Venture capitalists have poured billions of dollars into digital bank startups, and at least one more megadeal is expected before this year is over. Questions are being raised, however, about whether this fintech craze is another quixotic quest for market share that burns cash but doesn’t generate much profit in return.
Some of the most ambitious banking startups, like N26 and Revolut, aim to be a kind of Amazon for finance, an umbrella brand offering everything from bank accounts to insurance and trading. These banks are quickly amassing customers: Digital-only banks added around 5 million users during the first half of the year, bringing their total to 13 million in Europe alone, according to Accenture.
As they expand, these upstarts are running up against entrenched incumbents, and financial regulators that don’t have a lot of patience for cutting corners. Recent episodes, from MoviePass to Uber and WeWork, have shown that rapid growth and high valuations are far from a sure sign of success. The question for fintech unicorns is whether customers will continue to use them as niche providers of peer-to-peer payments or travel spending or fully embrace them as a one-stop-shop for financial services.
Some investors think they’ve found an even better bet in the fintech sector. Point 72 Ventures, the venture arm of the hedge fund founded by Steven Cohen, thinks traditional banks won’t be disrupted by the unicorns. However, they are going to have to learn new fintech-inspired tricks to fend off the challenge: Older lenders need things like cloud-hosted software and systems that make it easier to sign up for a new account.
Top-tier banks already have scale, well-known brands, and (crucially) profits, said Tripp Shriner, a partner at Point 72 Ventures. “What they tend to lack is the modern technology,” he said. “For a majority of the new features or capabilities that neobanks are talking about, you can almost inevitably point to another technology provider that is enabling incumbents to do something similar.”
Shriner previously worked in JPMorgan’s strategic investment group. The venture fund is buying stakes in companies like Mantl, a startup that develops software for digital account openings at regional and community banks. Another of its investment is in Flybits, which uses machine learning to make recommendations to customers.
These startups aren’t as sexy as the notion of an Amazon for finance. But taken together, if they help old-school banks leap into the 21st century, they could serve as neobank killers. If traditional banks can offer fintech features, why switch?
Mark Tluszcz, chief of self-described contrarian investor Mangrove Capital Partners, said the software companies getting banks up to speed are a “terrific play.” The longtime fintech skeptic doesn’t see why a startup would be any better at assessing creditworthiness or risk management than a traditional bank. If a startup’s main offering is just a better interface, he thinks banks will catch up in a matter of time.
“Valuations don’t mean a whole lot right now, as we’ve learned,” Tluszcz said.
There’s a neobank segment, however, that even the skeptics think has potential, and that’s in developing markets. Point 72 Ventures has multiple investments in Latin America, while Mangrove has a stake in Oriente, which offers credit in the Philippines and Indonesia. In these regions, there’s far less incumbent competition and millions of customers without bank accounts. As commerce increasingly goes online, these consumers will need financial services more than ever.
“Our belief in the US and Europe is generally that people are well banked—they’re just not well served from a consumer experience perspective,” said Shriner of Point 72 Ventures.
Based on current valuations and recent funding rounds, it is clear that there are still plenty of smart people who see immense promise for neobanks in the West. Eighteen of Europe’s biggest fintechs are now valued at more than $1 billion, according to Richard Diffenthal, a partner at Hogan Lovells. Investors are lining up to give them even more money.
This year’s biggest deal could come from payments and banking app Revolut, which is looking to raise as much as $1.5 billion through a combination of convertible loans and equity, according to Sky News. The deal, which will help the London-based fintech expand around the globe, could value Revolut at as much as $10 billion. Another high-flyer is San Francisco-based Chime, which Bloomberg recently reported could be valued at more than $5 billion, more than three times its price tag in March. Brazilian digital bank Nubank raised $400 million this summer and was valued at $10 billion.
Among the investors who believe in the neobank dream is Peter Thiel’s Valar Ventures, which has a stake in Berlin-based N26. Thiel made his billions by founding PayPal, a payment company created at the turn of the century that racked up users quickly and figured out how to make money later. The San Francisco-based firm is now worth about $122 billion; it generated more than $800 million in net income in the second quarter.
For now, not unlike PayPal’s early days, N26 says it’s focusing on customer growth and things like daily active users, which is the kind of metric you would expect to be cited by a social network, not a bank.
“It’s very clear that there is a proposition from neobanks that resonates very strongly with customers,” said Will Sorby, general manager for the UK at N26. “The next step for us is demonstrating that we can take that and build upon it a set of financial services beyond what we have today.”
N26 says its cost base is around one-sixth that of a big bank with branches and outdated systems. It has 3.5 million customers and is expanding around the world, from the US to Brazil. It doesn’t disclose how many of those customers receive paychecks into those accounts, but says users hold more than €1.5 billion ($1.7 billion) with at the company. According to Accenture, customers at banking startups maintain average deposits of only around 4% of their counterparts at incumbent banks.
Some digital upstarts, meanwhile, sell software while also running their own financial institution. Starling is a neobank that also provides payment and banking software (Quartz member exclusive) to other companies. OakNorth, which lends to smaller business, sells its analytics to other institutions. OakNorth’s banking unit is profitable and Starling said it aims to make money next year. The biggest fintech of them all, China’s Ant Financial (Quartz member exclusive), also sells its cutting-edge tech services to traditional banks—it was valued at an eye-popping $150 billion last year.
Can centuries-old banks ever really adapt to the era of cloud computing and mobile apps? If you ask a neobank executive, they’ll probably say it’ll never happen. The old banks’ tech is archaic, based in coding languages that today’s university grads have never studied. Their culture is too slow and bureaucratic to innovate. And even if they adopt fintech-inspired features, scrappy newer banks will always be a few steps ahead.
Eugene Danilkis, founder of Mambu, takes a more nuanced view. The company makes “core engine” software for banking, and it’s used by digital upstarts like OakNorth and N26 as well as traditional institutions. The company’s software sits in the background and provides servicing for accounts—things like calculating interest—while clients still build their own apps and develop their own credit models and analytics.
Danilkis admits that traditional banks can’t just ditch their old systems and start over from scratch. These efforts have failed in the past, running far over budget and taking longer than projected. Older institutions may also struggle to adopt the iterative, “agile” software development used by tech-savvy startups.
Instead of a massive overhaul, he says banks are upgrading one system or business line at a time. This shows that they’re modernizing, gradually. “The reason banks are working with us is because they know they need to adapt,” Danilkis said. “They can’t stay on their old systems forever.”