The Rise of Neobanks and Cloud-Native Financial Services

New digital entrants are disrupting virtually every sector of the global economy. This includes financial services, where neobanks have emerged as an attractive new sector within the banking industry. Featuring cloud-native and customer-centric financial solutions, these banks are a compelling choice for both consumers and businesses seeking greater control and transparency with their finances.

Now, Insider Intelligence predicts U.S. neobank account holders will grow by 46.4% from 2022 to 2026. To understand what’s driving this growth, it’s important to define neobanks and understand the factors contributing to their rise. This article explores those growth factors, identifies neobanks’ key advantages and disadvantages, and provides guidance on how both traditional and new financial organizations can embrace digital transformation and stay competitive in the era of neobanking.

01What Are Neobanks?

Neobanks are digital-only banks that provide banking services via mobile apps and web-based platforms. They do not have a physical commercial presence; they rely on technology to facilitate their banking operations instead. Even so, these digital banks may partner with traditional financial institutions to access the infrastructure they need to offer core banking products such as debit cards, savings accounts, and loans.

There are two types of neobanks in operation today:

• Full-stack: These are standalone organizations with their own banking licenses. They operate independently online, offering financial products and services without the support of traditional financial services institutions.
• Front-end focused: These are organizations without their own banking licenses; they must partner with existing banks to offer their digital banking services. This support enables them to focus on the customer-experience aspects of digital banking while their partner bank manages regulatory requirements, among other industry necessities.

Both types may offer a wide range of digital banking services, such as mobile payments, money transfers, budgeting tools, and automated savings plans. Notably, “neobanks” and “challenger banks” are often used interchangeably, but challenger banks are more often characterized by having at least some physical commercial locations.

02Factors Driving the Growth in Neobanks

In 2019, roughly 5% of U.S. consumers had digital-only bank accounts, Insider Intelligence reports. By the end of 2021, 15.5 million adult consumers had opened a digital-only bank account—66% growth compared to 2019. By 2022, Boston Consulting Group reported more than 200% growth in the number of neobanks across several global regions compared to 2015 numbers.

There are a variety of elements driving the growth in neobanks; for example, greater sophistication in consumer mobile devices and greater digital capabilities among financial groups and their partners. Here is a closer look at these and other factors driving the emergence and adoption of neobanks:

• Consumer demand for mobile services. With more people than ever spending time on internet-connected mobile devices, there is an increased demand for convenient and secure services of all kinds. For example, adoption rates for neobanks are particularly high in regions where convenience is a priority and travel to bank destinations can be difficult; neobank adoption in Brazil is 43%, Forbes reported in October 2022, where much of the population uses mobile devices as their primary means of internet connectivity.
• Greater availability of APIs. Application programming interfaces (APIs) allow banks to connect with third-party services, such as mobile payment platforms and online lenders. This has opened the door for front-end focused neobanks to offer digital banking services at lower cost than traditional financial institutions.
• Regulatory Support. Regulators around the world are introducing new regulations and frameworks which have made it easier for neobanks to launch in certain markets; for example, E.U.’s Payment Services Directive 2 (PSD2) has allowed neobanks to operate under the umbrella of established banks, while Singapore’s Open Banking framework has enabled access to customers’ financial data.
• Demand for innovative financial products and services. Neobanks are disrupting the traditional banking landscape by offering innovative products and services, such as budgeting tools, automated savings plans, and peer-to-peer payments. These offerings appeal to tech-savvy customers seeking greater control and transparency with their finances.

Despite these opportunities, most Neobanks are yet to turn a profit, Insider Intelligence reports. But as neobanks expand their services and advantages for both consumers and businesses—often beyond what’s possible with traditional financial institutions—the performance of neobanks may improve over time.

03How Neobanks Are Disrupting Traditional Banking

Now, “these fintechs are transforming the banking sector in a similar way as Airbnb revolutionized the hospitality industry or Uber and Lyft overhauled transportation,” Forbes describes in their June 2021 article. It is digital natives in particular that are driving their acceptance. These customers—Millennials and Gen Z consumers and professionals—are often more comfortable with digital banking than previous generations and are especially attracted to the convenience, transparency, and innovative financial products that neobanks offer.

THis is putting pressure on their business models. As neobanks continue to introduce new services at reduced costs, traditional banks have to adapt by investing in their cloud-based capabilities and embracing digital transformation.

Starling bank, a digital-only entrant in the United Kingdom, has already acquired 2.4% of all retail bank accounts and 9.4% of small and midsize enterprise bank accounts in the country, McKinsey reports. Meanwhile, the largest traditional competitors have at most 10% to 25% of retail banking accounts. Now, Starling is working to partner with legacy institutions to bring its digital advantages to their customers.

