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Meet the 'neobanks' trying to shatter the big four banking oligopoly
Australia’s first bank opened its doors to customers in 1817 from a small building that was previously a pub, at Macquarie Place in Sydney. The Bank of New South Wales — now Westpac — rented the premises from a convict turned businesswoman named Mary Reibey, who is pictured on the $20 note.
Some time next month, Australia’s youngest bank is opening to the public, but there won’t be a branch customers can visit, even if they want to. Instead, the unusually-named 86 400 will launch by making its app available to people with iPhones and Android smartphones.
Circling the wagons: Can neobanks disrupt the big four's oligopoly?Credit: Joe Benke
It only has about 90 staff today, but 86 400 (named after the number of seconds in the day) has its sights set on much bigger things: a slice of the $30 billion annual profit pool of the big four banks.
“There are 9 million Australians who are banking via smartphones, and that’s a really big market opportunity, and that number is growing every year,” says chairman Anthony Thomson, who founded United Kingdom lenders Atom Bank and Metro Bank.
At face value, this sounds hugely ambitious. Commonwealth Bank, Westpac, National Australia Bank and ANZ Bank have a combined market capitalisation of about $380 billion, a fifth of the ASX 200. They spend millions of dollars a year on apps targeting the same customers 86 400 is hoping to pinch.
Foreign giants such as Citi, HSBC and ING have struggled to make meaningful inroads into their retail market share over decades. However, Thomson’s sentiments are more common than you might think.
86 400, backed by payments company Cuscal, is one of a growing number of start-up banks with distinctly un bank-like names such as Volt, Judo and Xinja.
These so-called neobanks are attempting to do to banks what Uber has done to taxis, or what Facebook and Google have done to newspaper publishers.
Yet opinion in the investment world is divided about whether the neobanks can pull off their big plans. While major banks face plenty of challenges, do these start-ups really stand a chance against the might of the big four?
A banking ‘revolution’?
Despite their strange names, neobanks still have plenty in common with their traditional rivals. Neobanks will be licensed to take deposits, which will be guaranteed by the government, and they plan to use this money to fund loans to households and businesses.
We will make less money per person than probably any other bank in Australia, and I’m absolutely comfortable with that.
Eric Wilson, co-founder of Xinja
In other ways, however, the neobanks are a very different proposition — and this is what has some investors excited.
For one, they claim to have much lower costs than “legacy” banks. This is mainly due to a lack of branches, and their use of advanced technology, rather than the decades-old systems still used by some major banks.
With lower fixed costs, the idea is that neobanks can out-price the big four, yet still be profitable.
“We will make less money per person than probably any other bank in Australia, and I’m absolutely comfortable with that,” says Eric Wilson, a former NAB banker who founded Xinja, a neobank in the final stages of getting its licence.
Judo Bank’s co-founder David Hornery, a 30 year veteran from banks including NAB, ANZ and Macquarie, says the lender was able to start with a “blank sheet” to better serve small to medium enterprise customers. Judo doesn’t call itself a neobank, indeed its pitch is that it employs relationship bankers to deal with customers. All the same, he says having modern technology systems when starting a bank is an “unfair advantage.”
“They give you a much greater breadth and depth of capacity and flexibility... that gives you, in many ways, an unfair advantage over those that began with technology 20, 30 years ago, and have not comprehensively overhauled that,” Hornery says.
On top of the lower costs, Xinja’s Wilson says the real appeal to investors is the potential to disrupt the majors.
Xinja CEO Eric Wilson sees the neobank as the Airbnb of banking.
“What they are actually looking at is the future disruption. They’re saying ‘is it going to be possible for them to compete and be as flexible as a neobank?’” Wilson says. “It’s about a revolution in this industry and putting customers bang at the centre of the interests of the bank.”
He gives the example of credit cards, which Xinja won’t offer, because "the only way you can make money is if the customer stuffs up".
His attack on credit cards — regularly criticised by consumer advocates for their 20 per cent interest rates — is no coincidence. After the hefty brand damage inflicted on the big four by the Hayne royal commission, neobanks targeting retail customers are vowing to look after clients' "financial wellbeing," through features such as budgeting apps, or identifying ways to help customers save money.
Like so many big changes in Australian financial services, the UK's experience provides a precedent. A host of neobanks have launched in the UK in recent years, with one, Monzo, in June valued at £2 billion ($3.6 billion) in its latest fundraising, four years after launching. It claims to open 55,000 new bank accounts a week.
