Neobanks and digital challenger banks are agile, digital, and innovative competitors of a traditional banking system. They are gaining more and more popularity every year and have already taken over some verticals like payments and transfers. So what is the significant difference between neobanks, digital challengers, and traditional banks?
Neobanks vs Digital challenger banks vs Traditional banks
A neobank is a financial tech startup. It focuses on delivering excellent customer experience and acquiring as many clients as possible. Apart from money transfers, landing, and payment options, these businesses also offer other banking services.
Digital challenger banks are similar to traditional banking institutions in terms of their services, but they typically do not require or have physical presence.
The main difference is that neobanks do not need a typical banking license to operate and offer less services, compared to challenger banks.
The rise of challenger banks and neobanking
Every year more and more fintechs start offering banking services to their clients. The overall number of challenger banks and digital-only banks is growing. As of 2020, there were more than 300 neobanks launched worldwide. The neobanking sector was projected to grow at a CAGR (compounded annual growth rate) of 5% between 2019 and 2026, generating about $394B by 2026, according to Zion Market Research.
However, not all of them are still active or operating. For instance, Bó Bank operated for a little over two years.
The UK and the US market overview
The UK financial services market is leading the adoption of neobanking and the rise of digital challenger banks. More than 15% of the UK population have an account with an app-based bank, and almost a half of users have it as their main payment option.
The US market slightly falls behind in the share of digital-banking adopters, however it has a larger absolute number of users.
What makes neobanks so appealing to the clients
Customers’ frustrations with traditional banks play right into the hands of neobanks and challenger banks. People are fed up with hidden fees, ridiculous pricing policies, and not-so-user-friendly financial processing solutions. If retail banks don’t resolve these matters, they can lose up to $16B in revenues, $344B in retail deposits and 11% of their clients to rivals, including digital-only players .
Research shows that competitive pricing, simple and convenient apps, as well as clear communication are among the top charms for the clients .
Another pre-pandemic study revealed that clients want a better way to manage their funds, easier access to transactions, connection to other financial institutions, and real-time notifications.
Typically, these banks are more flexible, can deliver personalized experience, and tend to the client’s needs better. But what technological advancements allow these fintechs to challenge the traditional and deeply institutionalized banking system?
6 tech trends that are driving development of challenger banks and neobanks
1. Open Banking
Open Banking (OB) is an integration of financial institutions and third-party providers that allows access to clients’ data and enhances development of various software solutions. It speeds up real-time payments, improves financial transparency for account holders, and boosts cross-selling opportunities.
Open Banking API is mandatory for any fintech or bank within the UK. However, many financial institutions worldwide are also adopting it in order to improve their service offering. OB builds the foundation for:
- Smart onboarding, including account and identity verification, auto-fill forms, income verification, and much more.
- Analytical approach to personal finance (e.g., dashboards, smart budgeting, and tips for savings).
- SME finances, offering such services as account aggregation, automated accounting, and affordability checks.
2. Mobile apps
According to the survey , 89% of respondents said they use mobile banking. Also, 6 out of 10 people prefer mobile apps over websites to check their finances . Neobank is an app-based bank in its nature, while challenger banks often go for mobile-first banking strategy along with a regular website. A well-designed mobile application provides the users with a variety of features, like:
- Easier access to their funds,
- Real-time notifications,
- Personalized advice and analytics,
- Improved security due to the use of biometrics and face ID.
More and more users will switch to mobile banks, and the banking system should be ready for this.
3. Cloud adoptions and microservices architecture
Many fintechs and banks have already harvested the benefits of cloud adoption, especially of hybrid cloud. Here’s a short list of perks that this technology brings:
- On-demand scalability. Adoption of cloud and microservices allows fintechs to easily scale the whole system or its parts.
- Increased processing speed and improved performance. Properly set up infrastructure allows to have faster connection and processing capacity, compared to the on-premise one. It is also more stable. As a result, users can act faster and be more satisfied with the services.
- Advanced security. By introducing cloud, many fintechs can add multiple security features, effectively comply with industry standards (like PCI DSS or 3DS 2.0)
- Ecosystem connectivity. Cloud adoption along with microservices allows businesses to respond to market requirements for system integrations (like Open Banking) or connect with third-party providers to deliver even more services to their clients.
4. Advanced analytics
For both clients and banks, the development of data analytics brings multiple benefits. For a challenger bank, an advanced data analytics solution allows to:
- Collect data about the customers’ preferences,
- Set the ground for fraud prevention software,
- And introduce risk management algorithms.
For a client, the benefits are even more appealing, as it helps them:
- Analyze their spendings,
- Set recurring payments,
- Stay on top of their bills and debts,
- Have the overview of their financial situation,
- Get personalized financial advice and improve their financial literacy.
