What's not tallying in Neobanks' books?

Banks bank on customer experience these days. Not something that has been here for a while, especially if you take a not-so-formal review from customers in India. From lunch breaks that lasted till eternity to the only one you need (YO##), Indian banking has indeed come a long way.

What is set to be the next big thing for banking is Blockchain but that’s a long shot for now. Second to it, the next best thing is probably Neobanking.

Opening a zero-balance bank account without having to visit a branch, a card that you can both flick and flash, a wealth manager cum banker, or a superior digital experience with the facilities of a bank- a Neobank.

A neobank is basically a fintech company that has no physical existence, which means it exists 100% in the digital plane. For someone having basic ideas about Indian banking regulations, this might sound absurd because to acquire a banking license in India, you need a branch.

To clarify, Neobanks can be of various types. Some countries, like Singapore, Malaysia, etc., have issued banking licenses to Neobanks. Whereas, in India, you can open a Neobank only in partnership with a traditional (offline) bank.

More than 25 such fintech companies have cropped up in India in the past five years or so; the most popular today and close rivals are Fi & Jupiter, both of which are in partnership with Federal Bank. Although these are gaining popularity, how far they can go is still debatable.

Best not jump to conclusions. Let’s consider perspectives.

The Tom, Dick and Harry of Neobanking

Customer’s point of view. They open a bank account, chilling on their couch on a lazy afternoon. Paperworks, forms, KYC, everything’s done online in a few minutes, followed by a super quick account activation. The money they deposit goes to the partner bank (not the Neobank), and there’s no worry about maintaining a minimum balance.

They get an appealing debit card and can make transactions from the Neobank account just like any other bank account. Topping it all are top-notch customer services and tools for saving and investment habits. All this makes it no less than an online piggy bank (wallet) of sorts. 

But, 

A Neobank account holder can’t borrow money as the RBI has tied the hands of online wallets, curbing their interaction with credit lines. 

Partner bank’s point of view. Too bugged with daily operations with not enough time for modern-day branding? Neobank has got your back. Some stats show that Fi & Jupiter helped Federal Bank open over a million accounts in 12 months, which would require 40 branches if done offline!

The bank’s headache of customer service is transferred. However, owing to zero-balance accounts, customers withdraw faster than they deposit, and the bank is left with little funds to earn with.

Besides, branding every aspect of the partner bank's offering (the card, the account, and the service) as if it were of the Neobank’s is not fair. If the OG partner banks realize this fact, what’s stopping it from building its own Neobank, eh? Nothing. In fact, Kotak has 811, SBI has YONO, and so on.

Neobank’s point of view. Digital-only bank, no need for any expenditure on land, building and other costs of a physical setup. Don’t need loads of employees to reach and service every nook and corner of the country. An opportunity to become customers’ go-to banking and savings-management app.

Hell, they could even establish long-term relationships, only if there weren’t so many roadblocks!

Trust issues, insecurities, Neobanks 

Despite a superior digital experience and zero-balance savings account that Neobanks provide, they haven’t been able to gain the trust of customers. According to data from Statista, banking penetration in India is about 75%, while the same for Neobanks stands at just 0.7%.

Most of these Neobanking users don’t even use it as their primary account but rather as a wallet for making purchases, availing offers and setting aside money for investments.

Clearly, even though customers are dissatisfied with the creeping procedures of traditional banks, the trust they place on these long-run banks is relatively much higher.

Regulatory sword hanging overhead

The RBI doesn’t seem to be quite happy with the way Neobanks are operating in India. It has its reasons. Firstly, customer onboarding is very fast with Neobanks as the KYC procedure and formalities are done digitally.

As lucrative as it sounds for customers, the central bank feels that KYC done digitally isn’t as effective, which is why some stringent KYC regulations could be on the cards. If that happens, Neobanks could end up losing a large number of potential customers as a very important USP of faster customer onboarding would go out of the window.

