Neobanks are digital-only banks that operate primarily through mobile apps and websites. They offer financial services similar to those of traditional banks including savings and checking accounts, loans, and payment and money transfer services. Their services are accessible from anywhere with an internet connection, and they often incorporate features such as budgeting tools, real-time notifications, and personalized financial insights. By avoiding the overhead associated with physical branches, neobanks can charge lower fees and offer higher interest rates on savings.

Neobanks frequently target millennials, digital nomads, and those underserved by traditional banking systems with services that meet their needs and preferences. Changes in customer expectations and technological advancements made accessible, digital-first banking possible, and the number of neobanking users worldwide is expected to exceed 386 million by 2028.

Below, we’ll cover what you need to know about neobanks, including how they work, who uses them, and their advantages and drawbacks.

What’s in this article?

• The rise of neobanks in the financial industry
  
• Neobanks vs. traditional banks: A comparison
  
• How neobanks work
  
• Who uses neobanks?
  
• Advantages and drawbacks of neobanks
  
• Neobanks and regulatory considerations
  

The rise of neobanks in the financial industry

Neobanks have emerged in the finance industry as a result of technological advancements, changing customer expectations, and regulatory changes. Neobanks have gained popularity because of their ability to provide cost-effective services, target niche audiences, and effectively scale their operations. This banking model has disrupted traditional banking and reshaped the financial landscape.

• Technological advancements: These advancements have driven neobank development. New mobile and cloud computing technology have made neobanks’ digital banking experiences possible, while cybersecurity innovations have increased customer trust in the safety of digital banking.

• Customer expectations: Modern customers such as millennials and Generation Z expect convenience, speed, and personalization in their services, including banking. Neobanks cater to these preferences with user-friendly interfaces, instant notifications, personalized financial advice, and financial services that are accessible 24/7 from smartphones or computers.

• Regulatory changes: Changes in some regions’ regulatory frameworks have facilitated the emergence of neobanks. For example, in Europe, the revised Payment Services Directive (PSD2) allowed third-party providers to access bank data, letting neobanks develop a range of services and increase competition in the banking sector. Other countries have introduced similar regulations that encourage competition in financial services.

• Cost efficiency: Without needing to maintain physical branches and the associated overhead costs, neobanks can operate more cost-effectively. This lets them charge lower fees and set better interest rates than traditional banks.

• Market penetration strategies: Neobanks often target niche markets with specialized products such as banking services for freelancers, expatriates, or digital nomads. Combined with aggressive marketing and user-friendly technology, this helps them quickly grow and establish a strong presence in the financial sector. Their cost structure also lets them serve segments of the population that are typically underserved by traditional banks, including people with lower incomes or those living in remote areas.

• Global scalability: The digital model of neobanks lets them scale globally more quickly than traditional banks. Because they are not tied to a physical location, they can expand their services across borders without major additional investment.

Neobanks vs. traditional banks: A comparison

Neobanks and traditional banks have their strengths and cater to different market needs. The choice between them often depends on what the customer values most: the convenience and innovation of digital banking or the comprehensiveness and personal touch of traditional banking.

Neobanks

• Technology and innovation: Neobanks are built on modern digital platforms, allowing for swift deployment of new technologies and innovations. Their platforms often include features such as real-time updates, integrated budgeting tools, and automated savings options.

• Customer experience: Neobanks typically provide a user-friendly, mobile-first experience that appeals to digital natives. The absence of physical branches means all services are designed to be accessible online, often enhanced by sophisticated artificial intelligence (AI)-driven customer support.

• Fees and rates: Neobanks typically have lower fees and better rates on savings and loans compared with those of traditional banks.

• Regulation and security: Neobanks operate under the same regulatory standards as traditional banks but might start without a bank charter, operating instead through partnerships or special licenses. Their security features are typically strong and feature the latest in encryption and biometrics.

• Services: Neobanks focus primarily on basic banking services such as checking and savings accounts, payments, and—sometimes—loans. They are quick to adapt and provide new services that meet specific customer needs.

• Accessibility: Neobanks provide services that are accessible anywhere with internet access. This is a major advantage for customers who travel frequently or do not have easy access to a bank branch.

• Target audiences: Neobanks often target tech-savvy customers, younger demographics, and underserved groups who are looking for innovation in banking or have not been fully served by traditional banks.

Traditional banks

• Technology and innovation: Though traditional banks are increasingly investing in technology to grow their digital offerings, their systems are often built on older infrastructure, which can slow the development and integration of new features.

• Customer experience: Traditional banks provide a blend of digital and in-person services. Their physical branches have face-to-face customer service, which can be helpful for complex transactions or for customers preferring personal interaction.

• Fees and rates: Traditional banks often have higher fees for customers, though their broader range of financial products can sometimes justify these costs.

• Regulation and security: Traditional banks are well regulated and typically have a long history of managing regulatory compliance and protecting customer assets.

• Services: Traditional banks have a comprehensive suite of services including checking, savings, loans, mortgages, investment products, and wealth management. This can be more appealing to customers seeking all-in-one financial solutions.

• Accessibility: Traditional banks have online services and physical branches. Their online presence might not be as developed as those of neobanks, but their in-person options can provide a personal touch that some customers might find reassuring.

• Target audience: Traditional banks cater to a broad audience, including those who prefer a mix of traditional and digital banking experiences and those who value a wide range of integrated financial services.

How neobanks work

Neobanks have a fully digital interface, typically accessible through a smartphone app or a web-based platform. This interface is designed to be user-friendly, intuitive, and accessible 24/7 from anywhere with internet connectivity. Neobanks often rely on cloud computing, which lets them scale quickly and maintain data security while providing uninterrupted service to customers worldwide. They generate revenue through transaction fees, service charges for premium features, interest on loans, and sometimes by reinvesting deposits in the interbank lending market.

