Fin-Tech

Banking in the Modern

Age!

Syed Hashim Ali

 Banking in a Flash

 Banking has not changed in decades, products have remained static over generations
 Banks have two types of customers either depositors and borrowers
 Bank acts as an intermediary, using money entrusted to them by depositors to lend to borrowers at a higher
interest rate
 Banks have two main revenue streams, one being income from interest and the other the fees they charge i.e
NII and NFI. A third revenue line comprises cross selling of products such as insurance
 Traditional banking has thrived for years because customers trust the system
 They can generate a large amount of capital from customer deposits at a low cost because customers accept
low interest rates on their savings accounts. Traditional banks profit because of the large volume of funds that
they manage, and the spread that they make on the interest rates between borrowing and lending.
 So far, it has been difficult for new entrants to compete with them because of their size and capital.

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 Dangers

 Banks are struggling to fuse their physical and digital assets together to transform their present businesses
 Retail banking will face big challenges in the near future. Some people believe it may even soon disappear, as digital
technology is slowly eating up revenues. An estimated 30% of banking revenues from Italy, France, and Germany are
being lost due to digital technology
 Retail banks must be look into solutions such as:
 Transformation of business models
 Digital transformation programmes need to be set up that can react as quickly as start-ups do
 Retail banks must also reinvent by making changes from the outside in. This means that they must cater to their
customers’ priorities and needs, innovating in a way that may cannibalize their present business
 Many banks struggle regarding innovation because their aims are unclear. They lose market share to new entrants or
faster-moving incumbents because they do not have discretionary funds and become paralyzed by choice. Some of
them implement unconnected initiatives that yield small returns, squandering their investments
 Bank executives do not know how or where to start when it comes to innovation. The main obstacles that they face
are talent management, governance, and funding

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 Alternative Business Models
 Transform into infrastructure providers for fintech companies and financial institutions, eg Bancorp
 Big banks will find this model profitable, especially if they can spread compliance costs across a large number of
customers. However, they will not earn large profits from it, as this is a service that is likely to be commoditized.
 Become aggregators or distributors of financial services products. They do not create the products and services
but procure them from various partners. They do not incur manufacturing and compliance costs but can offer
customers access to different products and services
 Use customer data to help their clients make better operational and financial decisions. They offer the right
advice and/or service to a customer, through the right channel at the right time. These banks receive a small fee
for every product or service that a consumer buys
 The aggregator model allows banks to offer customers added value by working with them and understanding
their finances, thus providing options for them to make a decision. It can be very profitable for banks, especially
if they have economies of scale that can service millions of customers with just one application platform
 Some of the competitive advantages that banks have include large customer bases, trust, strong execution
capabilities, large data sets, large amounts of capital, and access to cheap funding through deposits

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 Banking and Open APIs

 For example, if a bank wants to connect with PayPal on the bank’s mobile app, the PayPal API would allow customers to see
the funds they have available in PayPal, and details of recent transactions. This would be useful for enriching a statement,
which normally just reads PayPal on the transaction line. On the PayPal app, an API created by the bank would allow PayPal
users to see their available balance. So before making a payment, the customer would know which account or card to use,
based on their available balances.
 Take this a step further, another company such as Supercard, a company that offers a card which can store several cards
from different banks, might decide to integrate both the bank and PayPal’s APIs, so that customers can establish a set of
rules which dictate how a transaction is paid for when they use their Supercard.
 Apply this logic to your LUMS smart card!
 Incumbent banks have a double dilemma. On one hand, there is a clear need to upgrade their core banking systems. On
the other hand, they need to decide how much the use of APIs opens them up to the rest of the world
 The Payment Services Directive 2 (PSD2) in Europe allow 3rd-parties to access the transactional data of European banks .
With the regulation becoming fully effective in 2021, the lock-in effects by banks will end and fintechs will have the ability
to access customer’s banking data. Customers can seek more suitable products and services and aren’t obliged to use the
offers of traditional financial institution.
 Latvian fintech startup Nordigen, offering first free API for credit assessments. Focusing on open banking data can get more
people in the credit system, than focusing on credit histories.
 Core banking systems have been built over decades, and are highly complex. If they had been created nowadays, a
completely different framework would have been chosen for their development. Upgrades to and maintenance of these
systems are costly, and every change to the system requires a lot of testing, due to the huge risk of getting things wrong. 5
 Neo Bank
A company that provides an upgraded and updated
version of a traditional bank, without really holding a
banking license. It uses websites and mobile
applications rather than physical branches to provide
its customers with banking services

