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Updated on Thursday, March 19, 2020
In the world of deposit accounts and personal finance, there is a new class of mobile-friendly, budget-focused apps called neobanks. Neobanks offer a range of services that are designed to improve the banking experience for consumers with fee-free accounts, user-friendly features and interfaces and competitive interest rates on deposits.
What is a neobank?
A neobank is a financial technology company — otherwise known as fintech — that offers banking services, most often in online or mobile-first formats. You may also have heard them referred to as mobile banks or challenger banks.
Setting aside all the jargon, very few neobanks are actually banks in their own right. That is because most of them lack a state or national banking charter. Instead, neobanks partner with established chartered banks to hold their customers’ deposits and provide Federal Deposit Insurance Corp. (FDIC) insurance (more on that below).
Neobanks are different from virtual banks, digital banks or online banks — these terms refer to a separate banking category. Online, virtual or digital banks are chartered banks in their own right, with federal deposit insurance, or they are online brands of bigger, brick-and-mortar banks that provide deposit insurance coverage.
Still, neobanks offer similar services, chiefly in the form of cash management accounts. These accounts typically earn an interest rate that is competitive with the best savings account rates on the market together with debit card access and the liquidity that comes with a checking account.
Neobanks break the brick-and-mortar mold
Many neobanks were founded by entrepreneurs hoping to tap into frustration with the banking establishment, which is stacked with institutions charging over-the-top fees and paying rock-bottom interest rates. It’s no accident that in the 2017 Survey of Unbanked and Underbanked Households, the FDIC found that 30.2% of unbanked households cited a lack of trust in banks as a reason for not having a bank account and about 45% noted issues with bank account fees as a reason for avoiding banking altogether.
This is the gap that neobanks are trying to fill for consumers’ benefit. It’s this innovation that Ken Tumin, founder of DepositAccounts.com, says is neobanks’ greatest strength.
“Innovation has helped neobanks come out with new banking products with greater simplicity, fewer fees and better interest rates,” said Tumin. “Neobanks are adding to the competition in mobile and digital banking. Added competition is always good for consumers.”
Common account features offered by neobanks
No fees: Neobanks often cut out all fees, which opens their products up to a wider range of customers. This goes well beyond that pesky monthly maintenance fee, as neobanks also nix the fees for overdrafts, excessive transactions and third-party ATM withdrawals.
Aspiration has attempted to build customer loyalty by operating on a Pay What Is Fair fee system. They don’t charge an upfront fee, but ask their customers to pay it forward in a fee that they think is fair, even if that’s $1 — or even zero dollars.
Check out the fee schedules of some of the top neobanks:
|Neobank||Monthly Fee||Overdraft Fee||Third-party ATM Withdrawal Fee||ATM Surcharge Rebates?|
|Empower||$6||$0||$0||Three a month up to $10 per fee|
Strong focus on online and mobile experiences: Neobanks are a product of changing times. Per the FDIC survey, more and more Americans are doing their banking on a mobile device, jumping from 23.2% in 2013 40.4% in 2017.
Neobanks put a heavy emphasis on the mobile experience they offer, knowing that customers are increasingly banking on the go and need well-designed, easy-to-use interfaces. While some neobanks make accounts accessible via both apps and online websites, many operate exclusively on mobile apps — these are known as mobile-first neobanks.
High interest rates: Similar to online banks like Ally Bank, neobanks can offer their customers very competitive interest rates on their deposits as they lack the infrastructure costs of conventional banks. Traditional banks and their standard offerings of 0.01% APY can barely compete. Take a look at the competitive interest rates these neobanks have to offer:
|Varo Money||2.80% (with requirements)|
0.81% (without requirements)
Customer focus: Neobanks are also attempting to disrupt the traditional banking industry with a real focus on putting their customers first.
Neobanks put a major emphasis on transparency, especially by being more upfront about the few fees they do charge, and communicating frequently about rate changes. For example, Chime and Varo Money boast no hidden fees, laying out clearly all the fees they do and don’t charge. For other neobanks, it’s as easy as going to their FAQ for the lowdown on their slim fee schedule. Simple, emails its customers when a rate change is coming up and tells you how that will affect you and your money.
Neobanks tend to include money-saving and budgeting features that are built into their products, at no additional cost. For example, Simple displays an additional Safe-to-Spend amount when you check your account balance on the app. This is the amount the app has determined you have to spend freely after taking care of bills and savings goals. You can also easily set up these savings goals, and even split your savings into different buckets, labeled according to your personal aims.
Chime recognizes the issues customers run into when paychecks and bills don’t line up. This neobank deposits your paycheck into your account as soon as Chime gets it, instead of waiting the traditional one to two days. This gives you real-time access to your money.
Neobanks and FDIC insurance
As noted above, neobanks are not state- or federally-chartered banks, and as such they cannot directly obtain FDIC insurance for their client’s deposits. To provide the crucial security of FDIC coverage, neobanks partner with one or more chartered banks. At the end of each day, neobanks sweep their clients’ money into accounts at the partner banks — sometimes referred to as program banks — where the funds receive FDIC insurance.
