The future of traditional banking – The rise of neobanks and digital banking

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What are Neobanks or online banks?

Digital banks are a type of financial institution that offers banking services designed to be managed exclusively from a smartphone or web application, without traditional physical branch networks. Neobanks are also referred to as internet-only banks, virtual banks, online banks or digital banks and these bank accounts aren’t only convenient, but often cheaper with fewer fees than traditional banks. Neobanks offer lucrative features such as multiple sub-accounts, budgeting tools, savings functions, push notifications and other in-app functionalities.

Traditional banks have faced little competition over the years and consumer passivity and the extensive costs for traditional banks to move away from existing working systems are the main reason why traditional banks remained at the forefront of the banking industry. However, the recent move towards a digitized world has forced banks to re-evaluate their approach to become compatible with a digital world. These basic adjustments have not yet ensured significant changes to traditional ways of banking, as traditional banks are layering modern front-end technology onto existing legacy systems to bring traditional products through new digital channels.

The disparity between the age-old legacy systems used by traditional banks and the new digital systems used by virtual banks is stark. Examples of legacy systems include hardware in power plants, manufacturing machines controlled by computers running MS-DOS, or outdated financial systems. In reality, however, legacy applications still power important business processes in many other sectors around the world. Most traditional banking legacy systems have been running for over three decades with countless amounts of money moving through their systems daily. With so much money relying on these systems to operate smoothly, one can understand why the risk and complexity to change them outweighs the need for digital revolution. Any change runs the risk of introducing errors and therefore banks have taken a risk averse approach.

Legacy systems come with two major hurdles: maintainability and flexibility. Firstly, the cost of maintaining traditional legacy systems become steeper, the longer it goes without being updated. This is because the systems were developed with technologies that are no longer well supported and do not have large pools of talent that can address them. These rising costs in turn starves new investment into more modern systems. Secondly, due to the difficulty to change these outdated systems, the more inflexible they become alongside industry and technology advances. Modern technology companies thrive on the ability to deliver lots of small changes quickly. The bottom line is that investing in new technologies is not feasible because they are simply too difficult to integrate or are incompatible with legacy systems and existing architecture.

The advantages of digital banking far outweigh what traditional banks offer. Signing up is almost instant. You can usually open an app-based account within minutes provided you have an internet connection. In the Netherlands you will need to provide proof of residency and proof of identity by way of either a passport or driver’s license. Your entire bank account is built to live on your smartphone. You therefore have access to most features where, and whenever to want. You can request money, send money, draw up budget and set money aside for saving all from the comfort of your phone. A big advantage of digital banks is they often have no fees for foreign currency transactions. This is a lucrative and unique selling point for travelers and expats alike. This benefits consumers when shopping online from an overseas site, or simply sending money across the border. Other features allow for holding multiple currencies in one account. This means that when the customer moves to another country, they skip the hassle of closing a traditional bank account as they can access this digital account from anywhere around the globe.

Help is available 24/7 and there is no need to visit a traditional bank branch to get support. With various ways to connect with the digital bank as well as their online community, most questions can be resolved instantly. Your digital bank will instantly notify you about your spending such as the time, place, location and amount of your and of course your balance. These spending insights can instantly be used to draw up a budget based on historical purchases or to categorize spending and saving habits. These useful budget tracking tools are designed to help the consumer take direct control of their money. What more could one ask for from a bank that automatically divides your spending into categories, ensures you have enough money to pay bills and helps you save towards your goals?

There are disadvantages to having an online bank. Many neobanks don’t offer credit facilities, cheques, mortgages or business accounts. This might result in higher interest rates on certain products due to the fact that not all of one’s financial products are bundles to the same account. Other restrictions may include a limit to free ATM withdrawals per month.

When choosing an online bank, it is important to note that your money might not have the same protection as it would with a traditional bank. In the Netherlands it is advisable to check if the bank has been granted a European banking license. This information should be published on the bank’s website or requested from bank directly. It is always a good idea to understand how your money will be protected.

Neobanks aren’t controlled by traditional banking technology and costly networks of physical branches, this is another reason their fees are mostly lower and sometimes come with free features. The entire banking service is conducted completely online via desktop or mobile app. Neobanks are categorized into two types of digital banks: a full stack neobank or a front-end focused neobank. A full stack neobank operates as an independent bank with its own banking license that operates completely independently. Comparatively, a front-end focused neobank does not have its own banking license and thus operates in partnership with a traditional bank to provide its services to customers.

Sources:

https://www.insiderintelligence.com/insights/neobanks-explained-list/

https://www.finder.com/nl/en/digital-banks

https://internationalfinance.com/legacy-systems-in-banks-explained/

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Photo by Ivan Samkov: https://www.pexels.com/photo/person-paying-using-her-smartwatch-7621142/

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