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Neobanks are online-only financial technology (fintech) companies that offer traditional banking services in a digital-first format. Though they’re called neobanks, these fintechs are not actually banks. They’re able to provide online banking services only by partnering with an established bank. Read on for a closer look at how neobanks work, how they make money, and the pros and cons of using a neobank vs. a traditional or online bank.
Key Points
• Neobanks offer traditional banking services through an app and/or a digital platform, typically without access to physical locations or branches.
• Neobanks can offer lower fees, higher interest rates on deposits, and faster, more convenient transactions.
• Disadvantages of neobanks can include fewer available services and reduced regulation.
• Neobanks appeal to customers who have struggled with traditional banking or who are looking for a strong mobile experience.
• Many neobanks partner with established banks to provide Federal Deposit Insurance Corporation (FDIC) insurance, but they differ from online banks, which are fully chartered and licensed.
What Is a Neobank?
A neobank, also sometimes referred to as a challenger bank, is a fintech company that offers traditional banking services through a digital platform, usually online and via a mobile app. Neobanks typically don’t 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 annual percentage yields (APYs) on bank accounts and charge low (or no) banking fees.
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.
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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 people 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, such as 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 many online banks that are licensed banks and directly offer FDIC insurance up to $250,000 per depositor, per account ownership category, per insured bank on deposit accounts. They typically provide an easy-to-use digital app and a full suite of banking services and shouldn’t be considered neobanks.
But if neobanks are not actually banks, what does that mean?
• While you can access traditional banking features such as checking accounts and high-yield savings accounts through a neobank’s online platform and 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, like 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 finalized a rule to supervise the largest nonbank companies offering digital funds transfer and payment wallet apps. And in recent years, the CFPB and state regulators have investigated certain neobanks for isolated events.
A neobank must also 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, this insurance can provide security.
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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 debit and credit card purchases. Such fees are also called interchange fees. Consumers don’t pay these fees. Businesses bear the burden instead.
Neobanks that offer credit cards and/or loans also make money on interest they charge borrowers.
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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:
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Pros:
• Lower fees
• Higher interest rates on deposit accounts
• May offer credit card without credit check
• Easy-to-use mobile app (mobile check deposit, peer-to-peer payments, etc.)
• 24/7 account access — and on the go
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Cons:
• Less regulated (not chartered with state or federal regulators)
• May not offer FDIC insurance
• May not offer a full suite of banking services (mortgages, auto loans, etc.)
• Typically no brick-and-mortar branches
• Untested 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 some examples of popular neobanks, whose names you may recognize:
• Chime®
• Varo Bank
• Albert
• Comun
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Neobanks vs Traditional Banks
So how do neobanks compare to traditional banks? The table below breaks down common differences, but remember that 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 | |
|---|---|---|
| Fees | May offer lower and fewer fees | May charge higher and more fees |
| Interest on deposits | May have higher interest rates on deposit accounts | May have lower interest rates on deposit accounts |
| Offerings | Typically offer checking and savings accounts, and may offer a credit card | Typically offer multiple checking and savings accounts, as well as credit cards, personal loans, home loans, auto loans, and mortgages and may offer investment and retirement accounts |
| Mobile app/online banking | Typically have highly rated mobile apps and online banking platforms | May lag in app and online quality compared to neobanks |
| Physical location | Typically do not have physical locations | Typically have physical locations |
| Insurance | May offer FDIC insurance through a larger bank | Typically carry FDIC insurance (or National Credit Union Administration [NCUA] insurance for credit unions) |
| Regulation | May not be regulated | Typically chartered and regulated |
What About Online Banks?
The table above doesn’t capture all the nuances of online banks, and the differences between online banking and neobanking have only been briefly noted. It’s worth doing your own research to see 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, unlike 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.
The Takeaway
Neobanks may be appealing to tech-savvy consumers who want high interest rates on their savings accounts, low fees, and easy-to-use apps. Traditional banks, however, may offer more stability and are formally regulated. The convenience of in-person banking and the full suite of banking services offered by traditional brick-and-mortar banks can also be appealing.
In some ways, online banks offer the best of both worlds — they’re licensed as banks and directly have FDIC insurance, but they also typically offer higher-than-average APYs, lower (or no) fees, and state-of-the-art banking platforms and apps.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
What’s the difference between a traditional bank and a neobank?
Traditional banks usually have in-person branches, are licensed as banks, and offer (Federal Deposit Insurance Corporation) FDIC insurance directly. They typically provide a full suite of banking services, including loans. Many neobanks are more narrowly limited to checking and savings accounts delivered digitally only. However, they often have 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 chartered banks with federal and state regulators. Instead, neobanks often partner with chartered banks. That said, the Consumer Financial Protection Bureau has finalized a rule to supervise and regulate the activity of the largest nonbank companies offering digital funds transfer and payment wallet apps.
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 Federal Deposit Insurance Corporation (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.
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