An Introduction to Neobanks

Neo is one of those word forms that acts as a kind of Game Genie to other words. If you’re missing the reference here, let me help. Game Genie was a popular line of videogame cheat cartridges from the 1990s that you would attach to other videogames. It allowed users to modify a pre-existing game, manipulate elements of it, and access unused functions. You popped Game Genie onto a Nintendo cartridge, put the combined cartridges into your console, and your character suddenly had infinite lives. The Game Genie basically allowed users to cheat. That’s not the point. The point is, we use the word neo like that. We plug it onto other English words that already exist on their own, and it helps us manipulate those words—it lets us modify them. It helps us mean something different and express new ideas by leveraging something familiar.

Neo is a linguistic element called a combining form. It’s often used in combination with other words to form a word all on its own, typically as a prefix. Words like neobank—an increasingly familiar word in the financial services lexicon that has really only been in existence for a couple of years, having been coined sometime around 2017 from what I can tell. We’re familiar enough with how neo is used. We have neoclassical and neotraditional and neoliberal. We throw neo in front of familiar terms to show new-ness of something or a modification of an existing thing—a revival of an old idea combined with a new idea.

See where I’m going here?

Do you know what the first cars were called? I’m not going to waste your time talking about car-things—this really is about neobanks—but I want to illustrate an important point about technology. The first cars were called horseless carriages. Prior to the invention of the motorcar, carriages were pulled by horses. So, when the first motorcars rolled into existence, the term “horseless carriage” was a simple way to express the idea of this new technology by leveraging something that was familiar. We could have called them neohorses, but we didn’t, and in the 19th century “horseless carriages” was ultimately the term that stuck. The first horseless carriages resembled regular horse-drawn carriages at first, but it wasn’t for long, and the horseless carriage was quickly modified and amplified to become what we now know as a car.

My point here is rooted in Marshall McLuhan’s theories in Understanding Media, where the media theorist writes, “every innovation must pass through a primary phase in which the new effect is secured by the old method, amplified or modified by some new feature” (323). Neobanks are in a horseless carriage phase. They do what banks do, the same way that the horseless carriage did what horses do. Banks are familiar, so we call these new things neobanks
because it helps us express what they do. They’re like banks—but modified. And it won’t be long until what makes them different redefines what they really are.

What’s a Neobank?

A neobank is a new type of digital bank that operates exclusively online or through a mobile app. Focusing on tech-savvy consumers that prefer the branchless, app-based banking model, neobanks typically don’t hold a banking license on their own. Instead, they partner with a licensed bank and build their own modern API-driven platforms that integrate with the traditional financial institution’s existing infrastructure. This unique approach allows these emerging financial technology firms to offer traditional banking products and services without the timely and expensive process of becoming a full Schedule I bank.

This unique approach has a number of benefits. While partnering with an existing licensed bank allows neobanks to get to market quicker and with considerably less capital, it also allows them to defer some of the complex regulatory and legal obstacles to the licensed bank. With some of the heavy lifting left to the traditional banks, neobanks are able to focus on building their brand and developing the one area of their business that really sets them apart—designing intuitive, customer-centric mobile banking experiences for the app generation.

Neobanks are just one of the new players in the evolving open banking ecosystem. Typically built on a Banking as a Service (BaaS) platform, neobanks often occupy the top two layers of a typical BaaS technology stack, leveraging APIs and sleek design to provide as-a-service banking technology, as well as the banking services, user interface, and brand experience. With their digital-only approach, neobanks can avoid many of the costs associated with operating traditional brick-and-mortar banks, allowing them to offer higher interest rates on basic banking products like chequing and savings accounts. In addition to deposit accounts, neobanks may also offer payment solutions, loans and mortgages, and money management features.

Over the past few years, we’ve seen an emergence of fintech companies that are focused on competing against the traditional banks—these include neobanks, white-label banks, and challenger banks. We continue to modify the word bank to try to express that this new thing—this new idea, this new technology—is something different, and we grasp at what’s familiar in order to try to explain it. We know it can change things, but we don’t quite understand how yet.

So, what’s the difference between all these new banks, anyway? Often their differences are marginal, and it’s easy to mistake one for another because they’re really not that different. Neobanks are really just white-label banks that are typically built on a Banking as a Service platform; whereas, challenger banks are well-established neobanks that may hold their own banking license of their own. If a neobank is successful enough to challenge the traditional banks and compete for their customers, you wouldn’t be wrong to call it a challenger bank—it’s just the natural progression.

When a neobank gains enough momentum and a large enough client base that it begins to compete directly with traditional banks, you have a challenger bank. And if that neobank is successful enough, it may decide to acquire its own banking license—not necessarily through the usual application process, but by acquiring a bank that already holds one.

At some point a neobank becomes a challenger bank. But what happens when that challenger bank—and many others just like it—begins to displace the traditional banks as our preferred method of banking?
For now, we’ll call them neobanks.

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