Neo-Banking: The New Holy Grail?

For several years now, fintechs have taken the proverbial nibble at the banks’ lunch, taking a specific product or part of the value chain and applying the best brains and technologies to it to transform the customer experience and value proposition. There are three specific aspects of the fintech business model that are especially relevant:

• The picture one gets is that banks are these slow-moving behemoths, serving multiple customer segments and offering multiple products while the fintechs are focused, agile and have outpaced banks in their specific lines of business. Hold on to this thread and we will pick it up later in this article.
• The other important narrative is that the fintechs have developed business models where the customer interface is almost entirely digital, even if the end-to-end model is not. Customers have also taken a fancy to the digital store, so much so that many customers do not recall when they last went to a branch. Clearly then, there appears to be a business case for a branch-less bank that can be accessed by customers only digitally.
• The final point is that the fintechs have done a significantly better job at leveraging data and analytics for need identification, pricing, cross-selling and risk management.

The Monetary Authority of Singapore (MAS) endeared itself to the fintech world when it invited applications for two categories of digital banking licences – a digital retail bank and a digital wholesale bank. Singapore has always encouraged innovation led by the startup ecosystem, but even then, to create branchless banks is indeed transformational.

It is widely expected that these neo-banks will help solve some of the toughest problems of financial services – that of making them available at an affordable cost to customers who need them most. The neo-banks that Singapore will create will have to be agile, branchless if not entirely digital and leverage data and analytics to build their business.

How would this neo-banks fare on the three aspects which characterize fintechs?

Focus Creates Agility

Banks are expected to play the role of maturity and risk transformation, i.e. they assure the providers of funds (depositors, for example) the right to take back their money anytime they choose, irrespective of the maturity and repayment ability of customers to whom these funds have been lent. This is possible only by creating significant diversification in both the depositor mix as well as the borrower mix, even if it is at the expense of speed and agility.

The other unique feature of banks is leverage – the diversification in the business mix allows banks to be highly levered, and thereby reduce the cost of lending for its customers. These are clearly issues that the upcoming neo-banks will have to think through.

One school of thought is that the neo-banks will target the white space of customers who currently have to borrow outside the banking system and at usurious rates, and hence even if the neo-banks are more expensive than traditional banks, it will still create value for their customers. There is certainly merit in that argument, but the need to create diversification in sources of funds will remain centre stage. Will the neo-banks score over traditional banks on this count – the jury is out!

Digital Storefront

This one is obvious – the neo-banks will be significantly more digital than the traditional banks, in fact their licence requires them to be branchless. There is one distinction that is pertinent here, branchless does not necessarily mean end-to-end digital. The challenge for the neo-banks is not really to have a digital storefront, there is ample evidence of how that can be done.

Their challenge is to really build customer service, operations and risk architecture that is almost entirely digital. The leading banks today have a very good digital storefront, their bête-noire is really what happens in the operations and customer service arena, and here is where the neo-banks could look to up the ante.

Leveraging Data And Analytics

While it is second nature for fintechs to build a business on data and leveraging it to build products, manage risk and so on, the fact is that the incumbent banks are sitting on enormous amounts of data. Should they start capitalizing on that data, they could give the neo-banks a run for their money.

In summary, the neo-bank model scores over the traditional banks in terms of its readiness to build a digital, data-oiled machine. It remains to be seen how the neo-banks will be able to transform the maturity and risk patterns in its loan portfolio to assure its depositors of their money at any time of their choice. Will incumbent banks start to put the vast amounts of data at their disposal to good use? Time will tell.

In one aspect, the neo-banks that may take shape as described above, and for that matter, most fintechs are exactly like banks: they are manufacturers of products.

Their primary objective is to get the customer to buy their product; this is not to say that their products do not add value, but clearly they are on the opposite side of the table as far as their customers are concerned. There are notable exceptions of course, for instance, the distribution platforms in personal finance/wealth management and insurtech, but, they are very narrowly focused on a part of the entire gamut of financial services needs of customers.

Is there a variant of the neo-banking business model that truly represents the customers and takes care of their financial services needs from the customers’ perspective?

What if a neo-bank decided not to manufacture any products at all (other than possibly payments, but only focused on understanding the customer and their financial needs (across borrowing, saving, investing and insurance), and then bringing the best products from the market to fulfil those needs? What if it underwrote the default risks from customers it recommended to other lenders for an underwriting fee akin to an insurance premium?

This neo-bank would effectively become a gateway between the customer and the financial services world. The financial services regulators would need to define governance guardrails to ensure that they do truly keep the customer at the focus of their business, adequately disclose details about the banks, investment managers or insurers whose products have been recommended to or selected on behalf of the customers.

Further, the regulators would need to ensure that they protect privacy and confidentiality of data, and put in checks and balances in their model to ensure that they take decisions in the best interest of their customers, and not by short-term business considerations as they aggregate demand from providers of financial services. If a model like this is developed, it would check all the boxes that a fintech is supposed to:

• Be focused in doing what is best for the customer, by sidestepping the manufacturer’s dilemmas around risk and maturity transformation at least partially, they retain the agility that one has come to expect from the fintech community
• Be truly digital, certainly to a greater extent than the manufacturers even if not end-to-end digital
• Leverage customer data for the benefit of the customer itself

In many ways, this seems to be the neo-banking model that is being developed in India, at least in the current regulatory framework. If these neo-banks can stay their course and be truly customer-centric, that would really be the holy grail!

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