‘Neobanks’ – evolution or revolution?

For volt co-founder Steve Weston, being able to describe the fintech company as a bank in the true sense of the word has a special resonance.  

“The truth is I love banking and I owe it so much,” he says, recalling how he started work experience in a bank as a 15 year old school dropout before rising to senior roles at Barclays, National Australia Bank and St.George, now a division of Westpac.

But Weston’s vision of what a bank should be is far removed from the imposing oak-panelled branches of his youth: rather than tapping an encrusted base of customers built up over generations, volt is starting out with a blank sheet.

His vision took a major step this month when it became the first of hundreds of Australian fintech start-ups that have proliferated in recent years to obtain a restricted banking licence under the regulator’s revised rules aimed at fostering competition.

As a so-called “challenger”, volt will target consumers – especially millennials – who may be less loyal, more tech savvy or disillusioned with incumbent banks.

Ironically, Weston was however inspired by the experience of one of his former employers, the 350 year-old major Barclays, which after recovering from a near death experience during the global financial crisis has discovered a “love of digital delivery” including a collaboration with EBay-owned payments giant PayPal.

“I thought as an old dog I could learn new tricks after all,” he says.
 
In some ways, volt’s newly-minted restricted banking licence marks the official entrance of so-called “neobanks” into Australia that can also accept deposits, a notable development in the fintech community that has to date mostly focused on lending and payments.

KPMG global banking partner Ian Pollari says in countries such as the UK there have been no fewer than 40 challenger banks granted a licence.

“The reality is, in the UK only a handful has been able to scale up and the jury is out in terms of proving their economic viability in the longer term,” he says.

Westpac’s general manager, corporate and business development, Macgregor Duncan, says the issue for the online-focused challenger banks in the UK is how they acquire customers beyond the “initial bang”.

“There may be 50,000 to 100,000 people in Australia who think it’s cool to bank with a challenger, but global experience suggests that it’s hard for challenger banks to scale beyond their early adopter base,” he says.

“However from an Australian consumer perspective it is good to have more competition than less. A lot of the digital innovators are really focused on a slick and seamless customer experience and they will continue to keep the incumbent banks on their toes.”

A blank slate for the likes of volt and its new comer rivals is both exhilarating and terrifying.

On the positive side, they’re not burdened with costly legacy systems or multiple layers of management. Winning a restricted banking licence also means that their depositors may be entitled to receive a payment under the Australian Government deposit guarantee in the event that the ‘neobank’ fails.  

Like for many fintechs, the downside is low awareness and the sheer enormity of the task of accruing a substantive customer base at a reasonable cost and retaining these customers over their life cycle.

Rather like a P plater limited to lower performance vehicles, The Australian Prudential Regulation Authority’s restricted licences are just that: restrictive. For instance, cumulative deposits are limited to $2m and total assets cannot exceed $100m.

Volt is easing into the task: initially it will attract deposits from friends and family, to test the systems. The first products are expected to be savings accounts, transaction and term deposits and foreign exchange.

Lending – including mortgages – is proposed to come later, with Weston targeting a 1 per cent share of the $1.7 trillion home loan market.

Volt may be the first neo bank to become a “restricted authorised deposit taking institution”, but it’s unlikely to be the last. Xinja, which has an existing payment app on the market, has also lodged the paperwork while at least three more have flagged plans to follow.

But is a restricted banking licence really the equivalent of a Willy Wonka golden ticket? And should incumbent banks be afraid?

Perhaps the “alert but not alarmed” mantra is more fitting: rather like global warming the threat is clear but the effects may be years down the track.

Of course, there’s also nothing to stop a traditional bank from entering the digital banking landscape itself – and many have done so globally.

Through its Propel Venture Partners arm, Spanish bank BBVA acquired UK mobile-only operation Atom Bank, followed by Simple in the US and Finland’s Helvi. BBVA didn’t stop there: it also founded its own operation, Denizen.

Undeterred by its small domestic market, Israel's Bank Leumi created digital bank Pepper and plans to expand the operation globally. Although not perfectly in line with the common definition of neobanks as being 100 per cent digital, online and new, in Australia global banks such as ING have long operated without branches, relying on third parties such as brokers and direct interaction via online banking.

Westpac’s Duncan says the key to success is to acquire customers early and cheaply. Hence, it might be easier for aspiring banks to build a customer base first and then pursue a licence.

“Success in financial services will likely to go to the lowest cost of customer acquisition, not necessarily the lowest operating cost,” he says. He cites the likes of locally listed ZipMoney – which counts Westpac as an investor – and fellow retail point-of-sale player AfterPay, which have built a collective customer base of millions at little cost, based on their “buy now pay later” proposition that appeals to millennials.

UK payments company Revolut (which recently launched in Australia) has also acquired millions of customers since starting in July 2015.

There’s also the scenario of “co-opetition” versus competition, in that the fintechs’ various products and capabilities can complement those of a traditional bank. Westpac itself has actively partnered with fintechs.  

The ASX-listed Change Financial is also partnering with banks, albeit focusing on the US market where 35 per cent of the country’s 92 million millennials are unbanked or under-banked.

Change Financial’s flagship product is a no-fee, Mastercard-branded transaction card called ChimpChange. But the company is also white-labelling products for partner banks, a model deployed by other fintechs such as GoBank and Moven.

“One of the differences vis-a-vis Australia is there is at least half a dozen “wholesale” banks that are really set up to partner with third parties,” Change Financial CEO Ash Shilkin says.

“They are wholesale providers that allow third parties like Change Financial to create their own products leveraging off the bank’s existing licence.

“The benefit of this model is you can get up and running in a relatively timely fashion compared with applying for your own banking licence.

“The downside is that you need to consider your banking partner in creating new products.”

Shilkin says he understands why his Australian fintech counterparts would want to become a bank in the official sense of the word.

“I can see the pros and cons of both approaches,” he says.

“Once you obtain a licence there is a greater degree of being master of your own destiny.

“But to go through the process of applying for a licence, managing it building the technology and acquiring customers is no short order.”

Volt’s Weston highlights Revolut as a non-bank acquiring a meaningful customer base on what in effect is a travel card.

“These people will tell you they haven’t spent a dollar on marketing,” he says. “Millennials are not listening to TV ads.

“Typically they will listen to social media or a conversation and if they something that meets their needs better than today they will buy it in a moment.”

While not all fintechs will succeed, the sector is clearly changing the face of banking globally.

What’s less clear, is how cloud and other “virtual” technologies such as blockchain are likely to forge even more radical changes.

“We don’t know a bank will look like in future,” says Westpac’s Duncan. “But it probably won’t look like a digitised version of today’s bank.”

And a development in China may be a sign of bigger looming changes: Baidu (the country’s version of Google) and top tier bank Citic have created AiBank to blitz the country’s tech-savvy populace.

“The incumbents would be more alarmed to see these sorts of partnerships,” KPMG’s Pollari says.

The views expressed are those of the author and do not necessarily reflect those of the Westpac Group.