NEO Banks: Future of Banking Sector
NEO Bank Overview
Banks have been around for a long time. Banking has a long history in India, dating back to 1750 BC. As people and organisations, we have historically relied on banks for all of our financial requirements.
Banks have provided us with everything we needed, from checking and savings accounts to credit cards, various forms of loans, and insurance and investment programmes. However, with the rise of fintech companies, businesses’ reliance on traditional banks for these services is steadily dwindling.
Neobanks are the general name for these new-age financial service providers. They are unbundling conventional banks with the use of technology. And in what way?
In the fintech world, the term “neobank” has recently become somewhat of a buzzword. A slew of neobanking platforms has arisen in recent years, causing a global uproar. The word has gotten so much traction as a result of the media that it has become a hot subject.
Neo-banking is the current term in the global financial start-up industry. They are entirely online banks with no physical branches. A neo-bank is essentially a collaboration between a fintech business or a non-bank and a bank or financial institution to increase client accessibility. They collaborate with established banks to help them gain new clients in an efficient manner. The non-banks want to deliver a variety of financial and value-added services through this collaboration. The non-bank relies on the partner bank to offer the key regulated services for this purpose.
As a result, the non-bank works as a service facilitator. While a non-bank may help a consumer create a current account or apply for a loan, the actual services must be delivered by the partner bank or an NBFC.
History & Its Expansion
Banking has advanced by leaps and bounds in recent years. Since the rise of neo banking, API banking, and open banking in 2016, the way companies and consumers use financial services has shifted dramatically.
It’s no secret that conventional banks are under growing competition from a variety of sectors of the digital world. Neobanks are quickly developing, leveraging cutting-edge technology to attract clients who want financial services that are easier, quicker, and more efficient. Neobanks have emerged as the next big thing in fintech in recent years.
As a result, we wanted to provide you with a picture of how Neobanks is transforming financial services throughout the world.
Banking is undergoing a fast transformation. Products and services delivered and developed on disruptive technologies are rapidly being placed in the hands of end customers, and bank behaviours in terms of customer convenience, transparency, price, and customer service are changing. The business and operational models evolve in tandem with changes in consumer behaviour and expectations.
Neo Bank Features
Through its technical capabilities and flexible and lean business models, a non-banking service provider may now access every element of the banking value chain, from what customers can utilise and anticipate in terms of banking services. Retail and small and medium-sized company (SME) banking services are largely supplied over the internet or other kinds of electronic channels rather than physical branches under these models. These non-banking service providers are known as neobanks, and they are challenging traditional banks’ current standing by providing lower-cost models and hyper-distinctive customer-centric service and experiences. Neobanks, unlike traditional banks, are not restricted by legacy systems, tightly integrated value chains, complicated administrative structures, or stringent regulatory constraints. Although neobanks do not yet have their own bank licenses in India, they work with partners to provide bank-licensed services.
Some of the features that are appealing to micro and small businesses and underbanked or unbanked customers such as freelancers and gig economy employees include the ease of opening and operating accounts, seamless payments, transfer and remittance solutions, and alternative methods for assessing creditworthiness. Neobanks have given these sectors access to financial services and products that were previously unavailable or came with high costs and tight terms.
What Neo bank Offering:
Neo-banks cater to both consumers and businesses, assisting them with the creation of digital savings or current accounts. The RBI’s recent changes to its KYC requirement will encourage neo-banks to build a completely virtual client onboarding procedure. Neo-banks also allow international payments and simplify money transfers utilising current payment rails. Automated bookkeeping and payment reconciliation are also available through business neo-banking platforms.
Neo-banks frequently operate as direct selling agents (DSAs) for financial institutions, assisting their consumers in obtaining credit lines. Neo-banks are similar to independent marketing agents in that they facilitate leads and connect them with financial institutions as DSAs.
In collaboration with banks, neo-banks frequently provide co-branded credit, debit, and prepaid cards. Because banks must follow outsourcing standards when engaging in co-branding agreements, neo-banks’ participation is restricted to the marketing and distribution of these cards.
