Finance

Neobanks like Chime are attracting billions in VC cash, but unlike most retail banks they don’t do any lending. Here’s how they’ve built a business on referrals and debit card swipes.

  • The traditional banking business model is pretty simple. Banks take in deposits, then lend that money out and charge interest. They make money on the ‘spread,’ or, the difference between the deposit and loan rates, as well as non-interest income like overdraft fees. 
  • Upstart digital banks like Chime, N26, and Varo—which are attracting billions in VC cash— for now only play on the deposit side of the balance sheet, offering checking and savings accounts.
  • Instead of earning interest rate spreads, neobanks rely on interchange fees earned from debit card transactions for revenue.
  • Chime also earns a modest percent of revenue from referring customers to other fintechs like SoftBank-backed renters insurance startup Lemonade and fellow DST Global portfolio company Root Insurance.
  • Chime is exploring lending-like products, launching a free overdraft program called SpotMe, and offering two-day advances on direct deposit paychecks.
  • Click here for more BI Prime stories.

The traditional banking business model is pretty simple.

Banks take in deposits from customers and pay them interest. Then, they lend that money out to other customers, charging interest. Traditional banks make money on the spread, or, the difference between the deposit and loan rates.

But upstart digital banks like Chime, N26, and Varo—which are attracting billions in VC cash— for now only play on the deposit side of the balance sheet, offering checking and savings accounts.

And these neobanks are attracting waves of VC cash. By the third quarter last year, neobank funding totaled $3 billion, surpassing 2018’s record $2.3 billion, according to CB Insights.

Chime, founded in San Francisco in 2013, is the most highly-valued US neobank. Its investors include Access Technology Ventures (Adyen, Ant Financial, Square), Menlo Ventures (Betterment, BlueVine), and DST Global (Robinhood, Root Insurance.)

Chime isn’t profitable, but its CEO Chris Britt told Forbes that it could be — if it reduced its marketing spend.

In December, Chime’s valuation quadrupled to $5.8 billion following its massive $500 million Series F. The round was the largest single equity investment in the neobanking space, a record previously held by Brazil’s Nu Bank, according to CB Insights.

Neobanks are growing fast

Since they’re not lending, neobanks rely on other sources of revenue. Interchange fees, for example, are paid by merchants to the banks for processing debit card transactions.

To grow interchange fee revenue, neobanks need customers to use their debit cards as much as possible. So their business models are focused on scaling their customer bases, and then ensuring customer stickiness.

To become the primary bank for their customers, the neobanks have deployed products — like access to wages two days early and no-fee overdrafts — specifically for customers who use the accounts for direct deposits

And their customer bases are growing. In September last year, Chime announced it surpassed the 5 million account milestone. Germany’s N26, founded in 2015, announced it has more than 3.5 million customers as of last June.

That said, the number of open accounts is not necessarily the same as the number of active deposit customers, so pinning down exact customer numbers is tricky. In some cases, one customer who opens both a checking and savings account could be counted with two open FDIC-insured accounts.

Since the neobanks are private companies, they are not subject to the same disclosures as public retail banks. Ten-year-old Ally, one of the US’s largest digital-only banks which went public in 2014, reported 1.9 million retail deposit customers in third-quarter earnings last year.

Chime Banking Mobile App + Debit (1)

Chime earns interchange fees from debit card transactions.
Chime

Chime makes money when its customers spend money

Chime earns the vast majority of its revenue from interchange paid to Chime by Visa, a Chime spokesperson told Business Insider in emailed comments. 

So every time one of Chime’s customers makes a purchase with their debit card, the bank earns a fee. 

Chime also earns a “modest percent of revenue” from referring customers to other fintechs like SoftBank-backed renters insurance startup Lemonade and fellow DST Global portfolio company Root Insurance, the spokesperson said.

While the bank doesn’t currently offer direct lending products, Chime has been vocal about its ambitions to enter the credit side of the balance sheet. But the timelines are unclear.

In March of 2018, Chime’s CEO Chris Britt told Bankrate that it would launch lending products within the year.

“Our initial efforts in the area have been focused on the short term lending segment, and more specifically, the overdraft fee epidemic facing our country,” the Chime spokesperson said.

Chime launched a new product called SpotMe in September, where customers who direct deposit at least $500 per month are able to overdraft their accounts up to $100. 

There is no interest applied to the overdrafts, which are repaid to Chime from the next payroll direct deposit. Users are offered the option to leave a tip to “pay it forward.”

“While we’ve publicly announced our intention to launch other credit and lending products, we’ll focus next on helping our members improve their credit scores and will announce a new service in this area in the first half of 2020,” the Chime spokesperson said.

VC cash flowing in

In addition to free overdrafts and getting your paycheck a couple days early, there are other features of these digital-only neobanks attracting customers. 

Across the board, they have leaned into fee transparency, and largely moved toward eliminating things like minimum balance and account maintenance fees. 

Incumbent retail players like JPMorgan and Bank of America both charge $35 for every overdraft, and $12 in monthly maintenance fees. 

According to Chime’s website, the only fee it charges is $2.50 for out-of-network ATM withdrawals. N26 doesn’t charge overdraft, maintenance, nor foreign transaction fees.

Digital-only players, who behave more like legacy retail banks, are competing on rates

While neobanks are winning customers with these no-fee checking accounts, other digital-only players like Ally and Goldman’s Marcus, which offer both deposits and loans, are luring customers with rates.

Digital-only banks like Ally and Goldman’s Marcus both offer high-yield savings accounts. Unlike legacy retail banks, these players are unburdened by the costs of maintaining brick-and-mortar branches. Similar to retail banks, they offer loans.

Ally currently offers 1.6%, Goldman’s digital-only Marcus offers 1.7%—all well above the national average savings rate of 0.09%, according to the FDIC.

Both Ally and Marcus are chartered banks, meaning they are regulated like any other retail brick-and-mortar bank. Neobanks like Chime and N26 don’t have bank charters, but instead rely on partner banks like Bancorp and Green Dot to provide core banking processes and FDIC insurance.

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