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 Neo Bank

 Neobanks are financial technology firms that offer digital or mobile-only financial services including but not limited to:
 Checking and savings accounts
 Payment and money transfer services
 Loans for individuals and businesses
 Other services, including budgeting help and more
 Unlike traditional banks and credit unions, which handle the same services, neobanks:
 Typically don’t have branches
 Might not be chartered with state or federal regulators as financial institutions
 Tend to provide a streamlined process designed for mobile devices
 Some neobank offerings come from existing banks and credit unions
 To appeal to tech-savvy demographics and unbanked populations, established banks develop new products with new
names. But the most interesting neobanks are probably fintech startups that improve your banking experience.
 With the increase of global investment in financial technology, neo-banks show a lot of promise in the United States of
America and Europe. Popular neo-banks include Revolut, N26, Moven, Simple, and GoBank

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 Neo Banks Pros
 Low costs: Products are typically inexpensive, with no monthly maintenance fees.
 Transparency: Expect fewer “gotchas,” like surprise charges and exorbitant overdraft penalties. Neobanks often
only let you spend what you have.
 Useful technology: If you’ve ever wondered why you can’t just do something simple on a mobile device,
neobanks promise to let you do more. In addition to basic banking tasks, you should be able to manage your
finances, predict activity in your accounts (and prevent problems).
 Easier loan approval: Instead of rigid and time-consuming loan application processes, neobanks use innovative
ways to evaluate your credit and speed up the process.
 Small business loans: Banks have traditionally focused on large loans and have been less interested in funding
small businesses.

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 Neo Banks Cons

Change is often good, but you need to be aware of several challenges:

 Deposit insurance: Funds at a neobank may or may not be insured by the federal government (FDIC or NCUSIF
coverage). If you keep money with a neobank, verify that deposit insurance exists or decide to accept the significant
risk of going without.
 Consumer protection: The current laws and regulations may not be ready for neobanks. If there’s a problem with apps,
new services, or non-regulated service providers, who takes the blame? In some cases, you (as a consumer) may not
have any legal recourse or well-defined processes to follow.
 No branch locations: Some people like bank branches, and you can definitely get a lot done in person. That said, it’s
becoming increasingly easier to do everything online. Plus, some neobanks allow you to deposit cash at retail stores
and use a vast network of ATMs at no charge.

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 Neo Banks: How They Work
 There’s no standardized definition of what is—or isn’t—a neobank.
 Open banking: Financial information is increasingly available for sharing. With open banking protocols, a variety
of services can combine data from multiple secure sources to provide you with intelligent suggestions and easy-
to-use dashboards. If you like everything in one place, it’s now easier than ever.
 Relationships with bigger banks: Some neobanks are startups that go through the trouble of becoming
chartered banks. But that’s a significant undertaking. Others form alliances with existing banks, allowing them
to offer FDIC insurance on the money you hold with the service. For example, Chime Bank is an online-only
bank that partners with The Bancorp Bank.
 Well-established banks: Big banks also see a demand for new ways of doing business, and they’re rolling out
new offerings to appeal to a mobile consumer base. Finn was a mobile-only bank offering from the behemoth
Chase Bank. The app included checking and savings accounts and a debit card, but it appealed to younger
customers who want to gain control of their money.
 Interface with existing accounts: Some financial products add functionality and make it easier to use your bank
and credit union. They don’t replace those financial institutions, but you might use neobank services instead of
(or at least more often than) your bank account.

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Neo Bank/Challenger Bank Stats

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 Challenger Bank
Fintech companies leveraging technology and software to digitize
and streamline retail banking. Challengers use digital distribution
channels, typically mobile, to offer competitive retail banking
services such as current accounts, savings accounts, loans,
insurance, and credit cards.

