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Countering future neobank competition

U.S. banks can kickstart their own neobank revolution

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  • Written by  Paul Schaus
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  • Comments:   DISQUS_COMMENTS
Banks can counter overseas challenger banks when they land here, but the secret will be in founding digital operations that operate independently of parents' look, feel, and strategy. Banks can counter overseas challenger banks when they land here, but the secret will be in founding digital operations that operate independently of parents' look, feel, and strategy.

The proliferation of “neo” or “challenger” banks in Europe has yet to take hold here in the U.S.

Regulatory barriers have so far prevented these upstarts from making waves, as such challengers have only been able to launch in partnership with incumbent institutions that actually hold and insure the deposits.

However, those barriers likely won’t hold back the threat these players represent to traditional banks forever.

Opportunity for infiltrators

U.S. banks make a tempting target for neobanks hoping to replace them with superior digital offerings.

A recent survey of nearly 1,700 US digital banking users by banking software provider D3 and Harris Poll found that 68% of the respondents had been frustrated with their digital banking experiences. Additionally, 32% of the respondents were willing to leave their bank for a better digital banking experience. This means U.S. banks will likely catch the eye of overseas neobanks as they mature and look for new opportunities.

For example, U.K. neobank Monzo plans to enter the U.S. once it reaches profitability at home, which it aims to accomplish next year. Additionally, the growing divide between what consumers want from their digital banking experiences and what traditional institutions actually offer will only provide the incentive for more U.S. startups and venture capitalists to target the sector. 

Even though neobanks haven’t been able to gain banking charters here yet, they still have avenues to market. They can, for example, apply for industrial loan company (ILC) charters that allow non-banks to obtain FDIC insurance, a path that Square and others are already taking. In the end, it’s highly unlikely the U.S. can sit out this trend as new players sprout up around the world and deliver new experiences consumers here crave.

A counter strategy

However, U.S. banks have an opportunity to drive this change themselves by launching their own digital-only brands that mimic many of the characteristics of these neobanks.

Such a “bank within a bank” must be highly targeted, with a specific type of customer in mind, and must be given significant operational flexibility and independence from the parent institution.

That can be difficult for many banks to execute. But this strategy also offers them a chance to differentiate their products and services from their peer financial institutions while mitigating any potential threat from startups looking to disrupt them.

U.K. banks seem to be succeeding at holding off the rise of neobanks in their country by doing just this. 2017 surveys of U.K. consumers by RFI Group found that willingness to use neobanks fell from 78% in the first half of last year to 54% in the second half. RFI said this drop was likely the result of new digital offerings by incumbents that have made neobanks less appealing. 

However, banks will have to be careful in launching and managing such digital-only platforms within their organizations. The most notable example of this approach in the U.S. so far has been BBVA’s botched acquisition of Simple, which provides an important lesson for others.

Since the acquisition in 2014, Simple’s team has been pre-occupied with integrating its own technology portfolio with the Spanish bank’s U.S. arm, BBVA Compass. BBVA set out to integrate the two brands on one combined platform, an unsuccessful effort that resulted in customers having to open new accounts because their information couldn’t be migrated to the joint platform.

For the vast majority of banks, trying to link this type of digitally native organization with its own legacy infrastructure and processes will only hamstring that organization’s ability to satisfy customers. The digital brand must be charged with rapidly developing new products and services and iterating on them, not with making the brand just another part of its parent organization.

Pick a target to go after

Banks would also be wise to target such digital brands to a specific customer segment to attract early adopters and better serve their needs. BBVA itself has taken this approach with its acquisition of Holvi—a Finnish neobank aimed at the small business segment, which the Spanish bank has wisely allowed to operate independently—as well as with its new Azlo digital banking platform similarly targeted towards small businesses in the U.S.

Fifth Third also recently invested $1 million in Current, which offers a debit card and accompanying mobile banking app for teenagers that lets parents manage their allowances.

Taking such a targeted approach will put these brands in a better position to offer unique products and services—a much greater challenge when trying to account for the needs of many different customer segments—as well as gain the kind of innovative reputation that banks have been unable to build themselves.

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