What Is Neobanking and How Does It Work?

By Timothy Moore · October 27, 2022 · 7 minute read

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What Is Neobanking and How Does It Work?

Neobanks are online-only financial technology (“fintech”) companies that offer traditional banking services in a digital-first format. Though they are called neobanks, these fintechs are not banks at all. Instead, they offer bank-like financial products, often designed for lower-income consumers and borrowers with a spotty credit history.

But how do neobanks work, and how do they make money? We’ll examine these and other topics — like the pros and cons of neobanks — below.

What Is a Neobank?

A neobank, also called a “challenger bank,” is a fintech that offers traditional banking services through a digital platform, usually online and via a mobile app. Neobanks typically do not operate physical locations or branches, meaning they’re a digital-only experience. This lack of physical branches means their overhead is lower — which may allow them to offer higher APYs on bank accounts and lower fees for consumers.

The big caveat with neobanks: They aren’t banks at all. Instead, they offer access to banking services and products that are overseen by true, federally regulated and insured banking institutions.

Recommended: Is Mobile Banking Safe?

How Do Neobanks Work?

Because of their digital-first strategy, neobanks are able to keep costs low and pass those savings on to consumers. Often, neobanks target their services at those who are frustrated with the traditional banking experience — those who may not qualify for a traditional credit card or loan or who have been burned by a mountain of fees on past checking accounts.

Tech-savvy users are often drawn to the advanced apps and platforms of neobanks in the same way they’ve been drawn to other digital disruptors, like Uber and Lyft in the rideshare space and Airbnb and VRBO in the lodging space.

Here’s an important distinction to note when thinking about what a neobank is: Just because a bank operates online doesn’t mean it’s a neobank. There are online-only banks that are fully regulated and directly offer FDIC insurance on deposit accounts. They provide an easy-to-use digital app and a full suite of banking services, and should not be considered neobanks.

But as we’ve pointed out, neobanks are not actually banks. So what does that mean?

•   While you can access traditional banking features like checking accounts, high-yield online savings accounts, and credit cards through a neobank’s mobile app, the neobank typically partners with larger traditional banks to offer those services.

•   Notably, neobanks do not typically offer a full suite of services, such as loans and investments, that full-fledged banks do.

•   Neobanks exist in a regulatory gray area. Many offer FDIC insurance through their partner banks, but the neobanks themselves do not answer to a primary regulator. The Consumer Financial Protection Bureau (CFPB), however, recently announced that it will enact stricter supervision of nonbank fintechs going forward. And in recent years, the CFPB and state regulators have investigated certain neobanks for isolated events.

   That said, a neobank must typically comply with its partner bank’s own standards and practices, dictated by federal and state regulation. Thus, indirectly, neobanks may face some regulation.

Pro Tip: While many neobanks offer consumers FDIC insurance through the banks with which they partner, it’s always a good idea to read the fine print before opening a deposit account to make sure it offers insurance. While bank failures are rare, that insurance can provide real peace of mind.

Recommended: Money Management and Setting Your Financial Goals

How Do Neobanks Make Money?

While each neobank is unique and likely to have its own varied revenue streams, these challenger banks commonly make money through merchant fees from card purchases. Such fees are also called “interchange fees.” Consumers don’t pay these fees; instead, businesses bear the burden.

As long as consumers regularly make transactions with their neobank debit or credit card, it can pay off big time for fintechs. Why? Smaller fintechs can charge merchants interchange fees seven times higher than larger banks that have more than $10 billion in assets.

Neobanks are relatively new, and many are still in the startup phase. As such, promising fintechs often receive millions of dollars in venture capitalist funding to get off the ground. Which players will be around for the long haul remains to be seen.

