Neobanks: Rapid Growth Or a Slow Burn?

Home , Transaction account, Ubank, Volt Bank, Xinja

July 2019 | FINTECH

Neobanks: rapid growth or a slow burn?

Revolut’s recent Australian launch marks the first neobank taking on the local market, with several others waiting in the wings.

Despite a willingness to consider using neobanks, Key takeaways particularly among / Revolut, one of Europe’s fastest-growing fintechs, has younger consumers, launched in Australia, with a staggered rollout expected over the next few months we expect market / Over 20,000 Australians have registered their interest in share growth to be Revolut to date, while local neobanks Volt, Xinja and 86 400 are relatively slow as a ramping up their operations / Neobanks typically offer a range of customer-centric result of low churn, a features, such as categorised spend tracking, payment rounding and access to the inter-bank exchange rate for foreign transactions lack of trust and / Venture Insights’ recent fintech survey suggests appetite for strong offerings from neobanks is high, particularly among younger consumers, with the incumbents. 63% of 18-44-year olds surveyed willing to consider using a neobank / However, uptake will likely be slow as a result of a lack of

trust and low industry churn, with 59% of survey respondents indicating they had not switched banks in the last 10 years / The major banks have responded strongly, with NAB’s UBank and Adelaide and Bendigo Bank’s Up leading the charge with compelling digital and mobile-first offerings. Separately, the incumbents will continue to invest in digital acceleration strategies

A compelling proposition

Neobanks are fully digital, typically mobile-first, branchless banks that provide a suite of financial products with a customer-focused approach. For an overview of the neobank proposition and an analysis of their opportunity to disrupt the banking landscape in Australia, please refer to Venture Insights’ October 2018 report titled “Neobanks – The David against banking Goliaths?”. On 13th June 2019, Revolut, a leading European neobank, launched in Australia to significant fanfare, and has garnered over 20,000 registrations of interest to date. As the first major international neobank to launch in Australia, Revolut is well-placed to capitalise on a growing interest in alternative banks in Australia, particularly in light of the recent Banking Royal Commission. Within this context, in April 2019, Venture Insights conducted a survey of 1,009 consumers across Australia on their views on and willingness to use neobanks.

A European ‘giant’ Revolut was founded in London in 2015, as a response to excessive foreign exchange and transaction fees. Its initial product offering, a multi-currency virtual wallet, allowed users to convert between USD, GBP and EUR and transfer money between users at no cost using the inter-bank exchange rate1. In addition, it allowed users to freely spend using a MasterCard debit card in an additional 20 supported currencies2. In the years since, its wallet has expanded to 15 currencies, and it now supports spending in over 140 currencies3. It has also expanded its services to include a cryptocurrency wallet and has integrated spend tracking and categorisation features.

Figure 1. Total funding raised by European neobanks (US$, to March 2019) 1,000 1,000

800

600 515 470 361 400

277 US$ millionsUS$ 180 200 98

0 OakNorth N26 Atom Bank Revolut Monzo Starling Solaris Bank Bank SOURCE: Medici

It quickly gained a strong following, particularly among frequent travellers looking to avoid exorbitant foreign exchange fees. More recently, it has attracted a broader audience, driving growth at a rapid pace. It now has over 4 million registered customers globally, up from 2.8 million in October 20184. This customer growth has been mirrored by its expanding valuation – it was

1 The rate at which banks exchange currency with each other, also referred to as the mid-market exchange rate. This rate is typically significantly better than that offered by most consumer-facing services, where a large spread, or a percentage-based exchange fee (often 3%), is usually taken.

2 TechCrunch 3 Revolut 4 Quartz

valued at US$1.7 billion at its most recent capital raising in April 2018, up from US$350 million just 6 months earlier5. Revolut has now raised a total of US$361 million, placing it among the most funded neobanks globally.

The customer proposition in Australia Revolut’s entry in Australia marks the first global neobank to launch locally and signals an escalation in the fintech assault on traditional banking – at a time when dissatisfaction with the major banks is at a high. In Australia, Revolut will be offering a disruptive suite of features including money management tools, security features, and the aforementioned currency exchange and foreign transaction benefits. These features are comparable or superior to those offered by most major banks and even smaller challenger banks.

