With so many digital banks and fintech companies in general, it seems that it’s incredibly easy to start a financial service business. You find an existing platform, slap your name on it, and voila, you have yourself a digital bank.
Although this is an extreme exaggeration, the fact is that many licensed banks are offering BaaS to fintech companies. BaaS stands for banking as a service, of course.
So, even if it might be “easy” to establish a digital bank, the real work starts then and there. Keeping your digital bank not only afloat but successful and a real contender is a feat.
Let’s explore some of the pitfalls that digital banks are facing by listing seven reasons why digital banks could fail.
1. Lack of funding
To manage a successful digital bank or a fintech company in general, you have to be terrific at raising funds. And you have to do it often. Some company heads excel at this, while others don’t like to do it.
Successful challenger banks can raise hundreds of millions or even billions of dollars like clockwork. Raising capital gives your bank the ability to scale faster than without it or with limited availability.
By raising funds, you’ll be able to raise more of it and easier and faster. It’s because you gain credibility, media exposure, and trust. You also get valuable expertise that comes along with the money and incredibly important connections, and a network of other business people and financiers.
There are arguably no digital banks that got bootstrapped by their founders as they would have to inject tens of millions of dollars into the venture. And, it still might not be enough.
Still, even if you do raise capital, it’s a sustained process that must be replicated repeatedly to ensure you don’t run out of money for developing and launching new financial products, scaling operations, and capturing new users at an increased rate.
2. Competitive and saturated marketplace
The digital banking space is getting saturated at an alarming rate as challenger banks are cropping up every month. And although there are still more than enough people using legacy banks that have the potential to switch over to digital banking, it’s a deceptive number.
First adopters and younger people are more eager to switch to a neobank. Still, there’s a substantial number of folks that have significant capital that isn’t even remotely thinking of joining a digital bank.
There’s simply no benefit for them to join a digital bank they’ve never heard of and don’t trust and that offers functionalities that they don’t really need. They would benefit more from investing their surplus anyway, rather than keeping it in a bank.
That means that challenger banks are fighting for the same pool of people that are already a member of a digital bank. They are just going to snatch customers from each other.
We also have to admit that a lot of neobanks offer the same features and that even their websites look the same. The thing is that many venture capital firms don’t want to miss the ship and keep throwing millions at fintech startups.
3. Economic downturn
There hasn’t been a major economic downturn since 2008. Up until the pandemic, the markets were like a steamroll engine. But once the world ground to a halt, some digital banks had to scramble to stay afloat.
There are two challenger banks that immediately come to mind – Monzo and Bo, both from the UK. Monzo is a major bank there that has more than five million customers. In fact, they acquired one million of them during the pandemic.
Still, the fintech had to raise £58M from investors last round at a 40 percent discount to its previous valuation and even sounded the alarm that the COVID-19 pandemic had threatened its ability to continue to operate.
Monzo isn’t a failed bank, mind you, but it goes to show how quickly tables can turn.
On the other hand, Bo was a failed experiment at rivaling the UK’s top challenger banks by the state-backed Royal Bank of Scotland (RBS). It was a challenger bank account that came with an app and a canary-yellow Visa debit card.
The RBS backed challenger was shut down after only six months due to the effects of lockdowns on its parent company, which saw its profits halved in the first quarter.
So, six months and 11,000 customers after the launch, Bo was merged with Mettle, RBS’s digital bank for SMEs that would use its technology.
Treating your company and investors’ money as a piggy bank is nothing new in the fintech world. Just look at Theranos and WeWork and how lavishly their founders, Elizabeth Holmes and Adam Neumann, lived.
But CEOs can frivolously spend money on the company itself as well. An example of that is the failed digital bank from Australia called Xinja. The challenger bank shut down for good in January 2021 by returning all the customers’ deposits and returning the banking license it recently obtained.
When Xinja declared its closure in December, the bank had 37k customers with 54k individual deposits that were worth more than $252 million. A year and a half before going belly up, the startup had moved into a new headquarters on Sydney’s famed King Street in the central business district where a much more successful Facebook once had its headquarters.
This move meant that Xinja would pay 7 times more in rent each year. From $224,000 to $1.6 million. The move occurred when the company was bleeding money left and right and was at risk of insolvency. Of course, this wasn’t the only bad decision and the only major expense as their marketing cost also ballooned up to four times.
Although this wasn’t the direct reason for the fall of this digital bank, the pandemic and a “tough capital raising environment” were certainly to blame. Still, they can also be the perfect scapegoat to many failing companies these days.
5. Lack of independence
Raising capital is extremely important, but raising it from wrong investors can be devastating. And no, we don’t mean the mafia. If the startup isn’t vetting investors and their management because they’re too busy opening champagne, they can find themselves in a firm grip and trying to meet unrealistic demands.
By not having the controlling stake in the company, you’re at the mercy of the investor or parent company. They can close you down if they decide so. This is what happened to one of the pioneers of digital banking – Simple.
The company announced that it would shut down its operations, and all its accounts would be transferred to Simple’s parent, BBVA USA.
BBVA acquired Simple in 2014, and PNC acquired BBVA USA in 2020. To cut costs, PNC decided to close the popular digital banks and move all the accounts over to BBVA.
6. Not acquiring enough customers
As a new and aspiring digital bank, one of your main goals should be to acquire as many customers as you can while still being able to tend to all of them in a timely manner.
While some digital banks seem to attract millions of customers effortlessly, others struggle to acquire more than 50,000. A small number of customers can be enough to run even a profitable business if you’re a lean company with a reasonable number of employees and little overhead.
On the other hand, even millions of customers don’t mean much if you are spending like crazy and hiring thousands of staff all around the world.
Still, a healthy number of customers is vital to the success of a digital bank as you have a wider base of people to test and upsell new financial products such as loans, credit cards, and similar gravy trains.
7. Not launching loan products
If you look at the balance sheet of successful digital banks, you’ll almost certainly see that they offer loans to personal or business customers, or both. This is arguably the single best way to become profitable as a challenger bank.
Checking accounts are the basis, savings accounts might be a foot in the door for many customers if you offer them a high promotional interest rate, but loans are what will bring you money fast.
Credit cards, mortgages, small business loans, student loans, etc., bring in a substantial amount of money that could not only keep the lights on but also make you profitable.
The biggest challenger bank in the world, Nubank, has started out by only offering credit cards with no fees and competitive interest rates. This strategy meant that customers came in droves. So much so that they now have more than 40 million of them – only in Brazil.
Failure to launch loans to existing and potential customers can make or break a bank, digital or not. Until you launch your own products, the least you could do is establish a marketplace where partners will pay you a commission for bringing them customers looking for loans, insurance, pensions, etc.
The bottom line
Although there haven’t been that many digital banks that failed, it’s probably because the industry is still in its infancy, and most of the challenger banks weren’t even launched until the last five years or so.
As more and more neobanks start to crop up, so will the number of failed ones rise as well. Some of them might get absorbed by bigger challengers, while others might go insolvent or even bankrupt.
This doesn’t necessarily have to be a bad thing. As the market is consolidating, the more capable banks will stay afloat and improve by making more and better financial products for their expanding customer base.
We can still count profitable challenger banks on the fingers of one hand, but as they are starting to mature, that number will also begin to increase, making their investors satisfied.
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Adrian Volenik is a fintech enthusiast who loves testing and reviewing digital banking apps and financial products in general. How many digital banking accounts can one man have? Not enough, if you ask Adrian. As his wallet will soon explode if he doesn’t cut back on the number of cards.