Neobanks vs niche banks

The neobanking industry is estimated to be worth $300 billion, with 400 neobanks around the world. Despite mass consumer adoption and lots of attention, and capital, from investors, only 5% of neobanks are profitable. In my previous article I discussed the emergence of the niche banking trend. Perhaps thinking "smaller" is the solution neobanking needed to reach profitability?

Product-market-fit

In neobanking I would argue product-market-fit could be divided into two scenarios: “free-product-fit” and “margin-product-fit”. The “free-product-fit” is focused on growth and not profitability. Neobanks such as Revolut, Monzo and N26 nailed the “free-product-fit” and achieved impressive user adoption and growth in Europe. But they don’t have the profits to show for it. Interchange revenue from card programs is the main revenue source for top neobanks and no bank can survive, or turn a profit, on interchange revenue alone.

“Margin-product-fit” refers to products offered with higher margins, such as loans, insurance and investment products. The reason neobanks have not figured this out yet? They try to serve a wide range of different segments in the market with the same “margin-products” and ultimately only fulfil the needs of some. Leaving the majority of the customers with unmet needs, confused, and having to use many different providers for their financial service needs.  Considering this, does serving a niche segment in the market increase the chances of success for a digital bank compared to a one-size-fits-all approach currently adopted by the majority of neobanks?

Brex is a recent example that deciding to drop a customer segment in order to serve its core customers better.

Lower barriers to entry

Why do we see more digital banks popping up? Barriers to entry are constantly lowering. The evolution of banking-as-a-service has lowered the barriers to entry for niche banks since licensing could be obtained “as-a-service” and therefore the cost and time associated with the regulatory burden have been decreased significantly. This allows digital banks to go-to-market much faster, with much less capital and not needing to aim for world domination to keep the lights on.

Running a niche bank can be attractive for many reasons

• Niche banks tend to have a lower risk since they have a narrower focus on geography and product, and they understand their customers better.
• They can be more efficient in addressing the needs of their customers.
• Niche banks can react better to changes in the market, be it tax incentives introduced by the government or student loan forgiveness policies.
• They imbue stronger brand loyalty with their specific target group.
• Lower operational overhead supporting a wide user base.

Where can niche banks get it right where neobanks have gotten it wrong?

The neobanking space is saturated and competition for customer attention is fierce. Neobanks’ “one-size-fits-all” approach leads to a lack of segment focus. The growth numbers are impressive and were sufficient pre-2022 to attract VC-money. Neobanks had an absence of monetization strategies, and it’s become clear great UX and metal cards are not going to pay the bills.

Niche banks can leverage the infrastructure and off-the-shelf solutions which is now at their disposal, and rather than focus their efforts on the tech stack, they can focus on identifying the right customer segment, the unmet needs of the segment and which high-margin products will help them reach profitability. A geographic focus can help them grow with network efforts rather than wanting to expand over borders, like neobanks, which often involves underestimated complexity, compliance and regulation – which equals more cost and less profit.

More importantly setting up a niche bank can be done at a fraction of the cost neobanks were set up 5-10 years ago. In the same way, Shopify has made it easy for e-commerce players to launch, the infrastructure is there to launch a neobank in a matter of weeks.

Interesting examples of niche banks

1. Mercury – serves startups

The unmet financial needs of startups are clear and Mercury moved right into that space: Offering venture debt when no bank offers loans to unporfitablile businesses, regardless of stage; earning interest on idle cash because in a start-up every cent counts; seamless integrations to Stripe and Quickbooks to automate processes and reduce unnecessary admin.

2. Cheese – targets the Asian-American community

Cheese eases the process to open a bank account for immigrants and helps Asian-Americans support each other by offering cash-back rewards when shopping at Asian-owned businesses.

3. Daylight – built for the LGBTQ+ community

Daylights allows users to choose a name for their card and app, regardless of the legal name. Cash-back rewards for spending with businesses in the community and automated savings for gender-affirming procedures. It also creates a community for conversations around financial literacy in a safe environment.

Rehive is all about making it easy to launch your own neobank, niche bank, or fintech app.  Create a sandbox project and try it out.