Digital banks are racking up users, but will they ever make money?

Think outside the box.
Think outside the box.
Image: Reuters/Axel Schmidt
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The UK has become something of a laboratory for newfangled digital banks, which are attracting thousands of new customers each day. But there are some big questions: Will bigger legacy banks eventually learn the fintech firms’ tricks? And will the so-called neobanks ever become profitable?

Talking about profit when these companies are growing so quickly may seem gauche to some investors, but there’s a lot of venture capital money riding on the answers to these questions. London-based Monzo raised about $145 million last month, while Revolut is looking to take in $500 million or more from investors this year. Berlin-based N26, which also operates in the UK, has raised $470 million so far this year.

London’s business circles were atwitter after an N26 executive told the Financial Times (paywall) that profitability isn’t a “core metric.” Young fintech firms are bleeding cash now as they spend on marketing and licenses for new markets, but some could potentially be profitable on a per-user basis if they weren’t spending so much on customer acquisition. Instead, they’re aiming to become big, global challenger banks.

Profits aside, heady valuations suggest that investors are counting on rapid user growth to continue:

Critics argue that digital upstarts are surging thanks to a small number of novel features—things like freezing and unfreezing a card if it’s misplaced—that older banks will copy, if they haven’t already. Traditional banks are also adding thousands of customers to their own apps: Barclays UK says it has 7.6 million (pdf) active mobile users as of April, up from 7.3 million at the end of 2018.

Big banks have been slow to catch up, but they’re getting there. And when they do, the thinking goes, these institutions will roll out whizzy features inspired by fintech competitors to their millions of customers.

“If they can do it before the challenger banks get to the mass market, then there will be less incentive for people to leave if the features are the same,” said Deborah O’Neill, a partner and UK head of digital at consulting firm Oliver Wyman.

Will Sorby, the UK general manager at N26, points out that the digital bank is still launching new features, like making its savings product called Spaces more versatile and sophisticated. Likewise, rival Revolut began rolling out commission-free stock brokerage to European customers today.

Death by COBOL

The entrepreneurs behind the digital banks counter that older rivals rely on obsolete tech that may well run on COBOL, a programming language that made its debut in 1959. Even if the banks catch up to where the fintechs were years ago, the upstarts say, their tech will be too clunky to make the leap when the next round of innovation comes along. N26 claims its costs are one-sixth of the incumbent banks because its tech is more efficient and it doesn’t have to support the cost of bank branches. (The COBOL issue is a real problem, O’Neill said.)

“I’ve heard of situations where core banking platforms are written in COBOL and the coders are starting to die out,” said Michael Kent, CEO of money transfer startup Azimo and a founder of Tandem, a neobank. “They’re spending billions and billion and billions to try to fix that huge technical debt.”

For institutions running on older technology, there are also startups that want to sell them neobank-style systems to help them catch up. ”Some of them are big bags of poorly designed spaghetti code that are going to cause their customers all sorts of headaches,” said Kent. “Some of them are fantastic, and they’re going to make a big difference to those banks who cant afford to build the technology themselves.”

Zeta, an Indian startup that was recently valued at $300 million (pdf), is one of the companies that sells this tech. Founder Bhavin Turakhia thinks shifts in digital banking will resemble the evolution of the internet, where banks are sort of like ISPs (providing lending and other core services involving the measurement of financial risk), and new fintechs provide an over-the-top service with a slick user interface, becoming more like a Facebook for money.

Automatic money

The holy grail for fintechs like N26 and Revolut is a kind of automated money, in which apps anticipate their users’ financial needs, notifying them when it’s time to refinance a mortgage, when they are overspending on their mobile phone bill, or not saving enough for retirement.

It may sound starry-eyed, but people who work in the industry say it is only a matter of time. For startups burning through cash to acquire legions of customers, this could help provide a path to profitability, whether that’s through a subscription service, broker-style fees for making recommendations, or some other way of making money based on the reams of data that their systems could collect. The trick is getting there before the venture capital money runs out, or someone else does it first.

“AI in financial services is not bullshit,” Kent said. “If you’re not doing it you’re going to miss the boat.”