The fintech funding boom of the past several years saw huge amounts of capital flowing into so-called neobanks, digital financial companies offering banking services to markets general and niche.
The overarching idea behind the push made sense — many traditional banks are IRL-first and digital second, and their brick-and-mortar way of doing things engendered costs that were passed on to consumers. So why not build a new bank, a neobank, that uses tech to augment a meager staff, eschews buildings, and passes along savings to customers instead?
With the help of some existing banks’ regulation-ready systems, neobanks could spin up cheaply, and quickly begin collecting revenue — thanks to the power of interchange fees — in the form of small slices of customer spending. It was a pretty good idea, frankly, and like any such idea, attracted a host of founders and financial backers.
But after a period of epic fundraising and a few exits, sentiment seemingly shifted against the model. How many neobanks could the market really support? Had some of these gone too niche in their work to segment the market more finely and tune their products?However, there’s some good financial news brewing — new data indicates that at least some of the larger and better-known neobanks are going to be OK after all.
Chime, Starling and Monzo
While the neobank model has lots going for it (who doesn’t want low-cost banking solutions built for the smartphone era?), the companies that came up in the space racked up large losses for a long time. They were losing so much money that when we covered neobanking results from the UK in 2020, where they are required to share more than most American neobanks, we were a bit shocked at the scale of the losses.
The earliest indicator of neobanks’ ability to climb up out of the red was Chime becoming EBITDA-positive in late 2020. And by August 2021, more neobanks were occasionally profitable or improving economics to the point that they were looking healthier as a cohort.
New data from UK-based consumer-focused neobank Starling concerning its financial year ended March 2022 paints a more positive picture of neobanks, at least in certain contexts.
Per the report, the following numbers from the company’s past two financial years make Starling’s progress clear:
- 2021 revenue: £87.8 million.
- 2022 revenue: £188.1 million.
- 2021 pre-tax loss: £13.7 million.
- 2022 pre-tax profit: £32.5 million.
As Starling’s revenue improved, so did its profitability. Now you might think, doesn’t that always happen? As it turns out, no. Improving profitability and revenue is called operating leverage, and it’s not as pervasive as you might think in startup-land.
That’s because many startups push harder on the accelerator pedal as they grow, and spend a lot to buy future growth. Venture investors love this, as it allows them to effectively compress corporate growth cycles until they fit inside the time period required for their funds to return money to their own backers.
Starling, however, is showing that even in competitive neobanking markets like the UK, operating leverage is not only possible, it’s workable to the point of real, no-bullshit profitability. That’s encouraging! We now have evidence that major neobanks in both the United States and a previously European country could make it.
That doesn’t mean that all neobanks will, however. Monzo reports that its June 2022 run-rate revenue reached £270 million. However, it’s “underlying loss before non-recurring items” widened slightly to £119.0 million in the financial year ended February 2022 from £116.2 million a year earlier.
But even with the bigger loss, Monzo had some good news to disclose:
The balance of revenue to costs continues to move further in the right direction. So while our underlying costs increased 30%, revenue hit new highs and grew by 92%, highlighting the value in our decision to invest.
That’s one way to spin a nine-figure loss, I suppose.
Regardless of how quickly Monzo and its ilk may be able to reach break-even status, the fact that some neobanks are going to make it is likely welcome news to investors still betting on the category. And many are. Don’t forget that Stash just got $270 million, Open just raised again, Fi was looking at a new valuation recently and others got checks earlier in the year.
I do not know whether those deals came to be because neobanking economics are working out in some cases, but it wouldn’t shock me if that was the case.
What we can say today, condensing the above into a single nugget, is that some neobanks are going to succeed, at least when it concerns profitability. The question now is how many, and what fraction of the total market they will represent. I bet you it’s less than half.
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