Collectively, neobanks have secured billions of dollars of funding to rapidly scale at all costs, however strategic priorities are now changing. There are currently 250+ neobanks live worldwide, with dozens of banking apps close on their heels and gearing up to launch. But how many of these businesses are profitable today, and how many will ever actually return a sustainable profit remains to be seen. Fast paced customer acquisition is one thing but charting a viable path to profitability is quite another. As competition heats up in the market, profitability is becoming increasingly important for investors – the ultimate test of a business model. 

Increasing focus on profit 

After years of eye watering marketing spend to fuel growth, larger neobanks are now turning their full focus to enhancing underlying unit economics. The vast majority are making changes to their fee structures, increasing existing charges and introducing new ones. For example, Monzo recently launched a premium account, complete with a metal payment card charging its customers £15 per month. Furthermore, both N26 and Revolut have announced that they will be introducing low- and mid-tier subscription plans for €4.99 and £2.99 per month, respectively. 

Generally, investors have increased the pressure on neobanks to create a path to profitability and sustainable unit economics. This has caused neobanks to ‘think outside the box’ and create new revenue streams from paid subscriptions, handing out loans, earning commissions from referrals, as well as broadening the product range to savings and investing products. The change in focus towards profitability has been amplified by COVID-19 as large-scale lockdowns have led to the implosion of one of neobanks' biggest revenue streams: the interchange fee that is earned when their customers use their cards to buy goods and services.  

Unit economics consists of two components. The first is the funds spent on acquiring a new customer and the second is the value generated over the customer’s lifetime. A measure of return on investment is calculated by dividing the customer lifetime value by the customer acquisition cost. The higher the resulting figure, the more value the company is able to generate from a newly acquired customer.  

In the past, neobanks were able to cheaply acquire new customers. Customers who were disappointed with the service they were receiving from the incumbent banks, were happy to try a fresh, new, digital-only product. Over time though, traditional banks have been successfully modernising their own offerings. They have also become better at acquiring new customers digitally, which has led to increasing acquisition costs for neobanks – additional incentives are required to capture those potential customers.   

Most customers are not using neobanks as their primary bank account 

Looking at customer lifetime values, one thing to keep in mind is that only a small fraction of users actually switch their primary bank accounts from incumbent banks to neobanks. The number of people switching current accounts between July and September 2020 using the official Current Account Switching Service rose almost two-fifths on the previous three months, data by personal finance site Moneycomms shows. During the last three months 36,575 switches took place as banks enticed customers with ‘welcome bonuses’. Account switching is key for challengers such as Monzo and Starling, as they battle to get people to use their offerings as a primary current account, rather than just a secondary one.  

Starling has proved to be the most popular,  gaining 12,786 customers in lockdown and losing just 788. Primary accounts are the most valuable accounts for a bank, as they are likely to generate higher payment volumes and larger numbers of payment transactions. Moreover, primary accounts usually have a substantially higher amount of funds deposited in them. These are accounts where customers receive their salaries, as well as pay their committed expenses from, such as mortgage payments. 

Becoming a customers' primary bank account will also lead to higher revenues from interchange fees, as well as substantially increasing the number of deposits on the neobank's platform. Interest earned from customer deposits invested at central banks or used in buying long dated investment grade debt instruments represents another revenue stream for many neobanks.  

Since arriving on the scene, neobanks have constantly refined and broadened their apps and features to make their offerings appealing enough to completely displace the incumbent banking providers. However, the proportion of customers that use a neobank as their primary account still remains very low. Less than 10% of UK consumers use neobanks to manage their money. 

The path to profitability – fraught with danger  

As large neobanks start to focus on increasing existing fees and leveraging new tariffs, this development also brings with it some very significant threats. On one hand, users may be happy to spend money for a valuable new feature or product. However, user satisfaction will decrease substantially if the fee structures of neobanks become opaque and hazy like their incumbent bank competitors, with the same low customer satisfaction rates and high fees that gave rise to neobanks in the first place.  

The global pandemic has triggered a clear pivot by neobanks to focus on unit economics and profitability. Neobanks will need to walk a tightrope of increasing customer monetization whilst not introducing fees and charges that will lead to decreased customer satisfaction and ultimately churn.  

Starling has recently been able to show that it is possible for neobanks to turn profitable as it announced that it had achieved break-even in October 2020. Contrary to its peers though, Starling has been focusing on building a sizeable SME loan book (from which it generates +60% of its revenues), instead of offering metal cards or other introducing other “trendy” features.  

The announcement of Starling’s profitability was followed by another leading neobank, Revolut, saying that it had reached break-even in November 2020, further underlining the shift in focus towards profitability. On the continent Bunq, the Dutch neobank, has taken a paid customer subscription-only approach since inception, ensuring all customers were prepared to pay for the services they benefited from since day one, instead of acquiring customers that could not ultimately be monetized. This approach seems prescient.  

What is clear is that there are no more ‘free lunches’ for neobanks when it comes to securing investor funding nor indeed for their customers.