Evolution of Banking System to Neobanks

 

Evolution of Banking System in India to Neobanks

"We can't change the inevitable. But we can play on the thing we do have and that's our attitude"

- Don Connelly

As has succinctly been said that transition is inevitable, but what we have now can do wonders for times to come. Gone are the days when people went to traditional banks to carry on the transactions. Banks, UPI Payments and now neobanks are classic examples of how quickly things change. A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. They are traditional deposit accepting and money lending institutions. Unified Payments Interface (UPI) is an Indian instant payment system as well as protocol developed by the National Payments Corporation of India (NPCI) in 2016. The interface facilitates inter-bank peer-to-peer (P2P) and person-to-merchant (P2M) transactions. But, the world is fast evolving. Neobanks are the new disruption. Neobanks, often referred to as digital-only banks, are financial technology firms that offer banking services entirely online without any physical branches. Unlike traditional banks, which rely on brick-and-mortar infrastructure and legacy systems, neobanks leverage modern technologies such as artificial intelligence (AI), big data, and cloud computing to deliver streamlined, user-friendly financial services through mobile apps and web platforms.

While traditional banks provide a wide array of services including loans, savings, investments, and more under full banking licenses regulated by central banks, neobanks typically operate under partnership models with licensed banks or through specialized banking charters, depending on the regulatory framework of the country in which they operate. Neobanks are at the intersection of traditional banking system and UPI interface. While traditional banks have physical presence, neobanks on the otger hand are more digitally available. Traditional banks need licenses from the regulatory authorities to operate, whereas neobanks are more centrally administered. While traditional banks are more developed with the requisite infrastructure and legacy systems, neobanks are more cloud-native and API driven.

Neobanks have witnessed explosive growth globally over the past decade, particularly in regions like Europe, the United States, and Southeast Asia including India. Success stories such as Monzo and Revolut in the UK, Chime in the US, and Nubank in Brazil have demonstrated the disruptive potential of these digital-only financial platforms.

India, with its massive smartphone penetration, digitally literate youth population, and supportive fintech infrastructure (like Aadhaar, UPI, and India Stack), has emerged as fertile ground for neobanks. Although the Reserve Bank of India (RBI) has not yet granted full digital banking licenses, Indian neobanks such as Jupiter, Fi, RazorpayX, Niyo, and Open have grown rapidly by partnering with traditional banks.

These firms offer niche, tech-driven financial products—like smart savings tools, real-time spending insights, and salary advances—that appeal to young, digitally savvy users. As a result, India’s neobanking sector is carving out a strong foothold, even within the constraints of the current regulatory framework and the limited financial offerings. Neobanking has thus been a disruption in the ever-evolving banking industry.

Inception of Neobanks

Neobanks, which are digital-first financial institutions, emerged in the early 2010s, particularly in Europe and the United States, before gaining global traction. They initially arose as a response to the perceived shortcomings of traditional banking and the desire for a more user-friendly and technologically advanced financial experience. The term "neobank" itself gained popularity around 2017, though the concept of digital-only banks had been around for some time.

Neobanks – a new hope in turbulent times

The 2008 recession gave birth to a new brand of banks driven by technology. The year 2009 saw Aldermore, the first bank of this kind. These banks moved from brick and mortar to digital-only (fintech with a banking license and providing banking services over the internet) or challenger banks.

By 2010, a new crop of fintech came up; they called themselves the Neobanks. They focused mainly on the underserved population and provided banking through licenses from conventional banks.

Irrespective of all the developments, it was business as usual for traditional banks till things started going awry when the pandemic hit the world in 2019. They had to digitize their products and services in the shortest possible time garnering the most value. It led the conventional banks to launch or improve the services of their pre-existing digital-only subsidiaries. Since then, there is no looking back. 

Cut to now, one cannot help but wonder what is in store for the future of neobanks. How are they going to evolve? But before that, we should understand what pushed neobanks to grow at such an astronomical rate and the global trends that will carve the future of neobanks. We analyse what pushed neobanks to grow with the help of SWOT Analysis.

The Strengths

Neobanks are the most obvious transition in the banking system in the 21st century. With the cutting-edge innovations, advent of Artificial Intelligence and increased awareness amongst customers, neobanks are the go-to things in the present as well as in the future. They are as quick as a blink of an eye. Transactions facilitated by the neobanking facilities are quick, easy and secure by multi-factor authentication. They facilitate payments and transactions as promptly thus building a healthier economy. They do not need brick and mortar infrastructure, just a mobile phone or soon rather an electronic device to facilitate the transaction.

