Fintech Thesis: Neobanks
Background and Context
Technological developments and innovations have reached the financial industry's forefront over the last few years. Publicly traded fintech companies reached a total market cap of $500B, with a staggering 272 unicorns with a combined valuation of over $900B. The funding nature of fintech has been relatively volatile over the last few years, with a 177% increase in 2021 to a 44% decrease in 2022, with a decline in the number of new unicorns due to big players like JP Morgan, Citibank, and Capital One incorporating their own AI/Fintech solutions. While risky, niche markets and products still have massive potential in this environment.
Neobanks Introduction
Neobanks, often referred to as digital-only banks or challenger banks, are financial institutions that operate exclusively online without any physical branches. Unlike traditional banks, neobanks focus on reducing overhead costs by eliminating physical infrastructure, enabling them to offer competitive fees, faster services, and more tailored financial solutions.
The core appeal of neobanks lies in their ability to cater to modern consumer demands. With their emphasis on mobile-first interfaces, user-friendly apps, and 24/7 services, neobanks tackle problems like high fees and slow processing times traditionally associated with legacy banks. They mainly target both individual consumers and small-to-medium enterprises (SMEs), offering services such as savings accounts, spending insights, lending, and payments, all designed to simplify financial management. Key drivers fueling the growth of neobanks include advancements in API-driven financial infrastructure, shifting consumer preferences, and financial inclusion efforts in emerging markets. For example, Europe in the last decade allowed third-party providers to provide bank data, allowing neobanks to develop a wider range of products. Many modern banking-as-a-service (BaaS) platform players like Stripe, Marqeta, and Plaid, have developed financial infrastructures that have also allowed neobanks to develop products that are much more scaleable and robust. These recent developments have enabled neobanks to focus on differentiation through features such as hyper-personalization, rapid product development, and integration with third-party ecosystems.
While the appeal of neobanks is clear, this industry provides many challenges. In developed markets like the United States, many neobanks struggle to compete with players that have established huge digital presences and taken up most of the market share. Big banks like Capital One, Chase, and Chime have all made significant developments that make online banking easier, and building startups in this competitive landscape is near impossible. High customer acquisition costs, thin margins, and increasing regulatory scrutiny create significant hurdles for new entrants.
However, there is a greater opportunity in emerging markets, as mentioned below, due to lower competition, increasing mobile device penetration, and improvements in regulatory frameworks. This thesis will go in-depth on emerging markets and trends as well as key indicators of success for any Neobank to position itself well in this competitive landscape.
Market Landscape
Current Landscape
As mentioned above, the neobanking industry has had explosive growth over the last few decades, with most of the growth centered around the North American and European Regions. As of 2023, the global neobanking market was valued at approximately $98.40 billion and is projected to reach $3,406.47 billion by 2032, exhibiting a compound annual growth rate (CAGR) of 48.6%. Below is a market map highlighting key players in certain regions (per TechCrunch):
Source: Flagship Advisory Partners, 2021 (EU/US based neobanks)
European, North America, and parts of Latin America are currently dominated by a few key players.
US: Chime, a leading US-based neobank, boasts over 22 million users as of 2024 and planning to go public sometime next year in 2025.
Latin America: Nubank, a Brazilian-based unicorn founded in 2013 offering neobank services in Brazil, Mexico, and Colombia, recently surpassed 100 million users earlier this year. Other banks like Brubank and Ualá have established a large presence in Colombia, and Mach in Chile.
Europe: Neobanks like Revolut and N26 have taken up a large chunk of European markets as well. Revolut recently surpassed 10 million users in the UK this year, indicating almost 15% of the UK’s total population.
Current Funding
Ever since the boom in funding around 2021/2022, fintech funding has remained relatively modest in the past few quarters. Many investors are shifting their focus towards earlier-stage rounds in response to over-inflated valuations of startups during the peak in 2021/2022. Firms like Anthemis Group and Better Tomorrow Ventures focus exclusively on fintech investments.
Emerging Markets
Looking through a geographical lens, there are many developing third-world countries that will soon adopt many fintech platforms. Regions like Latin America, Africa, and South Asia are expected to grow exponentially in the next couple of years, leaving a lot of opportunities for ventures to position themselves.
