Digital banking presents exciting new growth opportunities for banks. Neobanks, or challenger banks, are already harnessing these new revenue streams to stand out from the competition. Experts Christoph Stegmeier and Matthias Verburg highlight what traditional banks can learn from these upstarts.
In our recently published report on “The Future of Neobanking”, we provided a thorough assessment of the challenger banking landscape, that in many ways serves as an inspiration and disruptor for the wider banking sector.
It’s clear that this is a fast-growing market with now close to 400 Neobanks operating worldwide, serving nearly 1 billion customer accounts. However, despite the industry being valued at around 300 billion US dollars as of Q1 2022, we found that only 5 percent of Neobanks have managed to break-even today.
We discovered that the main reason digital banks struggle to break-even lies in a shortage of revenues, which we link to a lack of innovation and products offered. Too many banks are still heavily focusing on their core offerings – accounts and card-based payment services – which are responsible for an estimated 70 percent of revenues across the industry.
As an immediate remedy to boost income, several Neobanks have started to expand their product range for their core retail or SME customers. Digital investment accounts, crypto offerings, or highly automated lending and mortgage products are top of mind. Moreover, extending the product range and cross selling to existing clients is an obvious choice to raise income levels per customer.
But there are also new revenue options in the new digital era – options that both Neobanks and traditional banks are increasingly paying attention to. These options relate to indirect revenues, i.e., the monetization of data, expertise, or technology rather than the direct monetization of client relationships.
Three of these indirect revenue opportunities are receiving a particular large amount of consideration:
- Banking as a Service (BaaS) or Product as a Service (PaaS)
- Embedded Finance
- Open Banking and API Monetization
What these three opportunities have in common is that they target business clients (B2B, B2B2C, or B2B2B), they require advanced technological capabilities, and they make use of API technology.
BaaS and Embedded Finance, in particular, are closely related. Both these options enable third parties to provide financial services without requiring them to own full technical capabilities or regulatory licenses. Yet, there are some important differences.
BaaS or PaaS will differentiate banks from competitors
To tap into the BaaS or PaaS opportunity, banks essentially decide to become technology providers, offering their back-end platforms to other financial institutions or non-banks. This enables them to provide standalone financial products to their clients.
Most market participants will refer to BaaS if the service includes the usage of a license, whereas this isn’t the case in PaaS. In both options, the offer can be very narrow – e.g., just covering an individual step in the customer journey, like identity verification – or they can include turn-key solutions for entire products or services.
What makes BaaS/PaaS particularly attractive is that it diversifies revenue streams and monetizes technology investments. Looking for new revenue sources, Neobanks seem to pioneer the approach and challenge standalone BaaS providers like Solaris Bank in Germany, Treezor in France, and Railsbank in the UK.
Fidor and Starling Bank represent the most prominent examples of Neobanks moving in that direction, offering white-labeled digital bank accounts, cards, and payment services. We expect other Neobanks to follow suit and develop their own BaaS/PaaS offering, likely also becoming role models for traditional banks.
Irrespective of whether they are digital natives or long-established, to be successful in that area banks will not only have to provide state-of-the-art technology but also demonstrate a clear competitive advantage to attract clients. For example, those that can provide the “most flexible deposit product”, “the fastest loan application process”, or “the most secure onboarding process” should have ample opportunities to find clients.
Embedded Finance will be an additional distribution channel, with the prospect for banks to build promising partnerships
Embedded Finance, as mentioned, is similar in nature. However, strategically, it can be seen more as an additional distribution channel for banks. This is where third party non-banks – e.g., from the retail, travel, or health industries – sell bank products for a commission, seamlessly integrated into their customer journeys.
While BaaS/PaaS typically involves pre-packaged, ready-made (in other words white-labeled) modules, this isn’t necessarily the case in an Embedded Finance scenario. Take as an example the collaboration of Amazon and Barclays in Germany, where online shoppers can finance their purchases in the marketplace via a clearly labeled Barclays credit.
Neobanks are predestined to play an important role in this area, counting on modern infrastructure and an increased appetite to work with partners. One of the first Neobanks grasping this opportunity in a more strategic fashion is India’s digital bank Open, which recently launched its Embedded Finance platform Zwitch.
What makes Embedded Finance potentially appealing to a larger number of banks is the possibility to collaborate with technology providers. These oversee the technical integration of the distributor’s process. In that scenario banks are pure product providers, while outsourcing some of the technical complexity and the search for non-bank partners to the integrator. Arguably, this means that Embedded Finance is a more tactical play for banks, whereas the shift toward a full-scale BaaS provider is more strategic in nature.
Open Banking especially valuable to incumbent banks
A third option to indirectly monetize is to become a provider of Open Banking services. Again, there are multiple definitions used in the market, but for simplicity we refer here to two options:
- Either making own data available to fintechs or corporates, with the promise to improve their processes, marketing efficiency, or decision quality
- Or to use Open Banking technology to provide services to clients without owning their primary banking relationship
An example for such a strategy is the recent move of UK-based Neobank Coconut. The bank shifted from opening its own SME bank accounts to providing services via a newly established Open Banking platform to SME clients from any bank.
Stating the obvious, in order to sell data banks first need to have accumulated large amounts of data, which naturally comes with increasing scale. As such, the opportunity from Open Banking increases with the growth of a bank’s customer portfolio and therefore may primarily be useful to incumbent banks with a significant market share.
In our experience, a key success factor will not only be what data is offered but also how it is offered. Product packaging, bundling of services, a dedicated sales approach, and, last but not least, the pricing strategy will be crucial success factors to getting Open Banking models off the ground.
Undoubtedly, all three digital revenue streams have enormous potential. Banks need to have a strategy in place for each of them, even if they don’t yet plan to make all of them an integral part of their short-term positioning.
This holds true both for Neobanks and incumbent players. Following the footsteps of the most innovative Neobanks in BaaS and Embedded Finance will provide at minimum food-for-thought, and at best a blueprint for disruptive new revenue models in digital banking.
If would you would like to find out more about how Neobanks can unlock profitable growth, download our report here.