Credit cards meet the operating capital needs of small and medium businesses that would otherwise have to go through lengthy procedures to get loans from traditional banks.
What are the challenges for neo-banks?
- Regulatory ambiguity. The Reserve Bank of India does not recognise or regulate fully virtual banks. Some neo-banks opt to work as business correspondents (BCs) for traditional banks, which are generally thought of as institutions that help to expand financial inclusion in rural regions. Companies are expected to have a large number of retail shops in order to function as BCs.
- Technology and security. Before collaborating with neo-banks, traditional banks would want their infrastructure and security processes to meet globally recognised standards. To increase the array of goods supplied and maintain certain services, neobanks would need to improve their systems and procedures.
- Data privacy. The cornerstone of every effective digital product is ensuring data protection. Neo-banks would rely on client data and their capacity to cross-sell goods to stay alive, given the low fees for traditional product offerings. The passing of the Personal Data Protection Bill, India’s GDPR counterpart, may have an impact on this capacity.
Benefits of Neobanks over traditional banks for MSMEs
- Customer experience: Neobanks do not provide innovative banking services. Their services are similar to traditional banks, but with a more improved and personalised client experience. In comparison to traditional banks, neobanks have significantly leaner business models and superior technologies at their disposal, allowing them to provide ease and efficacy in services such as seamless account creation, round-the-clock customer service supported by chatbots, near real-time cross-border payments, and AI and machine learning (ML)-enabled automated accounting, budgeting, and treasury services.
- Automated services: Apart from basic banking services, neobanks provide automated and near real-time accounting and reconciliation services for bookkeeping, balance sheets, profit and loss statements, and taxation services such as GST-compliant invoicing, tax payments record keeping, and reconciliation, all of which are available on mobile platforms at low costs.
- Transparency: Neobanks seek to be transparent, providing real-time alerts and explanations of any fees or penalties paid by customers.
- Easy-to-use APIs: Most neobanks offer APIs that are simple to set up and use to link banking with accounting and payment systems.
- Deep insights: For services like payments, payables and receivables, and bank statements, most neobanks provide dashboard solutions with greatly improved interfaces and easy-to-understand and important information. It is advantageous for organisations with considerable expenditure and a sufficient number of people to be supplied with such insights, as it allows them to save costs while increasing productivity and income.
Regulatory Concerns for Neobanks in India
Virtual banking licenses are still not given in India, despite the fact that some international national banks have Indian subsidiaries that offer digital-only goods. The Reserve Bank of India (RBI) continues to emphasise the need for physical presence for banks and has recently reaffirmed the necessity for digital banking service providers to maintain some physical presence.
The purpose of brick-and-mortar bank branches is to provide personal service to clients and to resolve their issues and concerns. The RBI stated in its 2014 Guidelines for Licensing of Payments Banks that payment banks would not become “virtual” or “branchless” banks.
In India, neobanks are now dealing with the regulatory situation by outsourcing their banking tasks to licensed institutions, forming strategic alliances with traditional banks, and offering enhanced services on behalf of existing institutions. Some of the largest brands in neo banking are already using this approach throughout the world.
Neobanks work with traditional banks to offer corporate and consumer banking services as part of their business plan and to overcome regulatory barriers. The neobank provides financial and banking services to end customers, but monetary transactions are controlled by its partner institutions from a regulatory standpoint.
THE CURRENT REGULATORY REGIME
Virtual banking licenses are not permitted under the Indian regulatory system. The Reserve Bank of India required the necessity for digital banking service providers to have some physical presence in its 2015 Master Circular on “Mobile Banking Transactions in India – Operative Guidelines for Banks.” As a result, neo-banks can only provide banking services by outsourcing their banking functions to licensed banking institutions and non-banking financial firms. Many of these banks and fintech businesses are organised as outsourcing arrangements, with non-banks verifying data for credit requests or doing preparatory work for creating current accounts.
The 2006 RBI Guidelines on “Managing Risks and Code of Conduct in Bank Outsourcing of Financial Services” and the 2010 RBI Guidelines on “Financial Inclusion through Extension of Banking Services – Use of Business Correspondents (BCs)” will regulate this arrangement.
