MC Explains: Neo-banks and how they work

Neo-banks often have lower operational costs than traditional banks, allowing them to offer competitive rates and lower fees

The value of neo-banking transactions in India is projected to reach $76.99 billion in 2023, according to a report by Statista, a global data collector.

The transaction value is expected to grow at a compounded annual rate of 19.2 percent over the next four years to a projected $155.5 billion by 2027. The average transaction value per user in the neo-banking market will be $6,200 in 2023.

Here's an explainer on neo-banks:

What are neo-banks?

Neo-banks, or "new banks," are digital-only financial institutions that provide banking services entirely online without physical branches. They leverage technology to offer savings accounts, payments, lending and investment options. Neo-banks typically operate through mobile apps or websites and aim to deliver a user-friendly, streamlined and cost-effective banking experience.

How do they work?

Neo-banks operate digitally, relying on advanced technology and partnerships.

1.    Digital approach: Neo-banks have no physical branches. They focus on creating mobile apps or web interfaces where customers can manage their accounts, make transactions, and access various banking services.

2.    Partnerships: Many neo-banks tie up with banks or financial institutions to hold and manage customer funds in compliance with regulatory norms. The partnerships allow them to offer insured deposit accounts.

3.    Services: Neo-banks offer services, including savings and checking accounts, payments and transfers, lending (personal loans, credit cards), and investment options. They often prioritise seamless user experiences and may provide features like expense tracking and budgeting tools.

Relevance of neo-banks in India

Neo-banks have become important in India for various reasons, including financial inclusion. They cater to underserved or unbanked populations, especially in rural areas by providing accessible and affordable banking services through digital channels. They also offer user-friendly interfaces and tools, making banking more convenient and transparent for customers.

Additionally, neo-banks often have lower operational costs than traditional banks, allowing them to offer competitive rates and lower fees.

Some neo-banks in India are Fi Money, Jupiter, Freo and RazorpayX.

How are these different from payment banks and traditional banks?

Neo-banks, payment banks and traditional banks differ in several ways:

1.    Digital-only vs physical presence: Neo-banks are entirely digital, while traditional banks also have physical branches. Payment banks are digital-only but have limited services, focusing on payments and deposits.

2.    Services offered: Traditional banks offer a comprehensive range of services, including loans and investment products. Neo-banks typically provide a broader suite of services than payment banks but may not have the same depth as traditional banks.

3.    Regulatory framework: Payment banks operate under a regulatory framework established by the Reserve Bank of India, with specific restrictions on their activities. Traditional banks and neo-banks follow separate regulations.

How does the RBI define neo-banks?

Neo-banks are fintech companies that fall indirectly under the RBI’s jurisdiction. The RBI doesn’t recognise neo-banks as banks, so customers can get into legal trouble in case of any issue.