While some
These companies, which include SoFi and Qapital, are changing their business models and shifting away from a reliance on interchange fees. They are getting further into lending, charging subscription fees and offering investments, for instance.
"The question is always the revenue model," noted Wei Ke, a partner at Oliver Wyman.
The lending approach
Some challenger banks will need to offer loans to achieve profitability, the way traditional banks do, industry watchers say.
"At the end of the day, the main business of a bank is to take in cheap deposits and lend money, that's the most profitable model," said Robert Le, fintech analyst at Pitchbook. "The Chimes and the Varos will have to get into lending."
Starling Bank in the UK announced profits for the first time last year, largely by building a large loan book, Le noted.
"SoFi just announced earnings and it's still losing money, but on an EBITDA basis it's positive," Le said.
SoFi, which started out as a provider of student loan refinancing and then broadened out to a full-spectrum challenger bank, seems to be reaping the benefits of the bank charter it acquired with its purchase of Golden Pacific Bancorp, which was completed in February. Instead of immediately selling the personal loans and mortgages it makes, it is now holding them longer and obtaining more interest income. SoFi's net interest income was $122.7 million for the quarter, a significant increase from the $95 million it earned in the first quarter.
It is also holding the deposits it gathers in its checking and savings accounts, rather than having that money held by a bank partner. This provides a low cost of funding for its loans.
Among other U.S. neobanks, Varo is the most likely to start lending soon, because it has a banking license, Le predicted.
The San Francisco company has
The company reported improvements in its second-quarter results. Revenue was $23.8 million, up 8% from $22 million in the first quarter. Losses were $77.1 million, a decrease of 9% from $84 million in the first quarter.
Varo declined a request for an interview for this article. In a written statement, the company said its banking charter "gives us autonomy and total control of our costs and infrastructure. … We can gather deposits, lend and invest based on that capital, which others can't do."
Subscription fees
Some neobanks, such as Qapital in New York, charge a monthly subscription fee, borrowing a page from Netflix's book. Qapital has a tiered pricing model of $3, $6 or $12 per month.
Ke sees promise in this model.
"If you're not trying to nickel and dime based on transaction or based on some kind of an incident like an NSF or overdraft, a monthly fee is something that is increasingly popular," Ke said. "It has obviously been widely used in the consumer technology space, from streaming media to many other things like e-commerce over the last few years."
Subscriptions make sense for neobanks that have unique products, he said. Qapital, for instance, keeps adding new features.
"They have a unique proposition," Ke said. "They can tell a story about helping to save money better. Then it logically makes sense to have a monthly fee attached to it because it's a long-term relationship that they're building with the user to help them save better." Qapital is about to turn a profit, Ke said.
Pitchbook's Le, however, pointed out that many of the consumers that use neobanks have lower incomes.
"Those customer segments don't like to pay for bank fees," he said. "There are many free options out there."
Other fees
In addition to interchange fees, there are also added transaction-level fees that neobanks like Chime can charge, Ke pointed out, for instance for payday advances.
Another opportunity for neobanks and other fintechs is to offer software as a service.
Starling Bank in the U.K., for instance, has built a tech platform for its own bank that it rents out to others as software as a service, Le pointed out.
"SoFi does that as well," he said. "They have loan books and tech platforms that they turn into a [software-as-a-service] product. That's another revenue source."
Offering investments is another way neobanks could try to obtain revenue.
"Over time offering investment products would help, but those things are expensive and the unit costs are tight," Le said. "It will take them a lot of money and it's not a highly profitable business." Acorns, Stash and Qapital all offer investing services.
As they step up their fees, neobanks will have to be careful or they could undermine the very reason many of them were formed: to give consumers less expensive basic banking.
Ke says this is a matter of positioning products properly.
"Certainly, if you say that you are feeless, then you're constrained by that marketing slogan," he said.
Neobanks also can't suddenly start charging for services they used to provide for free. Bank of America learned this lesson in 2011, when it decided to start charging $5 a month for its previously free debit card. The bank had to retrench amid customer opposition.
Scaling up
Another path to profitability, according to Rex Salisbury, founder and general partner of Cambrian Venture Capital, is for neobanks to get to massive scale, so they can invest in the brand on a national level. Salisbury recently started a new fund for fintech startups that invests mainly in B2B fintechs.
Nubank in Brazil, for instance, is one of the most valuable neobanks in the world, he said. It has attracted more than 45 million customers.
Salisbury is also interested in Walmart's neobank
A recent report found that less than 5% of challenger banks are breaking even. Will these startups be able to achieve profitability before investors’ patience wears thin?
Walmart's massive reach answers the problem of distribution, Salisbury reasoned.
"How do you get affordable distribution in financial services?" he said. "Walmart is the largest employer in the country." Though the model for its so-called "super app" has not been proven out, "they have unique distribution and a good product, whereas some of the others have good products, but not necessarily differentiated and with real affinity."
"There are certain businesses that have struggled for a long time until they've gotten to a place where they're able to comfortably scale advertising and do national campaigns," Salisbury said. Credit Karma, for instance, hit scale when it started running national TV campaigns and driving its customer acquisition cost down.
Some of the niche neobanks targeting groups of customers such as immigrants will have to offer a differentiated product or differentiated distribution to succeed, Salisbury said.
But many observers see hope for neobanks.
"Do I think these neobanks are doomed? I don't think so, especially those with millions of customers," Le said. "Over time they could reach profitability."
