The systemic risk associated with traditional banks became apparent for everyone after the subprime mortgage-driven global crisis in 2008. The perception of trust regarding financial entities changed so dramatically that all centralized systems started to be questioned. These changes marked the beginning of a decentralization era driven by blockchain technology & cryptocurrencies. This paradigm shift accelerated the proliferation of neobanks which, unlike traditional banks, focus on solving the main problems of their customers like money transfer and savings efficiently rather than providing a variety of products.
Neobanks are a fintech solution. They are startups that establish more agile and transparent structures compared to the big players in the ecosystem. The most distinguishing feature of neobanks is the absence of physical branches. By eliminating the brick and mortar approach, they can offer cost-effective solutions to their users through reducing operational costs. Neobanks include all the basic financial actions such as free account opening, money transfer, BNPL, credit cards and even higher interest rates because of lower overhead costs. All processes take place digitally through an end-to-end mobile application. You can open a bank account in minutes with no paperwork. Revolut, N26, Monzo, Chime, and Aspiration are some of the most popular ones.
In the age of digital gratification, although neobanks meet many needs, there are still some user and ecosystem-oriented challenges they are facing. Now, let’s take a closer look at what these challenges are and which strategies can help overcome them.
1. Resistance of bank switching
Neobanks’ business models have a low variable cost structure, which means scaling up the business is less costly compared to traditional banks (e.g. no need for opening up new branches). However, this by itself does not guarantee fast growth. Although the number of consumers switching from traditional banks is increasing, the growth rate is below expectations.
By offering digital services, traditional banks have managed to slow down the leakage of customers. Although the trust issue has not been resolved, digital banking users whose basic financial needs are easily met are inclined to stay where they are. JD Power’s 2019 U.S. Retail Banking Satisfaction Study states that only 4% of customers left primary banks in 2018. According to Smart Money People’s survey, 37% of people who were asked why they didn’t switch banks stated the main reason was hassle. 23% said “all banks are equally bad” whereas 20% stated they didn’t know much about other options. What this data tells us is that convenience is not the only issue for users and they are not yet convinced about what neobanks have to offer.
Solution: In order to deal with these barriers, neobanks should define their value propositions based on user needs and clearly communicate them. People tend to stick with the status quo unless they are convinced that there is a better way to do things. In other words, the crisis of trust is not by itself a good enough reason for the majority of banking customers to make the switch. However, clever positioning coupled with a strong value proposition resonating with customers can make it happen.
2. No face to face customer support
When traditional banks are involved, what does one do when their problem can’t be solved via digital banking or phone? They go to a branch. As neobanks don’t have physical branches, customer service proceeds only through channels like chat, email or phone. Although the pandemic has reduced the rate of going to branches, knowing the existence of a branch can give customers a sense of security. Therefore, one of the risks neobanks have to overcome is the absence of physical touchpoints.
Solution: Neobanks, providing customer support from many channels, can improve this process with certain design solutions. First of all, support options should be easily accessible on all digital touchpoints, mainly the mobile app. Secondly, emphasizing transparency and personalization in the user experience can help build the feeling of trust and hospitality. This can be achieved by sharing openly how the support mechanism works and how long it would take to fix issues. Also, small things like addressing the user by their name, especially on help section can make up for the actual human interaction that occurs in branches.
3. Involvement of incumbents
Closing outstanding loans, transferring savings, recreating automated payments, or even changing payroll information to receive a salary can become quite a hassle. High switching costs for customers translate to high acquisiton costs for neobanks. Although neobanks have the advantage of a lean cost structure, traditional banks and big tech firms pose a threat as they can utilize their existing customer base for free to capture new market share. Considering the early phase funding of neobanks, large players with extensive resources can pose a great risk. To give an example, traditional banks like NatWest started to step into this world by establishing their own neobanks.
Solution: Big players can pose threats for startups in any emerging market as they can leverage their existing power to block the newcomers. Instead of trying to compete with big players financially, neobanks should play the game by focusing on their own strengths, focus and speed. User centricity, ease of use and lower costs are strong differentiation points for neobanks. Once these translate into a clear value proposition for customers, neobanks can cross the chasm and really start hurting established players.
The fintech industry’s dependence on regulations makes it vulnerable. A fintech solution that can work in one country can get caught up in the regulations in another. Even in the UK where neobanks have been successfully operating for several years, new demands from central authorities can become challenging. For example, The UK’s Financial Conduct Authority (FCA) asked e-money licensed companies not to “liken themselves to banks” and to tell customers about how their protections differ from those offered by licensed banks. This type of demands, also raised by American and Australian regulators, can push neobanks to acquire banking licenses and legally call themselves “banks”. On the one hand this can become costly for the challengers but on the other it can help them become more trustworthy in the eyes of potential customers.
Solution: Since regulations vary regionally, a “one size fits all” strategy can be crippling in some markets. Especially when setting operations in a new country, cooperating with experienced partners in the finance industry can reduce uncertainty. N26, one of the popular neobanks with German origin, has partnered with Axos Bank for its activities in the U.S market. Axos Bank provides the necessary oversight and control for the USA operation, minimizing risk for N26.