What Is a Neobank, and Are They Safe?

Fact checked by Brendan HarknessFact checked by Brendan Harkness

What Is a Neobank? 

Neobanks are financial technology companies that offer digital banking products and services through websites or mobile apps. They aim to disrupt traditional banking models by offering competitive rates on loans, low fees, and higher-than-average interest rates on deposit accounts. 

However, neobanks—on their own—are not banks. Banks are chartered institutions that have been licensed to accept deposits and issue loans; neobanks lack those distinctions. Instead, they partner with chartered financial institutions to offer bank accounts, loans, and wealth management services.

For consumers who prefer a completely digital experience or who have been disappointed with traditional banks in the past, neobanks can be appealing. However, there are some risks to neobanks you should be aware of before switching all your bank accounts. 

Neobanks are increasingly popular. As of October 2023, there were about 400 neobanks worldwide, according to a report from global consultancy firm Simon-Kucher.

Key Takeaways

• Neobanks, which offer digital banking services, can make bank accounts more accessible due to their online presence, low fees, and competitive rates.
• The global neobanking market was valued at $83 billion in July 2023, and it’s expected to grow at a compound annual growth rate of 54.8% through 2030. 
• Neobanks typically boast higher-than-average annual percentage yields (APYs) on savings and money market accounts.
• Neobanks rely on their relationships with chartered banks to provide financial products. 

How a Neobank Works

Neobanks partner with chartered banks to offer deposit accounts, loans, and other financial services. Unlike traditional banks and credit unions, which may offer digital portals while also operating physical branches, neobanks only offer their services and products online or through a mobile app.

For example, Chime is a well-known neobank. It’s a financial technology company rather than a bank. As the fine print on its website states, its banking services, credit accounts, and debit card are provided through partnerships with The Bancorp Bank and Stride Bank.

Important

The American Bankers Association reported that consumers conducted banking activities via mobile app more than any other method in 2023, highlighting the potential for neobanks’ growth as consumers increasingly use digital banking platforms to handle their finances.

Neobanks differentiate themselves through robust and easy-to-use digital platforms.

“Neobanks can offer customized services that traditional banks may not, such as budgeting tools and real-time transaction notifications,” said Thomas Henske, a certified financial planner (CFP) at The Affluent Insurance Advisor. “It’s easy to imagine that more banking will go in this direction, especially post-pandemic where there is less of a desire to visit a brick-and-mortar branch.”

Neobanks typically target consumers in specific groups:

• The unbanked and underbanked: As of 2022, approximately 6% of adults in the U.S. were unbanked, meaning they did not have access to a bank account. Adults may not have a bank account because of concerns about bank fees or deposit requirements, or because they lack a nearby branch. Neobanks serve these customers by making lower-cost banking options available online.
• Hourly workers: Hourly workers can take advantage of neobanks’ features to manage their cash; many neobanks have features like early direct deposit access so workers can receive their paychecks early or take out interest-free paycheck advances. 
• Students and young adults: College students and young adults are often on tight budgets, may have student loan debt, and may need assistance managing their finances. Neobanks can be appealing because they have low fees and low minimum deposit requirements, they may offer student loan resources, and they often provide financial education tools.
• Savers and finance enthusiasts: Neobanks can be a smart option for those looking to maximize their money. These digital-only institutions boast deposit accounts with higher-than-average APYs, helping you grow your money faster. 

“Two of the biggest advantages to the general consumer of using a neobank are that they often do not charge a lot of the fees that traditional brick-and-mortar banks charge, and [they] typically offer higher interest rates on savings accounts and certificates of deposit (CDs) than traditional banks,” said Drew Feutz, a CFP and founder of Migration Wealth Management. 

Neobanks tend to make money in other ways, such as subscription or membership fees and interchange fees. Interchange fees—the costs merchants must pay whenever a customer makes a purchase with a credit or debit card—are responsible for a major part of neobanks’ revenues. For example, interchange fees made up approximately 80% of Varo’s non-interest revenue in 2022, according to an analysis by market research firm Sacra. 

Pros and Cons of Neobanks

Pros

• Higher APYs on deposit accounts

• Lower account fees

• Robust digital and mobile platforms

Cons

• No physical branch locations

• Limited products and services

• May not be covered by FDIC insurance

Pros Explained

• Higher APYs on deposit accounts: Fintech companies and neobanks don’t operate physical branches. As a result, they have lower overhead costs than traditional banks, so they can provide higher-than-average APYs on savings accounts, money market accounts, and CDs.
• Lower account fees: Because neobank services are only available online or through a mobile app, the companies tend to charge lower account fees than traditional banks. For example, you can open a checking account with no monthly fees through several neobanks.
• Robust digital and mobile platforms: Neobanks specialize in comprehensive, easy-to-use digital platforms and mobile apps that allow you to handle most banking tasks online or with your smartphone. 

