Neobanks: Are they fulfilling the promise?

A blog post by Ryan Jacildo

Neo banks, digital banks, and virtual banks are terms that have been interchangeably used to refer to banks that only operate in virtual space without physical branches. The origins of neo-banks are rather unclear at this point, albeit many accounts indicate that they started after the global financial crisis in 2007-08, while taking advantage of the financial digitalization initiatives launched in many countries.

Neo-banks have interestingly evolved in different ways. Some like Fidor and N26 have been neo-banks from the start while others have started out as something else. The latter group includes digital payment and trading platforms, digital remittance outlets, digital wallets, and credit companies that have taken up digital bank licenses. With such interest, the number of neo-banks has ballooned in recent years. As of January 2023, The Financial Brand’s Neobank Tracker has listed over 350 active neo-banks globally that offer an array of banking services.

Digital innovations like neo-banks have been largely hailed for their potential to bridge the financial participation gap. Notably, according to the World Bank’s most recent estimate (World Bank 2022), approximately 1.4 billion people worldwide remain unbanked. The ease with which these neo-banks can be accessed–simply through mobile phones in many cases–aided by the substantial broadening of internet coverage in recent years, is a critical feature that countries hope to exploit to expand the reach of formal financial services. These digital solutions have also been noted to have helped avert a much deeper economic difficulty in many countries at the height of the COVID-19 quarantines and movement control measures, which have disproportionately impacted the more vulnerable segments.

Nevertheless, evidence of the linkage between access to full banking services for the previously unbanked population and the proliferation of neo-banks is still arguably not well-established. This, even though, there are ample accounts of increased usage of digital wallets to store and transfer funds among individuals who previously have no bank accounts (see for example: Rizwana, Singh, and Raveendra 2021, Riandani et al. 2022). It could be that neo-banks are largely simply pulling in the clients that are already banked. It could also be that different forms of digital financial solutions have differing impacts on financial inclusion.  Clearly, this needs an in-depth assessment for policies to be in line with the ground conditions.

Apart from the unclear financial inclusion linkage, the IMF (2022) also worryingly finds that neo-banks “are growing in systemic importance in their local markets” and are associated with “higher risk-taking in retail loan originations without appropriate provisioning and under-pricing of credit risk; higher risk-taking in the securities portfolio; and an inadequate liquidity management framework,” which suggest that macro-prudential frameworks have to catch up.

References

International Monetary Fund. 2022. Global Financial Stability Report April 2022. Washington D.C.

Riandani, O., D. Sari, N. Rubiyanti, N. K. Moeliono, and M. Fakhri. 2022. The Relationship between Digital Wallet Adoption and Usage to Financial Inclusion. Proceedings of the International Conference on Industrial Engineering and Operations Management. Nsukka, Nigeria, 5 – 7 April, 2022.

Rizwana, M., P. Singh, and P. V. Raveendra. 2021. Promoting Financial Inclusion Through Digital Wallets: An Empirical Study with Street Vendors. Financial Inclusion in Emerging Markets. Palgrave Macmillan, Singapore.

The Financial Brand’s Neobank tracker, https://thefinancialbrand.com/list-of-digital-banks/ (accessed January 2023).

World Bank. 2022. COVID-19 Boosted the Adoption of Digital Financial Services. Feature Story. Washington D. C.