Banking in the New Decade

Updated: Feb 17

Digital Banking is the digitisation on every level of banking - from front-end to back-end. This means that Digital Banks rely on technology, such as artificial intelligence, to automate back-end operations including administrative tasks and data processing. Not only do Digital Banks allow users to make account deposits and transfers remotely, but they also provide them with the opportunity to more easily apply for loans and access personalized money management services.

Neo-banks have demonstrated that simple products built on new technology platforms with a digital-only approach can operate at a fraction of the marginal and unit cost of the Incumbent banks. Transforming Digital Banking into a truly global phenomenon.

In 2020, around 242 Neo-banks existed worldwide, and as investors become increasingly enthusiastic when it comes to FinTechs, this number can only increase. In fact, since 2015, the Digital Banking industry has increased by 200% thanks to Startups such as Chime and Revolut which, through their extreme success, inspire other entrepreneurs. In 2021, despite the pandemic’s initial blow to the stock market, Digital Banks continued to attract investors, acquire funding, increase their customer base, diversify revenue streams, and reach a profit to boot.

Complimentary to this, record earnings for Big Tech companies helped the technology sector to flourish, and lockdowns and border closures accelerated pre-existing changes to consumer trends in banking. As Neo-banks were building simple products with a digital-only approach, they satisfied not only the customer’s desire for more intuitive and efficient ways to manage money, but also investor agendas, operating at a fraction of the cost of an Incumbent bank. In fact, a report by PitchBook found that more and more nontraditional sources are providing venture capital to disruptive players in the Tech industry, and as governments look to rebuild economies, opportunities for nontraditional investors continue to emerge.

Pitchbook research found that for some years now the UK and Ireland contribute the most value to the European Venture Capital sector. This is notably due to companies like Revolut, a London-based Challenger Bank which raised $800 million and reached a monumental $33 billion post-money valuation in Q3 of last year. Also a licensed Challenger Bank, Sweden-based Klarna closed a $1 billion round earlier in 2021. These deals are both the cause and effect of last year’s Software market trend, being the most valuable sector for VC.

In our latest research “In and Outs of Digital Banks' we also identified 4 distinct types of Digital Banks. The first two are categorised under ‘Challenger Banks’, and are those with a full banking license. Sub-categories are those which are independent and those backed by corporate institutions (Financial or non-financial). The second main category is ‘Neo-Banks’, and covers all startups without a full banking license. Some of these firms partner with a bank license holder in order to provide banking products and services, whilst the other type of firm constitutes start-ups that provide "bank-like" services without having a full license (like Qonto).

Although many of the top digital independent brands reached skyrocket valuations during 2021 and lending tech reached a total of $40 billion across 1,061 deals (nearly as much as the prior three years since 2018 combined), only 13 Challenger Banks globally are currently profitable. Notably, many of these players are Corporate-backed firms and come mainly from China and Japan. There are three Digital independent Banks in Europe that join the list; Oak North, Starling bank and Russian Digital player Tinkoff.

Whilst the pandemic created new opportunities, it also created new obstacles; reduced travel, shopping, eating out and spending in general had a negative impact on Neo-banks’ primary source of revenue - interchange fees. The pandemic taught companies the importance of adaptability in the New Decade, which often comes from outsourcing by establishing partnerships with companies to find quick solutions to customer needs. Rather than acquiring an immediate bank license, through partnerships, successful Startups were able to rapidly scale before expanding their offering. Startup “inexperience” vis-à-vis Incumbent institutions is compensated by this strong adaptability, as well as exceptional customer service, efficiency, and low-costs. These qualities reflect the power which Digitalisation has to improve public services, facilitate reforms and democratize the economy.

An example of such a Startup is Revolut, which ended 2020 with two months of profitability, having increased adjusted revenue by 57% from £168m in 2019 to £222m in 2020. Monzo, too, raised £58m of capital from investors in June 2020, during exceptionally difficult fundraising conditions, and by March 2021 about 25% of total revenue came from newly created products in response to consequences of Covid-19. This is testimony to the resilience and relevance of Challenger Banks (even though some initially launched as Independent, unlicensed Neo-banks).

Incumbent banks have realised that they now only have one of two options; imitate the Challenger Banks or be swiftly left behind. This has created new opportunities for Digital Bank founders, who either launch with the support of Incumbents, or as a Startup. If the company is backed by an Incumbent, this often allows it to launch with a more comprehensive suite offering from the get-go, including lending. Although this gives it the advantage against FinTechs, and the customer base is more easily acquired, it seeks to prioritise profitability over valuation from day one - these corporate-backed Challenger Banks are less likely to take risks nor will they make as much ‘noise’ in the industry. Regardless, the evolving Digital Bank sector and the rise of open banking are dissolving Incumbent bank’s monopoly on consumer data and are creating a more competitive environment, conducive to improved services.

At C-Innovation, we identified one key to success shared by all Digital Banks, regardless of their funding or customer base: diversification through USP (unique selling point).

We found that successful, independent start-ups offer a unique proposition and features, with the ability to also quickly build relevant offerings that cater to customers' needs, has worked as a powerful driver of customer acquisition and loyalty among key untapped audiences.

These start-ups also focused on quickly setting-up and acquiring customers as a priority. They launched their products through partnerships rather than through an immediate bank license, focusing to rapidly scale before expanding their offering, allowing them to avoid the time-consuming license application in such early stages. Examples include key market players such as Chime, Monzo, Revolut, NUBank.

However, Oak North Bank and Starling Bank, both profitable but with much fewer customer bases than leading independent brands as NUbank and Revolut, followed a very different approach as they started with a full banking license and focused on business profitability rather than customer acquisition.

Meanwhile, successful Incumbents have the Digital Bank initiative at the forefront of their strategy with a long-term investment commitment, and aim to expand their digital offering into more growth markets and segments where they have not previously had a presence. They reinforce the Incumbent heritage to build trust across the brand and cultivate a digital culture among all employees with a mix of IT and banking skills.

A good example of this approach is Goldman Sachs, which has been building a leading integrated consumer platform via Marcus proposition since 2016, diversifying from the capital markets-heavy businesses which historically has generated most of its revenue, getting great results as it progresses five years on.

On the other hand, unsuccessful digital brands experiments from incumbents, such as Finn by JP Morgan Chase and Bó by RBS serve as a lesson to prioritise product diversification. Similarly, our analysts found that other Startups which failed to successfully offer Digital Banking services were often highly reliant on funding and thus vulnerable to market shocks. Vulnerability occurs when Independent Digital Banks fall into the trap of "over-attractiveness", basing their business model on free services. Xinja and Moven are also examples of failed Digital Banks.

This brings us to the question; how can new Digital Bank players negotiate the fine lines between staying on-trend, being different, attracting users and reaching profitability?

C-Innovation recent report “In and Outs of Digital Banks' investigates this question. The report provides a comparative analysis of 80 Digital Banks from around the world, and investigates the diverse Go-to-Market Strategies. To elaborate on the trends of Digital Bank success mentioned in this article, our report looks specifically at case-studies on Marcus by Goldman Sachs but also Chime.

Our report balances data specifics with an analysis of the wider industry, providing readers with a to-the-point overview on where the Digital Banking market is headed, and where there is still room to improve. If you would like to know more, check out our Research page for all Deep-Dive reports.