What is neobanking and how does it work?

More and more customers are choosing to bank with neobanks.

Also known as challenger banks, these alternatives to traditional banks are growing in popularity – but do you know the difference?

What is a neobank?

The term neobanking is part-Americanism, and part financial jargon; neobanks are better known in the UK as ‘challenger’ or ‘online-only’ banks. 

Simply put: neobanking is all about offering customers digital-first banking; many may not even have a branch you can visit.

Instead, they tend to have apps or digital platforms where all your finances are at your fingertips.

Neobanks are also known by many other names in the UK including: 

• Digital banking
• Challenger banks 
• App-based banking

The rise of neobanking is closely tied to the rise in fintech, giving customers easy-to-use apps and platforms to interact with their accounts.  

The first neobanks in the UK gained popularity after the 2007-09 banking crisis, pledging an alternative to traditional banks and promoting low rates and greater transparency. 

Timed well with increases in smartphone adoption, regulatory changes and a shift in consumers wanting greater convenience across all services, challenger banks were able to grow exponentially. 

These online-only banks may have started out as relative unknowns, but some fintech titans such as Monzo and Revolut have become household names, while brands like Tide have dominated the small business market. 

Neobanks rarely have a physical presence, such as a high-street branch and tend to focus little on cash deposits and withdrawals. 

The digital-first approach of neobanks, combined with eye-catching branding and an emphasis on budgeting tools has made them a popular choice for younger customers.

Many neobanks also offer services for under 18s, with interactive features to help teenagers learn about money management.

Neobank vs online bank: what’s the difference?

So, what’s the difference between a neobank and online banking? Although neobanks may have pioneered digital banking tools, most traditional banks now offer online banking services, too.

More people choose to bank online as many bank branches are closing their doors for good. Statistics show between 2015 and 2022, more than half of the UK’s bank branches shut permanently.  

The interface of a neobank might be similar to the online banking service offered by a traditional bank. However, for neobanks, online services aren’t an add-on but are fundamental to their model.  

The competition is intensifying, with neobanks poised to surpass traditional banks in lifetime Android app downloads by the first quarter of 2025, according to a recent study by SplitMetrics.

One trademark of neobanking is the streamlined services they offer on a digital platform, but this slimmed-down banking experience can also mean a neobank offers fewer services than a traditional bank.

What are the advantages and disadvantages of neobanking?

Ultimately, how you like to look after your money is a very personal choice.

Whether you prefer the experience of using a neobank or you’re happy with a traditional bank is down to you.  

It also doesn’t even need to be a case of either/or; many people have accounts with challenger banks in addition to their traditional bank.

Some people love using a challenger bank to keep track of their monthly budget but stick with a traditional bank for investments and larger savings, for example. 

Here’s an overview of some possible advantages and disadvantages of neobanking. 

Advantages of neobanks

• Always there: As neobanks live online or in an app, you never need to worry about running down to the bank before the branch closes.
• Low fees: Typically, neobanks can offer you low service fees, as well as sometimes allowing you to use your card abroad without incurring high charges. But remember, whenever you’re thinking about switching accounts, shop around for the best deals.
• Budgeting tools: If you want to get better insight into your spending habits, many challenger banks offer you detailed breakdowns of your monthly budget.
• Easy-to-use apps: These apps give you tools to keep track of your spending and even create plans for saving into a pot for a holiday, a special occasion, or a rainy day. 

Disadvantages of neobanks

• Little or no face-to-face: Although neobanks tend to have customer service built into the app, these tend to be instant messaging services with an assistant, or may stretch to a phone call. If you prefer having a sit-down discussion with an adviser about your account, an online-only bank might not be for you.
• Limited services: Neobanks can offer you most day-to-day banking services but may not extend to some services, such as cash deposits, investment options, or loans. 

How do neobanks make money?

You might be thinking, ‘so far, so good’ — but what’s in it for them?  

Many neobanks make money often from interchange fees, which a merchant pays every time you tap your card or make a transaction. As neobanks are smaller operations than high-street banks, they often charge higher interchange fees. 

Some neobanks will also make money in the same way traditional banks do; through premium charged account services with additional features or higher withdrawal limits and through interest on loans. 

Who are the biggest neobanks?

Neobanks are transforming the financial landscape with their innovative, tech-driven services. To understand their impact, let’s look at some prominent examples of neobanks that are leading the charge globally.

Monzo

You may recognise Monzo by their signature coral-coloured cards.

Particularly favoured by younger users, the Monzo app features many tools to manage a budget as well as real-time spending notifications.  

Starling Bank

Like Monzo, Starling also offers spending notifications and budgeting tools.

Starling also offers customers a small percentage of in-credit interest and charges zero fees for using your card overseas. 

Revolut

Revolut is a popular challenger bank that particularly targets people who travel a lot by using real-time exchange rates.

It also allows customers to store money as cryptocurrency. However, as of April 2023, Revolut doesn’t yet have a UK banking license, meaning customers’ money isn’t protected by the Financial Compensation Scheme.

Get expert financial advice

Neobanking represents a significant shift in how we manage our finances, offering a digital-first approach that caters to a growing preference for convenience and innovation.

With their user-friendly apps, low fees, and cutting-edge features, neobanks are redefining banking for a new generation.

However, it’s essential to weigh these benefits against potential limitations, such as the lack of physical branches and limited services.

Whether you choose to embrace neobanking or stick with traditional banks, staying informed about these evolving options will help you make the best choice for your financial needs.

Unbiased will match you with a financial adviser for expert financial advice on choosing the best banking solutions and managing your finances effectively.