Understanding Neo-Banks and How They Are Challenging the Traditional Banking Models

A new wave of alternative banks termed ‘neo-banks’ surfaced a few years ago. However, far from dying out the conversations on these types of digital banks is still dominating the financial industry. A reason for this could largely be owing to recent regulatory changes that have made it more convenient for new startups to offer financial services to consumers worldwide.

For example, across the EU and EEA, banks are required to open up their data to third parties as per the second Payment Services Directive (PSD2), also known as the new ‘Open Banking reform’ in the UK. This enables consumers to not only perform cross border payments with ease but also have full control of their financial data. Traditional banking models still lack transparency and don’t appeal as much to the tech-savvy demographic.

So, what are these Neo-Banks, and how do they work?

What is a Neo-Bank?

Neo-Banks are fin-tech firms offering mobile-only or digital services, which include savings and checking accounts, loan services, money transfer and payment services, among others. The main distinguishing feature of neo-banks is that unlike traditional banks they do not have any physical branches. They offer bank-licensed services by relying on partners but do not own any bank license themselves. In other words, they may not be chartered as financial institutions with federal or state regulators.  

Understanding How Neo-Banks Work

You can think of neo-banks as apps made to offer a streamlined process designed for mobile devices. For example, apps that facilitate the administration of credit cards and accounts can be typically classified as neo-banks. They offer a user-friendly interface to the customer but depend on the customer’s account with a licensed bank.  

Different Types of Digital Banks

Since the terms ‘neo-banks’ and ‘challenger banks’ are almost used interchangeably, it can get confusing. Following is the classification of current digital challenger banks based on the services they provide and their business models.

·      New Banks

These type of digital banks can compete independently with traditional banks on equal terms by applying for a full banking license to provide all the bank-licensed services.

·      Neo-Banks

Neo-banks revolutionise the processes and practices associated with traditional banking through digital and mobile-only platforms. They do not have a banking license but partner with other financial institutions to provide bank-licensed services.

·      Beta Banks

Beta banks are subsidiaries or joint ventures of existing banks which provide financial services through the parent company’s license. So, for example, if the parent bank plans to expand across country borders, beta banks can also leverage the parent bank’s license to gain an entry in the target market.

·      Nonbanks

Nonbanks operate independently of existing traditional banks and share no connections with bank licenses. They offer financial services through other means that normally operates on an electronic money licence. These are the most exciting category of challenger banks and have a huge potential of disrupting traditional banking models.

What Are The Consumer Benefits of Digital Banks?

As a consumer, you can stand to enjoy these below-mentioned advantages from neo-banks:

·      Lower fees. Since neo-banks do not have physical branches, they have fewer operational and maintenance costs. Thus, they can price their services more competitively.

·      Easier loan approval. Some traditional banks have earned themselves the reputation for being rigid and resistant to technology. With neo-banks, cumbersome loan application processes can be speeded up and dealt with seamlessly.

·      Easy setup. Most digital bank accounts today are paperless and can be directly set up from a mobile device.

·      Security-centric. In comparison to traditional banking models, digital banks are more security-driven and flexible.

As per the recent reports by Global Market Insights Inc., the global banking market is expected to reach $9 trillion by the year 2024. Whether neo-banks are the future of banking, it remains to be seen.

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