Professional Documents
Culture Documents
potential routes
Yaroslav Taran
Jun 2, 2020 · 7 min read
Source: Medici
Until 2019, there was a widespread belief, led by Revolut and Monzo, that the
marketplace model is the main bet for neobanks and is enough to reach positive net
income territory. However, in late 2019 Monzo changed its rhetoric, acknowledging
that lending is a key lever to profitability. In May 2020 Revolut followed by launching
an official bank in Lithuania.
2) Boosting lending to consumers and SMEs. Incumbent banks make the most of
their money by lending out 80–95% of their deposits, while most neobanks merely use
10% of their deposit base for credit. Theoretically, increasing leverage will increase
profitability, however, there are several pitfalls. Lending to micro-companies, start-ups
and underbanked individuals could be extensively risky, long-term loans could hurt
solvency and liquidity. When it comes to individuals, mortgage or auto lending is not
something neobanks will be able to afford given their shaky deposit base (apart from
those owned by traditional banks, e.g. Atom). Direct short-term consumer financing
may have a flavor of pawnshops — not something digital challengers would like to be
associated with. The remaining niches — credit cards, overdrafts, salary-tied liquidity
financing and purchase financing could present significant revenue-generating
opportunities. However, the biggest sweet spot is SME lending, especially in a higher
market end, as established companies’ solvency is easier to evaluate and collateralize.
The only profitable UK challenger — OatNorth makes its money from lending to mid-
sized companies. Therefore, for the banks that signing up smaller companies today
(e.g. Starling, Tide) is of utmost importance to maintain the relationship as their
customers develop and grow in size — generating more revenue for their digital banks.
3) Getting into business banking. Businesses have much higher money flows and
deposits compared to individuals, a variety of unmet needs, and are more willing to
pay for the services that save them time or money. At the same time, small and medium
businesses tend to be underserved by banks, highly susceptible to innovations and
more flexible with switching their banks. Moreover, looking from the longer-term
strategic perspective, the SME banking segment is less likely to threatened by Big Tech
(Apple, Google, etc.) venturing into banking. Those factors make SMEs an ideal
playground for functionally mature neobanks. However, the client spectrum is quite
wide within SME: some Neobanks like UK’s Starling and German Penta focus on micro-
enterprises and freelancers, while others like UK’s OakNorth and French Qonto target
primarily higher end of small and medium-sized clients. There is also a diverse set of
monetization mechanisms: subscription and freemium models, charging for incoming
and outgoing bank transfers, FX services, company cards, accounting and other
integrations, and of course business lending. Feeling the segment attractiveness, even
retail-focused neobanks entered the space — Revolut in 2019 and Monzo in March
2020.
Given the market extensive competition, the upcoming trend is likely to be the
emergence of more industry-specific business packages, tailored to the needs of retail,
hospitality, travel, e-commerce, etc. The next product frontier is likely to be payment
acceptance, which is a high margin business currently overlooked by neobanks.
Currently, none of the challengers offers in-house payment acceptance, while a few
most advanced went into partnerships with established PSPs (e.g. Penta directs
customers to SumUp). Such partnerships are going to spread when neobanks realize
that this is a quick way to earn referral commissions, capitalizing on their SME
customer base. Furthermore, the upcoming PSD2 Payment Initiation functionality will
allow neobanks to break through into online payment acceptance — as many of them
already hold PIS licenses.
6) Getting into a consolidation game. The two most probable options include getting
acquired by a traditional bank and merge or acquire a fellow neobank. The first option
allows for quick investment return and potential for a variety of revenue-generating
and cost-saving plays: cross-selling services, using neobanks network and interface for
credit distribution, exploiting neobank technology, centralizing customer service and
overhead functions. We are likely to see acquisitions like this among the second
division of neobanks, while the frontrunners are likely to be protected from those deals
by their high valuations, risks to the client base, and founders’ resistance. Therefore,
the second option is more feasible: neobanks mergers allow for saving on marketing
and overhead budgets, product cross-selling, and potentially geographic synergies.
Imagine an N26-Monzo merger — the resulting neobank will create a pan-European
customer base, huge potential for cost-cutting, and rationalizing IT costs, create weight
for partner negotiations, and a strong base for US expansion, where both neobanks are
intensely trying to build a presence. The cost-saving and growth generating potential
of such a deal would be enormous.
7) Looking for new emerging niches. What made neobanks get to the market is high
sensitivity to changes in customer needs and technology. To advance to profitability
they need to keep adjusting to emerging customer needs — and doing it fast. A great
example is Starling’s launch of a card allowing delegated shopping on behalf of self-
isolating people — only 3 weeks after the pandemic started in Europe. The speed of
action and resulting first-mover advantage remains a key differentiator for the
overcrowded and commoditized digital banks market. For challenger banks being
ahead of the curve is key to pave the way to profitability. There are still plenty of not
covered and potentially monetizable use-cases: managing subscriptions for customers,
bill payments, payment initiation, SCA white-listing, money pots, etc.
As the neobank market develops and hype slowly fades away, it becomes clear that the
path to profitability — and survival — will be tough. For some it may go through
business model diversification and incorporating several options mentioned above, for
some it may involve piloting some of them and settling down with two or three, some
may find luck through going deeply into one specific business model. Anyway, the
market is undergoing tectonic shifts and the challenger bank landscape in 2025 is likely
to have very little resemblance with this in 2020.
If you’re interested in the topic and enjoyed the article, feel free to subscribe to my Medium
publication or follow me on Linkedin.