Neobanks are entirely online and have no physical presence. They offer several benefits for banking businesses and consumers, particularly those who don't live near a physical bank, to perform transactions. However, neobanks must also face the challenge of fighting fraud and complying with Know Your Customer (KYC) laws.
What is a neobank?
A neobank is a digital-only banking service that exists solely online — taking the form of an app, website, or both. It usually has no physical presence or associated infrastructure. Neobanks typically offer all the services and features one would expect from a traditional bank: secure savings accounts, current accounts, budgeting tools, money transfer, foreign exchange, etc. Additionally, neobanks also employ the latest technologies (AI/AR/VR) to provide superior experiences compared to traditional banking solutions.
Digital banks differ from online banking, so the two terms should be distinct. Online banking is a feature offered by many physical banks, but digital banks have no brick-and-mortar presence and offer all their services online to their customers. Neobanks are similar, but they are small businesses with banking licenses set up to promise much more customer service, transparency, and a better customer experience than larger traditional banks. Both digital banks and neobanks are quickly becoming a favorite for many consumers due to their commitment to more transparency and customer satisfaction.
What is a challenge bank?
A challenge bank is another form of digital banking, but the one difference is a challenge bank often has a physical location. Think of a challenge bank as a hybrid version of a neobank and a traditional bank. These banks have small physical branches in a few specific locations, but they focus mainly on their digital presence. A challenge bank is often the best choice for customers who prefer a physical bank. They, too, focus on customer trust and satisfaction, so challenge banks offer the best of both worlds for customers who want online features but like the option of traveling to a physical location.
Benefits of neobanks
For customers with no interest in physical banking locations, neobanks offer several benefits they can't get from traditional banking. You might be wondering why you would work with a neobank rather than a conventional bank, but neobanks have several benefits you can't get with large institutions.
Lower fees and account access
One of the primary attractions for neobank customers is lower fees and access to an account, even if they have a poor credit history. This can help individuals who struggle to open traditional banking accounts due to a lack of resources or a lower credit score. With neobanking, they can start fresh with an account tailored to fit their needs and help them reach their financial goals.
According to FinTech News, "neobanks build on elements of AI to maintain the personal touch in-branch service offers and offer a more sophisticated virtual personal assistant experience." Better customer satisfaction has been missing from most large banks, where customers often struggle to manage their money and get better support. Neobanks bring this personal touch to customers frustrated with traditional banking.
As you know, customer support during banking holidays is nonexistent with traditional banks. Because neobanks are online, transfers are much easier, and customers can perform most of their banking without needing a physical location. Virtual cards give customers access to their money, similar to having cash, and transfers often take much less time than traditional banking transfers.
The biggest obstacle for neobanks
Neobanks face a hefty challenge when it comes to fraud prevention. Any licensed financial institution must adhere to "Know Your Customer" (KYC) regulations, a set of requirements banks must follow to verify customer identities and avoid doing business with sanctioned countries and/or individuals doing illegal activities. Because banking activity is done virtually, neobanks must have advanced technology to verify identities and catch fraudulent validation documents.
Fraud comes in several forms, but all fraud in the banking industry is costly and potentially life-changing for customers. Not only do neobanks need to stop fraud, but their systems must constantly change to account for the evolving cybersecurity landscape targeting financial institutions. Taking the necessary steps to prevent fraud protects not only the bank's interests but also protects the bank's customers. A neobank with poor security and customer protections would conceivably lose the public's trust and enormous business and revenue, so fraud detection should be a priority.
A few common challenges for neobanks:
- Account takeover: Armed with a list of stolen credentials, cyber-criminals use automated tools to attempt authentication into various banking accounts. Any customer using the same credentials across multiple accounts would be at risk of having their account compromised and funds depleted.
- Fraudulent new accounts: After purchasing sensitive documents on darknet markets, cyber-criminals use them to create fraudulent accounts to steal money from the neobank.
- Chargeback fraud: Even legitimate customers can participate in chargeback fraud, which is an activity that happens when items are purchased on a bank credit card and later a chargeback is used to get free items without paying for them.
- Loan fraud: Using fraudulent data or stolen data from legitimate consumers, cyber-criminals apply for loans and open accounts. Loan fraud affects both the bank and the consumer whose data was used to take out the loans, and it's a form of identity theft.
Another common challenge for virtual banks is peer-to-peer fraud. P2P fraud detection is much more difficult to detect because it often involves legitimate transactions from targeted consumers scammed into transferring money to a cyber-criminal. P2P platforms such as Venmo and CashApp offer the convenience of easy transactions, but they are primary targets for scammers and fraudulent activity.
Preventing neobank fraud
As the future of the banking experience shifts more and more to a virtual-first or virtual-only, identifying users accurately every time becomes a top priority for neobanks. This not only allows the bank to provide a hyper personalized user experience, it sets the standard for digital identification while also complying with KYC laws and regulations globally. There are a few suggested ways to accomplish this while not compromising on user experience.
Personalized user experience
By leveraging digital identification solutions, neobanks can provide clients personalized banking services that accurately meet their needs. Customers can benefit from faster onboarding processes and more customized product and service offerings tailored to their needs. This helps anticipate potential customer issues before they even occur – taking the digital banking experience to the next level.
Being proactive in fraud detection is imperative for businesses, especially for neobanks. Not only does proactive fraud detection benefit the bank, but it also safeguards user accounts and consumers from identity theft. To reduce the risk of a successful cyberattack, neobanks must implement a digital identity solution to detect suspicious activity and prevent further action from taking place. A device identification solution, such as Fingerprint, can identify users regardless if they are anonymous. This allows neobanks to prevent fraudulent activity, keeping their customers safe.
Customer awareness & education
Backend procedures shouldn't be the only proactive method in banking. Customers should be given tools to protect their data and provide educational content (e.g., blog posts and newsletters) to keep them informed about the latest scams.
For example, a digital bank should have machine learning algorithms to detect suspicious account behavior, but customers should have the ability to add two-factor authentication (2FA) to their accounts. With 2FA, an attacker could have the customer's banking credentials, but the attacker wouldn't be able to authenticate into the account entirely.
Even with tools such as 2FA, customers should be educated never to disclose their 2FA identification code. With all three personalized benefits, neobanks can work with customers to protect their accounts. Cybersecurity in the banking industry is a collaborative effort between customers and financial institutions to save consumer money and their identity proactively.