As a result, clients can develop healthier spending habits, make smarter choices, or even start investing, as a result of overall financial improvement.
5. Artificial Intelligence and Machine Learning
By introducing both AI and ML, the challenger banks and neobanks managed to hugely boost their service offerings and improve their internal processes. Some of the most common use cases for these two technologies are:
- Credit scoring and churn prediction,
- Process control and optimization (PCO),
- Customer service/chatbots,
- Improved fraud prevention,
- Personalized offerings and services.
Moreover, both AI and ML help companies to meet the requirements of industry compliances and effectively introduce new solutions.
Tech world has an on-and-off relationship with the blockchain technology. Some say it is going to change the world and save it from many tech threats. Others are skeptical and have little faith in the practical applications of this technology. However, there are several major areas that will definitely benefit from adoption of this technology:
- Customer identification,
- Trade facilitation,
- Fraud management,
- P2P transfers,
- Syndicated loan services.
All these technologies have significantly boosted the development of fintechs, which in result speed up the process of fintech becoming neobanks or challenger banks. Let’s take a look at one successful transformation.
Featured success story
As one of the leading UK fintechs, our client (under NDA) was obliged to implement an Open Banking API. In simple terms, Open Banking is a set of protocols that allows external providers to communicate with an online banking system and build software products around them. A team of N-iX experts led the OB implementation. We:
- Integrated OB components with the existing tech architecture and ecosystem,
- Developed an API according to the tech specifications and made it available for third-party providers,
- Closely monitored the system performance to ensure it is running smoothly, and provided regular reports to the Financial Conduct Authority (FCA).
We used the FIS Payment Gateway, which enabled fast card authorization forwarding, accurate settlement file submission, secure data hosting, and instant financial reporting. We managed all card payment and refund transactions from all of the multi-channel points of sale through the PCI DSS accredited data centers.
Another aspect of our cooperation is mobile app development. The client had a legacy application from the previous vendor. We designed and developed Android and iOS native apps. Together with our client, we paid a lot of attention to the application's security. Therefore, we implemented:
- 24/7 fraud monitoring,
- Biometric and face ID,
- Ability to block cards from the app or online,
- Instant app notifications for money transfers.
In early 2021, the client announced their intent to become a neobank. Since then, we have added new features, such as cashback and deposits. Also, we added dashboards and simple user analytics, e.g., how much money the user spent by categories. The mobile apps allow its users to:
- Check account balance, track spending, and make payments seamlessly,
- Manage multiple cards, including foreign currency cards,
- Request PIN on the go.
Together with the client, we have introduced a Strong Customer Authentication (SCA) and introduced push notifications. Now, we are working on a fraud detection tool 3DS 2.0. It uses a process called risk-based authentication to determine whether or not a customer should be challenged for further cardholder authentication during the checkout process.
- N-iX boasts an internal pool of 2,000 experts.
- The company has an excellent reputation on the global tech arena. We have been listed among the top software development providers by Clutch, in the Global Outsourcing 100 by IAOP for six consecutive years, recognized by GSA UK Awards, included in top software development companies by GoodFirms.co, and others.
- N-iX has been repeatedly recognized by CRN among the leading solution providers in North America in their ratings, including Solution Provider 500 and CRN Fast Growth 150.
- N-iX partners with leading global companies such as Currencycloud and Globacap to help them launch fintech projects and leverage all the benefits of hybrid cloud in banking.
- We are a Select AWS Consulting Partner, a Microsoft Gold Certified Partner, and a Google Cloud Partner.
- N-iX experts have proven experience working with such technologies as blockchain, computer vision, AI & ML, robotics which are essential in fintech web and mobile app development.
- We offer professional DevOps services, including cloud adoption (infrastructure set up, migration, optimization), building and streamlining CI/CD processes, security issues detection/prevention (DDOS & intrusion), firewall-as-a-service, and more.
- N-iX has been named No. 72 on the 2020 CRN Fast Growth 150 List for the substantial growth and performance over the previous two years.
- The company is compliant with PCI DSS, ISO 9001, ISO 27001, and GDPR standards.
- Accenture United Kingdom Consumer Study
- Beyond Banking – what traditional banks and neobanks can learn from each other (White Paper) by W.UP
- Making digital banking more human by Accenture
- The Future of Banking has arrived by Forbes.
- The ultimate guide to Open Banking use cases by TrueLayer
- State of Mobile Banking in 2021: Top apps, features, statistics and market trends by Business Insider
- Mobile Banking Competitive Edge [Research] by Insider Intelligence
- Finance apps vs. Mobile sites to check investments by Google
- Banking 2025: Four pillars of the digital-first bank by Backbase
- What neobanks are, how they work and the Top Neobanks in the US & World in 2021 by Insider Intelligence