Neo banking application development

Introduction of AI in business processes can reduce the cost of processing the incoming information by up to 70%, while creation of ecosystems for clients makes communication with the bank comfortable and raises onboarding. Neobank model is a new round in the field of banking mobile app development. A neo-bank is a fully digitized bank, accessible to the customer through a mobile app and supporting communication in convenient messengers. Another distinctive feature of a neobank is the absence of a physical service network.
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Advantages of mobile banking application development

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High interest rates on deposits. Since neobanks have no branches and fewer employees, they can offer better interest rates on deposits;

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Simplified way to get loans. The process of obtaining a loan from a neobank is more convenient and faster, because it uses modern technology to assess the credit risk of the client;

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Low fees. Neobanks often don't charge for card services and remittances;

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New financial analytics solutions. In addition to traditional banking services, neobanks provide automatic analysis of account balances and also offer personalized financial solutions to their users.

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Mobile neobank models

Model using a full banking license

Some neobanks have obtained a full banking license and their regulation is no different from that of conventional banks. However, a number of countries have introduced a limited type of banking license which is provided as an intermediate step before obtaining a full banking license, specifically for the needs of neobanks. In such cases, neobanks got the possibility to build up their resources to enter the full-fledged banking sector without reducing requirements from the regulator. This type of license exists, for example, in Great Britain and Australia.

Model of cooperation with another bank

Another model involves cooperation of neobanks with existing banks. In this case, all obligations to comply with the regulatory requirements, as well as the credit risks fall on the partner banks, while the neobank provides only technology solutions.

Mixed model

Some neobanks are licensed only for certain financial services and conduct the rest of their activities through partnerships with conventional banks. For example, in Europe EMI (Electronic Money Instutution) license allows the neobank to issue cards, transfer funds, and emit electronic money. Other services, such as opening deposit accounts, can be provided by neobanks only through cooperation with conventional banks.

Main trends in the neo banking application development market:

  • Focusing on national markets. As of the beginning of 2021, there are only 43 neobanks providing their services in multiple regions, while the rest are focused only on the national markets.
  • Active participation in digital banking of traditional banks and fintech industry. The latter promote 27% of all operating neobanks in the market;
  • Neobanks are gradually transforming into full-fledged banking institutions, providing a wide range of services: from opening accounts to selling travel cards.

Trends of Neobank development in 2021

Analysts forecast that mobile banking development area will be impacted by the following factors in 2021:

  • growth of smaller institutions focused on specific niches;
  • staffing with compliance specialists;
  • refocusing on core products and regions;
  • hiring local experts to fill senior positions;
  • finding new sources of revenue;
  • growth in lending through improved credit risk management;
  • increased oversight by supervisors.

What do neobanks make money on?

Despite the rapid growth of the number of users of neobanks, the long-term sustainability of their business model raises concerns. Let's take a look at what the challenger banks earn on.
Traditional banks have two main sources of income: fees and net interest income (the difference between the interest earned on loans granted and the interest paid on deposits).

Net interest income

A much more flexible underwriting policy of neobanks compared to traditional banks is their advantage and disadvantage at the same time. On the one hand, due to their more flexible policies, neobanks gain a user pool faster, but on the other hand, it significantly increases the risk of the loan portfolio. This raises the question of whether such a model would allow for profits in the event of a significant drop in the loan portfolio quality and an increase in past-due debt and loan defaults.
The "let's get into a fight now (i.e. attract the users) and get things straight (i.e. increase requirements for borrowers and clean up the base) later" approach is fraught with implications - a recent high-profile scandal in social media related to closing accounts of several Simple clients during the transition to BBVA bank IT platform is a good example of this. This is where traditional banks have the upper hand: closing the accounts of a small number of several million customers is unlikely to cause significant damage to their reputation, while it can be a serious problem for a challenger bank.

Fees

Fees are the most important source of revenue for neobanks. Even taking into account the fact that most startups in the industry use zero fees as a marketing gimmick to attract new users, this statement is not quite true, because they receive a share of interbank fees (fees that are charged on each bank card transaction and divided between the card-issuing bank, the bank that processes the transaction, the payment system, and other system participants).

In the long term the "fee model" of earning by neobanks is unlikely to work.

First, interbank fees are falling under pressure from regulators and will continue to move downward - similar processes are happening in the U.S., EU, Canada, and other regions. The founders of German bank Number26 agree with this trend. Large financial groups try to minimize these losses through vertical integration (for example, through merger of banks with processing companies) - this strategy allows to claim a larger share of fee and increase accuracy of scoring models by using data on transactions passing through processing centers, which, in its turn, increases profitability.

Secondly, neobanks, which do not have their own banking license, have to share interbank fee, which usually does not exceed 1.8-2.0% of the transaction, with the bank, whose license they use (although a number of banks receive licenses in order to increase this fee).
Third, in absolute terms, fee income alone may not be enough to expand the business and achieve break-even levels (for example, Brazil's Nubank showed a loss of $36 million in 2016, despite achieving a target of 1 million open accounts).

Some neobanks are trying to introduce new monetization models and have started charging subscription fees (in the case of Dutch Knab it ranges from €5 to €7.5 per month) from users, following the example of popular media platforms Netflix and Spotify, but we have yet to see if this model will take root in the banking sector.