By Patti Murphy
While the name may imply otherwise, neobanks are not new. Block, founded by Jack Dorsey and Jim McKelvey as Square in 2009, jolted the payments industry by launching a platform and dongle that enabled small merchants without a merchant account to use smartphones and tablets as POS devices. The startup quickly evolved into a nimble neobank offering a range of business and banking services.
"Square recognized early on that not only is banking services a great income opportunity, but it's also great for retention," noted James Shepherd, founder of ISO Amp. "When someone uses their bank as their payment processing provider they are much less likely to cancel that service."
Neobanks are financial technology companies that provide digital and mobile solutions for managing payments and other financial routines. They differ from digital banks, which tend to be full-service banks that operate online. Some observers consider neobanks to be a subset of digital banks.
Research firm Market.us estimated the global neobanking market exceeded $148.7 billion in 2023 and will chart a combined annual growth rate of 49 percent between now and 2033 when it is expected to exceed $5.4 trillion. Business accounts dominate the neobanking space with 66 percent of global market share, Market.us noted, adding that payments and money transfers are the most popular activities with a 41 percent share.
The typical neobank is lean and agile, using digital technologies, artificial intelligence and related processes to reduce costs. They rely on data-driven approaches to customer service, which in turn lead to seamless customer experiences. They do not rely on brick-and-mortar offices, and there is no legacy equipment to support, so they can make changes quickly and easily.
Neobanks tend to be niche-oriented and typically are not regulated as banks. The neobank Chime, for example, provides basic banking services to consumers who may not be able (or willing) to pay monthly maintenance and other bank fees. It offers a high-yield savings account, no monthly fees and fee-free overdraft protection. As is the case with all neobanks, funds are held at FDIC-insured banks (Bancorp N.A. and Stride Bank, N.A in the case of Chime).
Chime stands out among its peers by enabling customers to link all their accounts within the Chime app, which is said to amp up customer engagement. The consultancy McKinsey & Co. noted in its report Building a winning AI neobank that customers who link non-Chime accounts to the app typically spend more money using their Chime debit card than they spend using other cards loaded into the app.
Some neobanks focus on businesses and professionals. Neobanks "have gained favor among businesses due to their agility and tailored financial services, such as seamless payment processing, real-time transaction monitoring, and simplified expense management," Market.us wrote.
Karat Financial, based in San Francisco, caters to content creators and influencers. Last year it snagged $70 million in funding from a group that included celebrities and video game companies. Underpinning Karat's success, the company said, is its innovative underwriting model, which can measure the unique creditworthiness of creators by analyzing their spending and deposit activities.
Neobanks earn much of their money from interchange on debit cards issued to customers. The Durbin Amendment to the Dodd-Frank Act required the Federal Reserve to cap debit card interchange.
The cap applies only to the largest banks, however, which also are the largest issuers of debit cards. Banks with $10 billion or less in assets, like Chime's partner banks, are exempt. (Bancorp had total assets of $7.466 billion as of the third quarter 2023; Stride had $3 billion.)
In 2023, the average interchange for unregulated debit processed over dual message networks (like Visa and Mastercard) was 52 cents, more than twice the average for regulated debit, according to the Fed.
Netevia Banking, a neobank catering to SMBs, launched in 2023 with plans to leverage the ISO channel to reach those businesses. It even has an arrangement with Brinks to put smart safes in merchant locales to expedite cash deposits.
Brinks collects the cash and Netevia ACHs the money to accounts at a merchant’s designated financial institution.
Netevia’s partner banks are New Jersey-based Cross River Bank and Ohio-based Sutton Bank.
Vlad Sadovskiy, Netevia's CEO, is betting that ISOs will be attracted to the additional residual opportunities that come from selling banking services. These include interchange from transactions using the debit cards issued to merchants, as well as residuals on merchants’ banking activities, like deposits made and funds kept on deposit.
"We’re as close to being a bank as any [institution] can be," Sadovskiy said. "We may not be on the same level as Chase or BofA, but we can definitely compete with credit unions and local banks."
Shepherd suggested that over time ISOs and agents selling banking services will earn as much, if not more, from those services as from their traditional merchant portfolios.
"Neobanks are having a lot of success getting customers to open accounts, but very few are making any money," said Christoph Stegmeier, senior partner at the global consulting firm Simon-Kucher. The firm's data indicates there were about 400 neobanks globally in late 2022, which, combined, served more than a billion clients.
However, the consultancy added, the number of new neobanks launched last year, 36, barely outnumbered the 34 that were either acquired or shut down.
According to Simon-Kucher, Brazil counted the most neobanking customers, 217 million in 2023. And Brazil and the United States reported the most total revenues ($15.8 billion for Brazil, $12.3 billion for U.S. neobanks).
Evidencing the difficulty of charting a successful course in neobanking, HMBradley, a neobank catering to savers, just shut down its consumer operations to focus on providing its technology to mainstream banks.
"Banking is ripe for disruption and now more than ever banks are looking to deliver world-class customer experiences," HMBradley CEO Zach Bruhnke wrote in a November 2023 letter announcing the change. "The coming decade promises exciting advancements for customers."
While neobanks are not directly regulated—aside from having to abide by know-your-customer and other anti-money laundering rules—a movement is afoot to change that. For now its focus is on the largest players.
The Consumer Financial Protection Bureau stated in November 2023 that it wants to subject large fintechs and neobanks that process payments to the same supervisory exams that banks and credit unions undergo.
Initially, only the largest companies—those processing more than 5 million transactions annually—would be subject to CFPB regulation. Seventeen fintechs would qualify for regulation, including the big three, PayPal, Apple and Google, the CFPB said.
Meanwhile, the bipartisan Shadow Banking Loophole Act was introduced in the Senate to ban nonbank financial entities from operating like banks, and benefiting from federal deposit insurance, without federal regulation. That legislation would directly affect Square, which operates state-chartered financial institutions and qualifies for FDIC insurance up to $250,000.
The act, spearheaded by Senator Sherrod Brown, D-Ohio, chairman of the Senate Banking Committee, would appoint the Fed to regulate Square and similar fintechs in the same manner it regulates bank holding companies.
"Letting big tech and commercial companies operate banks without proper oversight will only open doors for predatory lending, invasions of consumer privacy and broader financial instability," Sen. Brown said. Senator John Kennedy, R-La., a co-sponsor of the legislation, added, "Allowing companies to run their own full-service banks without effective oversight puts individual Americans and the U.S. financial system at risk."
The Bank Policy Institute (which represents banking and consumer groups) urged lawmakers and policy makers to close the loophole "before it is further exploited by firms seeking to gain the advantages of an FDIC-insured bank charter without the concomitant supervision and regulation that Congress has established for corporate owners of full-service insure banks."
The likelihood of such legislation passing in the remaining days of the 117th Congress is slim.
Patti Murphy, self-described payments maven of the fourth estate, is senior editor at the Green Sheet. She also co-hosts the Merchant Sales Podcast, and is president of ProScribes Ink (www.proscribes.net).
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