The terms "challenger bank" and "neo bank" emerged a few years ago with the rise of a new type of digital bank aimed at providing tech-savvy customers mobile-first, branchless banking services. UK-based Monzo and Atom Bank were some of the first digital banks on the scene. Today, Monzo has more than 1 million customers, a billion dollar valuation, and plans to launch in the U.S. soon. Meanwhile, Atom Bank is gearing up for a potential exit with Spanish banking giant BBVA.
The digital banking market is accelerating around the world, largely because of recent regulatory changes that make it easier for new startups to provide financial services to consumers. For instance, across the EU and EEA, the second Payment Services Directive (PSD2) requires banks to open up their data to third parties. The legislation not only gives bank customers complete control of their financial data, but it also makes it easier for them to perform payment services across borders. In other words, consumers will be able to share their data, verify their identity, and make payments throughout the EU and EEA far more easily.
The new open banking reform is the UK version of PSD2 and requires banks to share customer financial data with other financial institutions securely and in a standard format should a customer request them to do so.
According to the latest Global Market Insights, Inc. report, the global digital banking market is set to reach $9 trillion by 2024. Though similar regulatory changes are taking longer to reach emerging markets like Latin America, many countries, such as Mexico, are also taking a step in the right direction with the introduction of new fintech laws.
The different types of digital banks
The terms "challenger bank'' and "neo bank" are often used interchangeably, and these banks can offer everything from simple transaction services to lending services for small businesses. As a result, it can be difficult to understand the difference between all the digital banks that now exist.
Here's one way to classify the current digital challenger banks based on their business models and the services they provide.
Neo banks do not have a banking license, but partner with financial institutions to offer bank-licensed services. Typically, neo banks still require customers to have an account at an existing licensed bank, and then they offer more user-friendly interfaces and fee-free services. WeBank by Tencent, Yolt, Lunarway, and Moven are examples of neo banks.
Beta banks are joint ventures or subsidiaries of existing banks that offer financial services through the parent company’s license. Beta banks are often set up as a way to enter new markets, offering limited services, but to a broader consumer base. Examples of beta banks include AiBank (a joint venture between China's CITIC Bank Corp and search giant Baidu) and Simple (a partnership between Bancorp and BBVA).
Nonbanks have no connections to traditional banking licenses. Instead, they provide financial services by other means. This unique model allows the company to operate independently of existing banks. For instance, Monese operates on an electronic money license.
The consumer benefits of digital banks
These different business models demonstrate just how diverse the digital banking industry is becoming. And while each type of challenger bank tailors its services to their target customers, they all provide similar benefits.
Easy setup – Creating an account with a challenger bank is a paperless and straightforward process. Most accounts can be set up entirely from a mobile device as well.
Lower fees – With fewer operational costs, challenger banks can price their services more competitively.
Greater financial inclusion – Branchless banks have lower operational costs and can, therefore, afford to accept customers who are unable to attain traditional financial services due to a lack of credit history or poor credit ratings.
Focus on security – Traditional banks are known for being slow to adapt to the demand for more flexible yet secure banking services. Not only are digital banks easy-to-use but many are security-driven and react quickly to the latest security threats.
Added Features – In addition to providing digital banking accounts, many challenger banking apps offer their customers built-in payment, budgeting, and savings tools.
The future of banking
As banking laws continue to evolve and consumer trust in digital banking continues to rise, there's no doubt the digital banking market will become even more saturated. More challenger banks will emerge, and legacy financial organizations will shift their focus to offer more friendly, flexible, and digital services. It remains to be seen which model consumers will adopt the fastest and how the digital banking industry will mature.