2021 marked a big year for neobanks, with firms like Nubank, Revolut, and Chime getting major boosts to their valuations.
Out of the hundreds of neobanks existing today, only 5% are actually earning a profit – most are earning less than $30 per customer per year, according to a May report from Simon-Kucher & Partners.
Meanwhile, neobanks are still appearing in the news, but for less fun reasons. Chime, for example, has delayed its IPO plans because of declining fintech stock, and Varo has been hitting some bugs in its business model. The average Varo account has a balance of $84 – giving the bank only $336 million in total deposits and putting a damper on lending capabilities. Revolut, finally, has been losing a stream of executives – including its only female exec Deirdre Halligan, who was the global chief operating officer.
And this new scenario leaves neobanks in a rocky situation – can they maintain consumer interest and usership amidst a point of financial uncertainty and the threat of a recession?
It's not neobanks' fintech-y side that leaves them at risk. Fintechs, themselves, continue to make their way into consumers' habits. 30% of millennial and Gen Z consumers say their primary accounts are with fintechs, according to research by Cornerstone Advisors. Meanwhile, 40% of consumers aged 21 to 55 say they subscribe to fintech services.
Rather, it’s the depth of neobanks’ hold on their users that leaves their future blurry.
Sure, a lot of them have managed to build a community and hype around their services, but a lot of the magic seems to end there.
Neobanks with precarious business models may have their work cut out for them. Going forward, we may see more of these digital banks taking steps to reduce operational costs, according to Patrick DellaValle, director of financial services advisory and compliance practice at consulting firm Guidehouse. That includes reducing headcount, going after additional funding – leading to lower valuations, and entering acquisition agreements with incumbent banks or larger players in the industry.
“This could be an opportunity for traditional banks to enhance their digital capabilities,” said DellaValle.
As for neobanks that aim to remain solo, their goal right now seems to be about diversifying their products so that they can offer more services that are appropriate during a time of uncertainty.
“We are already seeing some fintechs starting to pursue a trend towards diversification of products given the economic uncertainty – this could include expanding into lending products, which have more diverse fee and interest opportunities and different card and account types, like traditional credit or debit,” said DellaValle.
Zeroing in on niche neobanks specifically – according to Rachel Huber, market intelligence analyst at Marqeta, their main focus now should be sprucing up their more "boring" services, rather than just their personalized features. In that way, they can show they’re trustworthy when times are rough as well.
“The features that pull in niche communities to these products are important – for instance, offering rewards for businesses owned by that particular community – but getting the basics right is just as important,” said Huber. "The end user may like that feature, but if they aren’t able to offer other basic banking blocks such as loans or credit cards, they are naturally going to be limited in how much they can capture an already smaller addressable market."
When it comes to challenges neobanks may face going forward, DellaValle says those offering or expanding into lending products need to be especially wary.
“We have seen fintechs face some challenges in turbulent economic environments, as their credit and underwriting models are not always adapted to broader increases in delinquency, and they may lag by a quarter or two in making adjustments to tighter credit,” he said.
Another obstacle may be building a strong business model while still maintaining that customer-first approach that has so far defined neobanks.
“These organizations are very customer-focused, which has significant benefits and builds loyalty, but can also make it more challenging to manage collections, delinquencies, and fraud while balancing that customer-centric approach."
As to the question of whether a potential recession means the end of neobanks, DellaValle says most likely no. He believes neobanks will adapt in terms of cost structure, organizational approach, and product diversity, with a move towards more partnerships – both across fintechs and traditional banks – as they seek to increase revenue while keeping costs in check by building new infrastructure.
"Consumers may experience some concern over neobank viability and reduce their exposure to these banks in the short term – leading to some reduction in assets and market share – but I believe this will be cyclical, as consumers do like the digital-first approach and self-service model."