Infrastructure Finance: An Introduction
Traditional economists are of the opinion that infrastructure is the heart of the economy. Empirical data clearly shows that given a choice, investors prefer to invest their money in countries whose infrastructure is more developed. Hence, it can be said that rapid infrastructure development is one of the most basic ways in which a country […]
Privatization of India’s Public Sector Banks
The Indian banking sector is facing a crisis on an unprecedented scale. The problem becomes peculiar when more facts are brought to light. Indian banking sector can be divided into two categories. There are private sector banks, and there are public sector banks. The private sector banks seem to be performing well. However, public sector […]
Free Cash Flow to the Firm vs. Free Cash Flow to Equity
Free cash flow models can be further categorized into two types. There are certain kinds of models which pertain to free cash flow that the firm as a whole will generate whereas there are others that pertain solely to the perspective of equity shareholders. These models are quite different from each other. It is therefore […]
Need for a Theory of Accounting to Improve the Accounting Profession
Creative Accounting and the Need for a Theory of Accounting The rise of “creative accounting” practices, an euphemism for hiding some unfavorable financial details and highlighting favorable ones to create an impression of sound financial health has resulted in the accounting profession taking more hits to its credibility. It is a well known fact that […]
Problems with Bank Term Funding Program (BTFP)
The Silicon Valley Bank crisis has prompted the Federal Reserve to evaluate its emergency funding program. The original emergency funding program i.e. the discount window was obviously not sufficient to provide funding to failing banks such as the Silicon Valley Bank. This is the reason that the bank ended up failing. The Fed felt the […]
Traditionally, the commercial banking industry was largely controlled by commercial banks which had a huge brick-and-mortar presence. However, over the past few decades, customers have gone digital. In response to that, the banks were also compelled to go digital. This digital wave led to a dramatic increase in competition for commercial banks.
Many types of technology-based entities came into existence and started competing with commercial banks for their business. Neo-banks are one such type of entity that has recently come into existence.
Neo banks have grown at an alarming pace since 2016. Between 2016 and 2020, Neo banks have registered a compounded annual growth rate of over 50% worldwide! Also, the pandemic only helped the neo-banking business model since these banks largely operate online. These statistics indicate that neo banks are still in the nascent stage of their growth and are likely to grow at a faster pace in the future.
Since neo banks are a game changer for the banking industry, it is important to understand exactly what they are and how they function. In this article, we will have a closer look at the functioning of neo-banks.
Neo banks are not really banks in the traditional sense of the word. This means that they do not really have a banking charter. Hence, legally they are not allowed to provide banking services on their own. As a result, neo banks break their operations into two parts. There are some services that cannot be provided by neo-banks such as taking deposits. For these services, neo-banks tie-up with traditional banks. On the other hand, there are other services such as payments, loans, etc which can be provided by neo-banks since it does not require a banking license.
From a customer’s point of view, a neo bank is a completely digital setup. The neo bank does not have any branches. The customers interact with the bank via an app. Customer service is provided via chatbots and customer service helpline numbers.
However, neo banks are known for being digitally savvy. This means they are known for deploying the best possible technology and providing personalized services to customers as compared to more traditional banks.
From a customer’s point of view, neo banks act like full-fledged banks. This is because they perform all the tasks that a traditional bank does. However, internally neo banks have partnered with some traditional banks.
The revenue generation of neo banks is quite different compared to traditional commercial banks. Traditional commercial banks generate most of their revenue by borrowing at a cheaper rate and then lending at a higher rate to corporate customers. Neo banks are not legally allowed to do the same. Hence, they cannot take advantage of this revenue source. Hence, neo banks have to focus on other revenue sources.
The fact of the matter is that right now neo banks do not have many sources of revenue. In the current situation, neo banks have to expand their banking relationship with corporate customers considerably before they can break even and start making any money.
Neo-banks have an intense focus on keeping the operating costs as low as possible. Since neo banks do not have any physical locations and employ very less staff, their overheads are quite low. As a result, they can provide the same service at a lower cost to the corporate customer and still make a larger profit than traditional banks.
Also, since neo banks do not lend their own money, they face no credit risk. Hence, they do not need to have a lot of expensive risk management systems in place which helps them further cut down on costs. Keeping costs low is strategic for neo banks. They can only attract customers if their fee is lower than traditional banks and also they need more margin because they have fewer sources of revenue.
The bottom line is that neo banks are an important set of players which are quickly gaining prominence in the commercial banking industry. Their quick rise represents both a threat as well as an opportunity for commercial banks.
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