On top of it, a few Neobanks used to provide credit facilities to their customers. The RBI felt that only digital KYC, without a proper background check and credit bureau reporting, would not be prudent grounds to provide credit on.

If only I could be this practical while loaning money to my friend. 🤷‍♀️ Hence, in June 2022, it came up with a regulation that prohibits neobanks from issuing credit cards. Lending, the bread and butter of banks, was also snatched from their mouths.

Not only that, but the central bank also seems to have a problem with the way Neobanks market the traditional bank’s offerings. Find 10 people who use Fi cards and ask them if they know who the original banking partner is.

We bet not more than 4 would be able to tell. The RBI hints at bringing out regulations to limit how these accounts and cards are marketed. It has introduced guidelines which state that the customers’ data of these co-branded cards must remain with the original partner bank and not the Neobank, depriving the latter of their data goldmine.

Making money as a Neobank - Easier said than done!

One question must be troubling you, how does a Neobank make money?

The deposits customers make in these Neobanks go directly to the partner bank, which can float it in the market and earn some income from it. However, whether the Neobank takes a cut from it or not is still not clear. Even if it does, the movement of funds to/from the digital account is so frequent that it’s not a sustainable revenue stream.

Globally, Neobanks make a good amount of money from interchange fees. So, interchange charge is levied by card-issuing companies (like Visa, Mastercard, etc.) and paid to the various payment processors and other intermediaries for transactions made by customers.

Neobanks could have taken a good cut out of it if it weren’t for UPI. But the problem in India is that customers are so accustomed to the convenience of UPI payments that most of them use Neobank accounts only as a value-added alternative to the likes of Gpay, PhonePe, etc., paving the path for less card usage and less interchange fees. One more revenue box… unticked.

Although some Neobanks charge commission on account opening from the original bank and fees for the debit card from customers, both of these are one-time revenues, and the latter might discourage a significant number of potential customers.

They also offer discounts and cashback to entice customers. However, it is at the Neobank’s own expense and hence, further dents their bottom line. And lending, as we’ve mentioned before, is not a permissible source of revenue for Neobanks.

Numbers speak for themselves. Fi, Jupiter & Niyo earned revenues worth ₹1.24 crore, ₹11.7 crore & ₹32.2 crore, respectively, while they incurred losses of ₹50 crore, ₹14.2 crore & ₹79 crore, respectively.

With all other profitability gates apparently closed, the only possible source is affiliate income. Maybe if these Neobanks start selling insurance, investment products, loans, etc., or provide any other services, there could be some light at the end of the tunnel. The visibility of said “light”, as of now…

Everyone wants the bigger pie

With more than 50% of the Indian population below the age of 30 and just 0.7% Neobank users, the market is quite big and underpenetrated. This is why everyone wants to enter the market. More than 25 Neobanks have emerged in India in the past five years, and everyone is trying to grab the lion’s share of the emerging market.

As if the competition was not fierce enough, traditional banks have themselves got on their toes to try their hands on this business. Many banks have launched their own digital banking versions, for instance, Kotak 811, SBI YONO, etc.

Obviously, if such services can be developed in-house without too many technical difficulties, traditional banks would not want to part away with their brand visibility. Plus, owing to their huge customer base and much lower customer acquisition cost, they would have a flair better than Neobanks.

For instance, Kotak 811 (the bank’s digital arm) accounted for 30% of Kotak Mahindra Bank’s newly-sourced bank accounts in the quarter ended March 2022.

The Bottom Line

While the word “Neobank” brings the Greek word “Neo”, meaning “New”, to the word bank, it seems to have failed in bringing any amount of acceptance with it to the age-old system. The Indian populace, with its “Jugaadu” mentality, has reduced a possibly “Neo” avenue in the banking industry to just a wallet app.

The authoritarian hurdles are another beast that needs to be tamed, too, if Neobanks want to survive.

Top all of this off with the fact that traditional banks are entering the game with the convenience of a Neobank, the added benefit of availing credit and the trust of the traditional bank all in one place, Neobanks could have a tough time fighting these incumbents.