The Weaknesses

The neobanks have long been prone to cyber attacks, digital theft and burglary. The neobanks come with a lack of in-person assistance and interpersonal engagement and potential trust issues due to their digital only approach.

The Opportunities

Many traditional banks lacked the expertise to convert most of their offline services to digital. It tied down traditional banks from transforming with their inflexible underpinnings. Customers began to incline towards fintech solutions. With these, customers could integrate their bank accounts and perform all the banking functions in one place.

The Threats

Neobanks, while disruptive, face numerous threats including cybersecurity vulnerabilities, regulatory compliance, phishing, exchange rate issues, intense competition, and customer acquisition challenges. Additionally, they rely on external partners for some services, which can create vulnerabilities. The specific threats include cyberattacks, fraud, regulatory compliance, competition, dependence on external parties, customer acquisition and retention, monetization, political and economic uncertainties, lack of physical infrastructure and data privacy.

Valuation

In 2020, the valuation of the global neobanking market was at $34.77 Billion. According to grand view research, the neobanking market expects to expand at a compound annual growth rate (CAGR) of 47.7% from 2021 to 2028. By 2028, the estimated market size of neobanks will be $722.60 Billion. Neobanks globally raised more than $12 Billion in 2021, despite the global economic slowdown due to Covid 19. Funding of this scale is not limited to geographical boundaries. The number of digital-only banks has risen from 250 in 2020 to 333 in 2021. The global neobanking market is experiencing a  substantial growth, with a valuation of $143.29 billion in 2024 and projected to reach $3,406.47 billion by 2032, according to Fortune Business Insights. In 2025, it is estimated at 210.16 billion with a CAGR of 48.90% between 2024 and 2032. The global transaction value for neobanks reached $4.96 trillion in 2023 and is expected to exceed $10 trillion by 2028, according to Statista.  This growth is driven by factors like low-cost banking services, faster loan approval processes, and increasing customer preferences for digital banking. 

The Rise of Neobanks

The whole BFSI industry and the world have undergone a faster transformation in the last few years than in the previous decades combined, and most likely, will continue to do so in the future. Covid 19 presented immense opportunities to the Finance/BFSI industry during the turmoil. The last two years of the pandemic undoubtedly forced people to stay indoors and asked banks and financial institutions to rethink their modus operandi.

Economic uncertainties, increased competition from digital-only banks, rapidly changing customer requirements, and fast-developing technology completely changed the banking ecosystem, forcing traditional banks to reprioritize their long-term versus short-term goals. However, what underpins a conventional bank becomes part of the resistance to required transformations, such as – high operating costs, the burden of back-office operations, limiting banking processes, resistance to change old ideologies, and outdated systems.

“Pandemic fallout has made the traditional retail banking environment even more demanding. For incumbents to remain relevant, now is the time to embed finance within customer lifestyle and embrace platform-based models — procrastination is no longer an option.” – John Berry, CEO of the European Financial Management Association (EFMA) in World Fintech Report 2021.

“42% of bank executives polled said that they were unsure about how to integrate and streamline office functions effectively from back to front, and 46% said they are unsure how to embrace open banking, orchestrate the ecosystem or become a truly data-driven organization.” – World Banking Report 2021

The solution to the problem lies in adaptation. Easy adaptation from traditional banks to digital banks is the key. When you look at the above situation, there are three ways to create a digital bank. They are:

• Greenfield: A completely new entity with a new infrastructure and a banking license offering innovative products and services is called Challenger Banks.

• Bluefield: A new entity using a mix of new and acquired infrastructure offering a blend of products and services. They are more likely to leverage the banking license of a traditional bank. They became the Neobanks.

• Brownfield: A traditional bank subsidiary leveraging its resources to deliver products and services to its customers digitally. They became the digital subsidiary of conventional banks and are essentially digital spin-offs of traditional banks.

Neobanks are financial technology solution providers capable of providing a suite of banking solutions to a highly targeted niche. They offer banking services in partnership with an established traditional bank.

Thus, traditional banks had to dig deep to digitize their products and services quickly. While they tried to rise to the opportunity, there was a considerable gap in the market up for grabs for the third parties to enter this space.

Many customers switched to neobanks as they felt traditional banks could have done better given the immense resources available at their beck and call. The gap between the services offered by conventional banks and what customers expected out of them widened. The disparity between banks and customers became more evident during the pandemic.

