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The Future Is Bright For NeoBanks

NetBanker recently published a post titled Neo-Banking is Just Getting Started, in which Jim Bruene wrote:

“I believe we will see dozens, if not hundreds, of neo-banks launch in the next few years.”

Jim lists four reasons supporting his opinion: 1) Simple’s $100-million exit to BBVA; 2) Marketplace lending provides a path to profitability; 3) Third-party financial watchdogs become trusted services; 4) It’s much, much harder to launch a real bank.

My take: I agree with Jim 99.999% on this. The difference is that I lean more to the “dozens” estimate than the “hundreds” estimate. But that’s a nit. Jim’s arguments for the proliferation of NeoBanks are spot on–but I do see additional reasons supporting the NeoBank trend.

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Before we get to those additional reasons, let’s address some of the skepticism regarding NeoBanks future. NetBanker cites a blog post from an industry analyst firm that isn’t the one I work for, so you’ll have to find it for yourself. The author of that post wrote:

“In recent months, the neo-bank model has hit a few stumbling blocks that call into question the promise of the digital-only model, and gives credence to the skeptics. GoBank recently announced that it was going to stop allowing account opening via the mobile device. Users will now have to purchase an account opening “kit” from a store, adding significant friction to the process. Simple has experienced a number of issues related to payment scheduling, the “safe-to-spend feature,” and service outages or delays. Moven received $8 million to begin moving their app overseas in an effort to garner higher adoption.”

The author goes on to say that his firm envisions “a couple of different paths over the next few years” for NeoBanks (Snarketing note: A “couple” would imply two, and as there are three paths listed, this just supports my contention that my competitors aren’t as good at counting as I am): 1) NeoBanks are acquired and rolled into larger digital channels offerings; 2) Traditional institutions begin offering their own NeoBank, digital-only services:and 3) NeoBanks never become viable stand-alone business models, but they influence the way banks think about digital channels.

A “couple” of reactions: 1) It seems to me (and perhaps to NetBanker) that there is a fourth path: NeoBanks become viable, stand-alone businesses; and 2) Regarding NeoBanks getting acquired by larger firms, I said that three years ago in The Future of Movenbank (nice to see my competitors catch up to where I was three years ago).

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So, what are my additional reasons for supporting NetBanker’s optimism on the future of NeoBanks? Supply and demand.

On the supply side, a new business model is needed in banking–one based on improving consumers’ financial performance (not from an assets/investments perspective, but from a liabilities/spending perspective).

Today’s retail banking business model is based on lending and money movement. In a low-rate environment with low borrowing demand, it’s tough to grow the business. So banks (and credit unions) have looked to supplement revenue by focusing on money movement (i.e., payments). But there is little value-added to the consumer to simply move money from point A to point B.

That’s what NeoBanks are trying to address with “safe-to-spend” and instant mobile receipts. Ne0Banks aren’t simply about “mobile,” “digital,” or “branchless”–they’re about added value. I think that’s what Jim i getting at when he talk about “third-party watchdogs become trusted services.” Can NeoBanks make money at it? Surely that’s the $64k question, but I’m betting the answer is yes.

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There are some demand side factors at play here, as well. While no shortage of industry observers point to Gen Yers’ proclivity to use technology, and mobile technology at that, perhaps the most important differences about this generation has nothing to do with technology.

Instead, one defining characteristic may be their willingness to entertain alternatives to the traditional checking account. For the first time in generations, this young generation does not automatically open a (or another) checking account upon college graduation.

While some don’t want that alternative product from a traditional bank, I don’t think that number is particularly large. Which means that there are opportunities for traditional banks to offer alternative products (that they develop and launch themselves), or to acquire NeoBanks who accelerate the traditional banks’ launch of these alternative products.

There is another distinguishing factor: Gen Yers are more involved in the management of their financial lives at this stage in their lives than previous generations were at that age. This is a critical factor. In essence, younger consumers care more about having and using money management tools and capabilities than older consumers.

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Bottom line: Like NetBanker, I’m bullish on the future of NeoBanks. I hear the skeptics arguments, but the “evidence” against NeoBanks are examples of execution hurdles and hiccups, not dis-proofs of concept. The skeptics’ examples of NeoBanks’ “stumbling blocks” are examples of individual firms’ problems, not of the category’s problems.

Will all NeoBanks survive and/or thrive? No. Of course not. Remember that competing operating system to MS-DOS back in the late 70s? (The under-50s reading this don’t “remember” because they never knew, and us over-50s don’t remember because, well, we don’t remember anything, anymore). The company didn’t survive, but PC computing sure as hell survived. Did the company that first came out with a PC-based spreadsheet make it? No, but that was not a sign that spreadsheets weren’t viable.

I have a book coming out (any day now, I hope) called Smarter Bank. The subtitle of the book (if it survives the publisher’s scrutiny) is “Why money management is more important than money movement to the banks and credit unions.” What NeoBanks represent are advancements in money “management” not money movement. NeoBanks are the bridge between the old world of banking and the future of banking.

 

 

Ron ShevlinRon Shevlin is Director of Research at Cornerstone Advisors. Get a copy of his best-selling book, Smarter Bank: Why Money Management is More Important Than Money Movement. And don't forget to follow him on Twitter at @rshevlin.

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Comments

  1. Great post, as always! Regardless of whatever the subtitle for Smarter Bank ends up being, excited about it and look forward to reading it soon!

  2. Two thoughts…

    1. Neo-banks is they will be more like niche-banks serving niche markets backed by larger players.

    For example… there could be a bank brand for dog lovers. And another bank brand for cat lovers. These will share the same backend platforms. The only difference is the context (experience), content (advice and thought leadership applicable for the niche market) and community. The “guts” of the each bank are the same.

    2. These niche-banks will make money through reselling third party products applicable to the niche communities they serve. For example, The “Dog Bank” will make additional revenue off things like pet insurance and other pet related products. Maybe they will even charge a membership fees (like AMEX) to get access to premium services like discounts to related brands like PetCo.

  3. JRL: Interesting thought. But let me ask you this: Why couldn’t/shouldn’t it be the other way around? That is, why won’t it be that the firms that already sell dog food/products and have a loyal customer based will add banking services to their offerings?

    I also can’t help but wonder here if we need to more tightly define “NeoBank.” Simply being “digital only” — or serving a niche segment — doesn’t seem to me to quality a bank as a NeoBank. I think of NeoBanks as firms that are trying to create alternatives to the traditional checking account.

    That said, I realize it’s a fool’s errand to try to impose definitions.

  4. Thanks, Barret. Appreciate the kind words.

  5. You are right. It could be the other way around.

    A few articles on the topic for those interested:

    http://www.wired.com/2014/03/next-big-thing-missed-starbucks-next-bank/
    http://time.com/90268/starbucks-bank/
    http://www.cnn.com/2014/08/05/opinion/starbucks-nike-currency/

    And you are right. Definitions are difficult.

  6. 1. “For the first time in generations, this young generation does not automatically open a (or another) checking account upon college graduation.” Is that because more of them opened a checking account even before entering college in order to get college loans?
    2. The NetBanker article defines NeoBank as “Delivering banking services without touching the funds”. At first blush, this sounded like glorified PFMs but the article goes on to give examples of neobanks like BillGuard, CreditKarma, etc., which I agree are not PFMs. No doubt some of them will generate significant traction and even cash out by selling out to traditional banks, but, given that their services are mostly free, not sure how they’ll make much revenues or profits.

  7. Not that I’m looking for an argument w/ NetBanker, but I think of a NeoBank as a “bank, but without the charter”

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