Neobanks: The Future of Personal Finance?

INDUSTRY BACKDROP

Largely a response to the shortcomings of the traditional financial services industry, which came under scrutiny after the 2008 global financial crisis, financial technology companies are disrupting the financial services industry by offering digitized financial products and services. Fintech companies create a better customer experience by eliminating manual processes, automating tasks, decreasing costs, and personalizing services. The global fintech market is expected to grow at a CAGR of 24.8% to $310 billion by 2022, with 88% of financial institutions believing that part of their business will be lost to FinTech companies over the next 5 years.

Within fintech, neobanks, such as Chime, Current, MoCaFi, and Greenlight, have revolutionized personal finance with apps and software that streamline banking solutions without any physical branches or offices. The global neobanking market was valued at $34.8 billion in 2020 and is expected to grow at a CAGR of 47.7% from 2021 to 2028. Despite much of the world's financial services still being offered by a small group of incumbents, there is an increasing demand for customer convenience in the banking sector, creating a long-term disruption opportunity for neobanks.

TAILWINDS AND TRENDS

The increasing presence of AI, smartphones, and general consumer expectations regarding convenience and speed of services are accelerating the growth of Neobanks.

• Artificial Intelligence: 70% of fintech companies are using AI today, and the technology is predicted to dominate the market by 2025. The popularity of robo-advisors (AI-powered financial planners) has been growing rapidly in recent years. AI is also a strong tool for data security and fraud detection, which can reduce individuals’ anxiety over their finances and increase customer loyalty for neobanks.

• Consumer Expectations: In an increasingly digital world, consumers expect convenience in all aspects, including mobile and online access, 24/7 customer service, ease of use, and speed. Consumers now expect these services from their banking providers as well, so developing capabilities that save customers time and effort is of paramount importance for neobanks.

• Smartphone Ownership: Smartphone ownership is increasing rapidly around the globe, with 85% of adults in the United States owning a smartphone in 2021, up from only 31% in 2011. The increased penetration of smartphones and the internet across the globe has boosted the market potential for neobanks, which only require mobile access to access their features and services.

DIFFERENTIATORS

When evaluating Neobanks, certain characteristics will differentiate stronger investment opportunities from others:

• Customer-First UX: Rather than assuming the needs of their customers, Neobanks that conduct consumer research before rolling out new products will ensure that new features directly benefit the customer’s actual needs. Neobanks offering a variety of useful and convenient features can surpass the services offered by traditional banks and attract more customers. Neobanks that partner with incumbent institutions to offer additional features will also benefit from lower customer acquisition costs.

• Lower Operation Costs: With no branches or legacy IT systems, digital-only neobanks benefit from low operation costs. Automation and cloud-based infrastructure also contributes to lower servicing expenses that can be 40-70% less than mainstream banks. These low operation costs allow neobanks to charge customers low or no fees and provide higher interest rates on savings accounts to successfully attract customers.

• Predictive Analytics: Neobanks that leverage AI to offer personalized banking advice, savings and expense management, and wealth management tools will attract and retain users by creating high switching costs for customers. Hyper-personalization based on behavior patterns of specific cohorts (i.e. millennials) can also be a strong moat for emerging neobanks.

WHY NEOBANKS?

Modern banking solutions that increase financial inclusion and education within minority communities are a major contributor to closing the racial wealth gap. This mission is particularly important to me because Black Americans are massively underserved in the financial services industry, despite a collective spending power of $1.4 trillion annually. By investing in neobanks that are tailored towards historically underbanked communities, VCs can help increase accessibility to financial products and services and help erase the wealth gap through education and awareness.

Want to connect? Follow me @theraquelscott or send me a message!