Insights + Resources

February 11, 2020

Neobanks: Can They Challenge the Big 4?


‘Neobanks’, also known as ‘digital banks’ and ‘challenger banks’, are terms which synonymously refer to the next wave of banks that are 100% digital. These entities, with a heavy focus on and expertise in financial technology, provide similar financial services and products to traditional banks, but as a purely online service without physical branches.

A “banking business” is defined by the Banking Act 1959 (Cth) (Banking Act) as a business that is carried on by a financial or trading corporation and consists, to any extent, of either both taking money on deposit and making advances of money, or other prescribed financial activities (currently the provision of a purchased payment facility within the meaning of the Payment Systems (Regulation) Act 1998).

Neobanks have already established a legitimate presence in the Australian banking market; the banking brand 86 400 (named after the number of seconds in a day) launched in June 2018, and has obtained a full banking licence. Other rising neobanks include Volt Bank, Xinja and Judo Bank. These neobanks are leading the digital banking trend and are widely expected to disrupt and transform the financial services industry in Australia.

What has enabled these banks to launch?

Neobanks have a banking model that differentiates them from traditional banks. This includes lower costs, higher interest rates on savings, intuitive user interfaces on their customer-facing digital platforms and use of advanced technologies, such artificial intelligence. Their technology-heavy model not only significantly reduces employee count, but incorporates progressive methods of managing customer interactions.  This currently includes, for example, user features to track savings goals, notify the user if they are spending too much and provide with suggestions as how to manage savings. Digital banks aim to transform the relationship between bank and customer, providing a more tailored, intuitive and cost-effective experience.

Are neobanks licensed?

There are two licences neobanks can be granted, both of which dictate the types of services and products they can legally offer:

  • Authorised Deposit-Taking Institutions (ADI) licences
  • Australian Financial Services (AFS) licences.

They are the same licences under which Australia’s four major banks are currently regulated.

  1. Authorised deposit-taking institutions (ADIs)

ADI licences are regulated by the Australian Prudential Regulation Authority (APRA), Australia’s independent authority that supervises financial institutions. This licence allows neobanks to hold money on behalf of retail depositors, offer deposit accounts and hold money on behalf of customers. Money held under an ADI is protected under the $250,000 Financial Claims Scheme (FCS) that protects customers’ savings.

Restricted ADI licences were offered by APRA in 2018. They are provisional accreditations allowing neobanks to conduct a ‘limited range of business activities’ for two years whilst they grow their business. However, a number of neobanks have now received full ADI status, including:

  • 86 400, in July 2019
  • Judo Bank, in April 2019
  • Volt Bank, in January 2019
  • Xinja, in September 2019 

ADIs are primarily governed by the Banking Act, Reserve Bank Act 1959 (Cth), Financial Sector (Shareholdings) Act 1998 (Cth) and Corporations Act 2001 (Cth) (Corporations Act).

  1. AFS Licences

An AFS licence is compulsory for Australian businesses that provide regulated financial services under section 911A of the Corporations Act. The requirements for receiving an AFS licence are more stringent than being granted ADI status, demanding neobanks to demonstrate experience and proficiency in the operation of their financial services.

86 400 and Volt are two neobanks that have successfully obtained the full AFS licence. AFS-licensed neobanks are governed by the Australian Securities and Investments Commission (ASIC), which regulates the operation of their risk management strategies, conduct, managerial competence and resource quality.

Neobanks vs the Big 4 – Will they revolutionise the banking industry?

 In Australia, banking is dominated by the so-called “Big 4” banks: Commonwealth Bank, Westpac, ANZ and NAB. In 2018, the Big 4 accounted for 80% of Australia’s deposit and home loan markets, and they are among the world’s most profitable banks.

Despite their current dominance, the Big 4, with their legacy systems and institutional practices, are not well placed to compete with nimble, technology-led competitors offering a product that young consumers, in particular, increasingly expect and demand.  Further, the reputations of the large banks as trusted brands, to varying degrees, has been damaged, at least temporarily, by the well-publicised findings of the 2019 Royal Commission into banking.

Whilst neobanks are anticipated to seriously impact traditional banking models in the future, they have numerous challenges to overcome before infiltrating the mainstream financial services industry. Neobanks face higher costs in accessing money than traditional banks, and their higher customer interest rate offers may reduce profit margins. Nevertheless, neobanks have already established themselves in the global banking industry; in the UK, Monzo is valued at $3.6 billion, placing it at the second most valuable fintech start-up in the UK. A quarter of persons under 37 years are registered with neobanks in the UK, perhaps providing an insight of neobanks’ projected growth in Australia.

Concluding remarks

According to a KPMG and Commonwealth Bank report, within 15 years key parts of Australian banking are set to be totally transformed. With their lower operating costs, better return on savings and modern approach to customer services, neobanks are seeking to be the agents of this change. In the Big 4 banks, they face massively entrenched and resourced institutions, albeit ones that are not digitally nimble and whose practices have been questioned by the 2019 Royal Commission into banking.

If you have any questions involving the legal and regulatory requirements of neobanks, please contact us below.

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