Neo Banks: Threat to Traditional Banking System

This research analyzes the impact of neo banks on traditional banking systems and whether they pose a serious threat. It examines the performance, strengths, and weaknesses of both types of banks.

Research
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Table of Contents
Chapter 1: Introduction....................................................................................................................3
1.1 Background to the problem....................................................................................................3
1.2 Background of the study........................................................................................................4
Chapter 2: Objectives of the study...................................................................................................6
2.1 Problem statement..................................................................................................................6
2.2 Objectives of the study...........................................................................................................7
2.3 Hypothesis statement.............................................................................................................7
References......................................................................................................................................12
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Chapter 1: Introduction
1.1 Background to the problem
Technological advancements are resulting in rapid changes within the banking industry. Banks
are trying their best to use disruptive technologies in a way of changing customer behaviors
through targeting the transparency, customer service and customer convenience and so on. Banks
change their operational as well as business models with the changing expectations and
behaviors of customers. This dynamic aspect of banking industry has given rise to new business
models named neo banks. Hopkinson, et al., 2019, explained that neo banks define as the digital
banking firms offering financial services through digital platform such as payment transfer,
banking account transactions and personal & business loans and so on. Substantial growth of neo
banks is fuelled by low-cost business model. There are many perspectives through which neo
banks are challenging the traditional banking systems and making them different from each other
(Hopkinson, et al., 2019). Neo banks do not have any physical location or branches for providing
financial and banking services. These banks have aimed to offer the new banking evolution age.
Such type of banks reaches directly to customers through personal computer and mobile app
platforms without having physical branch networks. These systems have mostly affected and
challenged the traditional banking models. Neo banks drive traditional banking to integrate
innovation in their business models and financial services they offered. Digitalization has driven
high pressure to banks for meeting customer expectations and requirements. Due to this,
traditional banking has become highly burdened with such pressure in context of digitalization.
According to Barker, 2019, the substantial growth of neo banks has been largely contributed by
the customer behavior and preferences. Neo banks offer wider convenience, excellent services
and greater customer experience than the not-so-digitalized banking systems. Digitalization
brings wider convenience which is preferred by all the customers. Neo banks eliminate the need
of standing and waiting in a long queue or visiting far-distanced banks requiring time
consumption (Barker, 2019).
Legacy system of traditional banks has added to the vulnerability of customer shifting towards
neo banks. Their legacy system features with high-cost maintenance and rigidity for
implementing changes. The cloud-native and digital platforms of neo banks are grabbing
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traditional banks’ customer share through the adoption of digital-first strategies. Due to these, the
traditional banks are fighting with their head-to-foot efforts for bringing their customers back.
Neo banks are disrupting the banking sector of the world (PRITCHARD, 2019). They have
brought innovation in key areas of customer experience, transparency, money management tools
and low-cost structure. Neo banks have become prominent mainly in few major markets such as
Australia, Europe and the US. The cause behind the emergence of neo banks has identified as
bringing transformation in banking industry. The neo banks are a step ahead in the global
banking sector due to their profitability fuelled by low-cost business structure (Hastie, 2019).
With the rise of new banking platforms such as neo banks, banking functions have gone beyond
paying off credit cards, invoicing of an item cost and paying off the debit cards and so on.
Traditional banking systems have remained behind the neo banks due to the transformation of
the way of making and receiving payments regarding goods and services by people (Saksonova,
and Kuzmina-Merlino, 2017). Neo banks cater the needs and wants of customers who seek
beneficial alternatives of big banks. They offer an alternative to customers who are fed up of big
banks and their tiring services. Neo banks have created several problems to traditional banking
systems along with driving them for innovation. The legacy technological system of neo banks
has reflected a major shift in the banking and financial industry of the global market. SETH,
2019, explained that as per the previous research, the projections show an immense growth of
45% from 2017 to 2025 in the neo banking sector.