Figure 2. Comparison of Australian transaction accounts Account Account Fee Multi-currency Foreign Savings Tools wallet Transactions Commonwealth $4/month or none N/A $5 withdrawal fee Spend tracker and Bank Smart Access if at least $2000 + categorisation per month 3% of transaction Transaction deposited or withdrawal notifications value Westpac Choice $5/month or none N/A $5 withdrawal fee N/A if at least $2000 + per month 3% of transaction deposited or withdrawal value ING Orange None N/A Full rebate of Spare change round Everyday withdrawal and up transaction fees if conditions met UBank USaver Ultra None N/A Free overseas Daily budget tracker ATM withdrawals Sweep Technology No foreign to move excess transaction fees funds to savings account Revolut Standard None No fee exchange Free overseas Vaults to track Account in 15 wallet ATM withdrawals savings goals currencies, up to up to $350/month Spare change $9,000/month No foreign roundup transaction fees Category-level monthly budgets Real-time budget progress tracking Spend analytics tools SOURCES: Bank websites

One area that Revolut fares poorly is in terms of savings interest rate – larger banks typically offer linked savings accounts, allowing users to easily move money from no-interest transaction accounts to higher-interest savings accounts. Revolut, for now, does not offer such an option. However, in a very low interest environment, this is increasingly irrelevant – with major banks offering rates between 1.4% and 2.2% and often including restrictive balance and withdrawal requirements in order to access these rates. Even the category leading UBank offers a historically low 2.41%6 on its combined savings and transaction account.

5 Forbes 6 As of 22nd July 2019

Change is in the air

The year of the neobank? Prior to Revolut’s launch, no independent consumer-facing neobank has offered a banking product in Australia. Nonetheless, behind-the-scene machinations are well and truly underway. In January, Volt Bank became the first neobank in Australia to secure a full Authorised Deposit- Taking Institution (ADI) license and has claimed it will be launching banking products this year. 86 400, owned by payments processor Cuscal, received its full ADI in mid-July, while Xinja secured a restricted ADI7 in late 2018. In the enterprise space, SME lender Judo Bank has made significant strides, receiving its full ADI in April and raising a record $400 million in its recent capital raising. Revolut has, at least initially, opted not to apply for a banking license, and will instead partner with a traditional bank to hold customer deposits. However, its behaviour in Europe would suggest that it is a matter of when and not if. Moreover, other international neobanks, such as Atom Bank and N26, may take heart from Revolut’s impressive level of interest and make their own local launch plans, while local upstart Douugh, founded by SocietyOne co-founder Andy Taylor, is in the process of listing on the Australian Stock Exchange.

Consumers are interested but uptake may be slow While neobanks are still perceived as relatively niche players by consumers, their consideration levels are surprisingly high, particularly among younger consumers. Our recent consumer survey suggested that 63% of 18-44-year-old consumers may be willing to consider using a neobank8. Expected uptake in the 45+ year old age group is predictably more muted, although a still-high 46% might consider using a fully digital bank.

Figure 3. Would you consider using a neo bank (digital only bank)?

37% 54% Yes

29% Maybe

29% No 34% 17%

18-44 year olds 45+ year olds

SOURCE: Venture Insights Fintech Consumer Survey 2019 Across the age divide, the main reason for considering using a neobank is an expectation that a digital-only bank would be better value than a traditional bank. This is firmly in line with our primary research on other fintech products, such as online superannuation platforms and robo- financial advisors, where perceived value is a key driver of uptake.

7 In May 2018, APRA established a restricted version of the standard ADI license to assist small players to enter the banking market. The license allows recipients to offer a limited range of banking services for a period of 2 years while they build out their capabilities. 8 Comprised of those who answered ‘Yes’ or ‘Maybe’ to the question “Would you consider using a neo bank (digital only bank)?”

Figure 4. Why would you consider using a neo bank (digital only bank)?9

70% 64% 60% 50% 41% 40% 31% 30% 26% 20%

10% 3% 0% Better value More convenient Better features Don't want to use Other a major bank

SOURCE: Venture Insights Of greater concern to the banking incumbents is the finding that 85% of younger consumers that indicated they may try a neobank might be willing to use a neobank exclusively. Even amongst the 45+ age group, the comparable figure was 75%. As neobanks start to launch more comprehensive suites of products such as credit and loan offerings, cannibalisation of market share may become a real risk to banks across the gamut of financial services products.

Figure 5. Would you consider using a neo bank exclusively (i.e. instead of your traditional bank)?10

16% 26%

Yes

46% Maybe 55%

No 39% 20%

18-44 year olds 45+ year olds

SOURCE: Venture Insights Fintech Consumer Survey 2019

Despite the positive signs, we expect uptake of neobanks to be relatively slow for two main reasons. Firstly, trust levels for non-traditional banking providers are currently low, with around 40% of those unwilling to consider using a neobank citing a lack of trust as a primary reason for this. Building trust is a key challenge that neobanks, and fintech challenger products more broadly, will need to overcome to reach mass market acceptance. We believe that ADI licenses, with their government guarantee of up to $250,000 in deposits per user, may be a catalyst in building this trust, and as such, neobanks looking to enter the market should pursue licenses early in their scale up.

