The financial services sector has witnessed a paradigm shift in recent years, with digital banking leading the charge. This transformation is driven by changing customer behaviours and technological advancements, propelling the growth and demand for digital banking and challenger banks or neobanks. With over 500 digital banks worldwide catering to approximately 1 billion customers as of 2022. This growth signifies consumers' increasing inclination towards digital banking solutions that address their evolving needs.
Europe has emerged as a frontrunner in the digital banking arena, owing to supportive regulatory reforms such as PSD1, PSD2, and licence frameworks for EMIs. These measures have enabled startups and entrepreneurs to offer innovative solutions without navigating the complex process of obtaining banking licences and accessing customer data from traditional incumbents. Consequently, Europe saw a boom in digital banks, with an estimated 162 digital banks by the end of 2022, based on Fincog's research.
Europe's robust innovation and technological infrastructure, coupled with thriving hubs like London, Berlin, Stockholm, and Paris, have accelerated digital banking adoption. Furthermore, lucrative returns from VC-backed businesses in the EU over the past two decades have made Europe an attractive investment destination. Despite recent global economic challenges impacting the combined value of European tech firms, Europe's tech market remains relatively mature.
The region's appeal is also attributed to its diverse and well-educated talent pool, world-class research institutions, and a large population with substantial internet penetration, reaching 86.9% in Eastern Europe and 97.4% in Northern Europe by 2023, according to We Are Social and Hootsuite research.
The rising popularity of neobanks has positioned digital banking as a viable alternative for numerous market players in Europe, resulting in a surge of new ventures. While independent neobanks such as Revolut, Wise, and Monzo maintain a strong market presence, traditional incumbents are also implementing digital strategies and launching digital greenfield banks to reinforce their market position.
European contenders, including New10 by ABN Amro (Netherlands) and Hello Bank by BNP Paribas (France), vie for market share alongside startups and scale-ups across the region. The growth of embedded finance and banking-as-a-service solution providers also facilitates the establishment of standalone digital banks by vertical movers like telcos and entrepreneurs, further intensifying competition in the EU banking landscape.
The allure of digital banks for consumers stems from the diverse business models and differentiation strategies that neobanks employ to capture market share and win over customers. European digital banks typically focus on rapid customer acquisition and scaling in a short timeframe to gain market foothold and attract investor interest. Neo banks employ various tactics, including clever marketing strategies, superior front-end customer experiences, and competitive pricing.
However, high customer growth rates are only part of the equation. Digital banks eventually reach an inflection point where cost management, revenue, and income diversification become paramount. Historically, many European digital banks have grappled with profitability due to an initial focus on customer growth over economic sustainability. Nevertheless, the number of profitable challengers has increased recently, particularly those offering lending services, a traditional profit generator for banks. Notably, Norway's SME-focused Aprila Bank joined OakNorth and Starling Bank as profitable neobanks in 2022.
In general, neobank profitability varies across regions and depends on diverse product and service offerings. Effective product portfolios and customer engagement are critical for improving overall profitability as digital banks strive to retain customers and reduce attrition rates. The introduction of engagement features such as gamification and personalised money management capabilities helps create a more immersive and interactive banking experience for customers.
Amid escalating cost-of-living crises, budgeting tools that help customers save in uncertain times can effectively increase customer loyalty. One example is bunq, the Amsterdam-based Dutch challenger bank, which recently announced a profit for 2022. The announcement follows several acquisitions in the past two years, including Irish lending company Capitalflow and mobile money management app Tricount, which enables users to manage group expenses.
Europe's digital banking landscape is diverse, with a plethora of digital banks launching every month. However, quantity does not necessarily imply quality, and many digital ventures falter along the way. Those that succeed often have business models that significantly deviate from traditional banks. Rather than relying on relationship managers, branch networks, or extensive product portfolios, digital banks typically specialise in offering unique services to customers.
For neobanks targeting niche customer segments, it is crucial to identify a specific pain point that resonates with their audience and for which customers are willing to pay. Without this, they risk failure due to the lack of differentiation and scale. For instance, Aprila Bank, which turned profitable in 2022, successfully identified a monetizable pain point: the challenges faced by small business owners and entrepreneurs in obtaining affordable and flexible overdraft facilities and business loans to overcome short-term difficulties. This enabled them to offer a unique and valuable solution to their customers.
Other strategies employed by digital banks include exploring alternative revenue streams and cross-selling opportunities by creating marketplace solutions and embracing the concept of financial and non-financial Super Apps. As the digital banking revolution in Europe continues to unfold, innovation and adaptability will remain key drivers of success in this dynamic and rapidly evolving landscape