1.2 Background of the study
This research is conducted for analyzing neo banks pose a serious threat to traditional banks. The
thesis defines the research problem as neo banks as a killing factor of traditional banking system.
To some extent, it would be wrong to refuse the validity and accuracy of this thesis due to
shifting customer behavior towards neo banks. It has been identified that the performance of
traditional banks is affecting due to the substantial growth of neo banks. Neo banks have created
barriers to the growth and success of traditional banking system due to the convenience and
experience it offers to customers (Ketterer, 2017). Digitalization has contributed to these barriers
and neo banks have overtaken the traditional banks.
This research will analyze the root causes of superiority of neo banks over traditional banking
system. Previous studies have researched how neo banks are killing the traditional banking
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system. However, it would be wrong to say that only neo banks have grabbed higher customer
share of traditional banks. Most of the studies have focused on the advantageous factors of neo
banks over traditional banking systems. Only few studies researched how traditional banking
system is still a choice of today’s customers from different perspectives. This research will add
to these few studies by highlighting those perspectives. The previous studies have identified only
the key factors of neo banks that kill the traditional banking system. This research gap will
contribute to the current research gap.
The scope of this research has been defined from the analysis of performance of neo banks and
other banks adopting traditional banking system. The main purpose of this research would be to
analyze whether neo banks has been established as a killing factor of traditional banking system.
This research would identify those areas that fuel the effectiveness of this factor. In simple terms,
its scope has been extended to the identification of those factors that make both the system
distinct from each other. It will also include highlighting the positive and negative hypothesis
including superiority and inferiority of neo banks over traditional banks (Letts, 2017). This
research will involve analyzing the performance of real-time banks for driving to the outcomes
and research objectives. It will analyze the performance of some neo banks such as N26, Revolt
and Monzo and traditional banking systems such as Barclays bank and SEB banks. This research
will use certain theories such as financial intermediation theory, fractional reserve banking
theory and credit creation banking theory for analyzing the constructed thesis.
Using these theories, it will provide some aspects of differentiating neo banks from traditional
banking systems. The financial intermediation theory says that banks are not distinct from other
non-bank financial institutions and function merely as financial intermediaries. This theory
works on the assumption that these banks create liquidity by short term borrowing and long term
lending to customers. According to the fractional reserve banking theory, it would not be wrong
to consider every bank as a financial intermediary. This theory counters the previous theory of
financial intermediation supporting the bank’s macroeconomic and collective role (Werner,
2016). However, it supports the previous theory from the perspective of money creation by the
banking system based on multiple deposit expansion process. The third theory of banking
disagrees with both the previous theories. The credit creation banking theory strongly argues
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with the fact denying the banks as financial intermediaries neither from collective nor individual
perspective.
From the cultural contextualization, customers of banks are more inclined towards better
experience and convenience through wider customer services. Customer inclination towards neo
banks has been identified due to the advantages it offer such as personalized services and user-
friendly experience and many more. Neo banks are majorly attracting the tech-savvy millennial
generation. It is because these banking system offer completely cloud-native and digital services
through mobile apps and without any physical branches. People can make payment transfers,
operate their personal accounts and apply for business and personal loans (Moysan and Rudnicki,
2019). From economic perspective, neo banks are beneficial not only for the customers but the
banking institutions as well. Neo banking system constitutes by a low-cost model having zero
withdrawal costs and monthly fees. Due to this, it becomes economically beneficial to customers
along with higher rates on fixed and saving deposits than traditional banking systems.
The research is accomplished after analyzing the performance of neo banks and traditional banks
for identifying whether neo banks are threatening the traditional banks. This research is most
suitable and successful when secondary data method will use. Secondary method will be used
with the analysis of quantitative and qualitative research data. The mixed research method
(quantitative and qualitative) will help in accomplishing research objectives. Data will extract
from the financial statements and annual reports of the selected companies for driving to the
outcomes.
Chapter 2: Objectives of the study
2.1 Problem statement
Neo banks have created several barriers for traditional banking system. However, to some extent,
emergence of neo banking is essential for the transformation and evolution of banking sector.
