11 Mar 2021
When I was employed in supermarket food retailing, we used to look enviously at what we perceived were the much larger margins bankers were earning on their products. So much so, to console ourselves, we would tell anybody who would listen about the “banker’s 3-6-3 rule”.
The famous rule was: “they take money in at 3 per cent, lend it out at 6 per cent and are teeing off on the golf course by 3PM”.
"Any aspiring bank needs to be able to take the rough with the smooth in terms of lending, but unless you lend the deposits you are taking in, there is no business case for continued existence.”
This perceived banking ‘margin’ and the profits it seems to generate are partly why so many non-banks have aspired to become banks over decades. These challengers range from retailers like the United Kingdom’s Tesco, disrupter brands like Virgin, tech giants like Microsoft, social media platforms such Facebook - and now the so-called “neo-banks” emerging from the fintech phenomenon.
Fintech – financial technology specialists – have long been around but since the global financial crisis (GFC) their prominence has surged, facilitated by venture capital, new technologies including artificial intelligence and the use of apps on smart phones. The COVID-19 pandemic turbo-charged the shift to digital purchases and payments, further amplifying their profile.
The 2020 Accenture Global Banking Consumer Survey, which obtained feedback from over 47,000 consumers from 28 different markets, revealed there was an increase in neo-bank adoption (23 per cent of survey respondents in 2020 maintaining a neo-bank account, compared to only 17 per cent back in 2019). However, the number or percentage of people that actually use their neo-banking accounts as their main account remains quite low at just 12 per cent.
The research study noted that consumers’ overall interest in neo-banking service providers is now fairly moderate, with customers claiming that these platforms offer more convenience, simplicity and potential cost savings. Notably, the survey respondents said they were most pleased or content with personalized offerings from neo-banks (or their brands in general), instead of their “novel” features.
Some neo-banks who target particular sectors of the banking market have prospered. However, others with wider aspirations failed to take advantage of the opportunities and have underperformed, even to the point of exiting the financial services market once the perceived margins failed to appear.
That’s the story globally but is there something more to what works and what doesn’t besides the normal high failure rate of start-ups?
Failure to launch
Various reports on the fintech industry in Australia have noted the emergence of hundreds of start-ups but less than a dozen that would be classified as “neo-banks”.
For example, EY’s 2020 Fintech Census noted “neo-banks (are) striving to build their customer profile… The last 12 months saw growth in the neobank sector with offering of loans and new services. While there is early enthusiasm for the sector, wider consumer knowledge of the benefits of engaging with their offerings will take some time”.
Let’s look at one of Australia’s earliest neo-banks - Xinja. Founded in May 2017, Xinja was one of the first neo-banks to gain a banking license from the Australian Prudential Regulatory Authority (APRA) in September 2019. By late December 2020 it had abandoned its model.
Xinja’s headline product for depositors was a high interest savings account originally paying an interest rate of 2.25 per cent – it was aptly named “Stash”. This product did initially attract a considerable amount of money with APRA figures showing $A413 million in resident deposits at the end of October 2020 – looking good on the first three of the 3-6-3 rule.
However, Xinja never launched any borrowing products, meaning there was no revenue stream from lending money out. As bankers know, lending money out is a risky business. Do you lend to individuals, organisations, governments? Are these loans based on tangible assets such as mortgages or are they on speculative ventures like new businesses? There may well be good returns but there will be also be bad debts.
Any aspiring bank needs to be able to take the rough with the smooth in terms of lending but unless you lend the deposits you are taking in, there is no business case for continued existence.
In short, you will always miss the six in the 3-6-3 rule.
Keeping up with risk
A similar story can be told of the British neo-bank Monzo. Launched in 2015, a short five years later it had over 4 million customer accounts with deposits of around £1.4 billion. However, by early 2020 Monzo had only made £124 million of loans and advances and, of that, only £68 million was actual loans with the remaining balance made up by customer overdrafts.
In this sense, Monzo’s business model is equally as challenged as Xinja’s. It failed to develop any substantial revenue generating products to offset the costs of doing business. In Monzo’s annual report for the 2019 UK financial year a £113.8 million loss was reported with the directors report stating: “The Directors recognise there are material uncertainties that cast significant doubt upon the Group’s ability to continue”.
In the same annual report, Monzo’s auditors also note: “the pace of improvement in governance and control is not keeping up with the pace of growth in the business and the accompanying risks”.
Small- and medium-sized banks in the UK have long argued high regulatory costs make it particularly difficult to both start and grow. The Prudential Regulation Authority (PRA) has said it would consider new ways to “create a smoother path” enabling smaller banks to grow. However, at the same time it warned new entrants must not “underestimate the development required to become a successful, established bank” and called for clearer paths to profitability and stronger governance.
Ups and downs
Neo-banks and fintechs in Australia have also long argued the regulatory system is biased in favour of incumbents but there are examples of successful new entrants - usually those with a focused and viable business model.
Judo Bank, which was formed in early 2018 and licensed by APRA to operate as an authorised deposit-taking institution (ADI) in April 2019, now has nearly $A3 billion in loans to over 800 borrowers backed by a $A2 billion deposit book from some 9,000 depositors.
Their model is to provide banking services to a target market of small- to medium-sized enterprises (SME). Judo employ and enable banking professionals to deliver a ‘personalised’ service through the appropriate use of technology. The timeframe both for their own business and that of their customers is medium to long-term with an acknowledgement that success will require ‘fortitude’ from all participants given there will inevitably be ups and downs.
The life cycle of a neo-bank is in this sense very similar to that of a typical SME. Establishing the business will be exciting and, for many, a new experience. But nevertheless, there may be casualties with only the strongest making it to adolescence. Some of the successful may then be acquired either to be copied or left to wither on the vine if their business model is too threatening to income streams of incumbents.
Ultimately, size and scale do matter in banking and for customers, regulators and governments the big banks are simply just too big to fail. The challenge for the challengers is how to overcome the converse of that sentiment, namely that the small are too small to save.
Steve Worthington is a bluenotes columnist and professor at Swinburne University Business School
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
11 Mar 2021
25 Nov 2019