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Have Neobanks lost their DNA?

One of the more interesting developments in the consumer retail banking sector in recent years has been the emergence of the “Fintech” banks, also known as Neobanks (“Neobanks”). These banks operate virtually, avoiding the costs of a brick and mortar branch network. They appeal to a younger demographic by offering a transparent, seamless banking relationship using smartphone applications with no hidden fees or transaction costs. In the last five years they have been successful in attracting significant numbers of customers and large amounts of investment capital.

Bottom-line reality check

Since most are unable to issue credit products (credit cards, loans, etc), Neobanks are overly reliant on debit card interchange fees for revenue. Debit cards generate much lower interchange fees than credit cards and, as such, frequent and consistent card use is vital to the success of Neobanks. Interchange revenue streams are also very sensitive to payment card fraud and, since debit interchange fees are very low, Neobanks need a very high ratio of transaction volume to fraud claims in order to recover fully the cost of the investigation and resolution of fraud claims.

As fairly new industry entrants, the long-term viability of the Neobank business model has been questioned. Moreover, recent news from the UK suggests there is some merit to this speculation. Specifically, Neobanks Monzo (1) and its competitor, Starling (2) recently announced that they would begin charging fees for certain services they previously offered for free. While Starling recorded its first profitable month in October, Monzo, despite opening over 4.4 million accounts since 2015, lost over 113 million pounds in 2019 (1)

Monzo, Starling and other Neobanks, like every commercial enterprise, ultimately have to make a profit in a competitive environment and are not immune to the challenges of the retail banking marketplace. Two of the biggest issues they face are (i) establishing profitable revenue streams from their account holders and (ii) lowering their costs, especially with fraudulent payment card charges.

Catering to customers actual needs

From the account holder’s perspective, debit card fraud is far more traumatic than credit card fraud. The former results in money being immediately removed from his or her account and a delay in replenishing it while an investigation is conducted. This experience is not much different than if the fraudster had removed cash from the account holder’s wallet or pocket. Consequently, debit card holders are more reluctant to use them for online transactions, register them in e-wallets, and save them as a card-on-file in online stores. Rather than debit, they are more likely to use a credit card, prepaid card, or other payment method for this purpose. The loss of opportunity on these eCommerce transactions lowers the potential interchange revenue for the Neobanks that only issue debit cards.

Using innovation to increase existing revenue and generate new revenue streams.

Instead of charging account holders for things that were promised to be free, Neobanks should consider remaining true to their DNA. They should propose a balanced, innovative solution for fraud protection that their clients recognize as solving a problem and value enough that they are willing to pay for the value-add. This would be a win/win for all involved.

Realigning core strengths

Neobanks are founded on the premise that using technology as their building blocks enables them to increase security, efficiency, and performance; improve the level of service; all while providing around the clock availability. 

For most Neobank customers, the payment card is the only tangible representation of their financial institution. There is no better way for a Neobank to materialize its core strength than to offer a debit card with a Dynamic Card Security Code. This new payment card feature replaces the current printed three-digit static Card Security Code (known as CVV for VISA or CVC for Mastercard) with a small digital screen that displays a code that changes frequently. It is designed to address fraud and false declines that are rapidly growing in eCommerce or so-called “card not present” transactions. Dynamic Card Security Codes are the latest innovation in the payment card industry. In addition to the “WOW” effect, this simple and elegant solution is a powerful anti-fraud tool that will provide card holders greater confidence to use their debit card online and in e-wallets.

Unlike the new ATM, lost card replacement, and account maintenance fees that they are starting to charge, Neobanks should offer a debit card with a Dynamic Card Security Code. This is a value-add feature for which their clients will prefer to pay.

The Dynamic Card Security Code is the most innovative available solution to address CNP fraud and false declines that is entirely consistent with the technology-centric DNA of Digital Banks. Its potential to generate additional debit card interchange revenue from eCommerce transactions and user fee revenue for value-added, anti-fraud protection could help fill the revenue gaps in the Neobanks business model.






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Comments: (6)

Nahum Goldmann
Nahum Goldmann - - Ottawa Canada 17 December, 2020, 02:05Be the first to give this comment the thumbs up 0 likes

Cyril, no, neobanks have not lost their DNA, as they have never had any to speak of.  They just do not realize that retail banking has always been and will always remain conceptually unprofitable whatever they do (as postulated by Peter Drucker, who BTW started his working life as a London merchant banker). 

The new business and socioeconomic paradigm that we all live through now (aka "interesting time"), commodizes all transactional delivery of services in a hurry; i.e., it substantially speeds up margin erosion for every globally competing business.  Plus you can't make much money with free checking accounts and negative interest rate.

This of course does not mean that each and every bank is unprofitable at every given moment of time; Peter was talking of a long term process.  It does, however, mean that "novel" banks should be built on the solid foundation of microeconomic analytics; not on the wishful thinking.

Cyril, carry on the good work; unlike challenger banks you have a courage of asking right questions.


Nahum Goldmann

Mark O'Keefe
Mark O'Keefe - Optima Consultancy - Manchester 18 December, 2020, 14:38Be the first to give this comment the thumbs up 0 likes

Neobanks run at about 1/7th of the fraud rates as their traditional peers - just ~1BP. Card controls, real-time notifications, in-app SCA make the dynamic CSC a bit old school and irrelevant.

Cyril Lalo
Blog group founder
Cyril Lalo - ellipse Inc. - Culver City 18 December, 2020, 20:381 like 1 like

Thank you Nahum for your insights. 

It’s true that Neobanks must face the reality of the banking business however, they should still continue to bring innovative features and value for which their clients will be willing to pay. (like Dynamic Security Code Cards...) 


Cyril Lalo
Blog group founder
Cyril Lalo - ellipse Inc. - Culver City 18 December, 2020, 21:011 like 1 like

Thank for your input Mark. 

Dynamic CSC provides protection right at the card level. The solutions you mentioned operate as a second line of defense as they do not prevent theft of information present on the physical card or stored (such as the recent Ticketmaster database breach), which can be used subsequently by fraudsters. Not to mention that SCA itself brings a whole different set of issues, just look at the numerous reports linking SCA with low authentication success rates, cart abandonments, etc. 

Most Neobanks issue debit cards only, that have very low interchange rates. Any fraud that occurs requires a lot more transactions to recover the total cost of the fraud that include the fraud management costs.

For cardholders, the impact and experience are terrible as funds leave their account right away. It’s already expensive for banks to acquire new clients, challenging to keep an account active, so you can imagine the titanic effort that is necessary to retain them following a fraud. The stakes are much higher for Neobanks, which makes it essential to provide security at every layer. 

In addition of the security, DCSC card bring a WOW effect, top of wallet and a great marketing tool.  

BTW would you mind sharing the source of the fraud rates that you made reference to. 


Mark O'Keefe
Mark O'Keefe - Optima Consultancy - Manchester 19 December, 2020, 19:58Be the first to give this comment the thumbs up 0 likes

Revolut and Monzo websites and annual reports both publish they are at just 1bp

Cyril Lalo
Blog group founder
Cyril Lalo - ellipse Inc. - Culver City 21 December, 2020, 23:48Be the first to give this comment the thumbs up 0 likes

Thank you Mark. 

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