Neo banks have risen for the future of banking sector in regards to digitalization. Here, the main
arises that whether neo banks have succeeded in overtaking the customer share or performance
of traditional banking system. This dilemma arises due to countless customers inclining towards
traditional banking system offering wider services than neo banks. Traditional banks offer better
operational experience along with wider services such as home mortgages and car loans and so
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on (Rao, 2019). But neo banks provide opportunities to customers for personalized discounts and
offers with engaging mobile experience. Neo banks offer 24x7 customer support which is lacked
in traditional banking systems. Therefore, the problem statement for this research has been
developed as
“Neo banks are killing the traditional banking system that transformed the retail banking and
developed a new banking generation for millennial wherein the traditional banking systems are
fighting back for maintaining their position within the global banking sector.”
2.2 Objectives of the study
Traditional banks are severely competing with neo banks. This research is accomplishing the
analysis of performance of neo banks and corner banks for identifying the strength of former
banks. Neo banks target almost all type of banking customers with personalized services. Neo
banking offers digital platform to banks due to which fintech companies are also entering and
grabbing the opportunities. Neo banks have created huge threats to traditional banking systems
majorly in terms of customer experience, service and convenience. Although, traditional banking
systems are also competing tightly with neo banks for gaining back their charm and rivalry in the
global banking sector. The primary objectives of the study have been identified as:
General objectives
 To analyze whether neo banks are developing a killing factor to traditional banking
system
Specific objectives
 To assess the performance of neo banks and traditional banking systems
 To identify the factors based on which neo banks have become superior from the
traditional banking system
 To analyze the strengths and weaknesses of neo banks over the traditional banking
system
2.3 Hypothesis statement
It has been argued by the authors in their previous studies that neo banks have been significant
impacted the traditional banks. But the performance of traditional banking systems explains
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something else. The customers still prefer the traditional banking systems rather than neo banks
from different perspectives. The traditional banks offer wider services that are not provided by
the neo banks such as business loans, home mortgage and car loans and so on. It is true that
traditional banks are slow in adaptation to changes but neo banks are still running behind these
banks even after having flexible infrastructure. Neo banks are similar to traditional banks but
they offer great competition to traditional banking system (Минарченко and Сайко, 2018).
Traditional banks are characterized with higher operational experience as compared to neo banks
that makes customers attract more towards their traditional banking system. Traditional banks
face lesser complications in regards to regulatory and supervisory requirements. Apart from this,
large loans become difficult to manage and deal through digital platforms. It is because
traditional banking system offers better customer service and interaction that helps in better
dealing with large loans.
Barclays bank refers to the British company operating at multinational scale as a investment
bank and company of financial services. Barclays Bank PLC has a diversified business model
providing services to international banking, wholesale and large corporate customers and clients.
Performance of Barclays has been enhanced in 2018 as compared to 2017. In 2018, the company
earned a profit of €835 million wherein it had been dealing with a huge loss of €1,154 million in
2017. In consolidation, the company made a financial investment in debt securities of € 58,963
million in 2017 (Barclays Bank PLC, 2018). The company made an investment of total of €718
million in joint ventures and associates in 2017 while this amount was increased to €762 million
in 2018. Barclays Bank Group maintained a balance of €4,716 million with central banks and
other regulatory authorities in 2018 which was an increase from 2017.
Established as a Sweden financial group, SEB group offers financial services for corporate
institutions, customers and private individuals. These services include banking services, life
insurance operations and Eurocard services and so on. The company has reported a significant
increase in its profits from 2016 to 2018. It has enjoyed a significant annual growth since 2016
wherein the net profits were SEK 10,618 million. This amount was increased to SEK 16,197
million in 2017 and further reached to SEK 23,134 million in 2018 (Sebgroup, 2019). This
shows that the company has been enjoying a constant growth in net profits reflecting the fact that
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even after the growth of neo banking sector, traditional banks have maintained their strength in
the global market. It offered loans to public of about SEK 1,486,765 million till December 2017.
