The emergence of challengers like Revolut, N26, and Monzo looks unstoppable. A new study looks at their primary stumbling blocks.

They're growing at an average 45 percent annually, a trend that the pandemic will only accentuate: digital challengers are clearly a threat to established traditional finance players. Digital-first banks like Revolut, N26, or Brazil's Nubank excel at user-friendly mobile apps and simplified onboarding which conveys an almost rebellious stance to clients.

The main obstacles for upstarts in turning profitable, according to an industry study by Rothschild & Co are:

1. Fees off card transactions are thin, so the start-ups would require huge volume

2. More lucrative premium products are often sold at a discount

3. Frequent partnering dilutes margins (key word: ecosystem)

Some providers are closer to break-even than others: Swiss N26 head Georg Hauer told finews.com the challenger bank is already profitable on a per-client basis: «Each new client won earns us money and brings us closer to breaking even,» Hauer said.

N26 is not yet profitable, but doesn't appear to need to plow huge amounts into acquiring new clients. «That's dramatically different to other start-ups, where every new client just costs money first,» Hauer said.

Corona's Dual Effect

Nor is the global pandemic purely a gain for digital banks. While the lockdown kickstarted online banking, clients also traveled less – so digital banks missed out on foreign exchange transactions, for example. Clients are also generally shopping less, which means lower transaction fees.

 Since digital banks are primarily free, and consumers view free services as less valuable, loyalty is an «elusive concept» for the challengers, Rothschild writes. Thus client loyalty springs from savings for clients, simplicity, and trust.

Resisting Temptation

It is that trust that has proven problematic for some – like Revolut – and continues to pose a threat, according to the study. The challengers need to resist the temptation of a quick buck by monetizing the piles of data they have on their clients.

«You only have to look at the Facebook data privacy scandal to see how damaging that can be,» study authors William Haggard and Willis Palermo wrote. Online banks need to keep in mind the data is mainly to assess their customers' credit quality and to maximize product placement.

Partner Vs Competitor

Banks are hardly differentiated from each other, Rothschild noted: clients opt for their mortgage lender or savings and loan based largely on price. This is currently the main weapon on digital banks – undercutting their more established competitors on price. 

Their main strength lies not in the pricing, but in sophisticated digital platforms and lower spending, thanks to newer, cheaper technology. How they expand and monetize their platforms is their main challenge: one road may be combining with traditional finance for a complementary fit of strengths, Haggard and Palermo said.