Steve Weston, co-founder of Volt Bank who was previously head of mortgages at Barclays in the UK, points to a survey that found one in four consumers in that country under 37 had an account with a digital-only challenger bank. And 61 per cent were considering opening a digital bank account. He is hoping to get a similar sort of response from Australians.
“That sort of penetration level is significantly higher than what even the most optimistic digital bank founder would have thought,” Weston says.
Aside from tech-savvy young people, he says the bank will target retirees in search of a better return on their savings, and people refinancing their mortgages. “Our bank will absolutely be targeting millennials, but we also expect non-millennials to use it,” he says.
'A lot of tears'
Yet, for all their optimism, the neobanks are going up against uniquely powerful incumbents.
In a sign of their remarkable staying power, Westpac, NAB and ANZ were all in the 10 largest listed Australian companies in 1917, and they are still in the top 10 today, a recent Reserve Bank paper found. (CBA was not listed in 1917, but it is the largest of the four today).
More so than other industries targeted by start-ups, banking is hugely capital-intensive. One industry observer estimates a neobank will need to raise more than $500 million in capital to get the business to a respectable size.
The big four banks have the in-built advantage of being able to access money more cheaply than their smaller peers, by tapping wholesale funding markets at lower cost, or drawing on transaction accounts that pay no interest. In contrast, it’s likely neobanks will need to pay higher rates to get people to open up accounts, squeezing profit margins.
And the established banks have deep pockets to fund a technology war with upstart banks.
For these reasons, some observers are sceptical about the wave of capital flowing into neobanks, highlighting differences between Australia’s market and the UK.
"All industries need disruptors, because the incumbents become lazy and generate super-normal profits, and the Australian banking industry is no different," says Rajeev Gupta, partner at Alium Capital Management.
However, unlike in the UK, Gupta says the incumbent big four have responded "relatively well" in terms of their apps and products.
"It looks to me as though some of the neobanks that we have in Australia are not sufficiently differentiated as a consumer opportunity."
In a sign of the resources banks are throwing into the disruption threat, CBA last month unveiled an app it said would give customers tips on sensible financial management, even suggesting how they might use a tax refund.
Lance Blockley, managing director of The Initiatives Group, predicts there will be "a lot of tears" for investors when there are so many neobanks all targeting a similar market — and when the big four have much more sophisticated apps than those of the British banks.
"There is really only room for one or two winners, and the rest are likely to fail. This will then provide the major banks with the opportunity to acquire a completely new digital platform at an “in receivership” price," Blockley says.
There are also questions over just how “disruptive” the neobanks really are.
Andy Taylor, chief executive of Douugh, a financial wellbeing app that he plans to float, says the neobank model still relies on selling products such as home loans or credit cards at a price point similar to the major banks. Douugh has a partnership with Regional Bank Australia, so it will not need its own banking licence.
“There’s no disruption in trying to be cheaper, you’ve got to change the business model,” Taylor says.
Plenty of others also show it's possible to pinch business from banks without becoming one. A prime example is Athena Home Loans, a non-bank lender backed by AirTree Ventures, that is on track to have settled more than $500 million in mortgages by the end of this year.
All the same, the neobanks themselves appear confident they can convince institutional investors to stump up the hundreds of millions of dollars they will need, and others in venture capital are more optimistic.
James Cameron, a partner at AirTree Ventures, says: “I would firmly expect that one or a few of the digital bank start-ups coming through in Australia at the moment should be able to break out of their niche market of early adopters and build a mainstream business.”
Whether the neobanks succeed as businesses or not, their ambitions underscore the massive changes facing banks in years to come, as technology transforms how we deal with money.
A recent report from KPMG in partnership with CBA attempted to peer 15 years into the future, and it argued key parts of banking would become “unrecognisable” compared with today.
It pointed to potential examples where customers could set up automated systems that may help with them saving, spending, or investing. It suggested that artificial intelligence would allow banks to give customers “nudges” to avoid making poor decisions with their money.
Whether that is a future in which banking is still dominated by incumbents, or names we have barely heard of, remains to be seen. But whoever is the winner, far-reaching and fundamental changes look inevitable.
“Over the next decade we will see more changes in the banking industry than we have witnessed in the past 100 years,” KPMG’s report said.