From a legal perspective, some neobanks operate under their own banking licenses, while others partner with traditional banks to use their banking licenses. These partnerships let neobanks offer insured deposit accounts and other regulated banking services without having a bank charter themselves. Neobanks must comply with the financial regulations of the countries in which they operate, including Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations.

Like traditional banks, neobanks provide services such as checking and savings accounts, personal loans, and payment services. They often enhance these services with digital features such as instant notifications, automatic categorization of spending, and real-time balance updates. Neobanks’ basic features are outlined below.

• Account setup: Setting up an account with a neobank usually involves downloading the app, providing some personal information, and going through identity verification processes, which might include submitting documents electronically or using biometric data.

• Customer support: Support is typically provided through digital channels such as in-app messaging and email and sometimes via phone. AI-powered chatbots are often used to handle common queries.

• Financial tools: Neobanks use data analytics to give personalized financial advice and product recommendations. They also engage customers with budgeting tools and goal-setting features to help manage finances effectively.

• Security measures: Neobanks use advanced security technologies including encryption, secure application programming interfaces (APIs), two-factor authentication, and sometimes biometric verifications such as fingerprint or facial recognition.

Who uses neobanks?

Neobanks appeal to a younger demographic, digital nomads, underbanked populations, and others. Here’s an overview of who uses neobanks.

• Millennials and Gen Z: Younger generations, particularly millennials and Gen Z, are digitally native, highly familiar with mobile technology, and more likely to adopt convenient and user-friendly financial services available through digital platforms.

• Tech early adopters: Many neobank users are individuals who are comfortable using advanced technology for daily operations. These customers often seek out new features that traditional banks might not have such as integrated budgeting tools, cryptocurrency trading, or real-time spending analytics.

• Urban dwellers: Neobanks often focus their marketing and services on urban populations. These areas provide a dense customer base that is more likely to be comfortable with digital-only services, influenced by urban lifestyles that prioritize convenience and efficiency.

• Underbanked populations: Neobanks are being used in regions with limited traditional banking infrastructure or where people have historically been underserved by traditional banks. This includes areas in developing countries where mobile phone penetration is high but access to physical bank branches is low.

• Freelancers and the self-employed: Neobanks often have tools and features that appeal to freelancers and self-employed individuals. These features might include invoice management, separate pots or subaccounts for tax savings, and expense-tracking tools, all managed through a single app.

• Cross-border workers and immigrants: People who work across borders or who have immigrated to another country find neobanks attractive because of their typically lower fees for international money transfers and the ease of setting up an account without needing a local credit history or residency status.

• Price-sensitive customers: Those who are sensitive to fees and pricing are often attracted to neobanks for their lower fee structures, no minimum balance requirements, and competitive interest rates.

Advantages and drawbacks of neobanks

Neobanks offer a modern take on banking that aligns well with the digital age, and they come with advantages and drawbacks. Here’s a detailed look at both.

Advantages

• Convenience: Neobanks operate primarily through digital platforms and are typically accessible anytime and anywhere.

• Lower fees: Neobanks often have lower fees than traditional banks. They might have no monthly fees, lower foreign transaction fees, or no fees for ATM withdrawals within certain networks.

• User-friendly interfaces: Neobanks focus heavily on user experience, providing intuitive apps and websites that make banking simple and straightforward.

• Innovative features: Many neobanks offer features such as real-time spending notifications, budgeting tools, automated savings plans, and detailed analytics on spending habits.

• Fast account setup: Opening an account with a neobank is usually quick and can be done entirely online with minimal documentation, making the process much faster compared with that of traditional banks.

• Services for the underbanked: Neobanks often provide services to populations that are underserved by traditional banks, including those without a stable address or who have a poor credit history.

Drawbacks

• Limited product range: Though neobanks have basic banking services, they often lack financial products such as mortgages, loans, and insurance or offer them through third-party providers, which can complicate customer service and integration.

• Lack of personal interaction: Customers who prefer face-to-face interactions for complex banking needs might find neobanks unsatisfactory.

• Regulatory challenges: Neobanks face substantial regulatory scrutiny and, depending on their setup, might not always have the same level of deposit protection as traditional banks, especially if they operate without their own banking license.

• Dependence on technology: Neobanks rely heavily on their technical infrastructure, and any downtime or technical issues can impede access to one’s finances.

• Market stability and trust: As relatively new entrants in the banking sector, some neobanks might lack the brand recognition and trust that traditional banks have built over decades. This can affect customer confidence, especially in times of financial uncertainty.

Neobanks and regulatory considerations

As of 2024, several key regulatory considerations and developments are affecting neobanks.

• Increased regulatory scrutiny: The regulatory environment is seeing heightened scrutiny, including more rigorous oversight of financial products and services with a particular focus on consumer protection and the safety and soundness of financial practices. This scrutiny also extends to the management of third-party risks, especially as neobanks often rely on fintech partnerships.

• Adoption of international standards: Major global regulatory frameworks such as Basel III are being finalized and implemented. These standards enforce stricter capital, liquidity, and leverage requirements to improve the resilience of the banking system. Though primarily targeting larger banks, these standards will affect smaller banks and neobanks, too, especially those looking to expand or stabilize their operations in competitive markets.

• Consumer protection focus: Regulators are putting a strong emphasis on protecting customers from potential harms caused by new and emerging banking technologies. This includes scrutinizing the deployment of AI and distributed ledger technologies, ensuring they comply with fair lending practices.

• Modernization of regulatory frameworks: Banking regulations are being updated to adapt to the digital nature of neobanks. This includes updates to frameworks that govern electronic transactions, data security, and the integration of nontraditional financial services. These updates are intended to promote innovation while ensuring strong consumer protection and stability.