04Neobank Advantages

The following characteristics are advantages that stand out for neobanks over traditional approaches to banking:

• Mobile-optimized services. Most neobanks are mobile-optimized, meaning that their services and customer experience are designed to be used on a phone or other connected device. This makes transactions easier than ever for customers, while offering greater control and transparency over finances.
• Optimized customer experiences. Neobanks offer highly personalized services, driven in part by the ability to access real-time customer data and insights. This allows them to deliver on-demand, easy-to-use services for their customers.
• Agile, modular architecture. Neobanks are built on an agile architecture that allows them to quickly deploy new services. This makes it easier for them to stay ahead of customer demand and competition in the market.
• Cost-effective infrastructure. Since neobanks don’t require physical retail branches, they can offer their services at lower costs than traditional banks.

05Neobank Disadvantages

However, there are some drawbacks to consider when it comes to neobanks. These include:

• Limited customer service resources. Since most neobank transactions are conducted online or through an app, customers have limited access to live customer support and may experience longer response times when seeking assistance.
• Fewer product and service options. In some cases, neobanks struggle to provide more complex financial products such as home loans, insurance policies, and investment services commonly sold in physical bank branches.
• Regulatory hurdles. Despite progress in the adoption of new regulations and frameworks, neobanks still face a number of regulatory hurdles when attempting to enter certain markets.
• Competition over a smaller customer base. The competition for customers between traditional banks and neobanks is intense, as neobanks look to capture a share of the market from big-name incumbents. Additionally, neobanks all focus on a segment of financial customers: those comfortable with cloud-native, digital-only services.

065 Success Factors for Emerging Neobanks

As we dive deeper into the universe of neobanking, it is crucial to understand the potential roadmap to success for these emerging entities. Navigating the digital finance landscape is no small feat; a unique combination of factors and strategic decisions can pave the way for growth and profitability. This section delineates five crucial success factors that prospective neobanks should consider to thrive in the competitive banking industry.

07Differentiate Your Offerings.

“Most banks aim to be customer-focused, but winning neobanks go a step further in ensuring customer delight by rapidly launching and reworking new products and propositions,” McKinsey observes. To set themselves apart from the competition, neobanks should focus on developing unique value propositions and products that target specific customer segments.

Digital banks may find success homing in on a particular domain within financial services and streamlining their offerings for customers in that area. Tide, one of the first neobanks for small businesses, “gives businesses the ability to open and set up a bank account in minutes,” says Forrester. “Once onboarded, the customer can view categorized income and spending, track invoices, upload receipts, and easily sync with accounting software.”

08Personalize the Customer Experience.

Neobanks can provide seamless, hyper-personalized experiences for customers beyond what’s possible at legacy financial institutions. They should use customer data to understand their needs and preferences, tailor services accordingly, and deliver real-time insights that add value to their relationships. Many of these functions can be automated, such as financial product recommendations based on customer data or savings advice based on spending habits. Neobanks may provide customers with self-service capabilities, such as setting up reminders or selecting criteria.

09Leverage Partner Ecosystems.

Partnerships with traditional financial institutions, including banks, insurers, and asset managers give neobanks access to their existing infrastructure and products. These digital banks may also partner with technology companies or fintech startups that can offer a range of services, as well as access to unique markets. “Leading [neobanks] can increase new-product sales within the partner ecosystem by around 50% to 70%,” according to estimates from McKinsey.

10Invest in Security and Compliance.

As entrants into an industry dominated by legacy institutions, many full-stack neobanks must start from the ground up to become compliant with all relevant regulations. Additionally, they must invest heavily in cybersecurity to protect customer data from fraud or misuse. Fortunately, many cloud solution providers support both managed security and regulatory compliance functions for new neobanks as part of their services, helping neobanks with their entry, Forbes reported in 2022.

11Integrate Open Banking and AI Features.

Generative AI (GenAI) query and customer support functions are ideal for neobanks, which can help customers manage their money more efficiently. Additionally, neobanks can take advantage of open banking APIs to access customer data from other financial institutions, giving customers a richer and more comprehensive view of their finances. These features will help differentiate neobanks from traditional banks as they strive to capture market share in the digital finance space.

12A Foundation for Profitability

As consumer connectivity increases and cloud-native capabilities grow more sophisticated, neobanks will become more prominent. But the competitive landscape will also grow as a result. Neobanks that both specialize in unique markets and capabilities and differentiate themselves through sophistication and personalization will realize lasting financial success.

13Partner with Semifly for Finance Cloud and Cybersecurity Capabilities

Neobanks and other financial institutions partner with Semifly for managed security and other cloud-native capabilities. Semifly supports solutions compliant with all regulatory requirements for financial institutions as well. Contact us directly to discuss opportunities for your organization.