Latin America
- While Nubank has taken up huge presence in Brazilian and Mexican markets, many other regions are still heavily underbanked and have opportunities for neobanks to penetrate the market:
- Peru’s population still remains heavily underbanked, but the Central Reserve Bank of Peru recently announced financial inclusion and mobile banking initiatives last year. These regulatory shifts provide opportunities for various fintech startups to take market share.
- Ecuador’s central bank has also made announcements in the last few years, attempting to shift towards electronic payments and financial inclusion as well.
- There are still quite a few challenges when building in this space. Many Latin American currencies have huge volatility, so Neobanks need to be wary of that. A few strategies include multi-currency accounts and integration with stablecoins/cryptocurrency as a hedge against currency volatility.
Africa
- There has been massive growth in this market compared to other regions, with a 57% CAGR and 70% of all funding being raised from 2021-2023
- The first wave of fintech set the foundation up, focusing on building transactional history (allowing credit scores), lending/insurance, and data analytics to overcome KYC barriers
- Cleva (YC W24) is a great example of this. They are building a banking platform for Africa, targeting Nigeria first.
- There are still many risks in this sector though. The lack of solid infrastructure as well as low cell phone penetration means that introducing ventures can be very costly. Currency volatility also is a thing to consider, as we’ve seen cases of rapid devaluation.
- Few other factors to consider when investing in this space
- Talent acquisition: Africa currently produces 50% of the skilled workers that are required. While this may be enough for seed/pre-seed ventures, talent acquisition is an important thing to consider
- There is still a massive need for developing consistent infrastructure to allow digital IDs, seamless onboarding, and effective data collection across borders
South Asia
Similar to regions in Africa and LatAm, many parts of South Asia previously underbanked have started to adopt more fintech products:
- India has had very strong fintech adoption rates in the last couple of years and explosive growth in various fintech startups taking up market share. Building a neobank in this space is competitive, as existing neobanks like Jupiter and digital payment apps like Paytm make it difficult for new ventures to crack into this space.
- State Bank of Pakistan announced Raast in 2021, a real-time payment system encouraging digital payments.
- A prime example of how ventures can successfully partner with larger agencies/banks is Bangladesh’s bKash, established in 2010 as a joint venture between BRAC Bank Limited and Money in Motion LLC. These collaborations exemplify how startups can effectively partner with governments and larger financial institutions to expand their service offerings.
Brief Side-Track: India Insurtech
During my research, I also noticed a prevalent opportunity with Indian-based Insurtech that I would like to note. Global funding in insurtech has recently declined, but India’s share of insurtech funding remained relatively stable. Despite having one of the world’s largest populations, India’s insurance penetration is still low, even though neobanks have had a decent market share. There is a high potential for increased penetration within more rural populations, as highlighted:
This, paired with a lack of awareness and trust issues, leaves opportunities for startups to enter the space. There have been 6 “Soonicorns” in India, but most don’t focus on the gap in Health and Life insurance. A focus on underserved/rural markets requires insurtech that has innovative distribution strategies, simple-to-use products, and customer-centric solutions. One example of this is Bimaplan, an affordable insurance platform for the underserved Indian population
Concluding thoughts: Startups trying to develop in these emerging markets should focus on working alongside government regulations, building joint ventures/partnerships with established banks, developing scaleable infrastructure, and building easy-to-use interfaces focusing on customer satisfaction. Successful neobanks in these regions are known to scale up to millions of users within a few years.
Industry Trends
Consumer Trends
Moving outside of emerging markets onto the broader playing field, many trends have been increasing in the last year, leaving more space for opportunities and positioning:
- There has been a growing expectation/reliance on AI in the fintech scene, with many consumers wanting AI assistance in cutting bill spending, budgeting, and subscriptions
- Alongside AI comes a newfound demand for hyperpersonalization. Consumers nowadays are expecting far more personalization in the apps they use.
- Consumers are increasingly open to Pay-By-Bank options even though credit and debit cards are available. This could be because 63% of consumers believe that traditional credit scores fail to capture their ability to pay back loans.
Regulatory Trends
Central banks worldwide have been pivotal in fostering digital financial ecosystems in the past few years by developing and promoting key infrastructure. These efforts are aimed at enhancing financial inclusion, reducing transaction costs, and increasing the efficiency of the financial system. For neobanks, this evolving infrastructure offers significant opportunities to integrate with these platforms and expand their reach.
