Neobanks: have the challengers become the challenged?
Free FX, onboarding in minutes, payments likened to texts, wonderful UX, iconic colourful cards, growth at all costs, millions of customers and eye-watering valuations – these are just some of the things that came to mind when thinking of challenger banks. Fast forward to December 2020 following Covid-19’s crippling impact on the global economy, and the sentiment is quite different: use of challenger banks fell by 90% (Beauhurst), Monzo took a 40% hit to its valuation, 55% of consumers believe challengers will be dead within a year (Accenture)…
As we get closer to 2021, a year we all hope will be different from the last, we ask ourselves what the future holds for challenger banks: what metrics will be important for investors? Are SMBs the key to unlocking sustainable business models? How does success differ by geography? Who will challenge the challengers – incumbents, big tech, China?
Isabel Woodford (Fintech journalist, Sifted) set out to address these questions in Wednesday’s panel which brought together VCs with an investment focus spanning the UK, US, Europe, India and Southeast Asia, with notable investments in the likes of challengers such as Chime (US) and Monese (EU).
To watch the full panel follow this link.
Were challenger banks ever really challenging? Is it all hype?
Terese Hougaard (Principal, Atomico) set the scene for the genesis of challenger banks, noting that they “emerged from the dust of the financial crisis where there was great animosity towards incumbent banks” and built much better products. Hougaard, whose fund Atomico has yet to make an investment in a challenger bank, argues that “these companies still have a way to go to realise their full potential” and while they may boast a better user experience, they have yet to build a lasting competitive moat.
Devin Kohli (Co-Head, Outward VC), adds that qualitatively there is no doubt neobanks have challenged on features, product set, UX, UI etc., but when you look quantitatively at what they have achieved there is still a long way to go. Kohli points to the data in the UK where 4 of 5 transactions are still with the incumbents, only 7% of people have switched their current account in the last five years and thus concludes “the jury is still very much out… especially when it comes to shareholder return.”
Moving away from Europe and the US, what is the state of play in LATAM? Are they moving quicker?
Fady Abdel-Nour (Global Head of M&A and Investments, PayU), comments that it is difficult to directly compare speed or progress of challenger banks across geographies due to the starkly contrasting environments they operate within. The benefit challengers have in emerging markets is that “they are not competing with as strong incumbents or in as crowded markets. They are giving people access to credit and banking for the first time and really broadening financial inclusion.” Thus, there is far greater opportunity to be had.
As challengers increase their focus on the SMB market, who will win? Classic neobanks or those that focus specifically on SMBs?
David Lofthouse (Venture Partner, Clocktower Technology Ventures) argues that SMBs are an attractive, sticky customer base with a product set that has the potential to be far larger than for retail consumers. In addition, for many SMBs, gaining access to a bank account is a genuine pain point. The big question according to Hougaard is “what wins in terms of entry point…and who do [SMBs] trust? Is an SMB more likely to trust a Shopify who they work with every day and who provides them with core services… to also provide them with a bank account? That’s a huge challenger to neobanks in terms of the SMB relationship.”
Threat of the big tech players?
Abdel-Nour sees emerging markets as “being a massive battleground” for the big tech players in future, however he does not see this evolving into a full neobanking offering given the added regulatory burden that comes with the handling of consumer financial transaction data.
Kohli, in agreement notes the overarching goal is for the big tech players to get as close as they can to the customer without the regulatory oversight that comes with a banking license. Kohli adds “what I do see [the big tech players] doing is buying the infrastructure and piping associated with open banking to get closer on data… There may also be an opportunity in the middle ground where they operate off of an eMoney licence which removes themselves of certain regulatory responsibilities.”
What happens now? Casualties and stand out winners?
From emerging markets, Abdel-Nour highlights Nubank as being the stand out player. In terms of the European challenger banks, Hougaard comments that she would be surprised if one of the bigger players were to fail given the amount of VC backing behind them. Going forward Hougaard will be watching out for “how these players start to react to new generations like GenZ” who are markedly different from those that have come before. Kohli states that the number of challenger banks in the UK market (currently over 42) will fall, and more money will be pumped into the perceived winners. Lofthouse points to players offering the underlying technology or ‘banking as a service’ as an area of success.