Challenger banks have targeted underserved and unserved

demographics, like consumers in lower income bracket. They have
also grown on the backs of improved user experience, appealing to
those who want to be able to bank from their phones instead of
visiting a retail location.

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 Quick Breakdown

 After the financial crisis in 2009, the Bank of England encouraged the establishment of new banks by lowering the
capital requirements
 Aside from being mobile-only, challenger banks also have other common characteristics. Their apps reflect changes in
customer behavior
 Challenger banks offer everyday banking experiences by becoming more relevant in the consumers’ lives. They don’t
only provide monetary transfers and transactions. They provide a meaningful context by offering a concierge-based
approach that traditional banking cannot offer. Challenger banks are focused on their API layer, thereby giving them
agility and flexibility to expand their products and services through strategic collaborations.
 Some challenger banks are very profitable. In 2014, Shawbrook Bank reported £18.6 million pre-tax profit during the
first half of the year, whilst Aldermore reported £50.3 million profit
 However, challenger banks can face potential problems. First, challenger banks must prepare for the effects of
increases in interest rates and the tightening of monetary policy. Since they began, after the financial crisis in 2008,
they have experienced supportive monetary policies and steady growth. They remain untested in a more hostile
environment.
 Lack of sustainability threatens challenger bank longevity, as they focus on growth more than profitability
 Some people quote iBanks as another emerging bank category. They look at monetizing banking in a different way.
Instead of making a profit through fees and interest, they try to gain revenues from monetizing data. An example of
this is the niche bank, Loot, which focuses on students.  They aim to profit from non-traditional revenue streams, such
as advertising and cross-selling. 13
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Challenger Bank

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 Regulatory Impact
 Over the past few years, the EU’s progressive regulators have made it easier for leading challenger banks Atom
Bank, Tandem Bank, Monzo, Starling Bank, Revolut (all UK based), and N26 (based in Germany) to obtain
licenses necessary to operate
 In the case of Atom Bank, Tandem Bank, Monzo, Starling Bank, and N26 they obtained a full bank charter, which
takes up to 2 years, but widens the services these banks can offer consumers. In pursuing this time-intesive
process, these challengers bet that a charter would build trust with consumers and allow them greater
flexibility in building their offerings
 Revolut’s strategy on the other hand has been to get an e-money license which can be obtained much more
quickly, though the scope of services that can be offered is more limited.
 Challenger banks have also been able to expand within the EU by leveraging the European Economic Area (EEA)
“passport.” The passport enables a firm licensed in 1 of the 27 EU member states to provide financial products
or services in another country without needing further authorization in each country. N26 has already
leveraged a passport to expand its service to 17 other EEA countries.
 As of Jan 1,2021 after Brexit many UK based fintechs will have their ‘EU passport’ expire. They wont be easily
able to pitch their services to the 27-nation bloc. Bank of America moved some activities to Paris, while the new
fintech group Bankable chose to relocate to Brussels.

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 Bank Charter Approach

 Atom Bank, Tandem Bank, and Starling Bank prioritized having a bank charter prior to launch and built a suite of
services that required a charter, believing it would create a moat around the platform. Atom Bank, for example,
launched a savings account and SMB lending after regulatory approval. They also plan to launch current accounts but
that roll out has so far been delayed.

 The biggest drawback to this approach has been missing the first wave of early adoption. Despite having added
regulatory protection and wider approval to launch products, they were behind on getting a product to market and
didn’t launch until mid-2016, 18 months after registering with the Financial Conduct Authority (FCA).

 Another drawback to the charter is that it can be revoked. Tandem lost its banking charter after failing to secure
funding. It acquired Harrod’s bank division in December as a way to restore its charter, but that was a costly and time-
intensive process.

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 Semi Traditional Approach
 Monzo and Germany-based N26 wanted to get customers onto the platform. To do so, Monzo launched a
prepaid card instead of a full account product.

 The benefits of this strategy include getting products to market faster, getting customer feedback, and fixing
bugs during early product releases. But a drawback to this strategy is that it could potentially jeopardize
growth.