- Brazil’s PIX, launched in 2020, is a real-time payment platform enabling instant peer-to-peer and business-to-consumer transactions.
- India’s Unified Payments Interface (UPI) launched in 2016 does similar things.
Other open-banking initiatives have also enabled third-party financial providers, including neobanks, to access customer data with consent. For example, India announced their Account Aggregator Framework in 2021, allowing financial institutions to securely share customer data with authorized third-party providers.
Digital Currency has also been on the rise lately. China’s e-CNY and Nigeria's eNaira offer opportunities for financial inclusion and transaction efficiency. Neobanks developing in these spaces can integrate digital currency wallets and offer innovative payment solutions.
Indicators of success
The next generation of neobanks is likely to be shaped by several emerging trends and models that focus on innovation, customer experience, and financial inclusivity. Some trends and models that drive success are:
Negative CAC
Negative CAC is a business model that allows companies to acquire new customers without spending any more CAC money. This typically involves a B2B business that operates on a subscription revenue model, and customers acquire more new end customers at no additional cost. While this has been around in many other industries with various viral marketing strategies and referral programs, this concept is relatively new within the fintech/neobank industry due to decreased friction in customer onboarding and transactional revenue models. Neobanks need to minimize their CAC as much as possible, as the most successful neobanks rely on no-fee or low-fee models, which cut down on profits. A few notable examples include:
- Referral programs: PayPal had a program where they gave away money to new users and the users who invited them; Robinhood had an amazing pre-launch campaign that gathered 1 million users before it even launched.
- Effective Partnerships: Nu Mexico and Felix Pago have recently announced a partnership where customers of Nu Mexico can receive money from the US.
Fee-based vs. Subscription
Generally, startups with fee-based or pay-as-you-go (PAYG) business models are seen as more volatile and risky, but oftentimes, a PAYG model works better within the fintech space. The fee-based/PAYG model offers more immediate feedback, allowing for better scalability and adaptability. When paired with the right product, this model can also increase customer retention due to shorter feedback to customer signals and allows clients to better understand and justify their spending than flat subscriptions
Hyper-personalization
When it comes to fintech consumer apps and neobanks, customer experience is by far one of the most important things for user retention and customer attraction. For this to work, neobanks need to build a robust and effective AI-and-analytics-led decision layer in their platform. Various machine learning models should be employed across most features and services, including credit analytics, customer reach-out, fraud detection/prevention, etc…
Innovative features/products
The idea of a neobank is quite intuitive, but there are many ways for a neobank to develop new products and features. This innovation goes beyond cost-saving efficiencies, introducing features and business strategies that enhance customer experience, increase accessibility, and unlock new revenue streams. For example, Nubank gives their customers the option to use government bond investments held in custody by Nubank as collateral to increase their credit limits. Aspiration, a US-based Neobank, combines banking with sustainability by offering debit cards that track the carbon footprint of purchases. Revolut also recently announced plans for their home mortgage loaning product.
Final Thoughts
The neobank industry represents one of the most dynamic and high-potential segments of the fintech landscape, characterized by rapid growth, intense competition, and continuous innovation. While developed markets such as North America and Europe are reaching saturation with established players, emerging markets like Latin America, Africa, and South Asia present vast opportunities for neobanks to drive financial inclusion and meet the needs of underserved populations. Building a successful neobank requires deep insights into the cultural, economic, and regulatory nuances of the target market. Teams with substantial exposure to the region they are attempting to serve have a clear advantage in designing products and services that resonate with local customers and navigating market-specific challenges.
Neobanks that are best positioned for success should follow these traits:
- Early development in emerging markets: Neobanks should be countries with rapidly developing financial infrastructure and moving towards a more digital financial ecosystem. Competition kills success.
- Obsession with customer lifetime value: Unlike traditional banks, neobanks must entirely rely on digital presence. This combined with intense competition in developed countries requires a need to maximize customer lifetime value.
- Rapid innovative product delivery: Most modern banking platforms include hyper-personalization. New neobanks trying to enter the market must differentiate by delivering new features and products much faster than their competitors. The use of fee-based/PAYG rather than subscription models can aid rapid product development iterations.
- Scaleable Infrastructure: Successful neobanks like Chime also focus on an API-first architecture: The ability of a neobank to integrate with other platforms, products, and agencies is crucial for scaleability.