A few weeks ago, we wrote about the latest fundraising of Revolut. But is Revolut a Challenger Bank or a Neobank? Techcrunch wrote about Revolut as part of the neobanking sector, Forbes talks about the challenger bank trend, and it’s not just Revolut, but also others such as Bunq (as a neobank. Or challenger bank).
You might be wondering, is it really important? What’s the difference? Is it just semantics, or is there something deeper behind ? Read ahead…
Neobanks and challenger banks are digital banks
This is certainly what most agree on: From Revolut to Bunq to Lunar to Nubank to Chime to Mox, we are talking about digital banks, where customer interaction is done through a digital interface, usually mobile-first.
But although they are digital, most of the new entrants wouldn’t necessarily define themselves as digital banks, which has a connotation of incumbent digitalising their offering.
What is the definition of neobank and challenger bank?
As for everything in Fintech, there is not a universal definition. However, here is the definition that we use at CFTE, which helps us to clearly understand two different types of business models:
A challenger bank?
- A challenger bank is a new digital bank that has a bank license.
- The most important word is “banking license”: a challenger bank is regulated as a bank
- It is new, so not an existing bank digitalising its business
- And digital as we mentioned before
What about a neobank?
- A neobank is a company that offers some banking services without being regulated as a bank.
- A neobank is not regulated as bank. It does not mean that it is not regulated however, and most would be authorised on frameworks such as e-money regulations.
- A neobank cannot therefore be called a “bank”
Why is “challenger bank” vs “neobank” important?
From a customer’s standpoint (and even in general, as seen from the examples above), people do not make a difference between neobank and challenger bank.
For most people, using a debit card, making a transfer, viewing their accounts, those are the frequent interactions with their banks, and they can get it from both challenger and neobanks.
However, it is for the less frequent events that consumers would start to see a difference:
- A loan
- A mortgage
- An overdraft
- And in the most extreme case, if the provider goes bankrupt
In the first 3 cases, only challenger banks can directly provide lending activities. And only clients of challenger banks benefit from the national protection funds.
So if for consumers, challenger banks were the same as neobanks, but with more services and more protection, does it mean that challenger banks would be always favoured? Not necessarily.
And that comes to a question of startup development and business model:
- A neobank is almost a pure tech startup: focus on customer experience through product management, fast iterations, with the objective to acquire as many clients as possible. This is the framework of “faster, cheaper, better” that we use at CFTE. This is made possible because they are lightly regulated, and their objective is to make (a bit of) money on (a lot of) customers. Just like a tech company.
- A challenger bank is a bank built with modern technologies: at its core, it is a bank and needs to manage its activities like a bank, from asset liability management to credit risks. Their objective is to make money first and foremost through lending, which means that their objective is to grow their balance sheet. Just like a bank.
Which is why neobanks have been growing their customer base much faster than challenger banks, but challenger banks have been growing their deposit and lending base instead.
Neobanks and challenger banks are fundamentally two different business models. At some point, as these companies grow, they converge, with neobanks applying for banking licenses.
- Neobanks and challenger banks are two different types of companies, with different objectives and setup.
- Neobanks act like tech companies and are looking to quickly build their user base through unbundling, then to offer more services as they reach a critical mass of users.
- Challenger banks act like modern banks and are looking to grow their balance sheet in a profitable way, and to become the main bank for their customers.
- Number of customers is the main KPI for neobanks, not profitability (at least at first). Profitability through proper risk management is the main KPI for neobanks.
- Both models are valid, and can lead to very successful companies.
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