 Monzo was going through a period of rapid growth, adding a reported 60K users a month when the company
was granted a charter. In December 2017, they stopped adding new customers and announced plans to focus
on transitioning the 500K existing customers off of prepaid cards and onto Monzo’s own current accounts.

 As of February 2018, the company had a waitlist for new current account registrations, which means it was
missing out on roughly 180K potential new customers (at the peak growth rate of 60K per month) as it focuses
on transitioning its existing customers off of the prepaid cards.

 Another drawback is having to partner with other corporates in the interim while waiting on a bank charter.
N26, for example, partnered with Wirecard, and had to give them a cut from every transaction.

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 Accelerated Approach

 Revolut challenged the conventional go-to market strategy by applying for an easier-to-acquire e-money license and
targeting currency exchange rather than current accounts. Revolut initially focused on frequent travelers, a niche they
believed was underserved. It built a digital currency exchange app, which allowed people to exchange money more
frequently across countries without establishing multiple bank accounts.

 Revolut leveraged the EEA passport to expand across Europe and partnered with other fintechs to iterate quickly. It
was able to launch this product without waiting on a charter, while quickly gaining access to a roster of potential
clients for a broader eventual banking offering.

 The most viral product Revolut has launched to-date is a cryptocurrency exchange. Following the announcement in
November 2017, the company crossed 1 million users and was adding 3,500 users per day. As of February 2018,
Revolut reports it has 1.5M customers. It is the first challenger bank to announce breaking even on a monthly basis.
This means that the company is monetizing enough customers to offset the cost of acquiring new ones.

 In 2020, Revolut became one of the fastest growing fintechs with more than 10 million customers in the UK and
Europe. It has launched its Financial Super App and debit card in the United States making it take a more global
approach.
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 Mobile adoption

 In 2011, customers still relied heavily on branches and were just starting to embrace internet banking. But challenger
banks bet that mobile would be the next platform for retail banking distribution. That has proven prescient. As of
2016, mobile interactions have quickly grown to account for 56% of customer’s banking engagements in Europe. The
total value of payments made using mobile devices will have reached $503 billion in 2020. By 2021, there will be
roughly 7 billion mobile users worldwide.

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 Upcoming Trends for Challenger Banks
 Products & Partnerships:
 Firms that partnered with challenger banks like Revolut and N26 have been quick to add new
services, which has helped banks drive down costs, add to their value proposition and begin
breaking even
 Challenger banks may also look to partner with bulge bracket banks they set out to disrupt in
order to take advantage of new open banking requirements, facilitate network speed, and ensure
information security
 Because partnerships are costly and create contingency risk, challenger banks with scale will look
to launch new products in-house, following Revolut’s growth model
 Focusing on digital banking user experience
 Covid Impact:
 The pandemic has boosted adoption of digital banking which opens opportunity for challenger
banks. But the effects of COVID19 also brought losses to some banks.
 Monzo had to launch a a £5/month premium account called Monzo Plus to make up for lost
revenue. Starling Bank increased loan revenue to offset losses of reduced customer spending
 New Markets:
 Established banks will look to international expansions however the growth will come at the
added cost of further licenses and regulatory burdens
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 Upcoming Trends for Challenger Banks
 Predictive Personalization:
 Google to launch its much-anticipated bank accounts through an offering dubbed Google Plex this
year. These checking and savings accounts will be powered by banking institutions that Google has
partnered with.
 A prominent feature of Google Plex that Google clearly hopes will help it attract customers is AI-
based insights that aim to help customers plan, save and achieve their financial goals.
 Covid crisis highlighted need to customize communication to help customers deal with financial
impact of the pandemic
 This use of AI and machine learning will result in tailored websites, real-time financial
recommendations, and a level of test and learn capabilities

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 Neo Bank Vs Challenger Bank
You would have noticed the words neo and challenger are often used interchangeably. However, in reality, they are
quite different from each other:

 Neo banks do not have a brick-and-mortar physical structure at all. Challenger Banks, though small in size, are
physically present.
 Neo banks do not have a banking license but rely on a partner bank to operate. A Challenger bank has a full
banking license to operate the full suite of banking operations.
 Neo banks tend to focus on a particular customer segment like SMEs, but Challenger banks cover the entire
gamut of banking operations.

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