As most of you know I led channels for Citi back in the “direct banking” days. My team in the UK bought Egg (2007) and while I didn’t have oversight of the US I did have the 35 other Geographies. I also ran online and payment services for Wachovia (3rd largest online bank at the time). I’m here at FinTech NerdCon this week and have listened to Nubank co-founder and Chime. While I congratulate their growth and their Nubanks’ progress outside the US, count me as a skeptic of their profitability (and progress) in the US. 

Make no mistake, these digital challengers will grow in the US, but growth is not profitability. New entrant non-bank firms and neobanks now have over 200 million account users in the U.S. But replacing the top-tier institutions? A “threat” to mainline banks? Not even close.

In my view, the primary innovation of neobanks is a radical reduction in the cost to serve a customer. One study projected a 12x reduction in transaction cost of Neobanks to top 5 retail banks. I don’t put much weight on this, as multi-line banks typically don’t break out operational efficiency by product. A problem we faced at Wachovia is that the retail bank bore 90% of the cost of branches even though they served as sales centers for wealth, mortgages, small business and every other product. This cost allocation was not fair at all, but it was the common base account and we found a way to make it up in chargebacks to the various product lines. In other words retail banking was the loss leader and cost to doing business. Retail deposit-taking is, fundamentally, an awful business.

Today’s Neobank cost to serve focus isn’t any different than the 2005 direct banking efforts (banking 2.0), the problem we faced in 2006 was that we depended on legacy banks’ tech from our parent. It took us 12 months to make changes with products that closely resembled the existing core. The 3.0 banks have much more flexible tech stacks operating in a mobile-first model, and enjoy a significant cost advantage over traditional Insured Depository Institutions (IDIs) burdened by physical branches. This model allows them to service individual accounts at a fraction of the traditional cost.

Key Measure is Not Growth – Long Term Profitability

The key to long-term profitability in banking is the traditional, vertically integrated model: using sticky deposits (liabilities) as the lowest cost of funds to support an asset business that lends against them. IDIs generate net interest income (NIM) from the spread between interest paid to depositors and the higher interest rate charged to borrowers.

Neobanks, however, attract a segment of the population that is notoriously difficult to monetize sustainably:

1. Less Profitable Clientele: Neobanks often target “everyday Americans” earning under $100,000 annually. For large incumbent banks, the bottom four deciles (40%) of retail consumer banking are generally unprofitable. Neobanks are soaking up these low-margin clients.
2. Churn Risk: While incumbents benefited from incredibly sticky relationships (the average US consumer changes banks every 14 years), neobanks face a retention challenge. The customer base acquired often results in “dormant” members, and many neobank accounts are secondary, holding low blended balances (often $250–$350).
3. Lacking the Golden Goose: Incumbents are very protective of their high-margin products. Credit cards are frequently referred to as the “golden goose” of banking, being the most profitable consumer product in history. Payments are the primary way banks intermediate commerce. 
4. Durbin enablement. Neobanks can’t grow more than $10B in Assets or they loose exempt status (debit interchange of 125bps) and fee caps (not much of a worry today).

The scale differential is massive. The top four US banks maintain annual technology budgets totaling around $50 billion, which is higher than the total aggregate private FinTech fundraising in 2023 (approximately $40 billion). When traditional banks impose fee increases, it is NOT out of fear of competition, but recognition that the “threat” they face is the underlying unprofitability of the vast majority of consumer accounts.

Challenges Facing the Neobank Model

I see 5 key hurdles to long-term profitability of Neobanks IN THE US. 

1. Profitability Reliance: Neobanks not demonstrated sustanted profitability, funding “growth” with new investments. Fewer than 5% of neobanks break even.
2. Customer Acquisition Costs (CAC): These firms spend heavily on marketing in the race for users and competition from Block’s cash app, as well as investment first RobinHood. 
3. Durbin-dependent Card Arbitrage: The vast majority of monetization today is derived from interchange earned on card spend, a revenue stream vulnerable to regulatory changes, particularly concerning debit interchange caps.
4. Regulatory Arbitrage Exposure: Many operate as a TBBK or Meta enabled bank in a box, outside the full bank regulatory perimeter, avoiding comprehensive supervision and compliance costs, but leaving them reliant on cards, and bank enablers. 
5. Competition for Primacy: They face intense competition from incumbents and Big Tech to become the primary account (the “holy grail” of consumer banking, often secured by winning direct deposit).

In short, neobanks are mostly selling a superior, low-cost front-end experience while relying on a profitable and heavily regulated back-end controlled by the institutions they claim to be destroying. They are attacking the low-margin edges of the incumbent business, and the big US banks, with mult-line asset businesses.  Big banks are well placed to stem losses of any profitable segments.. And are quite happy to let their low margin high cost to serve customers flee. 

Thoughts appreciated.