The new era of banking in Europe: Neobanks, Banks and future of industry

The development of digital technologies has impacted the majority of industries, including banking which has transformed drastically over the past 20 years. In the mid-2010s, neobanks emerged in the arena of banking services and gained significant traction over the past 7-8 years. It will be very interesting to see how the banking scene will look in the future as the already tight battle for the retail segment has transformed into a real battle for both - retail and SME segments.

The recent years have seen a significant surge in digital banking services, which have evolved in parallel with the e-commerce industry. This growth, prospered by the COVID-19 pandemic, has firmly established e-commerce as a continually relevant and enduring sector also supporting the growth of neobanks, as neobanks have been fast enough to adapt their offerings tailored to digital-only businesses.

In the European Economic Area (EEA) alone, there are over 30 million SMEs and over 25 million self-employed. The market is huge and has a lot of untapped potential. Currently, there are slightly more than 35 well-established players in the EEA SME-focused neobanking market. Among the leaders, there are Revolut Business (Over 500 000 business customers), Qonto (400 000+ clients), Wise (more than 300 000 business clients), VivaWallet (around 180 000 customers estimated) and Bunq (at least 150 000 business clients estimated). Some of them first launched for private customers and then expanded their offering to SMEs creating a full banking ecosystem for both businesses and consumers. At the same time, certain neobanks, like N26, focus solely on providing their services to self-employed and freelancers. Of course, some of them are only available in selected countries and each offers a varying range of services to its clients. 

Only a few, like Revolut and VivaWallet, possess actual banking licenses. The key difference between classical banks and neobanks is that they are fully online banks that often operate as Electronic Money Institutions (EMI) or have a Payment Institution license (PSP). The latter does not provide deposit insurance, lending, and investment while traditional banks can do that and additionally are part of the European Deposit Insurance Scheme and provide coverage up to €100,000.

Varying offering

Each neobank falls into a different category of players. There are classic SME neobanks, like Pleo and Manager.one, that cater to SMEs, offering features such as capital deposits and live support. Also, MyPos and Vivawallet are market players that focus on SME clients but have entered the market through offering payment acceptance solutions providing POS terminals and other payment acceptance solutions. E-commerce-focused neobanks, including Juni and Floodlight, target SMEs with offerings like partner deals, local IBANs, and direct integration with e-commerce platforms. N26, Holvi, and Knab specialize in serving freelancers. For businesses in international trade, neobanks like 3s Money, Multipass, Wittix, and Mistertango, offer tailor-made solutions for international entrepreneurs. Meanwhile, super apps such as Qonto, Revolut, Bunq, and Finom aim to address the financial needs of a broad spectrum of customers providing all sorts of financial management tools for clients' convenience offering a one-stop-shop financial management solution instead of just banking.

There is a set of common must-have features that the majority of SME-focused neobanks provide to their customers. Many features, that were considered as advanced just 5 years ago now are essential in the Neobank offering (various BaaS solutions such as Crassula make it easier and cheaper). Almost all SME-focused neobanks offer features like mobile apps, instant registration, and account opening within 24/72 hours. Clients now expect tools for simplified business management, including basic invoicing, accounting exports, and expense management. These tools save business owners time from tedious tasks. Given the globalized trade landscape, both Single Euro Payments Area (SEPA) payments and SWIFT transfers are also essential. To streamline employee management, neobanks provide user roles, limits, and both debit and virtual employee cards, facilitating transaction-specific payments and easier expense control.

Traditional banks’ response

Neobanks’ offering to SMEs is built around simplifying business management for founders by integrating tools for accounting, bookkeeping, and automation of processes. Traditional banks rarely bother to build an advanced offering to their SME and freelancer clients because add-on products are not one of their key revenue streams. In addition, the vast majority of banks have IT systems dating back to the last century, and introducing new digital solutions is costly and not time-effective for them. Here is where the neobanks arise with modern IT infrastructure and an easy-to-use interface. 

To engage with the fight for customers traditional banks on their part have been building second layer infrastructure connecting each other and streamlining payments. Switzerland's TWINT, backed by major banks and boasting 5 million users, integrates payments effortlessly. The Netherlands introduced Tikkie by Amro Bank for quick peer-to-peer payments which is widely used for local payments. Poland's BLIK connects its major banks for instant transfers, with mBank being a leading innovator. Belgium's Isabel provides access to 23 banks on one platform. These steps showcase traditional banks' adaptation to digital banking trends to enhance customer satisfaction.

Simultaneously In several countries, traditional banks are actively engaging with the neobanking model by partnering and investing. In France, classical banks have adopted various strategies to tap into this digital revolution. For instance, BNP Paribas has invested in Compte-Nickel, which offers no-frills banking services, and Société Générale has launched its own neobank, Boursorama. Meanwhile, in the UK HSBC introduced HSBC Kinetic, a mobile business banking app designed for SMEs. In Spain, CaixaBank launched ImaginBank.  These strategic moves underscore the global trend of traditional banks embracing neobanking, reshaping the financial landscape, and diversifying digital banking options for customers.

