Neobanking is a new player in the banking arena. Here we explain how they work.

A new player in the banking arena is turning the business model of traditional financial institutions on its ear. Called the “neobank”, this new model is powered by heavy-duty technology, unencumbered by the high cost of maintaining branches and banking centers. Neobanks not only match service levels of conventional banks, but also may exceed them with advanced offerings, such as letting customers buy Bitcoin with a bank account.

Also known as “challenger banks”, neobanks were formed to help ease the severe economic stress in the UK following the 2008-09 financial crisis.  Banks had stopped lending to each other, and credit for consumers and businesses alike dried up. In response, the UK changed banking regulations to allow startup digital banks to raise capital and build systems before they applied for a full banking license.

The subsequent success of a 100 percent digital bank quickly caught on worldwide. In 2019 neobanks signed up 39 million users, and venture capitalists invested more than $3 billion into neobanks.

“Disruptive technology” is the neobank engine

Key to the neobank’s success is what’s sometimes referred to as “disruptive technology” – a catchy term for the combined power of big-data analytics, artificial intelligence (AI), and cloud computing.

This technology resonates with the cyber-savvy younger generation. It’s a popular segment that also is open to advanced services – such as buying popular cryptocurrency, Bitcoin with a bank account.

It is a tragic twist of luck that the global COVID-19 pandemic has heightened the need for remote banking. Locked-down customers previously disinterested in digital banking have been forced to use it.   Many may not return to the old way of banking when the pandemic subsides.

Traditional banks are taking notice

The worldwide community of traditional bankers are painfully aware that their industry is changing. Terms like “challenge banks” and “disruptive technology” are unsubtle reminders of what the future may look like.

Understandably, large traditional banks have resisted the all-digital trend. Online banking is commonplace for most institutions, but often their services require a one-on-one encounter at a branch location to consummate certain transactions, such as turning in a signature card or closing on a loan. Online investing also may have limitations at some traditional banks offering brokerage services.

This is especially true for the investor wanting to buy and sell cryptocurrencies online. Many institutions have resisted the move toward digital money, at least in part because of the potential competition it poses. Some bank executives have even taken a never-crypto stand publicly.

This had been particularly true in the US until this year. In July, the Office of the Comptroller of the Currency (OCC) granted national banks authority to open bank accounts and provide custodial services to cryptocurrency businesses.

The future of banking clearly will be redefined in digital terms. One thing is certain — neobanks are here to stay. Less clear is how traditional institutions adapt.

Summing it up

Neobanks offer a full array of services without the cost of bricks and mortar. Disruptive technology powers an all-digital platform that attracted 39 million new customers in 2019. The new banking genre appeals to the cyber-savvy younger generation. Large traditional banks have resisted the digital trend, but that could be changing. How quickly those institutions will adapt so far is unclear.