9 Asked to respondents who indicated they would or might consider using a neobank 10 Asked to respondents who indicated they would or might consider using a neobank

Figure 6. Why would you not consider using a neo bank (digital only bank)?11

60% 53% 18-44 year olds

50% 45+ year olds 41% 40% 40% 35% 31% 32% 30% 21% 20% 16%

10% 3% 4% 0% Lack of trust Happy with current Want to wait and Don't want to Other bank see interact online

SOURCE: Venture Insights

Secondly, there is high stickiness associated with consumer banking choices, with 59% of survey respondents indicating they hadn’t changed banks in over 10 years. Furthermore, 53% of 45+ year old respondents that would not consider using a neobank indicated contentment with their current bank as a primary reason for this. These data points suggest that customers may need a strong trigger in order to change from their current bank, whether that is a substantially better product and service proposition or a major life or financial event such as taking out a home loan. Interestingly, in figure 6, there is an age-based divergence with regards to contentment, with younger respondents much less frequently citing happiness with their current bank as a reason to not consider a neobank. This is suggestive of two things: (1) younger consumers have much higher expectations of their banks than older consumers, and (2) loyalty to existing established institutions is likely to be lower in younger age groups. Both of these factors point to the opportunity for neobanks to take market share from the incumbents, particularly among younger consumers.

The incumbents’ response

There is no doubt that the incumbent financial services providers are acutely aware of the threat that neobanks pose and have responded in kind. Some major banks, such as NAB and Adelaide and Bendigo Bank have launched their own challenger bank spinoffs (UBank and Up respectively), which offer digital-only customer-facing platforms while still relying on the traditional banking infrastructure of their parents. These platforms often provide a strong value proposition, with few or no fees, relatively high savings rates and mobile wallet support. Consumers have thus far embraced these ‘digital banks’, with Up announcing it had achieved 100,000 customers in its first 8 months of operation12. Another alternative is acquisition. There are a number of examples internationally, especially in Europe, where established banks have acquired neobanks. Spanish giant BBVA has a near-40% stake in Atom Bank, with rumours of a full acquisition persistently popping up, while the French BPCE fully acquired German neobank Fidor in 2016. This option would allow an incumbent to quickly establish a presence in the neobank space, while often gaining technical know-how that

11 Asked to respondents who indicated they would not consider using a neobank 12 Up

they are able to integrate into their mainline product offerings. Despite these instantaneous benefits, traditional banks and neobanks can differ substantially in terms of culture and operations, which can lead to sometimes untenable friction. Indeed, recent reports suggest that BPCE’s late 2018 decision to sell Fidor was due to irreconcilable differences in culture and strategy between the two hundred-year-old incumbent and the upstart challenger13. A final, more conservative approach involves incumbent banks building out their own digital capabilities in order to provide offerings comparable to those provided by fintechs. Market leader Commonwealth Bank of Australia, for example, expects to spend more than $5 billion on technology investment over the next 5 years, starting with a relaunch of its popular smartphone app with advanced analytics and personalisation features14. Such a strategy allows banks to increase digital investment incrementally, while retaining their core operational structure and culture.

Conclusion We expect that several local and international neobanks will look to enter the Australian market over the next year, following Revolut’s lead. While consumer interest in these offerings is high, particularly among younger consumers, we expect that uptake (and market share erosion of the incumbents) may be slower than expected as a result of a lack of trust and low industry churn rates. A potential strategy for neobanks may be to aim to be consumers’ secondary banks of choice, at least initially. As neobanks gradually build trust and consumers start to see the benefits of neobank offerings, consumers may be willing to move more of their financial activity away from traditional banks. Of greater concern to the challengers, we expect that traditional banks will increasingly encroach on the neobank proposition with innovative brands such as UBank and improved technical capability in their core products and services. The majority of neobank features are in fact relatively imitable, and incumbents, with greater scale and deeper pockets, may be able to replicate many of the technology-based features on which neobanks are planning to differentiate themselves. This possibility poses somewhat of an existential threat – if neobanks are unable to maintain a technological edge over the incumbents, they will have to find an alternative differentiator in order to entice consumers to their platforms. One strategy that some neobanks have leaned into is the ‘Un-bank’ approach, in a similar vein to T-Mobile’s ‘Un-carrier’ commitment, promising a customer-first experience that is antithetical to the profit-hungry, shareholder-first image of the traditional banks. This strategy is likely to be particularly effective in the wake of the Banking Royal Commission, which exposed many of the ills confronting the financial services industry.

