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