is this more true than in countries or regions where cash is a cornerstone of the payments landscape.
Germany and Austria would be two good examples of such countries. According to S&P Global, in 2017 almost half (47.5%) of all transactions in Germany including online payments were still conducted in cash. According to Deutsche Bank 74% of retail transactions are still made using cash in Germany.
And consumers in Germany and Austria carry more cash on them than consumers in virtually every other country in Europe. According to Deutsche Bank the average German carries €107 in cash; separate reports have stated that the average German carries €103 and the average Austrian carries €89.
For digital banks to make the significant market gains required to profitably scale in these countries they will have to offer competitive cash services to traditional banks, which is no easy task considering the vast number of bank branches high streets in Germany and Austria.
A solution would be to enable eCash to act as a bridge in this scenario. By harnessing the power of the physical paypoints of an eCash product such as Paysafecash, digital banks could enable consumers to conveniently deposit cash into their neobank account by making the transaction online and then handing over the cash at a pay point.
The growth of digital only banks promises to be an exciting journey in the next few years with one ultimate winner: the consumer, by way of more choice and better value. How traditional banks and neobanks look to leverage their advantages and mitigate their disadvantages, will be one of the most interesting evolutions in banking in the coming years.