You’re certainly familiar with traditional banking institutions in the mortgage industry, but how familiar are you with neobanks? Neobanks are an emerging set of technology-forward, online-focused fintechs, providing banking services in partnership with a traditional bank — you may have heard of Sofi, Revolut, Klarna or Chime, but there are more out there and more to come.
But what is the relationship between neobanks and traditional banks, and what can financial institutions learn from neobanks?
The relationship between neobanks and traditional banks
Neobanks are typically nondepository institutions themselves, without the technical debt of traditional banking institutions, which affords them a very high degree of digital efficiency. Neobanks do not have branches, and some don’t even have a traditional web presence, opting instead to operate mobile only.
“Neobanks have to tie up with regular financial institutions to get depository insurance, so there is a cost of business buried into neobanks in terms of how they obtain deposit insurance and working capital,” said Matthew Wood, head of Banktech at Tavant. “Even though their platforms elevate consumer banking to be focused in and executed solely digitally, they have to come back to the traditional banking infrastructure to provide depository insurance.”
This creates an asymmetrical relationship between neobanks and traditional banks. To a checking account holder, a neobank provides efficient, low-cost banking. While neobanks are minimizing most fee revenue, for the most part, neobanks make money from merchant and ATM fees.
“On the one hand, a neobank relies on traditional bank partnerships for depository insurance. Yet, on the other hand, a neobank finds itself competing with bank and payment providers for transactional revenues,” Wood said. “This fundamental asymmetry will likely continue to work against neobank growth.”
“It’s not surprising that we’ve had many entrants and exits from the neobanking space as they’re trying to figure out how to manage this low-cost approach within the constrained scope of fee income,” he said. “It’s important to understand how, while they’re using a new platform that allows them to be elegantly simple, direct, mobile-forward (if not mobile-only) and super communicative, the compromise of tying back to the traditional banking creates systemic problems.”
Traditional banks benefit from coverage, depth and sustainability through the diversity of product offerings across a wider customer base. Neobanks are proving to the financial services industry, when your offerings are incredibly targeted, easy to use, customer-relevant and needs-responsive, a financial institution can grow, even when the times are challenging.
Benefits of neobanking
Neobanking is delivering on long promised benefits of low-cost, efficient banking. With a narrow product scope and focused customer base, everyday checking and savings account-only consumers are finding great value.
“The neobanks tend to be very purpose-focused,” Wood said. “And through that narrow focus can serve their targeted customers very well. They don’t have the confusion or the complexity that results from a wide-ranging product set for a very wide-ranging group of people.”
This narrow focus allows neobanks to solve specific problems very quickly and conveniently.
What FIs can learn from neobanks
Wood believes that traditional financial institutions can learn a lot from neobanks.
The main lesson comes from their purpose-driven model.
“By focusing on a given problem, the neobanks are successfully generating revenue and unique business value,” Wood said. “They’re proving the point that for other financial institutions, there is a path to creating value by focusing on purpose driven value creation.”
In contrast, the mortgage industry tends to be complex, he said. For example, look at the high production cost per loan — up to $13,171 in the first quarter of 2023, according to the Mortgage Bankers Association.
“From a neobank perspective, they would say, ‘Which one problem are you solving?’” he said.
Instead of spending millions on trying to drive down the cost per loan, top competitors in the industry could start by changing one aspect of the equation — for example, automating operations, investing in elegant loan processing and creating lowest-time-to underwrite for a given product.
“Trying to unwind the entire sweater all in one go is a really difficult prospect because it puts you in a position of having to solve too many problems at the same time,” he said.
In a similar vein, independent mortgage banks could learn from the way neobanks place primacy on the customer to drive the financial product — looking at what certain customers in certain segments need. Right now, Fannie Mae and Freddie Mac data show that most defaults are related to collateral or income verification. IMBs could focus on the customers that need a better experience around appraisals and income verification and exert their time and effort there.
“I think what will probably happen on the mortgage side, as neobank-like focus takes hold, we will find a much finer striation of who the customers are and what those customers need,” Wood said.
Focus enabled engagement
Ultimately, the lesson to take from neobanking is that targeted focus and being specific about your customer base make a difference. A financial institution doesn’t need to serve many segments to be relevant, sustainable and successful — instead, they can serve one given segment, one given need, a certain kind of relationship. As financial institutions make meaningful decisions around what a focused strategy means, they will find true digital engagement more attainable and impactful.
As we realize the positive value of neobanking engagement to the fullest, it is not only about what can be offered to millennial or Gen-Z consumers but there is a greater promise on the horizon.
“This is where I think purpose-driven institutions can come into the equation and will be strengthened,” Wood said. “I would love to see the neobanking ethos, platform and technology become so pervasive, available and intuitive that the institutions serving the underbanked in the U.S. can take full advantage of neobanking lessons.”