The emergence of niche banking

There is no need for brick-and-mortar banks. The days of traditional banks are gone. The reasons they have not disappeared yet? Three major reasons:

1. They don’t have the right software or skills to serve customers virtually.
2. They occupy and carry big real estate assets on their balance sheets which will lose a lot of value if they decide to vacate overnight and do business virtually.
3. They still serve (an aging and decreasing) generation of clients that see physical presence as credibility.

Luckily for the digitally-native consumer, banking-as-a-service has lowered barriers to entry for neobanks which are popping up all over, most of them not being profitable (yet). Out of 400 reported neobanks, only 5% are breaking even. But it’s clear they serve a customer need that traditional banks don’t, and once they successfully tweak their business models they will become profitable.

One size does not fit all

The majority of digital banks only fulfill one of the needs of consumers: to be served digitally with a simple user experience. Some digital banks, such as Revolut, go further with their offering to add premium features (for example travel insurance) and good FX rates. But that’s only useful in a market where customers travel often and they value this feature, like Europe. In a different market, like the USA where international travel is less common, different features are needed to attract very different consumers. One size does not fit all, which is why European neobanks are struggling to succeed in the US market – with N26 and Monzo recently admitting defeat.

This is why some describe Niche Banking (also referred to as Vertical Banking) as the future of banking. If you could cut customer segments into different verticals and develop banking products specifically for that vertical, that will be called a niche bank. Instead of offering a broad range of products to a wide audience, assuming “one-size-fits-all”, niche banks know their customers very well and specialize in products that serve their particular needs.

A niche bank has a strong brand and targeted marketing at a specific segment through the channels best suited to reach those customers. It would design specific products to fulfill the needs of the segment (examples later on) but also offer basic financial services associated with commercial banks, including custody, payments and lending.

The segmentation

The segmentation for niche banks could be based on:

• demographics (for example children under 18 years, pensioners, certain religious groups, etc.)
• ecosystems (for example students, Uber drivers or other gig-workers, real estate agents, etcc)
• regions
• communities (migrants, refugees, single parents, etc.)
• causes/interests (vegans or ESG-warriors)

The products

The products are carefully designed and targeted to meet the needs of a specific segment. The products will be a mix of high-margin lower volume and high-volume lower margin to ensure the profitability of the bank. Here are examples of products that will fulfill the needs of specific segments, or “verticals”:

• For children: allow remote mentoring by parents, gamify investing and saving, reward good financial habits and limit spending to a pre-defined list of merchants.
• For students: Tuition loans, enable re-sale of textbooks, guide budgeting and spending with automated tracking and alerts, bill splitting and easy transfers between students.
• Pensioners: Low-risk investment products, Budgeting and saving guidance, platform to promote pensioner specials and discounts.
• Career starters: Create financial goals such as saving toward a house and offering automated saving advice accordingly, refinance student debt, introduce investment products with e-learnings included, and reward progress in financial management and investments.
• Freelancers or gig works: Integrate invoicing, easy cashflow management and budgeting considering irregular inflows, low-interest short-term loans to even-out irregular cashflows, automate bookkeeping and receipt keeping based on banking data.

Current niche banks

• Purpose bank serves ESG warriors and brands itself as Planet and Animal friendly, supports environmental and animal advocacy and rewards ethical shopping
• Kontist bank serves freelancers by integrating invoicing and automating bookkeeping, tax and VAT calculations based on banking data
• Zelf, serves metaverse enthusiasts by enabling digital asset purchases and transfers between community members
• Chase First Banking for kids ages 6 to 17 to teach children and teens about saving and budgeting
• Virtual Wallet student by PNC caters to students with help on budgeting, leniency on overdrafts fees with alerts to prevent excess fees

It’s all about market positioning

Niche banking is less about the feature set and more about the market positioning. It is about the soft association and relevance to the user with some direct financial benefit. An example of the direct benefit we have seen is for an ecosystem of truck drivers, giving them discounts on fuel. Or giving low-interest loans to gig workers.

We have seen more and more niche banks being founded and I will analyze, for my next article, what it will take for niche banks to become successful and how neobanks can use segmentation of the market to better meet customer needs and drive profitability.