Into the Unknown for Challenger Banks (The Monito Briefing Issue #3)

Hello! This week, as high-street banks rush to adjust to a world that's slowly moving away from in-person banking, digital-first challenger banks appear to hold a clear edge.

However, for an industry that has surged onto the scene in recent years, it too faces a bevvy of unique challenges that range from brand placement to regulatory challenges and increased competition.

Industry Highlights

Before we get started, here's what's been happening over the past two weeks:

• Digital bank Revolut has pulled out of the Canadian market amid stiff competition and licensing struggles while simultaneously applying for bank status in the US;
• US Federal Reserve Chair Jerome Powell stated his belief that global cross-border payments remain one of the "less efficient" areas of the global financial sector and in need of "improvement and digitalization";
• Crypto remittance platform Afriex has become the latest recipient of a large seed funding round for its zero-fee international money transfers to African countries.

Money Transfer Operators Still Have Room to Grow

In light of Wise's recent rebranding and Remitly's 2020 launch of its Passbook account, one could easily think that more traditional money transfer services are feeling the heat and attempting to adapt to the challenge posed by neobanks. But the situation is not so clear-cut, and remittance providers such as Wise and Remitly might actually be better equipped than neobanks to face the coming years:

• Although neobanks have grown at breakneck speed over the past few years, many will soon face challenges when it comes to turning a profit as they reach their scale goals, according to a recent white paper by Exton Consulting. Fee raises and features locked behind subscriptions might become commonplace as international expansion beyond a home market becomes more complicated. Customers who rely on a neobank account to move money around might soon find it more expensive.
• Money transfer services, on the other hand, already have a significant international presence, which can facilitate their expansion into new bank-like features, tapping into markets underserved by "traditional" neobanks.
• While neobanks still rely on and compete with traditional banks, remittance providers are more easily able to work in partnership with other actors of the banking and financial sector, opening new streams of income. They can and do, for example, offer their services to banks and neobanks who want to improve their international payments offerings.

Read more about the competitive landscape emerging between digital banks and international money transfer operators here.

Wise — A Transition In Focus

The number of new challenger banks has exploded in recent years (growing from 60 in 2018 to 258 in 2020 according to Exton's white paper). However, not all of these companies are brand-new startups.

Wise — A Transition In Focus

The number of new challenger banks has exploded in recent years (growing from 60 in 2018 to 258 in 2020 according to Exton's white paper). However, not all of these companies are brand-new startups.

Wise, which just last month rebranded itself from TransferWise, is now facing a bold transition into a challenger-bank-like entity, soon to be equipped with a public listing and investment features, all in addition to its existing debit card, virtual card, and multi-currency bank account features that set it apart from other money transfer services.

And so far, the transition is looking rather promising:

According to brand searches landing on Monito (one of the main destinations for Wise- and TransferWise-related search queries), residual searches for TransferWise are decreasing while new brand searches for Wise are picking up at a fast pace. However, a month after the announcement, new brand searches have not yet matched the rate of decrease of the old —leading to a 2.8% net loss in brand searches, as of 20 March.

With only a month having passed by, a lot remains to be seen. However, even at such an early stage, it's beginning to seem clear that Wise's bid to rebrand itself has met some success — at least as far as consumers are concerned.

A Regard for Regulation

Looking at the size and distribution of the world's neobanking industry, one can be forgiven for thinking that the US, UK, Australia, the Eurozone, and Canada are the most "neobank-friendly" regions. After all, they appear to be home to a vast majority of the world's neobanks:

However, it's well worth noting that as a global phenomenon, digital banks have only caught on in places already possessing well-developed financial sectors and large, wealthy populations. Moreover, it also appears that the greater the number of neobanks, the more attention they draw from state regulators — now one of the fastest drivers of change in the industry, according to Exton's white paper.

Broadly speaking and regardless of the country, three overarching regulatory trends and challenges appear to be emerging:

• Systemic relevance: As challenger banks grow older, larger, and more widely-adopted, regulators are no longer treating them with "kid gloves". For instance, the UK's Prudential Regulation Authority (PRA) to publish a supervisory statement in 2020, detailing the requirements and expectations for "new" non-systemic banks in the UK as they grow in prominence.
• New KYC and AML considerations: While not specifically aimed at neobanks, a slew of new Know Your Client (KYC) and anti-money laundering (AML) regulations have sprouted up across the globe in recent years, all having a sizeable impact on the industry's operating costs. Examples include laws and guidelines such as the Economic Growth, Regulatory Relief, and Consumer Protection Act in the US, FINTRAC's AML methods in Canada, and similar FCA guidelines in the UK.
• Procurement of banking licenses: Regulators are quickly redefining what it means to be a bank by raising the bar to entry. A notable example of this includes the case of the Australian Prudential Regulation Authority (APRA), which recently tightened requirements for revenue-generating products and minimum capital.

What To Watch

All things considered, challenger banks are a rather new phenomenon, and their future remains difficult to discern amid the flurry of fintech innovation over the past years.

However, arguably the biggest challenge facing the burgeoning industry in 2021 is the cost of customer acquisition. In an environment where this figure is as high as US$3,119 per customer by some estimates, only those players with significant capital at the outset stand a chance. And, the cases of Wise and Remitly aside, other new entrants to the scene appear to have just that:

• HSBC has come out with HSBC Kinetic, a low-cost digital-only banking service aimed at small businesses that runs in direct competition with challenger banks;
• Singapore's financial regulator granted fully-fledged banking licenses to four digital banks in December last year in which Ant Group, local telecoms giant Singtel, and ridesharing outfit Grab hold significant ownership.

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