Neobanks function as online-only banks. Here’s how they operate and why you might choose one

• Neobanks are digital-only banks that don’t have any physical branches.
• Neobanks often operate on top of a regular bank’s charter, which might limit their services.
• Neobanks tend to appeal to specific types of customers that benefit from online-only banking, rather than casting wide nets.

In today’s digital world, you can seemingly do everything from your phone, ranging from ordering food to reading the news to managing money. While many traditional banks have gotten on board with this digital revolution, new players have also emerged: neobanks. 

Rather than trying to transition old systems online, neobanks are building new, digital-only financial services platforms. 

What is a neobank? 

A neobank is a new type of financial-services offering that essentially functions as an online-only bank.

“First and foremost, it’s digital-only, and it’s mobile-first in its presentation,” explains David Whitcomb, vice president of product at MX, a financial data platform. 

Not only do neobanks operate without physical branches, but they tend to break the mold of traditional banks by having more niche focuses. “A [traditional] bank may enter a community trying to make an impact in the business, the wealth management and the retail areas, [whereas] neobanks will have a much more targeted focus,” says Whitcomb. “It’s often very distinctly purpose-driven or has very focused services.”

For example, neobanks might target certain professions, identities, or tout particular benefits like having no fees. 

How do neobanks operate? 

While neobanks often operate solely online, mobile versions of banks, many are technically fintech companies rather than actual banks. That’s because neobanks often leverage the charter of another bank, where customer deposits are actually held. The neobank then provides additional services and a digital interface that tend to appeal to different types of customer segments.

“The vast majority of neobanks don’t have a banking charter. That means very little to an end user when they’re just getting really good banking services. But what it means is that they’re not sitting on pools of funds, like a traditional bank, that they have to balance out with loans,” explains Whitcomb. “The result is that many neobanks don’t bring lending products in until they potentially get their own charter. And that’s not happening very often right now.”

But even if neobanks typically aren’t offering lending capabilities, such as for mortgages, car loans, or even traditional credit cards, they still can provide unique services that appeal to certain customer segments.

For example, Whitcomb points out how the neobank Daylight focuses on the LGBTQ+ community, offering services such as those “that are incredibly attractive to people who might be transitioning, that normal banks just would never have thought of and may not have not even considered taking the time or using the technology to do it.” For example, Daylight lets customers use their preferred name on their debit cards, even if that differs from their legal name.

How do neobanks make money?

While traditional banks often make money from services like lending, neobanks often don’t have that revenue source. Instead, they tend to rely on interchange fees, particularly from debit cards. 

These interchange fees are the transaction costs that merchants pay each time a customer uses a card, like if you swipe your debit card at the grocery store or use your card to book a hotel online. 

Neobanks also often promote the absence of fees on things like monthly account maintenance or overdrafts, which further underscores their reliance on capturing fees from card transactions.

If neobanks “don’t catch a transactional relationship [with customers], it’s really difficult to have [consistently] increasing revenue,” says Whitcomb.

Well-known neobanks 

Since neobanks often focus on particular customer segments, the popularity of specific neobanks can differ depending on who you ask. That said, some examples of generally well-known neobanks in the US include:

• Albert: Albert is a tech-forward neobank that focuses on areas like financial education and automated savings strategies.
• Aspiration: Aspiration focuses on environmentally friendly banking, such as by enabling customers to plant trees via card purchases.

• Chime: Chime notes that it was “founded on the premise that basic banking services should be helpful, easy and free.” Chime does not charge fees such as for overdrafting and can even temporarily spot customers some money for overdrafts in some cases, without fees.

• Dave: Dave touts itself as “the banking app on a mission to build products that level the financial playing field.” Similar to Chime, it offers benefits like no overdraft fees and the potential to get small, interest-free advances.

• Varo: Varo is a neobank that similarly emphasizes no-fee services. In 2020 it became a nationally chartered bank, which Varo says makes it “the first US consumer fintech to receive a national bank charter from the OCC” (Office of the Comptroller of the Currency).

Other types of well-known financial services brands like PayPal and Cash App could also be considered neobanks, notes Whitcomb. Even though these types of platforms are well known for enabling peer-to-peer payments and thus differ from what many other neobanks offer, they’ve also expanded into banking areas like enabling customers to receive direct deposits. 

Pros and cons of neobanks

Neobanks aren’t just shiny new versions of banks. There can be significant differences in terms of the advantages and disadvantages they provide.

Pros	Cons
Tend to be easy to use online and on mobile devices	No physical branches, which some consumers may not be comfortable with
Often offer no-fee or low-fee services	Often have limited services in areas like lending
Often appeal to specific groups, such as with card rewards that benefit specific causes, or offering services geared toward certain professions	May have customer service challenges, such as if they lack physical call centers.

In addition to these pros and cons, potential neobank customers may want to consider what financial institution a neobank leverages for its charter, if applicable. Not only might customers want to know for their own consideration, but logistically, they may need to know that information, such as if they need to mail a physical check to the underlying bank.

Neobanks vs. online banks 

The terms neobanks and online banks are sometimes used interchangeably, so there might not be any difference between neobanks and online banks, depending on who you ask. Some people might look at whether the financial organization has its own charter or leverages one from another bank, but that still doesn’t necessarily differentiate neobanks from online banks.

For example, Ally is an online-only bank without physical branches. Yet it’s a chartered bank with a full suite of services, including lending. So, while some people might say Ally is an online bank, not a neobank, Whitcomb considers Ally to be one of the original neobanks.

But just because a bank offers online services, that does not make it a neobank. Traditional banks now offer a variety of online and mobile banking services, but they still operate physical branches, which in part differentiates them from neobanks.