Cons Explained

• No physical branch locations: Neobanks don’t operate physical branches, so you can’t get in-person help. 
• Limited products and services: Neobanks may have limited partnerships with chartered banks, so they may only offer some accounts and services. For example, some may have savings accounts but may not offer CDs or money market accounts. 
• May not be covered by FDIC insurance: Neobanks aren’t chartered banks, so they aren’t backed by Federal Deposit Insurance Corporation (FDIC) insurance. If the neobank you choose has partnered with a chartered, FDIC-insured bank, your deposits are protected in case the bank fails or closes, but not all neobanks are affiliated with FDIC-insured banks. 

Warning

Even if your neobank has partnered with an FDIC-insured bank, the funds you deposit are only covered once the neobank deposits them into an eligible account at an insured bank. Your money may be unprotected during the transfer process. 

Popular Neobanks

Some of the best-known neobanks include Chime, Dave, and Varo.

Chime

Chime is a San Francisco-based neobank that partners with The Bancorp Bank and Stride Bank to provide bank and credit accounts. Through its platform, consumers can open checking accounts and high-yield savings accounts and take out credit builder loans. Neither its checking or savings accounts charge monthly fees, and Chime offers benefits like early direct deposit access.

Dave

Dave is a neobank known for its budgeting app and cash advance benefits. There are no monthly account fees, but Dave does charge monthly membership fees—while this is widely reported online to be $1 per month, Dave’s own site only refers to it as a “small fee.” 

Dave’s banking services are provided through Evolve Bank & Trust, an FDIC-insured financial institution. The app launched in 2017, and since its inception, it’s served over 10 million members.

Varo

Varo was one of the first neobanks to qualify as a full-service chartered bank. As a result, its products are issued through Varo Bank. Varo offers checking accounts, savings accounts, secured credit cards, and cash advances. It also recently announced that it will begin offering lines of credit in summer 2024. It currently has more than 3 million customers.

You can use the FDIC’s BankFind tool to look up whether an institution, such as a neobank or its chartered bank partner, is FDIC-insured.

Frequently Asked Questions (FAQs) 

Do Neobanks Charge Lower Fees?

In general, neobanks charge lower fees than traditional banks that operate brick-and-mortar branches since they have lower overhead costs. 

Can I Get a Loan Through a Neobank?

Some neobanks—such as SoFi and Varo—do offer loans or lines of credit. But neobanks typically have fewer products than traditional banks, and not all offer borrowing options. It’s wise to check the best loan rates currently available from all sources before making a decision.

Are Neobanks Failing?

Neobanks are largely dependent on interchange fees for their revenue, and any adjustments to that fee schedule affects their profitability. According to the U.S. Department of the Treasury, several neobanks have operating losses, putting them at risk of failing. 

“No business can last forever without earning a profit,” cautioned Feutz. “Even the largest neobank in the U.S., Chime, is not profitable yet.”

Will Neobanks Replace Traditional Banks?

Neobanks present a significant challenge to traditional banks, but they’ve struggled to become profitable. Rather than replacing traditional banks, neobanks complement the current banking institutions and have motivated traditional banks to adapt to changing technology by offering online accounts and financial mobile apps.

Are Neobanks Risky?

There can be some risks with neobanks. Perhaps most importantly, your deposits are only protected if they’re deposited with an FDIC-insured bank. 

“Not all neobanks have such insurance, so it’s crucial for customers to check this before opening an account,” warned Henske. 

Additionally, there have been issues in the past with neobanks that handled cryptocurrency transactions misrepresenting themselves as FDIC-insured, so be aware that crypto transactions aren’t covered under FDIC insurance. 

Important

Use the FDIC deposit insurance estimator tool to find out how much of your money is protected by FDIC insurance.

The Bottom Line

For those who prefer to handle their finances on the go or who want to maximize their savings, neobanks can be useful alternatives to traditional banks. They typically offer higher APYs and lower fees than brick-and-mortar banks, and they may provide added benefits like early direct deposit access or low-cost cash advances. 

However, be sure to choose a neobank that works with a chartered, FDIC-insured bank to issue its products. Otherwise, you risk losing money if the neobank fails. 

Read the original article on Investopedia.