Some neobanks cooperate with only one partner bank, which provides deposits with the standard level of FDIC insurance. Many neobanks utilize multiple partner banks, which allows them to promise deposit insurance coverage amounts that are multiples of the standard level of FDIC insurance. For instance, Aspiration claims that each of its customers gets up to $2 million in FDIC insurance on their deposits.
If you have a high balance in your deposit accounts, this is a great way to maximize your FDIC coverage. Let’s say, for example, you have $600,000 in savings you need to place in a new account. Conventional banks provide the standard level of $250,000 in FDIC coverage per account, per client — which means you would need to open three accounts at three separate banks to obtain full FDIC insurance coverage for your $600,000 balance. Alternatively, you could place the full amount in a single Betterment Everyday account.
Take a look at some of the big neobank names, their partner bank(s) and the extent of their FDIC insurance for individually owned accounts.
|Account||Partner Banks||FDIC Insurance Limit*|
|Aspiration Save||Available in customer statements||$2 million|
|Betterment Everyday Cash Reserve||The Bancorp Bank|
Wells Fargo Bank, N.A.
East West Bank
TriState Bank Capital Bank
|Chime Savings Account||Stride Bank, N.A.|
The Bancorp Bank
Are neobanks safe?
Money deposited with a neobank is safe as long as it secures FDIC insurance from partner banks. In terms of online security, neobanks are just as safe and secure as traditional banks and their own websites and online systems. Of course, when you’re working with the internet, there is always a chance of internet failure — not just for you, but for your bank, too.
For example, neobank Chime experienced an outage in October 2019 due to technical issues with a third-party payment processor. This led to intermittent outages for customers trying to access the Chime app, website and ATM transactions. The Chime team responded swiftly to outage reports and helped its customers recoup any out-of-network ATM fees and righted any awry transactions.
This isn’t a neobank-specific scenario, however. In the same month, Bank of America and its customers suffered a similar outage, while Wells Fargo had its own outage earlier in February 2019.
In the event of a bank outage online, it’s important not to panic. Your money isn’t lost in this situation. To get more information on the extent of the outage, it helps to check the company’s social media accounts for updates or give customer service a call. Just keep in mind that thousands of other customers are going to be calling customer service as well.
Finally, your money and information are still protected by several tech safety measures like firewalls, encryption and two-factor authentication. While these measures help protect your money, you should also do your due diligence in checking your accounts during a bank outage for potential fraudulent transactions.
No branch access
The lack of branch access is a potential drawback, especially for more traditional banking customers. If you need to speak with a neobank representative, that’s mostly done online or over the phone.
Neobanks aren’t completely without physical access, however, partnering with ATM networks for nationwide ATM access. For example, both Varo Money and Simple provide access to over 55,000 Allpoint ATMs.
If you’re still wary, though, Tumin suggests keeping an account at a local brick-and-mortar bank or credit union in addition to an account at an online-only bank, whether it’s a traditional online bank or one of the new neobanks. That way, you can take advantage of the best of both worlds.
When you place your money with a neobank, it is acting as a sort of middleman between you and an FDIC-insured partner bank. While your money is just as safe and secure once it reaches that bank, FDIC coverage typically doesn’t apply until your money is moved into an account at a partner bank. The money is not insured between the time you make the deposit and the moment it is deposited with the partner bank.
Tumin points out this issue with some neobanks where they have a cash sweep account that distributes deposits into multiple banks. These neobanks don’t clearly disclose their program banks until you have an account with them or ask specifically. It’s not entirely clear that these sweep accounts are as safe as the standard checking or savings accounts that are held at one bank.
Neobanks are getting their own bank charters
Varo Money is an example of a neobank that has gone most of the way through the arduous task of getting its own banking charter. In February 2020, Varo Money was the first neobank to be approved by the FDIC to receive deposit insurance. Once the FDIC’s move gets a final sign-off from the Office of the Comptroller of the Currency and the Federal Reserve, Varo will no longer need to deposit its customers’ funds with partner bank, The Bancorp Bank, for deposit insurance.
Square, a payments fintech, applied for a new industrial loan company (ILC) charter in 2018 and in March 2020 was approved by the FDIC to create a new industrial bank in Utah, pending approvals from the Utah Department of Financial Institutions. This is a slightly different authorization than a bank charter, but an ILC can offer deposit accounts and can obtain FDIC insurance. Investment and loan fintech company SoFi also applied for an ILC charter in 2017, but withdrew its application shortly after.
Varo Money plans to expand product line
Varo Money’s COO Wesley Wright credits Varo’s success to its dedication to “providing better and fairer banking for everyday Americans and breaking barriers from the very beginning.” He also expects Varo Money to receive final charter approval by the end of 2020. Once they receive that green light, Varo plans to expand to additional financial services including credit cards, loans and additional savings products.
“We do anticipate that other fintechs will apply to the FDIC for a national bank charter,” he shared. “Our progress with the charter application underscores a bigger shift in the banking industry toward technology-driven experiences as well as a renewed regulatory commitment toward financial inclusion.”