What is neobanking and how does it work?

More and more customers are choosing to bank with neobanks.

Also known as challenger banks, these alternatives to traditional banks are growing in popularity – but do you know the difference?

What is a neobank?

The term neobanking is part-Americanism, and part financial jargon; neobanks are better known in the UK as ‘challenger’ or ‘online-only’ banks. 

Simply put: neobanking is all about offering customers digital-first banking; many may not even have a branch you can visit.

Instead, they tend to have apps or digital platforms where all your finances are at your fingertips.

Neobanks are also known by many other names in the UK including: 

• Digital banking 
• Challenger banks 
• App-based banking

The rise of neobanking is closely tied to the rise in fintech, giving customers easy-to-use apps and platforms to interact with their accounts.  

The first neobanks — originally called ‘challenger banks’ in the UK — gained popularity after the 2007-09 banking crisis, pledging an alternative to traditional banks and promoting low rates and greater transparency.  

These online-only banks may have started out as relative unknowns, but some fintech titans like Monzo and Revolut have already become household names.  

Although for some customers the benefits of neobanks might be tangible, their services tend to be anything but.

Neobanks rarely have a physical presence (e.g. a high-street branch) and tend to have little focus on actual cash deposits and withdrawals. 

The digital-first approach of neobanks, combined with eye-catching branding and an emphasis on budgeting tools has made them a popular choice for younger customers.

Many neobanks also offer services for under 18s, with interactive features to help teenagers learn about money management.

Neobank vs online bank

So, what’s the difference between a neobank and online banking?  

Although neobanks may have pioneered digital banking tools, most traditional banks now offer online banking services, too.

In fact, more and more people choose to bank online and many bank branches are closing their doors for good.

Statistics show that between 2015 and 2022 more than half of the UK’s bank branches shut permanently.  

The interface of a neobank might be similar to the online banking service offered by a traditional bank. However, for neobanks, online services aren’t an add-on but are fundamental to their model.  

One trademark of neobanking is the streamlined services they offer on a digital platform, but this slimmed-down banking experience can also mean a neobank offers fewer services than a traditional bank. 

Advantages and disadvantages of neobanking

Ultimately, how you like to look after your money is a very personal choice.

Whether you prefer the experience of using a neobank or you’re happy with a traditional bank is down to you.  

It also doesn’t even need to be a case of either/or; many people have accounts with challenger banks in addition to their traditional bank.

Some people love using a challenger bank to keep track of their monthly budget but stick with a traditional bank for investments and larger savings, for example. 

Here’s an overview of some possible advantages and disadvantages of neobanking. 

Advantages of neobanks

Always there

Because neobanks live online or in an app, you never need to worry about running down to the bank before the branch closes.  

Low fees

Typically, neobanks can offer you low service fees, as well as sometimes allowing you to use your card abroad without incurring high charges. 

But remember whenever you’re thinking about switching accounts to shop around for the best deals.  

Budgeting tools

If you want to get better insight into your spending habits, many challenger banks offer you detailed breakdowns of your monthly budget.  

Easy-to-use and engaging apps give you tools to keep track of your spending, and even create plans for saving into a pot for a holiday, a special occasion or a rainy day. 

Disadvantages of neobanks

Little or no face-to-face

Although neobanks tend to have customer service built into the app, these tend to be instant messaging services with an assistant, or may stretch to a phone call.  

If you prefer having a sit-down discussion with an adviser about your account, online-only banks might not be for you.  

Limited services

Neobanks can offer you most day-to-day banking services but may not extend to some services, such as cash deposits, investment options or loans.  

How do neobanks make money?

You might be thinking ‘so far, so good’ — but what’s in it for them?  

Many neobanks make money from interchange fees.

This is the fee a merchant pays every time you tap your card or make a transaction.

Because neobanks are smaller operations than high-street banks, they can charge higher interchange fees, too. 

There’s another advantage neobanks have over high-street banks when it comes to balancing their books: no bank branches to run mean lower overheads for them. 

Who are the biggest neobanks?

Monzo

You may recognise Monzo by their signature coral-coloured cards.

Particularly favoured by younger users, the Monzo app features many tools to manage a budget as well as real-time spending notifications.  

Starling Bank

Like Monzo, Starling also offers spending notifications and budgeting tools.

Starling also offers customers a small percentage of in-credit interest and charges zero fees for using your card overseas. 

Revolut

Revolut is a popular challenger bank that particularly targets people who travel a lot by using real-time exchange rates.

It also allows customers to store money as cryptocurrency. However, as of April 2023, Revolut doesn’t yet have a UK banking license, meaning customers’ money isn’t protected by the Financial Compensation Scheme.