Post-script: What about the tech players? Another threat looms for incumbents and challengers alike – that of the tech giants. In late March 2019, Apple announced its entry into financial services with Apple Card, while Amazon and Google have had their own forays into payment platforms and even credit cards15. There is a possibility that more of these typically well-regarded and tech-forward players will move fully into financial services, possibly even attaining banking licences and competing directly with traditional banks. This could pose a real risk not only to the banks’ payments revenue but, if consumers start

13 Bloomberg 14 Australian Financial Review 15 See Venture Insights’ April 2019 report ‘Apple Card – allowing the fox into the henhouse…’ for a full analysis of the launch of Apple Card

to deposit their savings with these tech companies, to their cheapest source of funding in the form of retail deposits. Facebook, for one, has signalled its intentions by announcing that it will launch a new digital currency, Libra, by the first half of 2020 with the aim of allowing frictionless financial transactions between billions of users around the world. Despite the challenges it is likely to face, Libra will almost certainly disrupt payments providers and banking institutions if it executes successfully on its intentions16. In China, this shift has been underway for more than a decade, where popular payment platforms WeChat Pay and Alipay dominate the payment space and banks have been largely bypassed. We will be releasing a report in the coming months detailing the moves of the big tech players into financial services internationally and how this may unfold in Australia.

16 See Venture Insights’ April 2019 report ‘Facebook Libra – the cryptocurrency arms race has begun…’ for a full analysis of the announcement of Libra

About Venture Insights

Venture Insights is an independent company providing research services to companies across the media, telco and tech sectors in Australia, NZ and Europe, with a special focus on new disruptive technologies. For more information go to www.ventureinsights.com.au or contact us at [email protected]

Important notice: By accepting this research note, the recipient agrees to be bound by the following terms of use. This research note has been prepared by Venture Insights Pty Ltd and published solely for guidance and general informational purposes to authorised users under the terms of a licence agreement between Venture Insights Pty Ltd and its subscriber. You need to be expressly authorised to use it, and it may only be used for your internal business purposes and no part of this note may be reproduced or distributed in any manner including, but not limited to, via the internet, without the prior permission of Venture Insights Pty Ltd. If you have not received this note directly from Venture Insights Pty Ltd, your receipt is unauthorised. If so, or you have any doubt as to your authority to use it, please return this note to Venture Insights immediately.

This research note may contain the personal opinions of research analysts based on research undertaken. This note has no regard to any specific recipient, including but not limited to any specific investment objectives, and should not be relied on by any recipient for investment or any other purposes. Venture Insights Pty Ltd gives no undertaking to provide the recipient with access to any additional information or to update or keep current any information or opinions contained herein. The information and any opinions contained herein are based on sources believed to be reliable, but the information relied on has not been independently verified. Neither Venture Insights Pty Ltd nor its officers, employees and agents make any warranties or representations, express or implied, as to the accuracy or completeness of information and opinions contained herein and exclude all liability to the fullest extent permitted by law for any direct or indirect loss or damage or any other costs or expenses of any kind which may arise directly or indirectly out of the use of this note, including but not limited to anything caused by any viruses or any failures in computer transmission.

Any trade marks, copyright works, logos or devices used in this report are the property of their respective owners and are used for illustrative purposes only. Unless otherwise disclosed, Venture Insights has no affiliation or connection with any organisations mentioned in this report. However, the information contained in this report has been obtained from a variety of sources, including in some cases the organisations themselves. In addition, organisations mentioned in this report may be clients of Venture Insights.

The recipient hereby indemnifies Venture Insights Pty Ltd and its officers, employees and agents and their related entities against any direct or indirect loss or damage or any other costs or expenses of any kind which they may incur directly or indirectly as a result of the recipient’s use of this note.

Level 8 GIORGIO KRINGAS 333 George Street [email protected] Sydney, NSW 2000

NIGEL PUGH Level 6 [email protected] 90 Collins Street Melbourne, VIC 3000 190730 Neobanks: rapid growth or a slow burn? IMPORTANT DISCLOSURES ARE PROVIDED AT THE END OF THIS REPORT Page 9 © 2019 Venture Insights Pty Ltd. All rights reserved www.ventureinsights.com.au