Coronavirus will reveal which neobanks have built a solid foundation
Relying on continuous investor funds to support loss-making business models could prove fatal for certain players.
Prior to 2020, neobanks already faced significant hurdles on the path to becoming successful, profitable enterprises: traditional financial institutions with their large customer bases and extensive resources, regulatory constraints, and skepticism regarding the trustworthiness of a “bank-in-an-app”, to name a few. Many people had taken to downloading these digital-only banking apps, but customers largely used their accounts as niche, travel-only options thanks to low foreign transaction fees. Sure, the apps are slick and contain some neat features, but customers have stubbornly refused to make a digital-only bank account their primary bank account. So, while app download numbers have been impressive for a number of these fintechs, even the top challenger banks such as Monzo, Starling, Revolut, or N26 have continued to lose money on every customer.
I wrote back in March about Amsterdam-based Fintech Consultancy Group's analysis of more than 150 challenger banks worldwide. Every digital bank they observed has negative profitability, losing money on every customer. Investors have provided funds to these industry challengers according to valuations based on continued, expected growth and eventual profitability. The strategy - raise gobs of money and then plough that money into acquiring users – has largely been sustainable, assuming favorable economic conditions and investors continuing to open their wallets.
Then, 2020 arrived and along with it, a global pandemic that has completely upended the way people work, travel, and do business. While one might assume that prolonged periods of home confinement might serve as a catalyst for digital banking adoption (and there is some evidence it has), it has also cut into some of the primary gateways and revenue streams for neobanks. People are no longer traveling and spending as freely. The steep drop off in travel in Q2 was obvious given lockdowns across the world, but international travel restrictions look set to be a fixture of life for the foreseeable future with countries imposing travel restraints seemingly overnight based on the Covid situation in a given country. The new (and hopefully temporary) travel reality has rendered those low foreign transaction fees nearly useless. Another major source of revenue for neobanks are interchange fees on card transactions. At Revolut, for example, interchange fees make up 60% of their income. Consumer spending has plummeted across the globe and is likely to stay muted for the rest of 2020, hitting neobanks from another angle.
With those adverse conditions in mind, Monzo, Starling, and Revolut all released their annual reports recently. The situations were similar at each of the British challenger banks. In 2019, all of the banks made significant losses even while growing their revenues. Operating and customer acquisition costs continued to outpace what the upstarts are bringing in. These reports were a reflection of the situation pre-Covid. Now, as Covid is rebounding throughout Europe (to say nothing of the situation in the U.S.), some of these banks’ very existence is on the line.
Monzo said there was “significant doubt” about its ability to continue amidst Covid uncertainty. Even though their revenues more than tripled last year, their losses soared from £47.2m to £113.8m. Revolut also reported losses north of £100m even after growing its revenues by 180% from the year prior. Starling, on the other hand, predicted that even though their losses also grew in 2019, they would break even by the end of 2020 and be profitable in 2021. It might be an overly rosy projection, but it speaks to how widely fortunes can diverge in a short amount of time.
Investors will not be patient forever. Revolut’s CEO admitted as much following their most recent round of funding: “Our investors obviously shifted their mode to profitability,” said Nikolay Storonsky. This trend is evident throughout the startup world. Whether it is mattresses or car sharing apps or last mile delivery, startups burn through cash at incredible rates in pursuit of user growth. It can be difficult to determine who is building a solid foundation for a profitable business and who is merely spending investor cash ineffectively while neglecting to build sustainably.
Foundations are not exposed during good times. As in the Biblical parable of the wise and foolish builders - when the two houses are tested by floods and winds - foundations are put to the test under trying circumstances. A global pandemic causing double digit GDP drops in virtually every country certainly qualifies as a trying circumstance. There is no guarantee that every neobank survives this crisis intact. Covid-19 will reveal which neobank has a business and operating model that can weather a crisis. In other words, which neobank built their house on rock. Those that opted for the “Growth at all costs, worry about profits later” business model might soon realize they built their house on sand.
As neobanks continue to be a major topic in the industry, we decided to look at the subject through a different lens: by talking to executives at major banks that have created their own challenger bank. In our latest report, “Challenging yourself: how traditional banks are forging their own challenger banks”, we spoke with 12 banking executives from around the globe who have decided the best way to take on challenger banks is not to merely create a better app for their legacy institution, but instead to create a new bank and brand that is targeted at the next generation of customer. Pre-order your copy now.