Neobanks and Their Gradual Transition to Full-Service Digital Banks

In this age of digital services, FinTech has revolutionized the way people fulfill their banking needs. Even as traditional banking institutions strive to expand their customer base and offer new-age solutions, neobanks—a new entity in the ecosystem—are increasingly becoming prominent in the banking space. Also known as challenger banks, these next-generation FinTechs operate exclusively online and offer low-cost direct financial services. The success of their low cost business model hinges upon the absence of physical branches and their ability to innovate consistently and quickly. Neobanks offer a range of services, boast almost paperless KYC procedures, and are user-friendly. Some of these challenger banks are collaborating with major traditional banks to ensure efficient customer service and hassle-free transactions. 

Though neobanks find many takers because of the limited yet efficient neobanking services in verticals such as savings accounts, money transfer, payments, and financial education, the banking landscape seems primed for a change. Are neobanks eying a larger slice of the banking pie and inching toward becoming full-service digital banks?

Evolution of Neobanks – From One Service to Many

Neobanks have gained strong traction, thanks to their low cost business model and seamless, innovative services. They are widely popular among millennials, micro, small, and medium enterprises (MSMEs), and people with irregular pay structures as their policies are more in line with the requirements of the gig economy. Further, high rates of neobank adoption are attracting venture capitalists and intrepid investors. The humming neobanking segment is clearly ready to take the next step in its evolution.

Let’s take a look at Razorpay, one of India’s top neobanks offering seamless transactions to popular companies such as CRED, OYO, Flipkart, Facebook, Byju’s Goibibo, Zomato, and Swiggy. With 300 million end consumers, this neobank has become India’s first full-stack financial solutions company. It enables Indian businesses, regardless of their size, to accept digital payments without any hassles. Over a span of seven years, Razorpay has evolved from a payment gateway provider to an entity offering a host of solutions, from accepting and disbursing payments to raising capital.

Open is yet another popular neobank in India focusing on enabling efficient financing solutions for SMEs and startups. Backed by major traditional lenders such as ICICI Bank, Yes Bank, and Kotak Mahindra Bank, Open provides a business account that allows small businesses to collect and auto-reconcile payments and ensure efficient payouts. In addition, it offers an integrated payment gateway, automated accounting, and expense management. With more than 15,00,000 SMEs and annual transactions worth 24 billion dollars, Open onboards 50,000 new SMEs and startups every month. With top neobanks increasing their service areas, other companies are expected to follow suit.

Future Outlook  

Neobanks are not licensed by the Reserve Bank of India (RBI). However, the explosive growth attained through their fully digital processes suggests that they are now eying a bigger prize. With consistent growth and an evolutionary arc different from that of traditional banks, neobanks are expected to become full-fledged digital banks in the years ahead. Their reliance on bank partners for bank-licensed services may come down. Equal collaborations between traditional lenders and neobanks—offering customers the best of both worlds—are likely to follow. In addition, neobanks’ ability to leverage next-generation technologies such as the cloud, artificial intelligence (AI), big data, machine learning, and blockchain will expand the reach of their traditional banking partners. 

With Banking-as-a-Service (BaaS) set to become the next big thing, neobanks enjoy tremendous scope in terms of growth and expansion. Neobanks are the future of banking, thanks to their data-driven approach to decision-making and emphasis on customized solutions and delightful customer experiences. Though originally formed to bridge the gaps in traditional banking services, they are now more than capable of promoting financial inclusion and covering the underbanked population. Add to it the strong interest from traditional banks and investors and neobanks stand a good chance of obtaining RBI licenses and evolving into full-service digital banks. However, these challenger banks need to assess the depth of the market before taking the proverbial leap. Further, with most neobanks yet to show sustainable profitability, a slight pause before they evolve into full-service digital banks is likely. Nevertheless, there is no doubting the massive potential of these new-age banks.

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