Neobanks: Are they a Scam?

During the end of this pandemic, something nice that happened was my finally landing a job. Yes, the end of a global pandemic was a great positive too, but by the end of year one, the whole thing had become too regular for its end to register as significantly.

As a result of landing a job, I had to visit a bank to open a savings account (yes, I didn’t have one till then. It’s ok, be nice).

The bank was still dealing with staffing issues as an aftereffect of the pandemic and an increased number of customers visiting to solve almost a year's worth of problems. The customers were allowed to visit subject to limitations. But nobody wanted to go to a bank and end up in a hospital, so people avoided visits.

As a result, I was suggested to apply for the account opening process online. Which I did, and the process was pretty much just filling out forms and uploading pictures as necessary, nothing too complicated. What I couldn’t wrap my head around was the KYC process.

As far as I knew, the KYC process needed an in-person meeting, where the legitimacy of my legal self would be verified. Now, since the process was online, there was no branch of the bank associated with my account. Thus I did not know where I needed to go for the KYC. A home visit was out of the question because, well… Corona.

The solution was a video KYC. I joined a call with a bank employee on the other end, showed him some documents that needed to be scanned, and voila! I had a savings account in my name. This video KYC had me wondering about the feasibility, obsolescence and necessity of traditional banking. Fast forward a few months, and I was exposed to the subject of today’s article.

Neobanks and their faster and more efficient account opening processes. So let’s learn a bit about neobanks, why don’t we?

What is Neobank?

Neobanks are, well, precisely that… new banks. Neobanks are the latest version of commercial banks. These “banks” have no physical presence (branches), and the entire consumer experience is catered to on an app-based platform.

If you’re wondering, I am adding quotes to the word “banks” because neobanks are only called so. The RBI does not recognise these platforms as banks, which means they are not granted the banking license to operate as one in India.

In the current scenario, these limitations aren’t a problem as neobanks are more of a marketing tool for brick and mortar commercial banks. Presently, neobanks partner with traditional banks to provide the same services as the traditional banks but on a digital platform.

Neobanks provide similar or even greater interest rates on their accounts than traditional banks. Neobanks also boast greater speeds in account opening and customer service.

But if these “banks” do not truly function as traditional ones, how do they work? Let us find out.

Business Model of Neobanks

As you read above, a neobank needs to partner with a traditional bank to perform its operations properly. To start off, neobanks focus on a particular feature provided by traditional banks and make said feature its USP. Neobanks are very asset-light and, as a result, get to focus all of their resources on the tech aspect of their business to make their USP as popularly known and feature-rich as possible. This allows the neobank to make its product offering more lucrative than its competitors.

Neobanks generate revenue by providing the same features as traditional banks but on a digital platform. The digital platform makes the process easier to avail and affords the provider a greater reach as more of the country is moving towards digitising its financial activities. Some of the most common ways for neobanks to generate revenue are as follows:

• Lending: While the instances of lending to retail customers are not very frequent to consider it a source of income, a few neobanks like RazorPayX and Mahila Money provide loans to the SME business category and female entrepreneurs, respectively.

Through these lendings, neobanks are able to generate interest income.

• Prepaid Cards: Prepaid cards are the equivalent of a traveller’s cheque in the way that it allows their user to carry a limited amount of money without having to carry any cash. Prepaid cards are not linked to any bank account. Its purpose is to act as portable storage of a limited amount of money that is specific from card to card. The user can deposit whatever amount they please within the card's limit and use the card up to the deposited amount’s limit.

Prepaid cards act as a source of revenue for the issuing party in two ways. First, the amount deposited in a prepaid card is accessible by the issuing financial institution; the said institution uses this amount as funds for investing and lending. The return or interest generated by this use of the funds acts as revenue for the institution.

Since the balance of these cards is not linked to an account, the issuing institution does not need to repay any interest on this balance. Usually, the institution needs to repay interest on every account’s balance to the account holder. The interest rate paid is generally less than the rate of income generated by using these funds. The difference in the receipt and payment rates is the institution’s revenue. However, in terms of prepaid cards, all the return from the amount in the prepaid card belongs to the institution.

• Buy Now Pay Later: The Buy Now Pay Later (BNPL) system allows users to avail short-term, unsecured, personal loans. They are different from credit cards as the repayment period is shorter. The interest rate of BNPL is also lower than the credit card from the same provider. Some BNPL providers allow interest-free loans during the repayment period and charge a penalty on default of repayment, while others charge a small interest for even availing of the loan at all.

Benefits and Drawbacks of Neobanks

While the “new and shiny” brought some positives with it, neobanks aren’t a flawless system. Here are the pros and cons of this new financial system:

Advantages:

• Easy Account Opening - The anecdote mentioned in the introduction to this article wasn’t made up; the account opening process with neobanks is speedy and easy. With document submission and verification being held online, customers do not have to fill out lengthy documents and wait for insufficient employees to go through the same documents. Online submissions also reduce the risk of misplacement or theft.

• Faster Customer Service - Since all the services of a neobank are held online, customers can avoid long wait times on calls. Application of A.I. based chatbots allows for faster resolution of basic complaints. As a result, human interaction is limited to particular cases that are few and far between, saving time for customers and reducing costs for neobanks.

• Affordable - Since neobanks do not need to maintain a physical branch, they can reduce the cost of operations. This is why neobanks do not levy too many charges like account maintenance charges, card charges, etc.

• Greater Benefits - Neobanks also pass the benefits of reduced cost of operations to their customers in the form of greater interest rates than traditional banks on their deposits and rewards.

Disadvantages:

• Possible Security Threats - The online presence of neobanks opens it to threats and breaches that are ever-present on the digital platform. The lack of consumer awareness, as well as the nature of the platform, might attract more attacks on the customers’ funds.

• Physical Absence - While the digital-only presence acts as a benefit, it is a double-edged sword, too, as a lack of physical branches adversely affects the neobanks credibility. A physical branch or presence otherwise gives customers a sense of security due to having a point of personal contact.

• Limited by Partner Bank - Since neobanks cannot get a banking licence, their operations are limited to those provided by the traditional banks they partner with. Neobanks do not have many options in terms of banks ready to partner with them as the new platform doesn’t garner a lot of trust yet. The fact that neobanks may render traditional banks obsolete doesn’t help the former’s case either, as no business would openly want its competitor to succeed.

Closing this Account

The neobank phenomenon is relatively new, and there is still a lot of untapped potential in this sector. The first step towards letting this sector flourish would be to grant neobanks a banking license. This would allow these platforms to operate with some degree of autonomy.

As far as the protection of the interests of the public is concerned, stringent laws can be applied to these banks that can be changed and relaxed, should the performance of these new entrants allow such relaxations.

That being said, as far as rewards are concerned, neobanks sure have a lot of lucrative ones with them. Are these rewards enough to lure you and me and many more people to open an account with them? How has your experience been with neobanks? Let us know in the comments section below.

Also, be on the lookout for a “Top 5 Neobanks in India” blog, where I list some of my personal favourites in this new field.

Until next time.