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 current accounts, loans, and payment and money transfer services. Their services can be accessed from anywhere with an internet connection, and they often incorporate features such as budgeting tools, real-time notifications and personalised financial insights. By avoiding the overheads 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 scale their operations effectively. 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 the digital banking experiences offered by neobanks 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 personalisation in their services, including banking. Neobanks cater to these preferences with user-friendly interfaces, instant notifications, personalised financial advice and financial services that can be accessed 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 specialised products, such as banking services for freelancers, expatriates or digital nomads. Combined with aggressive marketing and user-friendly technology, this helps them to grow quickly 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 and more quickly than traditional banks. Because they are not tied to a physical location, they can expand their services across borders without any major additional investment.

Neobanks vs traditional banks: A comparison

Neobanks and traditional banks each 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 the swift deployment of new technologies and innovations. Their platforms often include a range of features, such as real-time updates, integrated budgeting tools and automated savings options.

• Customer experience: Neobanks often provide a user-friendly, mobile-first experience that appeals to digital natives. The absence of physical branches means that 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 through partnerships or special licences instead. Their security features are typically strong and feature the latest in encryption and biometrics.

• Services: Neobanks focus primarily on basic banking services, such as current 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 can be accessed from anywhere with internet access. This is a major advantage for customers who travel frequently or do not have easy access to a 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: Although traditional banks are increasingly investing in technology to grow their digital offerings, their systems are often built on an older infrastructure, which can slow down the development and integration of new features.

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

• Fees and rates: Traditional banks often charge customers higher fees, although 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 offer a comprehensive suite of services, including current accounts, savings accounts, loans, mortgages, investment products and wealth management. This can be more appealing to customers who are 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, as well as those who value a wide range of integrated financial services.

How neobanks work

Neobanks have a fully digital interface that can usually be accessed 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, all while providing an 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 licences, while others partner with traditional banks to use their banking licences. 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.

In the same way as traditional banks, neobanks provide services such as current and savings accounts, personal loans and payment services. They often enhance these services with digital features, such as instant notifications, automatic categorisation of spending and real-time balance updates. The basic features of neobanks are outlined below.

• Account setup: Setting up an account with a neobank usually involves downloading an 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 generally provided through digital channels, such as in-app messaging and email. However, sometimes, it may also be offered by phone. AI-powered chatbots are often used to handle common queries.

• Financial tools: Neobanks use data analytics to offer personalised financial advice and product recommendations. They also engage customers with budgeting tools and goal-setting features to help them manage their 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 with using advanced technology for daily operations. These customers often seek out new features that traditional banks might not offer, 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 prioritise convenience and efficiency.

• Underbanked populations: Neobanks are being used in regions with a 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 sub-accounts 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 an attractive option. This is because they generally charge lower fees for international money transfers and make it easy to set 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 thanks to their lower fee structures, lack of 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 can typically be accessed at any time, 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 cash machine withdrawals within certain networks.

• User-friendly interfaces: Neobanks focus heavily on the 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 those who have a poor credit history.

Drawbacks

• Limited product range: Although neobanks offer basic banking services, they often lack other 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 licence.

• Dependence on technology: Neobanks rely heavily on their technical infrastructure, and any downtime or technical issues can prevent customers from accessing their 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 the 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 have been affecting neobanks.

• Increased regulatory scrutiny: The regulatory environment is seeing heightened levels of scrutiny, including a more rigorous oversight of financial products and services, with a particular focus on consumer protection, as well as 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 finalised and implemented. These standards enforce stricter capital, liquidity and leverage requirements to improve the resilience of the banking system. Although these standards primarily target larger banks, they will affect smaller banks and neobanks, too, especially those looking to expand or stabilise their operations in competitive markets.

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

• Modernisation 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 non-traditional financial services. These updates are intended to promote innovation while ensuring strong consumer protection and stability.