Neobanks’ challenges in taking on big four laid bare by COVID-19

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But the abrupt exit of Xinja last year and National Australia Bank’s plan to buy 86 400 have underlined the challenges facing neobanks. At the same time, equity markets are putting huge valuations on fintech firms that compete with banks for customers but very deliberately avoid the industry’s regulatory and capital demands — the most obvious local example being Afterpay.

A partner at venture capital fund Airtree, James Cameron, says it has become clearer in recent years that successful neobanks do not necessarily need to have their own banking licence, which comes with high costs for a start-up.

“You don’t have to have an ADI licence to be competitive with the banks anymore, I think that’s the big realisation,” he says.

Given the high costs and strict capital requirements that come with being a licensed bank, Cameron says more challenger banks could rent a licence from smaller players such as regional banks. “Up bank, with their partnership with Bendigo, is a great example of this,” he says.

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Managing partner of Westpac’s Reinventure fund, Simon Cant, also highlights the high capital costs of setting up an entire bank from scratch. “I think there’s still a very strong disruption in banking coming along. That particular pathway of creating a neobank, which involves getting a licence first, is obviously very challenging. It’s very capital intensive,” he says.

The idea of launching start-up banks to compete with the big four was always ambitious, but the economic backdrop of COVID-19 has made it harder still, by affecting capital-raising plans and squeezing industry profitability.

EY’s Oceania banking and capital markets leader, Tim Dring, highlights this unfortunate timing, while also pointing to the success of fintechs in the UK, such as aggregators, that provide services to customers without holding banking licences.

“What we are seeing here is to be a bank and to accept deposits requires significant capital, and the faster you grow, the more capital you need, in a period when return on equity and hence return on capital is under pressure,” Dring says.

The big four banks’ huge technology budgets present a further hurdle.

Managing director of payments consultancy The Initiatives Group, Lance Blockley, says a key challenge facing the neobanks in Australia is that they are up against major banks that have invested heavily in technology and digital channels, unlike in the UK. “There’s probably room in the market for one or two really good neobanks,” he says, also pointing to Up.

Despite these challenges, neobank Volt maintains it can disrupt banking through a business model focused on “banking as a service”. It is expected to unveil major corporate partners soon.

Other fintechs are still eyeing a banking licence in the longer term, such as the UK’s Revolut, though it has initially focused more on niches such as foreign exchange or crypto-currency trading.

Business-focused Judo Bank has also successfully raised capital and growing its share, but it’s telling that Judo has chosen not to call itself a “neobank”.

Whatever happens, it is clear the big four banks are gearing up for a fight against their new rivals, with CBA flagging higher tech spending. The banks’ goal will be to protect their lucrative businesses from all manner of potential challengers — neobanks or otherwise.