According to one tally, there were around 250 neobanks in the world as of August 2022. How many might be there a year later remains to be seen.
Like their brethren in the buy now, pay later space, the past several years has seen a wave of neobanks enter the market accompanied by a seemingly never-ending hype cycle. Now, it seems as if many may not survive into the future.
Even the most well-known and established neobanks are dealing with headwinds. Varo Bank laid off around 10% of its workforce in July. Starling Bank pulled its application for a banking license in Ireland. Revolut last month saw a glut of resignations in its risk and compliance department. MoneyLion is facing investor skepticism as it burns through cash, the Financial Times reports. BNPL platforms Affirm, Klarna and Robinhood have all seen their valuations crater in recent months.
Challenging Times:
Many digital-only neobanks, cash-strapped, are having to scale back their ambitions.
Still, it’s not all bad news. Starling, for example, despite its pullback from Ireland, posted its first annual profit, becoming part of an exclusive club of neobanks to achieve profitability. It’s clear that when the dust settles, there will be winners and losers among the current crop of digital neobanks.
Factors Separating Winners from Losers
The neobanks that offer a truly differentiated value proposition for their target customer and have, as a result, established a sticky consumer habit that can be monetized are in solid positions to survive going forward, says David Brear, CEO and Co-Founder of consulting firm 11:FS.
“I’d bet on those that have some sort of connection to their customers’ payroll,” he adds. “If they hold on to their base, manage tightly, and enable their ‘digital native’ advantage to more efficiently achieve profitability over time, the continuing evolution of fintech will make it easier and more cost-effective for them to extend the loyalty they have today into more revenue-generating activities in the future.”
Indeed, there could be a “thinning of the herd” for many neobanks that don’t differentiate themselves over the next 6-12 months.
“Most neobanks, in the U.S. or otherwise, built business models that are highly dependent on interchange income,” says Jason Mikula, publisher of Fintech Business Weekly newsletter. “Even in the U.S., where interchange is significantly higher than other markets, that model looks dubious. Neobanks that have developed a meaningful lending franchise have fared better — SoFI, in the U.S., and Starling, in the U.K., for example.”
Jason Henrichs, CEO of Alloy Labs, a fintech/bank innovation lab that invests in fintechs, likewise agrees that too many neobanks “are highly dependent, or totally dependent, on interchange fees.”
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Venture Capital Funding Drought for Fintechs
Part of what will determine who those winners and losers will be is which firms can continue to gain access to increasingly dwindling venture capital funding. Global fintech funding fell by 23% in Q2 2022, according to CB Insights data. This represented “the biggest quarterly percentage drop in funding in nearly a decade,” according to the firm.
The decline was prevalent in all geographical regions, with funding in the U.S falling by 25% to post the country’s lowest quarterly funding amount since 2020. Exit activity also fell by 16% during Q2, meaning less fintech firms were in a financial position to go public or were less appealing to potential buyers.
Where the Money Isn't:
VC funding for fintechs saw the biggest quarterly drop in nearly a decade between Q1 and Q2 2022.
With VCs tightening the grip on their purse strings, the funding squeeze has begun to put pressure on neobanks around the world, says Mikula.
“You’ve begun to see neobanks exit certain markets (like N26 in the U.S., Revolut in Canada, or Bnext in Mexico) and some outright failures (Ahead Money in the U.S., Xinja in Australia, and Dozens in the U.K.),” he adds.
When looking to potentially invest in a fintech, Henrichs says Alloy looks at a number of factors and is very judicious before making an investment. These factors include the LTV to CaC ratio (lifetime value to customer-acquisition-cost), which is a prime signal of profitability. It reflects whether the lifetime value of a customer is higher or lower than the marketing and sales costs to acquire that customer. Alloy also looks at “time to pay back” — the time to recover the cost of an investment or the length of time an investor needs to reach a breakeven point.
“The first ratio tells you how good of a business you have and the second shows how much money you need to raise,” explains Henrichs. “Many neobanks focus too much on growth and affiliation without thinking about how it impacts these metrics.”
Read More:
- Can Banks Beat Neobanks at Their Own Game?
- Inside the Digital Marketing Strategies of Neobanks Revolut, Monzo
- Four Strategic Lessons from Digital-Only Banks and Neobanks
Opportunities for Traditional Banks in Neobank Troubles
The drain in funding and associated freefalling valuations of many neobanks could present an opportunity for banks.
For example, Affirm and Klarna are currently worth around $8 billion and $7 billion respectively, compared with peaks of almost $50 billion.
“Their fast-growing consumer-lending businesses could be appealing for Goldman [Sachs], which is already dabbling in the sector through a credit-card partnership with Apple,” writes an analysis from Reuters. “Meanwhile, $8 billion trading app Robinhood is worth little more than its net cash. Buying it could help a lender target the so-called ‘mass affluent’ U.S. wealth market, like UBS.”
David Brear notes, however, that despite the falling valuations of some neobanks that “digital is still the future” and there could be opportunities for banks to increase their digital capabilities.
Time to Pounce?
Downsized fintech valuations could spur a round of acquisitions by banks looking to grow their digital chops and customer base.
“Double down if you can,” Brear adds. “The good news is that lessons learned on the neobank ‘playbook’ over the past couple of years make that easier to do organically, and lower valuations should make inorganic moves easier as well.”
Mikula says that this path may appeal more to medium-size and smaller banks since many of the large global banks have robust digital capabilities already.
“While neobanks had an early lead in digital features and mobile UX, large establishment banks have largely caught up, if not surpassed them,” Mikula says. “Major U.S. banks like Chase, Bank of America and Capital One have full-featured, polished mobile apps these days.”
Mikula also notes that while the tech or user base of neobanks could be appealing to smaller community banks or credit unions that for the most part “these institutions are ill-equipped technologically to manage the integration and ongoing operation of such businesses.”