The outcome of the 2008 financial crisis and Banking Royal Commission has seen historical lows of consumer trust in traditional financial institutions;
Neobanks are usually independently owned digital banks, not associated with the traditional banks. They have no physical branches and exist solely online;
Open Banking policy is scheduled to take effect in Australia from February 2020. This development could further strengthen the value proposition of Neobanks, becoming a viable choice for Australians.
Point of View
In recent years, there has been a growing incursion of a ‘new’ type of banking service globally. This new kind of digital-only financial institution known as a neobank has emerged in response to customers’ growing expectation for alternatives to traditional banking options.
Neobanks are usually independently owned digital banks not associated with the traditional banks. They have no physical branches and exist solely online. Neobanks are built from scratch without relying on the technology and legacy infrastructure that traditional banks have been built on. Neobanks embrace a customer centric design. They offer customers a range of different banking services that traditional banks offer – savings accounts, transaction accounts, debit and credit cards. Often neobanks also provide customers with access to beneficial tools; such as apps that help with money management, budgeting, saving, personal accounting and planning.
Neobanks have witnessed a significant growth in market share. The global Neo-banking market is expected to grow at a compound annual growth rate of 46.23% from 2018 to 2025. In the last two months, Neobanks globally have secured close to $1 billion in funding, with the first half of 2019 proving to be lucrative. They have raised $2.5 billion this year through the end of July.
The surge in Neobanks and their increasing popularity amongst customers can be attributed to three main factors:
The 2008 global financial crisis resulted in the loss of millions of jobs and vast amounts of funds in financial capital. The crisis culminated in customers undermining the trust and confidence they had in their banks. Former Chairman of the US Federal Reserve, Alan Greenspan liked this event to a “once-in-a-century credit tsunami”, where its recovery will require the restoration of peoples’ trust and confidence in their banks.
Ten years on, peoples’ concerns about trust in their financial institutions show no signs of diminishing. In Britain, results from a 2018 YouGov survey found that 66% of adults do not trust banks to work in their best interests. The survey also found that 72% of British adults believe that banks should have faced more severe penalties post the financial crisis. In Australia, EY’s 2016 Global Consumer Banking Survey found that trust in banks was a key concern amongst those surveyed. The survey results indicated that 48% of customers have complete trust in banks to keep their money safe, while only 20% trust that banks will give unbiased advice.
Global digital commerce is growing at an exponential rate. Figures from McKinsey indicate that global digital commerce volume exceeded $3 trillion in 2017 and will more than double by 2022. In Australia, figures from a J.D. Power research indicate that 89% of banking customers used a digital channel to interact with their primary bank in 2017. The rapid rise in the use of mobile banking in Australia has also seen a spike in mobile banking usage, which has increased 3.1% to 46.5%. Comparatively, the number of branch visits has declined 3.5% to 45.1%. Fewer Australians are also paying with cash than ever before, with cash now accounting for only 37% of all payments.
Traditionally, banks had a focus around products. Therefore, traditional financial institutions have built their infrastructure with the aim of supporting products, not necessarily servicing customer needs. The growing trend towards a digital economy has led to banks implementing digital banking to provide customers with convenient and streamlined experiences. However, the digital transition for traditional financial institutions from legacy product centric infrastructure to customer centric infrastructure has proven to be both difficult and expensive. Often customers can be categorized into different silos within the one organisation. For example, the credit cards system does not reference the same customer as the mortgage system. This gives neobanks an advantage as their systems are customer-by-design from inception.
The UK’s Prudential Regulation Authority amended bank license rules in 2014 to encourage applications from start-up banks. Fourteen new banks have been approved in the UK since then, and a further 20 have been talking to PRA about licenses. Europe’s implementation of PSD2 has further encouraged competition. Traditional players must share customer data with other institutions based on customer instruction and consent. New fintech firms have been able to securely access customer data that was previously the sole preserve of traditional banks.
In Australia, neobanks are able to acquire a Restricted ADI license (RADI), which allows them to conduct limited banking capabilities for two years. After the two-year period, neobanks apply for a full ADI license provided they meet the set regulatory requirements. In January 2019, Volt Bank was awarded a full ADI license, making it the first of a new generation of completely digital banks to compete with the big four. This was followed by Judo Bank which received its full banking license in April 2019. In July 2019, 86 400 another digital-only bank backed by payments provider Cuscal received its full banking license. Xinja is currently on its RADI license, awaiting to receive its full ADI license.
In Australia, the banking sector is dominated by the Big 4 banks – Commonwealth Bank, Westpac, National Australia Bank and ANZ Bank. Together, they have a combined market capitalisation of $380 billion, a fifth of the ASX. These four banks also dominate the Australian financial landscape, with combined assets (mainly loans owed to them) totaling more than $3.6 trillion.
In recent times, Australian customers’ trust in the big 4 banks has fallen. The Banking Royal Commission report was released in Feb 2019, which divulged gross misconducts by several banks and financial services firms. It was found that banks have been charging customers for services they had never received as well as charging fees to customers who had died.
Post-Royal Commission Sentiments
A ME Bank survey of 1000 Australian banking customers found that 94% agreed that banks do not act in their best interests and 95% agreed that banks charge unfair fees. According to ME CEO, Jamie McPhee, “Australians have always had a level of ambivalence towards banks, but the level of distrust uncovered by this survey is extreme.” Similar sentiments were found in the Deloitte Trust Index 2018, which surveyed 2072 Australians to provide their views on trust in banking in Australia. Figures indicated that 21% believed banks in general have their customers’ interests at heart while only 26% trusted banks in general to keep their promise.
The royal commission provided the perfect platform for neobanks to offer up their competitive edge to customers. According to Steve Weston, CEO of Volt Bank, “it’s not about providing banking services – but allowing people to live better.” Similarly, Melisande Waterford, the GM of licensing at APRA stated that neobanks have a “completely different mindset and a different approach to providing a service” that the major banks have difficulty replicating because of their legacy systems and frameworks.
The new Open Banking policy is set to take effect in Australia early next year. This development could potentially pave the way for neobanks to become a default choice for Australians. The new regulations will mean that Australians will have greater access to their personal data, allowing them to change banks more easily if they want to.
Recent research from Nielsen found that two thirds of Australians still bank with the big four, but there was a significant spike in numbers of those who said they would go digital instead. From the 2.1 million that were wanting to make the change, 16% said that they would opt for a digital banking alternative. According to Eric Wilson, CEO of Xinja, “neobanks are made for open banking because of the ability for us to see the banking data history that the customer gives us permission to access, to allow us to make tailored individual credit decisions…it short-circuits the big six’s ability to monopolise the industry.”
In Australia, the emergence of neobanks could not have come at a better time. As the level of trust in incumbent banks continue to dwindle, customers are increasingly looking to explore alternative options. According to Steve Mickenbecker, Group Executive of financial services at Canstar, “you’d have to say there has probably never been a better time for these businesses to launch. People are probably more receptive to alternative propositions than they have ever been – there’s a better reception for new brands and new ways of doing business.” Neobanks are offering the value proposition that will sit well with customers – making banking transparent and quick, and using technology to help customers make the right decisions. According to Jo Brockhurst, head of financial services at Nielsen, “it’s early days in Australia, but if you look at the penetration of neobanks globally, in larger markets than Australia, they tend not to take out a huge percentage of market share.”
Trust plays a critical role in the way customers interact with their banks. Since the Royal Commission, customer satisfaction with traditional banks has fallen and this dissatisfaction might push customers to seek out and try new banking alternatives. Neobanks can capitalise on this sentiment by offering consumers a different value proposition that engenders trust and has a focus on customer experience.