One of the hottest fintech firms in the U.S. wants your deposits.
The company, Social Finance (often shortened to SoFi), is set to launch its SoFi Money business in the next few months. With this new product line, the company adds its name to the growing list of so-called “neobanks,” alongside firms like Chime, Simple and Varo Money. If you’re interested, there’s a waiting list for SoFi Money.
At their core, neobanks are companies that claim they can do a better job serving consumers than traditional banks. They are known for low fees or no fees, extra tools to help users manage their money and a better digital experience.
However, up until now neobanks have tended to stick to narrowly focused product lines, offering only checking or savings accounts. They have also needed to partner with specialty banks to ensure deposits are covered by the Federal Deposit Insurance Corp. (FDIC). This was part of a bigger unbundling trend in financial services a few years ago—startups were taking individual pieces of the financial services ecosystem and attempting to reinvent them with slick technology, and without the burdens of running a global bank that dated back to the 1800s.
SoFi’s expansion into deposits marks the beginning of a new phase, characterized by a rebundling of financial services. Companies that sought to revolutionize one little piece of banking are moving on to the next sliver. Note that SoFi has also launched wealth and life insurance products.
Is my money safe with a neobank?
Never place your non-investment dollars with any entity that doesn’t offer some sort of deposit insurance, either offered by the FDIC or the National Credit Union Administration (NCUA). If you don’t see either logo, don’t trust that your money is safe.
To be granted deposit insurance, companies must have a bank charter from a state or the federal Office of the Comptroller of the Currency (OCC). For now, neobanks have avoided getting bank charters by partnering with a group of specialty banks that handle the back-end tasks that you never see as a consumer. Social Finance is working with a network of FDIC-insured banks to hold and insure deposits made under SoFi Money.
Should you become a customer, your debit card would say SoFi Money and you’d use the SoFi app to check your balance and call customer service when you have a problem, but your money would be on deposit at one of SoFi’s partner banks. Additionally, WSFS Financial is the issuer of the debit card.
So, why don’t neobanks just become banks? If it were only that easy.
Getting a bank charter is really tough. The regulatory process is strenuous and costs a lot of money, both in startup costs and the amount of capital regulators want new banks to hold in order to serve as a backstop for operations. There have been very few new banks created in the U.S. after the 2008 crisis.
But neobanks are starting to warm up to the idea of getting charters, because they could cut out the middleman and add more products and services. In fact, SoFi was pursuing one last year, but pulled its application as management pivoted to address a crisis: The search for a new CEO after its founder stepped down amid alleged sexual harassment. SoFI has said it would like to revisit the application at some point.
Varo Money is another startup eyeing a charter. The company, which offers deposit accounts and some lending products, announced last month it has raised $45 million to help it clear regulatory hurdles.
Digital banks versus neobanks
It’s understandable if you don’t quite grasp the difference between digital banks, like Ally Bank, and neobanks, like Varo Money. Adding a bit more confusion to the picture are digital-only efforts by larger banks, like Chase’s new experiment, Finn.
Each of these different types has a specific play, but they tend to share a few similarities. They target digitally savvy users, so clients tend to skew young (but not exclusively so). They generally do not charge monthly service fees and do not require minimum deposit amounts. The products are typically designed to help you get better at budgeting and saving. Many employ the practice of design thinking when they build their platforms. The companies start by looking at what customers need and then create products that fill those needs, rather than offering products and then finding customers who want them.
Broader product offerings is the big advantage digital banks have over neobanks. If you’re a young millennial struggling with a budget, having a full-service bank might not matter. But if you’re looking for a bank where you can open a CD with a competitive rate, and later get a loan for a house or a car, a digital bank is a better fit.
Before picking one or the other, “you have to decide what you’re trying to accomplish,” says Mark Schwanhausser, an analyst at Javelin Strategy & Research. “Do you just need a place to move your money through—a transactional relationship—or are you looking for this plus a place to start building your financial life.”
Neobanks typically don’t let customers overdraft accounts; digital banks allow overdrafts and charge you for the pleasure. For instance, Ally’s overdraft fee is $25, which is quite a bit lower than the national average of $33.38, according to the 2017 Bankrate checking account survey.
Some people may also choose a neobank because they want access to bank-like products without having to do business with a bank. As they see it, neobanks are less likely to create fake accounts or tank the economy.
Different banks, different business models
There is another major difference between the digital banks and neobanks: how they make money. A digital bank earns profits just like a regular bank. Its revenue is primarily the difference between the interest it pays on deposits and the interest it collects on loans. That’s a time-tested way to make money.
A neobank that only offers checking accounts and savings accounts has to come up with another way to make money, because it doesn’t originate loans. Many rely on interchange fees—the money that merchants pay to card issuers on debit card transactions—as their primary source of revenue.
But critics say that’s not enough margin to build a sustainable business. Notably, last year savings app Digit announced that it would start charging customers a $2.99 monthly fee to avoid having to do things like selling customer data to find other revenue makers.
Here’s where the SoFi model gets interesting. It already has a lending business to rely on for revenue.
“A lot of neobanks have struggled to get any scale, but people are starting to understand the fact that there is a whole marketplace out there with better options,” says Jim Marous, co-publisher of The Financial Brand. “So, I think we are starting to see a revitalization of [neobanks] but this time with an expanded product line.”
Neobanks will likely either expand into other products that can make them money or they will turn to traditional banks to be acquired or license their platform, Marous says.
For a consumer considering a neobank, here’s the bottom line: You’re dealing with a young, ambitious company that wants to provide you with really cool free products, but the company will eventually need to make money and that could affect you. Those effects could be great, by the way. After all, Amazon started as an online bookseller.
Across the pond: challenger banks
Just like in fashion, everything is cooler in Europe. There, neobanks are called challenger banks, there are a lot of really interesting options, and people are flocking to them. This situation is connected to the larger push for open banking there. Recently enacted laws there make it easier for consumers to access, share and control their financial data.
The newest one to emerge is Buddybank in Italy, which comes with concierge-like service for average banking customers. Imagine asking your bank for a lunch recommendation in Rome and a real person messages you back.
Many of them see the U.S. as a potential place for expansion, but they are waiting to see if Americans will embrace them and whether the U.S. regulatory system will become easier to navigate.