Chris Ward
Chris Ward Dec 20, 2018

U.S. neo-banks: A digital revolution and its roadblocks

Being an app-only, startup bank in the U.S. has, historically, been a tough gig. It’s not that a fintech appetite on the part of entrepreneurs or investors doesn’t exist: The market remains active with many players. But they've focused on the areas where regulation is less frustrating and there’s more money to be made, namely in lending and investing.

Nor is it that no one has tried; just a few years ago we pointed to Simple as the top dog in the mobile app banking world. But in Europe, it's all about the “locals” Monzo, N26, Revolut and Starling Bank (you can hear Starling founder Anne Boden on a BAI Banking Strategies podcast).

The reality is that U.S. neo-banks have failed to keep going as standalone entities. Let’s look at a few case examples of this:

  • Simple was consumed by BBVA, resulting in a less-than-simple transition onto a new technology system that put off many users.
  • BankMobile looked promising but was also acquired and hasn't accepted new customers for most of this year.
  • Moven, a former flagship disruptor, has very clearly transitioned into a tech vendor actively pedaling its aggregation capabilities in Europe.

But the real issue that undermined neo-banks of the early 2010s is this: regulation and charters. Each of the aforementioned entities had to piggyback on an existing bank’s charter. This isn't necessarily bad; most neo-banks and fintechs must rely on third parties for technology, regulatory permissions, products and distribution to keep costs down and get to market quickly.

Yet to succeed these brands must mature and take on more of these things themselves. Take the example of N26, an E.U.-wide neo-bank. It started out leveraging Wirecard’s card issuing and banking license to build a foundation in Germany. Two years ago, it received an E.U. banking license, ditched Wirecard’s tech platform and broke into 17 European markets.

Simply put, it’s now easier to get a banking license in the E.U. (and especially the U.K.) than ever before. But a similar transformation has not reached any critical mass in the U.S.—even though customers clearly await the benefits neo-banks can offer.

Recent BAI Banking Outlook findings point to a growth in P2P providers over the last year. While greater than 70 percent of Gen Xers and baby boomers trust their bank over PayPal, only 57 percent of millennials said the same—with 14 percent calling PayPal their “most trusted” source for P2P activity.

This September Varo Bank became the first fintech to receive preliminary approval from the U.S. Office of the Comptroller of the Currency for a national bank charter. It still requires approvals from other bodies to become fully authorized and for now remains on Bancorp’s platform. Other players to watch include Chime (which also uses Bancorp) and established fintech lender and saving provider SoFi, which also plans to launch an app-only checking account.

For ambitious mobile banks and hopefuls, the regulation issue isn't about to go away. Witness Robinhood, which announced checking and savings accounts this week with a stunning 3 percent interest rate. Just a day later, they backpedaled and said they would rename and relaunch the products after regulators and Wall Street sounded the alarm. It was, as one UBS analyst labeled it, "an epic fail."

This next wave of neo-banks will not only work exclusively through apps. More importantly, they all claim to offer low-cost banking. As we saw in Europe, viable neo-banks do not compete on digital alone: They leverage price as well.

And so the big question: Will these brands and their European counterparts that expect to launch in the U.S. (N26 and Revolut) go on to success?

They seem to follow a recipe that has worked in Europe but also comes down to how incumbent brands respond. Chase has already rolled out its app-only checking account Finn, and Wells Fargo is unveiling its Greenhouse proposition. One obstacle for the latter is that Wells has only promised to waive monthly service fees during its rollout period and not after; Chase’s offering, meanwhile, clocks in at a paltry 0.01 percent APY for accounts up to $10,000.

Meanwhile, other big financial services firms have also sensed an opportunity. Goldman Sachs’ Marcus already offers savings and loans and earlier this year bought aggregation application Clarity Money. Its savings APY is 2.05 percent.

The lowering of regulatory barriers in Europe has created favorable conditions for neo-banks. The advent of PSD2 and an open banking regulatory framework look increasingly geared to favor neo-banks and disruption. If the same conditions take hold in the U.S. (it’s great to see open banking firmly on the agenda), it really is a case of when and not if change will come.

The digital banking space is about to become more crowded than ever in the U.S. Players of every description have seen the opportunity and are moving rapidly to get in the right place at the right time.

We expect one of the startups to soon make waves in the U.S. And while the leader of this movement remains to be seen, neo-banks, true to their name, will herald the dawn of something new.

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Based in London, Chris Ward is principal consultant at Mapa Research.

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