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Pros and Cons of Neobanks

Neobanks may make sense for some consumers, but they’re not for everybody. Before opening an account, it’s a good idea to weigh the pros and cons:

Pros

Cons

Lower feesLess regulated (not chartered with state or federal regulators)
Higher interest rates on deposit accountsMay not offer FDIC insurance
May offer credit card without credit checkMay not offer a full suite of banking services (mortgages, auto loans, etc.)
Easy-to-use mobile app (mobile check deposit, peer-to-peer payments, etc.)Typically no brick-and-mortar branches
24/7 account access — and on the goUntested in the market (no long history of success to instill confidence in consumers)

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Examples of Neobanks

In the last decade-plus, the fintech market has been teeming with myriad newcomers. Here are six examples of popular neobanks, whose names you may recognize:

•   Varo Bank

•   Chime

•   GoBank

•   Aspiration

•   Current

•   Daylight

Recommended: How to Manage a Checking Account

Neobanks vs Traditional Banks

So how do neobanks compare to traditional banks? The table below breaks down common differences, but remember: Each bank (or neobank) is different and offers varying levels of services, rates, and fees. These are broad generalizations and may not apply to every financial institution.

Neobanks

Traditional banks

FeesMay offer lower and fewer feesMay charge higher and more fees
Interest on depositsMay have higher interest rates on deposit accountsMay have lower interest rates on deposit accounts
OfferingsTypically offer checking and savings accounts; may offer a credit cardTypically offer multiple checking vs. savings accounts and credit cards, as well as personal loans, home loans, auto loans, and mortgages; may offer investment and retirement accounts
Mobile app/online bankingTypically have high-rated mobile app and online banking platformsMay lag in app and online quality compared to neobanks (especially true for traditional, brick-and-mortar banks)
Physical locationTypically do not have physical locationsTypically have physical locations
InsuranceMay offer FDIC insurance through a larger bankTypically carry FDIC insurance (or NCUA insurance for credit unions)
RegulationMay not be regulatedTypically chartered and regulated

What About Online Banks?

The previous table does not capture all the nuances of online banks. The differences between online banking and neobanking were briefly noted above. However, it’s worth taking a closer look at how online banks compare to traditional brick-and-mortar ones. While they may offer the same breadth of products, online banks typically offer better rates and lower fees than traditional banks. Online banks also usually offer leading-edge mobile apps as well as FDIC insurance.

Online banks can afford to pay those higher interest rates and charge lower fees because, compared to traditional banks, they don’t have to pay for physical locations and on-premises staff. They can then pass some of those savings on to their customers.

Wondering if an online bank is right for you? Do your research on the pros and cons of online banking before making your decision.

Recommended: Online Banking vs. Traditional Banking

The Takeaway

Neobanks may be appealing to tech-savvy consumers who want high interest rates, low fees, and easy-to-use apps. Traditional banks, however, may offer more stability and confidence — and are formally regulated. The convenience of in-person banking and the full suite of banking services offered by traditional banks can also be appealing.

Online banks like SoFi can offer the best of both worlds. For example, when you open an online bank account with us, you have the security of knowing we’re FDIC-insured and the convenience of an easy-to-use mobile app, plus a Checking and Savings account that lets you spend and save in one place. What’s more, when you sign up with direct deposit, you’ll earn a hyper competitive APY, and pay no fees.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

What’s the difference between a traditional bank and a neobank?

Traditional banks usually offer in-person branches, are federally regulated, and offer FDIC insurance directly. They typically offer a full suite of banking services, including loans. Many neobanks are more narrowly limited to checking and savings accounts delivered digitally only, but they often offer more competitive interest rates and lower fees.

Are neobanks regulated like regular banks?

Neobanks do not face the same regulation as regular banks simply because they are not charted as banks with federal and state regulators. Instead, neobanks often partner with chartered banks. That said, the Consumer Financial Protection Bureau has announced that it will increasingly supervise and regulate the activity of neobanks.

Is your money FDIC-insured with a neobank?

Some neobanks offer their banking services through chartered financial institutions. Through those institutions, the neobanks may be able to offer FDIC insurance for their accounts and services, but some don’t. It’s therefore a good idea to read the fine print of a neobank before opening an account so you know where you stand.


Photo credit: iStock/Prostock-Studio

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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.


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