Neobanks in the African market are solving two problems for the continent’s population. First, neobanks are bringing banking services and products to populations that traditionally did not have access to them such as savings, investments or capital. Access to capital is one of the key hinderances to economic growth and this is a major challenge across Africa. According to World Bank as at 2021, 57% of the African population was unbanked. On the other hand, of the roughly 60 million MSMEs in Africa, 70% of them are financially underserved according to the Africa Development Bank. Neobanks intend on closing this funding gap at the personal and business level, by extending access to financial resources that businesses and people need. This will eventually translate to increased productivity among the people, which leads to economic growth.
Neobanks are also enabling banking to be done in a more convenient and modernized way, something that Africa and the global population demands too. The Covid-19 pandemic period saw a major shift in people’s behavior, whereby they embraced technology in most aspects of their lives, including for banking functions. Restrictions on movement meant that people could no longer visit a bank branch or ATM; and hence had to find alternatives. Commercial bank’s such as Standard Chartered that have gone digital and performing all onboarding functions online have seen their customer base grow by 500,000 since the start of the Covid-19 pandemic.
A growing population as well as increased internet penetration and smartphone use in Africa has augmented the neobanks’ market opportunity in the continent. In Sub-Saharan Africa, there were 480 million unique mobile subscribers by the end of 2019; and this number is expected to jump to 600 million by the year 2025. The continent also has a young and growing population that is tech savvy and one that is demanding for simplification of banking processes using technology such account opening. These two factors of a young population and an unbanked market clearly show that there is an opportunity for neobanks to thrive. However, these institutions must be ready to navigate strong competition coming from traditional banks that are going online, a regulatory landscape that is slowly but surely adapting and a customer market that have different needs and preferences when considering a bank to work with.
Neobank clients generally pay less fees to transact or maintain their account when compared to those who use traditional bank accounts. The main reason behind this is that neobanks do not have branch networks and therefore have lower operational costs. Most recently, due to the Covid-19 pandemic we have seen neobanks increase the number of their employees working remotely, which reduces their operational costs even further. This allows for such institutions to provide cheaper credit and charge less transactional fees to their clients; hence making them more attractive from an affordability point of view.
Despite the benefits that come along with having a neobank such as convenience and reduced fees, the industry still faces a lot of competition from traditional banking players. Legacy banks are not sitting and watching these new fintechs take up some of their market share. They are also providing digital banking channels to their clients that offer the same features and products that a neobank would provide such as easier payments and quick balance checks. Majority of the commercial banks within Sub-Sharan Africa have implemented digital banking. They have also built their capacity internally to be able to fully leverage this new trend by hiring qualified development teams, and implementing innovation as a core component of their operations. Additionally, these traditional bank accounts are the most used accounts even for customers who also have a neobank account. This account is where for example salary payments are received and hence the volume of transactions on the legacy bank account is still high. This then begs the question as to whether neobanks are as disruptive as they are perceived to be; bearing in mind traditional banks are also evolving technologically and not sitting back watching neobanks eat their lunch.
What next for neobanks in Africa?
Majority of neobanks generate their revenues from interchange fees. These Interchange fees are similar to what merchants are charged by card networks such as VISA or Mastercard for processing debit or credit card transactions, and maintain security in the entire network. Neobanks rely on this revenue stream as a main source of income, especially for those that do not have a banking license to offer other products such as loans. Unfortunately, neobanks that do not have banking licenses are the majority and this one revenue line is not sustainable. As already highlighted, majority of neobank clients who also have a traditional bank account carry out most of their transactions through the traditional bank account. This means that the volume of transactions happening on the neobank are limited. For example, the traditional bank account is where salary is ordinarily received, hence the customer would have a debit card under this account.
Neobanks have to look into acquiring banking licenses to operate as a full bank or seek strategic partnership with licensed institutions in order to offer additional banking products. These additional products include facilitating trade finance and offering overdraft facilities in order to attract more people to their platforms. In order to do this, neobanks should not only consider themselves as technological companies but also build their internal capacity to ensure that they have the requisite structures to operate as if they were a bank. For example, in addition to preventing cyber security risk they need to have risk management teams that understand the financial risks that a typical bank would face such as liquidity and credit risk that are also of concern for banking regulators.
On the other hand, these fintechs can leverage on their technological strength and choose to offer their software services for a fee to traditional banking institutions that may not have the expertise. That is, these institutions can leverage their strength of being able to build and maintain back and frontend of these online financial platforms, and offer these services to credit societies. We have seen this trend pick up with Future Link Technologies and Kwara helping SACCOs to go digital in Uganda and Kenya respectively. This allows such institutions to focus on their core mandate of providing savings and borrowings products to their clients.
Neobanks should also approach their customers as a community and build a relationship with them overtime. This allows the neobanks to engage their communities in product development that further strengths the trust that their clients have in them. To do this neobanks must first identify a particular market segment that they would like to appeal to. We have seen the likes of Bettr, a neobank based in South Africa offer products that are attractive to content creators and built a community around them. Neobanks can also bring in additional services such as offering education on saving and investing to their target markets; and use this to attract more clients.
Neobanks have to ensure that their LTV:CAC ratio – the ratio of their customer life time value (LTV) to the customer acquisition cost (CAC) is high. That is the value derived from keeping the client over a period of time should be higher than the cost of attracting them. Previously, when digital banking was still at its infancy stages, neobanks could easily attract clients who were looking for more convenient and cheaper banking options; and were tired of the inconveniences of the brick and mortar banks that were yet to implement digital banking. This kept their customer acquisition costs were low. However, over time, traditional banks have improved their products and services and fully implemented digital banking. This has made it more costly for neobanks to naturally attract customers; as they have had to implement programs such as referral schemes and one-off rewards to attract clients. When we compare this ratio between neobanks and traditional banks, we see traditional banks are able to generate a high LTV:CAC ratio since the volume of transactions is higher due to these bank accounts being primary and neobank accounts being secondary. It is therefore crucial for these neobanks to understand that establishing a community builds trust and long-term relationship; from which they can derive more value over time.
One customer segment that neobanks in Africa should consider is the cottage industry players who constitute a large number of SMEs in Africa. The number of cottage industry players increased due to job losses when the global Covid-19 pandemic struck. These small businesses are facing a significant challenge of access to capital due to limited access to collateral, and hence they have limited access to funding from commercial bank players.
Author: David Kageenu