Trends

One of the trends seen in the neobanking landscape is that it is experiencing significant transformations as traditional banks are actively acquiring stakes in neobanks to harness their innovative solutions and expand clientele. JP Morgan's acquisition of a 48.5% stake in VivaWallet in 2022 exemplifies this trend, aiming to bolster SME services and broaden its European footprint. Similarly, Societe Generale's €100 million purchase of Shine, an SME neobank in France, signals its ambition to enrich its asset base and fuel further growth. Nevertheless, neobanks aren't just passive targets, they're also charting aggressive expansions. Qonto's acquisition of its German rival, Penta, for approximately €200 million, added 50,000 customers to its ledger in 2022. There were other notable acquisitions that marked the consolidation of the market. But on the other hand, any fintech company can become a challenger to current players. In the past, we've witnessed how fintech companies like MyPos, Vivawallet, and others have successfully emerged and drawn substantial customer bases to their platform and the market overall keeps on expanding.

Challenger banks, whether they are consumer-centric or SME-focused, are still far away from competing with classical players. At the moment, only around 5 % of neobanks are breaking even and even fewer manage to record a profit. Coupled with the fact that the funding of neobanks has been cut down drastically over the past year, it may seem that traditional banks have the time to strengthen their positions. Challenger banks spend a lot of money on marketing, IT infrastructure, and even acquisitions, and with a low profitability rate, they could soon be in danger of running out of cash and we can see many shutting down in the next 5 years.

In comparison to classic banks, neobanks actively acquire customers through the expansion of new offerings and aggressive marketing campaigns targeting new clients. Challengers like Finom and others who focus on SMEs are increasing their presence through digital marketing campaigns and offering incentives such as free accounts in countries like Poland, Belgium, and the Netherlands. Recognizing the value of streamlined merchant transactions in the contemporary retail sector, many neobanks are also rolling out different payment acceptance tools.

For private consumers, neobanks are implementing active referral programs that offer a bounty for every new account registered on the platform with their assistance. Simultaneously, the integration of cryptocurrency into neobanking offerings marks a pivotal shift. Leading players like Revolut and N26 are enticing a wide range of customers with competitive crypto trading rates. As a testament to their broader ambitions, several neobanks are actively pursuing full banking licenses, emphasizing their intent to make a deeper impact in both SME and retail segments and to rival traditional banks comprehensively by extending financing options to their customers.

The future might be more interesting 

The impending evolution of neobanking, particularly within the SME sector, is one of convergence and adaptation. As a rising generation of young entrepreneurs is using digital banks for personal banking, they'll naturally move towards these platforms for their business needs as well—providing an additional customer base to challenger banks that serve both personal and corporate clientele. It is becoming more evident that the SME-focused neobanks need to include financing in their offering. At the moment, this is one of the main reasons why for SMEs, traditional banks are their first choice over neobanks is still the absence of financing products as one of the key things that SMEs are awaiting from their banking partner is the possibility to acquire financing. Already now, the largest market players are acquiring licenses and forging partnerships with other companies to deliver such products. For example, Revolut is set to offer mortgage loans for their retail clients, while Qonto is offering SME financing through an integrated partnership with Banxware, Defacto, and Silvr. Overall, to continue their market expansion, neobanks must address their current service limitations. By offering loans, they can establish themselves as more established players in the banking sector and make further expansion into the financial services industry.

Interesting to see how non-financial companies are transforming themselves into banking service providers. As digitalization advances, tech companies are increasingly likely to incorporate fintech solutions into their services and with time start providing banking services to their customers once the customer base is big enough. This trend is already happening across Europe from different angles, for example, Tellow by offering accounting and finance management tools afterward turned into a neobank. 

In recent years, the neobanks have received a lot of cheap VC money, yet around 95% of them are still not profitable. In the backdrop of these developments is the sad reality of reduced financing for neobanks. With VC funding for fintech witnessing a sharp 49% decline year-over-year, standing at $23 billion in H1 of 2023, it's evident that large-scale investments in these ventures are fading. Moreover, some larger neobanks are acquiring other firms to conquer a larger portion of the market which indicates that the market is slowly maturing.

As a result, those neobanks who are seeking banking licenses look at how to diversify their offerings, delving into insurance, embedded finance, loan, and stock trading to widen their service assortment. Only about 5% of neobanks presently achieve a break-even point, the pricing for their services is anticipated to increase to ensure their longevity and profitability in the market. While the EU is a mature banking region, regions like Asia and North Africa present a lot of unexplored potential, signaling the next frontier for neobank expansions. It remains to be seen how the neobanking market for SMEs will evolve in the coming years, but it surely is promising.

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