Neobanks such as Chime, Open, and Affirm offer innovative solutions with the help of their partner banks. Partner banks such as Celtic Bank, ICICI Bank, and Green Dot Bank lead the pack in working with neobanks to deliver banking solutions.

The Growth

Neobanks have seen immense growth in the past few years. In 2019 there were close to 250 neobanks globally. However, by 2021 the numbers have crossed 333 according to the neobank tracker from The Financial Brand. The number of neobanks across the world is 312 in 2025.

The reason for this astronomical rise of the neobanks is the vast opportunity of the underserved left by traditional banks that were up for grabs during the pandemic.

In 2020, the valuation of the global neobanking market was at $34.77 Billion. According to grand view research, the neobanking market expects to expand at a compound annual growth rate (CAGR) of 47.7% from 2021 to 2028. By 2028, the estimated market size of the neobanks will be $722.60 Billion. 

[Source: Exton Consultancy]

ABI Research predicts that the top 57 neo and challenger banks worldwide could potentially jump from 155 million customers in 2020 to 590.6 million in 2026. Neobanks will continue their growth spurt. They will continue to evolve while setting up new trends to carve their future.

Current trends across major markets:

Neobanking is going through a massive transformation. Developed markets such as Europe, the US, and the UK are going through regulatory changes that create a favourable environment for the neobanks. New players are now targeting ultra-niche segments of the market, such as artisans and teenagers. Neobanks are adopting leading-edge technologies, thus nudging traditional banks to reinvent themselves to serve the customers better and increase customer retention.

FinTech and Neobanks

Fintech is a portmanteau word made by joining two words Finance and Technology. Fintech thus implies technology in finance. Fintech is a specialized type of financial technology that uses cutting-edge innovations in applications, services, and processes to expand, enhance, automate, and scale the delivery of financial products and services. Fintech is an important market as it facilitates ease of transactions and payments amongst customers, is a cost-effective alternative, ensures transparency and compliance and thus helps building a better economy. India’s fintech market was valued at $50 billion in 2021 and is projected to reach $150 billion by 2025. India has the third-largest fintech ecosystem globally, after the US and China. 

[Source: BCG-FICCI Report (2022)]

Economic uncertainties, increased competition from digital-only banks, rapidly changing customer requirements, and fast-developing technology completely changed the banking ecosystem, forcing traditional banks to reprioritize their long-term versus short-term goals. However, what underpins a conventional bank becomes part of the resistance to required transformations, such as – high operating costs, the burden of back-office operations, limiting banking processes, resistance to change old ideologies, and outdated systems.

Regulatory Changes

Neobanks take the same risks, have unique product offerings, and follow similar processes as traditional banks, so regulators enforce identical rules on neobanks. However, the modus operandi of neobanks is different from the traditional banks. Neobanks are more digitally inclined than traditional banks. Ideally, the rules that apply to traditional banks need not apply entirely to the neobanks.

Therefore, many regulators across the globe are coming up with newer regulations to support the new breed of banks or neobanks.

The FCA’s regulatory sandbox in the UK that started 7-8 years ago also works with digital banks. In August 2021, the regulatory sandbox from FCA moved to always open, allowing neobanks to submit their applications throughout the year. Neobanks can now access the testing environment and services of the regulatory sandbox at the beginning of their development lifecycle to maximize the benefits of live market testing for progressing their innovative models.

Similarly, the NITI Aayog in India has recently recommended a similar approach for digital business banking. The participating fintech solution providers will be given a restricted Digital Bank license and operate as a Digital Business Bank in the sandbox. They will be monitored on matrices such as customer acquisition cost (CAC), volume and velocity of credit disbursed to MSMEs, technological capability, level of compliance, etc. The sandbox restrictions will be relaxed progressively based on their performance, and the licensee will be given a Full Stack Digital Bank license.

Conclusion

Change is inevitable, so is the banking system. The banking system is ever-evolving. Traditional banks with their conventional operations also locate themselves in the digitally transforming world of banking and payments. As the 'Customer is king' so the industry is highly customer-driven and excels in delivering its best. The Neobanks are not a threat but an opportunity to collaborate for the traditional banks. The transformation from traditional banking to neobanking is not formidable but to be embraced. And the system never fails to embrace changes.

[This article is not solely written by TheFinealist. Parts of the article have been taken from Medium, Open, cited data sources and Google]