So neo, yet so far!

From a large, profitable, incumbent bank’s perspective, one neo bank might not be a big deal. But when they start mushrooming in every opportunity segment – payments, lending, investment, retail, small business, community-focused, etc. – it is harder to ignore them collectively. Fuelled by a fair amount of posturing by Fintech firms who fancy themselves as incumbent disruptors, the conversation among industry participants is going into overdrive. Is the neo bank the new nemesis? Or a friend in the making? 

My view is that it is too early to come to any conclusion. Currently, the situation is one of co-opetition – part partnership and part rivalry.   

The partnership model – where a neo bank rides on an incumbent’s banking license, operational rails, etc. – is well established. On the other hand, opinion about the competitive aspect of neo banking is still forming and is pretty divided. This article takes a closer look at it in the Indian context.

So far, neo banks’ strategy has been to cherry-pick lucrative parts off the incumbent banks’ business, by pitting their superiority in customer experience and engagement, agility and innovativeness, against the weakness of their big rivals in these areas. Three areas seeing most of the action, which will define the future competitive landscape are – customer acquisition, customer engagement and monetization. 

Customer acquisition:  In a large market like India, a bunch of new players are constantly jockeying for customers, alongside the old guard. The good news is that there is plenty of room for everyone. Consider these market (under)penetration figures: credit card – 4 percent, versus 55 percent in China and 75 percent in the United States; stock market participation (India – 3 percent, China – 13 percent, U.S. – 55 percent); insurance premium as a percentage of GDP (3.8 percent,   4.3 percent, 11.4 percent). Paytm, one of India’s best-known Fintechs cites these figures to emphasize that expanding the market, rather than capturing market share, is a good way to play in the Indian financial services space. 

However, most neo banks seem to be following the same playbook: they introduce a product with an attractive price and great rewards; those with resources, like Cred and Jupiter, create a big advertising splash, while most others try to leverage word of mouth and the network effect. All are out to disrupt a digital-first market that is underserved by incumbent players. 

But, without a clear point of differentiation, most players will fall by the wayside, losing out to the few that are more resourceful and better funded. The firms that have managed to grow organically have done so by building affinity with their target groups or by creating adjacencies. FamPay is a good example of the former, with focused offerings for teens, while Razorpay is taking the latter approach, starting out as a payment aggregator for businesses and expanding into neo banking to capitalize on the opportunity with existing customers.  

Early results highlight the meteoric growth of the top neo banks and a faster customer acquisition rate than that of any incumbent institution. But they are also a reminder that the digital-only propositions of incumbent banks (digibank and Kotak 811) also enjoyed similar success when they were born. Neo banks may be well begun, but they are only half done. 

At present, even the most successful neo banks are playing second fiddle to customers’ primary (incumbent) banks. They have acquired the customers, but now they need to engage, and make money off them.                                                                               

Customer engagement: In its simplest form, digital engagement is the number of interactions a user has with a brand in a given time period. 

Once again, neo banks seem to be using the same playbook to encourage customers to use their apps. Firstly, they are providing their customers with relevant insights to improve financial outcomes. Neo banks are also trying to promote certain behaviors with the help of rewards and gamification. The third engagement tactic is to integrate commerce – booking holidays, buying electronic goods – into banking apps simply because customers spend a lot more time on those primary needs than on a secondary one such as banking. Many incumbent banks are also attempting this through their apps – SBI YONO, ICICI, HDFC among others – in an attempt to catch up with neo banks. 

Thus far, neo banks have benefited from the migration of bank transactions from physical to digital channels. But with the majority of transactions set to move to third-party channels outside of bank ownership, the situation looks less rosy. In this market, where UPI payments have achieved immense success, PhonePe and Google Pay are dominating the market, with traditional and neo banks nowhere in the reckoning. When Account Aggregators and Open Credit Enablement Networks become mainstream in the next few years, even lending transactions could migrate to popular customer apps like Google Pay and PhonePe.  As banks lose more transactions to third-party channels, so will neo banks.

Hence in future, these players will need a plank other than their app/ experience for engaging with customers. They need to find their place in the embedded finance value stream. For instance, can they offer far better “Banking as a Service”  and pricing such that consumer brands like Google, Amazon and Flipkart work with them instead of incumbent banks? Bank Open, one of largest SME focused neo bank, is attempting this with its Zwitch platform. Another way to engage customers is product innovation – churning out unique products that will keep customers coming back for more, albeit through third-party channels. 

Monetization: Making money off engaged customers is a challenging task for neo banks. In western markets, they have relied on the debit card MDR (Merchant Discount Rate) to carve out a part of the payments pie; not so in India, which is primarily an instant real-time payment market running on UPI, which is free of cost. That narrows the revenue opportunities to lending, investment, and referral income from other brands. Although building a lending business is hard, neo banks have the data capabilities, ecosystem partnerships and customer understanding to create opportunities in the form of small ticket, high volume loans, such as BNPL (Buy Now Pay Later). 

But many questions arise. Are neo banks attracting creditworthy customers looking for credit or just better rewards? Would they be able to support low rates beyond early promotion periods? Would their efficiencies be able to cover the additional cost of funds inherent in the neo banking business? Would they be able to charge better rates for convenience?

Entering the investment business is not easy either because the market already has several traditional players, as well as new firms such as Zerodha, Groww and Paytm Money. Neo banks need to identify their monetization options soon and incorporate them right away in their products and services mix, because it would be even harder to charge for something that was previously free of cost. 

 Neo banks are joining the banking industry at an inflection point. The digital divide is widening between the pioneers and laggards. The industry definitions are blurring. The financial services industry is unbundling and re-bundling in many different ways. Neo banks,  challenger banks, and tech giants are all adding a unique dimension. The way to succeed is to use first principles thinking and build the business model around getting customers’ jobs done – to create and deliver differentiated customer value through better offerings, engaging experiences, greater efficiency, and purposeful partnerships. Of course, it’s easier said than done. But anything worthwhile is never easy.