When neo banks first came into the financial services space, they immediately put the industry on caution. They were tech firms first, and banks second, and were backed by venture capitalists. Circle 2021, neo bank’s impact on the financial services industry landscape can now be assessed. One thing can be said with certainty is that they have forced traditional banks to come out of their comfort zone and focus more on being digital.

According to the Accenture 2020 Global Banking Consumer Study, 50% of consumers currently interact with their bank through a mobile app or website at least once a week, compared with 32% two years ago. The study also found that the number of consumers owning neo bank accounts increased from 17% in 2018 to 23% in 2020. As the financial ecosystem is focusing more on customer experience and satisfaction, it has created a gap between traditional banks’ offerings and customers’ expectations. This is the gap that the neo banks are striving to bridge.

Value for Money and a simple digital/mobile experience would tempt consumers to neo banks.

Q. What would motivate you to open an account with a neo bank, and to use it for most of your transactions?

What is a Neo Bank?

A neo bank is a digital bank that operates online without any physical branches. They are fintech firms providing digitised and mobile-first financial payment solutions, money transfers, digital savings/current bank accounts, money lending etc. Being fully digital, Neo banks focus on key areas depending on their partnerships with banks. They have a targeted customer base comprising primarily tech savvy millennials, SME and low-ticket salaried class, which are not the focus areas of traditional banks.

Advantages of Neo Banks

Neo banks offer many advantages and are being preferred over traditional banks by many businesses for various reasons:

How Neo Banks are Transforming Financial Services Globally

Globally, the neo banking segment is 10 years old, and neo banks across the world are expected to raise $394 bn by 2026. In India too, the segment is rapidly scaling up and they raised $90 mn in 2019.

·        Fintech startups across the world, particularly in banking and financial services industry, have over 15 million consumers, out of which, over 50% have been acquired by neo banks

·        The global neo banking market registered a CAGR of 50.6% during 2016-20

·        Europe and Asia Pacific are expected to provide exceptional business opportunities for neo banks in the upcoming years

·        US, UK and Germany have occupied prominent shares in the global neo banking market since 2016

·        China is expected to be the most attractive market for neo banks by 2025

Neo Banking in India

Globally, neo banks are fully digitised, however, in India, regulations don’t permit 100% digitised banks. They do not have a bank license of their own and partner with traditional banks to offer bankign services.

•      More than 15 neo banks are operating in India and a few more are expected to begin their operations. Neo banks in India are taking a differentiated and less confrontational approach in positioning their offerings vis-à-vis traditional banks

•      ICICI Bank, India’s largest private bank has taken a lead in the Neo Banks segment and has partnered with a few neo banks, including Open, Instant Pay

List of Top Neo Banks in India

Case Study – Open

Based out of Bangalore, Open is India's first SME-focussed neo bank that began its journey in May 2017. It offers small businesses an online bank account and a credit card that combines banking, payments and accounting in a single place. The neo bank’s revenue model includes pay-per-use charges, subscription fees for premium services and revenue share with app developers on its app store. It has over 500K SME customers across 15 partner banks and processes USD 15 bn-plus in annualised transactions.

•      By signing up on Open, businesses can get an online bank account and a business credit card within two minutes. This bank account enables SMEs to start collecting payments instantly without any limit on the amount.

•      Open’s payment gateway API can be integrated with the website of businesses where customers can pay during the checkout process. E-commerce platforms can integrate Open’s plugins to their websites for payment collection.

•      The neo bank has raised close to USD 40 mn from various investors including Tiger Global Management, 3one4 Capital and Beenext

 Challenges for Neo Banks in India

While neo banks are scaling up their presence aggressively, there are a few business challenges that they face:

•      Regulatory - One of the major challenges is the lack of regulations. RBI has not yet permitted 100% digital bank model in India. This will keep the future growth of neo banks in doubt as they are unsure as to whether they will be allowed to offer the full suite of banking services, including loans and deposits. Till then, they will have to continue to rely on traditional banks for offering these services.

•      Customer - Although neo banks will attract the urban population specially millennials, they will continue to face challenges in tapping the rural market. Despite offering an ease of access and better customer service, majority of the rural population might still prefer to visit physical bank branches and seek assistance from personal relationship managers. But with many more neo banks in the pipeline and regulator’s initiatives in this segment, the scenario may change over the next few years.

•      Revenue - Another challenge that neo banks could face is to find a consistent revenue stream. Low UPI transfer charges, interchange fees, and payments may not be the biggest revenue sources in future.

•      Security - Facing many incidents of breach and theft every year, cyber security has become a major focus area for the FS industry. Especially, for neo banks that run entirely on a digital banking model, this is a key challenge as they cannot afford to spend much on security or hiring a full-time cyber security team, which might lead to facing serious security threats.

 The Way forward

The growth potential for neo banks has been driven by their low-cost operating model with no or very low fees on various banking services. Some of the key growth drivers for the success of neo banks include adoption by millennials, MSMEs, and people with irregular incomes, and embedding innovative technologies. The high user adoption rates and successful business models of neo banks has caught the attention of investors and venture capital firms.

Neo banking can provide impetus to various measures being undertaken to solve the challenges of financial inclusion and bundling banking services with other financial services - for example, services like opening bank accounts through new onboarding procedures not based on traditional documentation. Neo banks could also expand by adding more services and functionalities over time.

Although neo banks are gaining momentum and have the potential to disrupt the banking and financial services industry, most are yet to show sustained profitability. The key towards getting profitable would be to convince traditional banks to invest in latest technologies and reform their processes to provide seamless customer experiences.

With ever-growing competition across the financial services industry among traditional banks, fintech, and non-banking entities such as big tech firms, it is to be seen whether the market will offer enough opportunities for neo banks to grow profitably in future. How these banks manage some of the key challenges related to regulatory and compliance, data and cyber security, API integration and product differentiation will be the major factors contributing to their success.