Why are Most Digital Banks Not Profitable? Global Consulting Group Simon-Kucher Has Some Ideas

Global commercial strategy consultancy Simon-Kucher (SK) recently released its survey and white paper on Neobanks, reporting that perhaps only five percent of them are breaking even, with most earning less than USD30 in revenues per customer per year. Titled ‘The Future of Neobanking: How can Neobanks Unlock Profitable Growth’, the consultancy holds out optimism for this growing banking sector, but also offers a healthy dose of realism. Hubbis ‘met’ with Christoph Stegmeier, the Munich-based senior partner in Simon-Kucher’s global banking practice and with Silvio Struebi, Managing Partner of Simon-Kucher's Hong Kong office and head of the company’s banking operations in APAC. Together, they offer their insights into how the neobanking game needs to be played in Asia for any new entrants to survive the inevitable cull or consolidation ahead. They explain that the mission is not only to garner new customers, but to deliver the right products and services and to stimulate deposit, lending and transactional activity. They consider that Asia’s authorities are issuing sensible numbers of licenses and that the region’s central banks want to drive these new entrants towards profitability as soon as feasible. They concede that there will be failures along the way but that for those that have the right approaches, the rewards will flow.

Simon-Kucher is a global consulting firm specialising in helping clients to achieve growth and profitability targets by applying practical, evidence-based strategies. Simon-Kucher is regarded as the world’s leading pricing advisor and thought leader and today has more than 1,700 employees in 42 offices worldwide.

The report explains that digital banks entered the banking scene a decade ago as mobile-focused challenger banks looking to establish primary, digital-only relationships with digitally savvy clients. Simon-Kucher estimates there are currently close to 400 Neobanks around the world, together serving nearly 1 billion client accounts.

The drive to profitability

However, despite their lofty valuations, only five per cent of these challenger banks have managed to reach a breakeven point, according to the Simon-Kucher analysis. Even for the most renowned challenger banks, this is the case. An analysis of 25 of the largest Neobanks in the world found only two have achieved profitability and that a majority of them earn less than 30 US dollars in annual revenues per customer.

The conclusion was that client acquisition is one thing, but by the sixth or seventh year of operation, they need to be at least breaking even, or the risk of failure rises exponentially. They noted that in Singapore, the MAS had stipulated when handing out licenses, approved neobanks must showcase a clear path towards profitability within five years.

Action stations

“A well-defined value proposition and the use of innovative technology to better serve customer needs and reach under-served segments and Millennials at reasonable cost of acquisition will be vital for success,” says Silvio.

He says that the single most important factor is to drive effective product usage and enablement, as many digital bank clients are inactive after opening their accounts, despite high acquisition costs. “Therefore, a superior customer experience combined with an attractive loyalty program and ecosystem will make the difference in delivering long-term profitability,” he adds.

Tempered optimism

Christoph has been following the progress of the neobanks since their inception. “We are realistic in our analysis and assessment of the state of play,” he reports. “But we are also optimistic, because beyond the phase of emphasising growth over profits, we think that the opportunities are still huge, at least for those that are really winning. Some of these neobanks will in several years be as big or bigger than some of the brand-name incumbent banks.”

He explains that the valuation of the roughly 400 neobanks is currently estimated at around USD300 billion, which with an estimated 1 billion accounts translates to USD300 per customer. “To really drill down into the realities, we looked closely at 25 of the most mature neo-banks and we found only two are profitable and 23 of them are still burning money,” he explains.

Incumbents and genuinely new entrants

He takes the opportunity to explain that there are two types of neo-banks. One segment emanates from the incumbent banks and existing financial groups and is known as the ‘speedboats’ in the Simon-Kucher report. This segment might include names such as BBVA, which has never had a retail banking presence in Italy, but that recently launched a digital bank there. And JP Morgan, which is launching Chase as its digital bank across Europe in order to access new markets and new segments.

Also in this first category, the other type of new incumbent-led entrant is typified by Deutsche Bank that in Germany launched a digital SME-focused bank called ‘Fyrst’, largely, Christoph says, because they were not seen as the go-to bank in that segment. And then the third type of incumbent-sponsored entrant is the bank that is launching simply to get access to more retail customers, and that might to some extent cannibalise their mother bank brand, but also at the same time stave off the inevitable and intensifying competition for those clients.

The second type of entrants includes the genuine start-ups, sponsored for example by those groups and investors that have plenty of retail clients and that want to expand into financial services. “It is this category, often backed by VC money, that seems to be focusing mostly on winning clients and not on the real business itself,” Christoph explains. “And that is largely what we are criticising in our report. You can take that approach initially, but it is not sustainable.”

Tighter focus required

Silvio mines down further into what is holding the neobanks back. “We see that their definition of the target group is too broad, and that they need to more rigorously carve out clear segments. Additionally, the ability to provide multi-product value-added services, and establish partnerships with third-party vendors, are super important. Those who collaborate with an ecosystem are more successful than others.”

He adds that embedded finance is another important element for success.

“There are digital banks out there that developed the system, the architecture, the whole platform and that are now starting to offer these to others, thereby boosting revenues out of system spend,” he reports, “and that can be a very profitable area.”

And the key issue for all of them is getting those clients who sign up to become active. “They spend a lot of money to acquire customers, but you then need to stoke the activity, to get those people to put deposits in, to get them to transact and then gradually move them up the value-added services tree,” Silvio elucidates.

Singapore – could do better

Silvio explains that despite the substantial market opportunity and a digitally smart client base, the study revealed Singapore is lagging in the development of digital banking. Singapore currently ranks 18 out of 60 countries for digital banking development.

“The penetration of digital banks is still far lower than expected when compared to other similar markets which show up to 50 per cent of adults with a digital-only banking account,” he reports. “This indicates a significant growth potential for the awarded conglomerates and Super Apps in Singapore.”

Differentiation and innovation

For new players, either pure digital banking challenger banks like Grab-Singtel or neobanks coming from the stables of established players like Standard Chartered and NTUC (Trust Bank), the report notes that it will be crucial to get the value proposition right and to develop the monetisation strategy before product launch.

“Introducing undifferentiated digital offerings such as high-interest saving accounts, credit cards, and MSME loans will not be enough to win the demanding client base in Singapore as incumbent banks have increased their digital capabilities to better serve the clients in recent years,” Silvio observes. “For new digital banks, it’s crucial to develop innovative growth strategies that resonate with the target customer base to acquire, hook, and retain these segments.”

Christoph offers more insight into the evolution taking place more broadly across Asia, observing that the firm anticipates the Asian markets, driven by the central banks, will continue to produce fewer licenses than some other markets, and drive the market towards success for a handful of entrants earlier than in some other markets, for example Brazil, where there are many more licenses.

“We think that in general, the authorities in the Asia region are aiming to avoid a major catfight around every single customer and encourage an environment where profitability is as important as growth,” he comments. “My view is that the Asian markets will develop differently, and profitability will emerge more rapidly.”

Silvio picks up on these points, observing that the regulatory aspect is very important. “In Indonesia, the digital banks need to have the same banking license as the incumbents,” he reports. “This opens the door for super-apps, for example, Grab Taxi or others, to use their cash to move into banking as a natural extension of their existing customer base, and that is also what we see in the Chinese blueprint from Ant Group.”

Only the strong…

Their final comment is that whatever strategies the individual neobanks adopt, only some of them will be the winners and the others will either fail and disappear or be bought over. “There will be a wave of consolidation,” Christoph reports. “Out of the universe of roughly 400, we estimate that only two or three per country will be the winners, and the others will be bought out or collapse.”