In addition to the aforementioned requirements, neo-banks must follow data privacy regulations since they allow a variety of services between consumers and financial institutions by offering an online platform.
The IT Act and the Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 define the Indian data privacy framework (SPDI Rules).
According to the SPDI Rules, every business that collects or processes sensitive personal data about an individual (such as bank account information and payment instrument details) must:
(i) create a privacy policy
(ii) before collecting the information, give the data subject a required notice/disclosure;
(iii) designate a grievance officer and give contact information;
(iv) allowing data subjects to access and amend their personal data;
(v) guarantee that the data gathered is not kept for any longer than is required by law;
(vi) before collecting sensitive personal information, get the data subject’s prior consent;
(vii)To secure sensitive information, put in place appropriate security methods and standards;
(viii) Ensure that all criteria for the transmission and handling of sensitive personal data are met.
The Indian data protection framework is expected to be overhauled this year, with the government proposing new legislation. A group of specialists drafted the original law, which was submitted to the government in July 2018. Once enacted, the proposed legislation will bring India’s data protection regulations closer to those of the European Union’s General Data Protection Regulation. The measure is anticipated to be introduced into Parliament during the winter session of 2019 or the following session.
VALUE PROPOSITION OF A NEO-BANK
Neo-Banks have played an important role in serving India’s neglected MSME sector. According to an RBI analysis from 2019, the credit gap is projected to be around INR 20-25 trillion. 2 Recognizing this vacuum, neo-banks have made this sector their primary target market, providing financial services that traditional banks have yet to deliver. The neo-banks have streamlined and demystified the credit disbursement procedure, which was formerly a long and tedious process. As a result, the MSME sector has experienced a rise in credit intake, enhancing the country’s financial inclusion.
Apart from making loans more accessible, neo-banks’ main selling point is the value-added services they provide in addition to traditional banking institutions. Some of the most common services provided by neo-banks include facilitating the opening and operation of a savings or current account with a licensed bank, providing access to loan offers or applying for loans, issuance of co-branded cards, payment gateway facilities, personal finance, or expense management, and providing value-added services like invoice generation, accounting, GST compliance, payroll management, enterprise resource planning, and so on.
This kind of service has made neo-banks quite popular among the country’s tech-savvy youth, who prefer banking through apps than travelling to a branch, which may be cumbersome and time-consuming.
THE WAY FORWARD
For a long time, neobanks have not lived up to their full promise. Because words like bank, banker, banking, and banking firm are only used by licensed banks, many neo-bank start-ups mischaracterize themselves as banks. 3 Since neo-banks are not responsible for delivering financial services to end consumers and simply provide an internet platform, there is no direct oversight by the RBI. Neo-banks may encounter operational challenges as a result of their external reliance on their banking partner and onerous partnership commitments. The danger of complex cyber security events and cybercrime is increasing, posing new safety and security concerns for neo banks.
To address the aforementioned flaws, the RBI should explore direct regulatory oversight of the fledgling industry. It launched a new regulatory sandbox in 2019 to test innovative financial technology. Given their potential to drive broad financial inclusion, a similar regulatory sandbox for neo-banks should be established. RBI has already experimented with differentiated banks in the shape of payments banks and small financing banks, issuing licenses to these banks to begin operations. In this vein, the regulator could consider awarding digital bank licenses and eliminating the necessity for a minimum number of physical branches.
This would benefit customers by requiring neo-banks to adhere to higher regulatory standards in areas such as data protection, deposit, and lending, among other things. Singapore and Taiwan, for example, have already made progress in developing structures for digital-only banks. It’s past time for the RBI to make use of the technology that underpins these new-age banks and seize the opportunities they provide.
Are Neo Banks Future?
Accessibility, cost-effective various banking and financial capabilities under one umbrella, and personalization are some of the key attributes and services for neobanks throughout the world. Second, FinTechs are developing speciality solutions for blue-collar employees and thin-file MSMEs, which is the way to go.