H0: Trend of Neo banks has not yet influenced the performance of traditional banking system.
On the other hand, it would be wrong to consider that neo banks are completely a failure in
competing with traditional banking system. Neo banks have come out as modernized banking in
the dawn of innovation in banking sector. Neo banks are similar to traditional banking system
but the only difference lies in the way of offering products and services. Traditional banks offer
financial and banking services through physical bricks and mortar branches while digital
platform is used by neo banks for offering technology-driven services to tech-savvy customers.
Neo banks have made bank account opening and handling more convenient through laptop or
smart phone (Moysan and Rudnicki, 2019). Customers prefer neo banks majorly due to the
convenience of cutting down the wait times at the physical branches. These banks have flexible
infrastructure with reduced overhead costs and due to this, the customers enjoy lower fees on
their banking services.
As per a report, small businesses seek their business banking partner based on criteria such as
established financial brand as well as low fees. Neo banks do not have to bear physical branch
costs and maintenance costs that lower the infrastructure overhead costs. They offer customers a
hyper-enhanced and personalized experience with their superior technologies. It offers intuitive
money-tracking, investing and budgeting tools to customers along with high security features
through mobile app including freezing and locking (NAGIYEV, 2019). Not only has this, but
neo banks provide facilities such as international payments through different payment and
banking partner at interbank rates. Customer experience has always a target of neo banks by
offering personalized discounts and offers based on the customer expense, income and spending
habits. These banks have eliminated the credit card usage due to the availability of Buy Now,
Pay Later services.
According to Mozo research, approximately 23 percent people agreed that they have stopped
using credit cards while 25 percent Australian population in research have cancelled their
applications and operations on credit cards. According to Allied Market Research, the global neo
banking market has experiencing an annual growth of CAGR of 50.6 percent as reported from
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2017 to 2020. Previous studies have shown that lower interest rates and convenience are the
biggest growth drivers of global neo banking sector (Bagri, 2019). Considering the global
market, European banking market has been an excellent example of neo banking growth. As per
a research, the European neo banking sector has been grown by 15 million since 2011 and it has
been forecasted that this figure will reach to 85 million by 2023. According to business insider, a
consolidated amount of $2.5 billion USD has achieved by the global funding for digital
challengers and neo banks. The key players of global neo banks have been identified as N26,
Revolut and Monzo (Bagri, 2019).
N26 is a German-based direct bank with headquarters in Berlin. It provides services in different
markets such as UK, US, Switzerland and most parts of Eurozone. It offers services such as basic
current account, Maestro card, Debit MasterCard, overdraft and investment services. In January
2019, this direct bank successfully raised an amount of $300 million with a total valuation of
$2.7 billion USD. However, this amount was driven to $3.5 billion USD till July 2019 with
additional raise of $170 million from the current investors (Patel, 2019). This shows that the
trend of neo banking has been significantly increased in Europe market. Since October 2018, the
company has successfully earned more than 200,000 customers alone in the UK market.
Another neo bank Revolut is a UK-based financial technological company offering banking
services such as commission free stock trading, peer-to-peer payments, prepaid credit card and
fee free currency exchange and so on. The company has 6 million registered customers till
August 2019 while approximately 350 million transactions have been made till April 2018. Till
April 2018, Revolut had a valuation of $1.7 billion with a raise of $250 million (Patel, 2019).
Similarly, Monzo raised an amount $109 million that resulted in a valuation of $1.3 billion till
October 2018. Monzo is a UK digital bank considers as a mobile-only bank that offer banking
and financial services through a mobile app.
H1: Neo Banks have been integrated with digitalization providing more convenience to people
and support to money preservation.
Secondary Questions:
1. How neo banks have killed the traditional banking system in major markets?
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2. What factors have strengthened the neo banking sector and pulling them in front of
traditional banks?
3. How neo banks and traditional banks are performing concerning their investments and
profitability?
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