Neo-banks are creating industry disruption, but how worried should community banks and credit unions be? What’s the risk of becoming the next Blockbuster or Toys R Us as consumers increase their adoption of digital-only alternatives?
Thus far in 2018, American neo-banks have received four times as much funding as they did last year, the New York Times reported. These start-ups and their investors are betting that traditional banks won’t be able to keep up with tech innovations and changing consumer preferences much longer.
Small, nimble, and operationally efficient, neo-banks are providing spending and saving accounts, digital payment capabilities, cards, loans, personal finance assistance, and more in rapid-fire, user-friendly interfaces. But here’s the catch: Digital-only banks must still rely on brick-and-mortar banks to hold their money to satisfy federal banking regulations.
Prior to the mid-term elections, banking regulators signaled that they would consider granting banking charters to neo-banks. Now, with Rep. Maxine Waters (D-California)as the likely chairwoman of the Financial Service Committee, banking pundits expect months or years of scrutiny as to the best way to regulate the exploding fintech industry.
Meanwhile, forward-thinking community banks and credit unions are raising their hands to power (and potentially share profits with) neo-banks and fintech solutions. For example, Cross River, based in New Jersey, is well-known for partnering with online lender Affirm Inc., money transfer company TransferWise, and cryptocurrency exchange Coinbase. Florida-based Seacoast Bank has paired with SmartBiz Loans to shorten the loan approvals process. And California-based First Tech Federal Credit Union is one of the first credit unions to join the bank-backed, peer-to-peer payments network, Zelle. Additional payments innovations are in the works for First Tech, including Pay-by-Selfie by Mastercard and the issuance of card credentials to a customer’s phone after a successful credit card application.
The British are coming
U.K. neo-banks have set their sights on the U.S. market. Their objective isn’t to become the consumer’s primary bank, rather they are content being one of multiple banks consumers use. One such example of the British invasion is Revolut. Techcrunch.com reports that“… the new-generation smartphone-based multi-currency bank, which is blowing up Europe right now, is taking its interesting combination of personal banking crypto wallet and fee-free stocks trading app to main street North America.”
“It’s not a winner-take-all market,” N26’s Nicolas Kopp said in a Tearsheet article. Kopp said European neo-banks like his will strive to gain market share among very distinct customer segments. For instance, N26 sees American Millennial consumers who live away from the largest cities as potential customers.
Banking on a niche
Both European and U.S. neo-banks realize the importance of having a distinct niche in the U.S. market, and it’s no surprise that most seem to be targeting the nearly 73 million Millennials. Plenty of research shows that this group wants digital solutions to manage their money and help them build their finances. And they want to be able to quickly and easily open accounts on a digital or mobile device.
Neo-banks are also betting that Millennials’ definition of customer experience is an Amazon-like experience where they can procure spending and savings accounts, loans, insurance, and credit cards and more with a few clicks. With their fresh and shiny tech stacks and analytics, neo-banks can deliver smart, personalized, streamlined experiences.
Lindsay Davis, a tech industry analyst for CB Insights, also points to another niche. In an American Banking article, she said there is also funding going to neo-banks “building alternatives for customers that have a difficult time accessing credit, like students and consumers with thin credit files.”
Extinction is not imminent
Right now, you have benefits that neo-banks do not, including deposit insurance and liquidity, an established customer base, marketplace credibility, settlement and compliance services, and perhaps most importantly, local branches. The majority of consumers (65%) feel it’s important to have a local branch, PwC’s 2018 Digital Banking Consumer Survey found. A quarter say they would not open an account with a bank that didn’t have at least one local branch.
Read about our client, Studio Bank, a new digital bank with a single branch in Nashville, TN.
But consumer preferences are changing fast and industry disruption is coming full force. PwC warns small and mid-sized banks that “many customers are already firming up their opinions on who is in this for the long haul—and who isn’t, and they are rewarding the banks that listen, and ignoring the ones that don’t.”
The best way to keep your relationships intact as industry disruption accelerates is to strive to offer the digital and mobile services and experiences your customers want and need. Maybe a good place to start is by taking a few pages from the neo-bank playbook.
- Forge fintech alliances. You don’t have to build your technology stack from scratch to offer customers a suite of cutting-edge digital and mobile banking services. According to the ICBA’s Fintech Strategy Roadmap, fintech companies offer possible partnerships and collaborative relationships that can help you enhance the customer experience and promote mutually beneficial relationships. You might even be able to access cutting-edge services through member groups, like CUNA Mutual, which recently acquired a fintech provider, Mirador, so it could offer members a completely digital small business lending platform.
82%of community banks expect to increase fintech partnerships in the next three to five years. – IABC Fintech Strategy Roadmap for Community Banks, March 2018
- Embrace open banking and APIs. Welcome to the platform economy, built upon secure application program interfaces (APIs) that let applications talk to each other. According to an analysis by Fintech Futures, APIs can increase innovation, foster collaboration, extend customer reach, and lower costs compared to existing legacy systems. For example, merchant biller aggregation APIs allow account holders to use payment cards within a user-friendly bill pay environment. Consumers have access to their preferred means of payment – and the institution gains interchange revenue from the use of payment cards.
Globally, 78% of banks rely on banking APIs to improve customer experience and to generate new sources of income. – World Retail Banking Report, Capgemini and Efma, 2017
- Maintain a robust technology infrastructure. In an open banking environment, third-party developers build financial applications on top of your bank’s existing infrastructure. To handle all the applications and the digital traffic they will generate, infrastructure must be modern and secure.
Overall bank technology spending will increase 4% this year, but 65% of spending will still go toward maintaining existing systems rather than new technology. –Gartner’s 2018 CIO Agenda Survey
- Study new competitors. Have you met Marcus, Erica, or Finn? Or checked out this list of 25 digital-only banks to watch prepared by Jeffry Pilcher, CEO of The Financial Brand? You’ll see which emerging technologies neo-banks are offering, including blockchain,cryptocurrencies, artificial intelligence and machine learning.
Use of digital wallets and mobile bill pay grew significantly between 2017 and2018, 53% and 48% respectively. – Fiserv Consumer Payments Survey, 2018.
- Don’t spend money on things that don’t add value. John Rosenfeld, president of Citizens Access, a new digital bank, explains his company’s philosophy: “If there’s a service we can’t offer without a fee, we won’t offer it. We have to tell the customer, ‘I’m sorry but we will never mail you anything on paper. You have to accept that. If you do, you’ll reap the rewards in other ways.’ We won’t spend money on things that don’t add value.”
83% of consumers believe they should not be charged more for choosing a paper bill or statement. – TwoSides North America, 2017
The importance of performance management
You’ll need sound fundamentals in order to fund innovation from the neo-bank playbook. Rely on your Dashboard (and your Dashboard team) to help you identify the financial adjustments that can maximize your efficiency ratio, return on average equity, and net interest margin. Adopt a rolling forecast so you have a predictive and actionable roadmap toward your goals. And finally, share the accountability for driving performance among your branch managers, line leaders, lenders, and even the board. The more people you have pursuing profit opportunities and tending to inefficiencies, the more successful your institution will be.