Neobanking can complement efforts to address the challenges of financial inclusion by bundling banking services with other financial services, such as the opening of bank accounts for immigrants, which can be facilitated through new onboarding procedures that do not require traditional identification documentation. Neobanks might grow by adding additional capabilities and services over time, starting with small goals.
Although digital and neobanks are gaining traction, the majority have failed to demonstrate long-term viability. Nonetheless, they have a lot of potentials to disrupt banking and financial services, and convincing existing banks to invest in new-age technology and re-engineer procedures to deliver smooth and quick client experiences would be the key to
With fierce competition from traditional banks, new-age FinTechs, technology businesses, and non-banking newcomers, it remains to be seen if the market is deep enough for neobanks to expand sustainably and fairly. The key drivers of neobanks’ success will be how they manage critical barriers in terms of legislation and compliance, data and cyber security, smooth API connectivity, and product and service expansion.
How is digitalization changing the banking sector?
The banking and payments sector has undergone a seismic upheaval as a result of digitization and the rising usage of mobile technologies. A recent entry in the digital payments market is the so-called neo-bank, which is a bank that operates solely online and does not have typical physical branch networks.
Despite their name, neo-banks in India are not directly supervised by the banking authority, the Reserve Bank of India (RBI), which does not issue licenses for running virtual banks. However, the recommendations on managing risks and code of conduct in outsourcing financial services by banks’ banks, published 3 November 2006, allow traditional banks to outsource some operations. By prohibiting outsourcing of essential managerial operations, the recently published outsourcing rules for cooperative banks have hampered their capacity to collaborate with neo-banks to serve the unbanked or underbanked sectors.
Indian neo-banks usually partner with traditional banks to provide a variety of goods and services, such as a digital platform for accessing banking services, co-branded cards, and payment solutions. Indian neo-banks are unable to provide key banking services because banks are not permitted to outsource core management functions such as internal audit, compliance, and decision-making functions such as determining compliance with know your customer (KYC) norms, sanctioning loans, and investment portfolio management.
While the contract would control the outsourced duties, the banks will have the final duty of ensuring compliance with applicable legislation. As a result, we may see banks contractually impose compliance with the recently issued master directive on digital payment security measures on neo-banks, which must also comply with existing data protection rules as an intermediary under the Information Technology Act of 2000.
Neobanking in India
Neobanks are completely digitised across the world. However, in India, restrictions prevent banks from being completely digital. Neobanks are fintech businesses that offer services that are built on top of traditional banking services.
Neobanks have arisen in India as a complete support system for banking and financial services, as well as small and medium-sized enterprises. However, the RBI’s regulatory regulations do not agree or disagree with the factuality of completely digitised online banks, implying that neobanks in India aren’t entirely digital.
The Reserve Bank of India (RBI) outlawed all kinds of cryptocurrencies in 2018, claiming that crypto transactions posed a security risk. Other technological advancements, such as online currency and related financial services, appear to have come to a standstill. Because regulatory requirements are unclear, this has placed a damper on the persistence of innovative business concepts.
However, RBI introduced a new policy in August 2019 that encourages budding fintech businesses to explore new fintech ideas in a limited ecosystem.
Neobanks have elevated commercial banking to new heights thanks to their broad variety of services for firms.
Payouts and disbursals are typically tedious and time-consuming operations that firms must deal with. Due to defective software and complicated infrastructure systems, these operations take several hours of manual labour.
Conclusion
The RBI launched payment banks in 2014 to expand financial inclusion by providing modest savings accounts and payments or remittance services to the underbanked people in a “secured, technology-driven environment.” The Reserve Bank of India emphasised that payment banks are neither virtual nor branchless banks.
In light of the pandemic’s onslaught, the RBI should consider completely adopting virtual or branch banking services and subjecting them to proper checks and balances under the RBI’s supervision.
Fintech firms all around the globe, particularly in banking and financial services, have over 15 million customers, with neobanks acquiring more than half of them.
The low-cost business model of neo banking platforms has led in widespread acceptance by small and medium-sized businesses, as well as firms with unpredictable incomes and earnings, and businesses that embrace new technology.
The rapid acceptance of neobanks has piqued the interest of investors, corporations, and venture capitalists all around the world.