The Rise of the Neobank: Is It Too Early to Invest?

Neobanks are gradually coming into their own. Despite persistent headwinds, including regulatory complications, major players in the Americas and Europe are becoming profitable, which could push an increasing number to go public over coming years.

• SoFi reports consecutive profitable quarters for the first time.
• Several European neobanks could be on the verge of IPOs as they also swing to profitability.
• ARK Fintech Innovation ETF has gained 33.5% in 12 months to 26 June.

Shares of Nu Holdings [NU], the company behind Latin American fintech prodigy Nubank, hit a 52-week high of $12.97 on 24 June after Jefferies raised its price target from $10.80 to $15.20. While these gains were wiped out by the close of the day, the upgrade means that the median price target for Nu among analysts polled by LSEG is $13.15, implying 10.9% potential upside from the 24 June close.

Read OPTO Foresight’s deep dive into Nu Holdings in Foresight, our Substack newsletter.

Nubank, which hit 100 million customers earlier this year, “is the poster child for Latin American neobanks and on course to become the region’s largest financial services provider”, Philip Benton, Principal Analyst at Omdia, told OPTO.

“The potential for Latin America has prompted interest from international neobanks, including N26, Revolut, and bnext, to expand into the region, although N26 has since announced its exit as it focuses on the core market of Europe,” he added.

Nu is the world’s largest neobank by market capitalisation as of 26 June.

Approximately one ninth of its size is US fintech and online bank SoFi Technologies [SOFI], which is in the process of proving the viability of its business model, having posted its second consecutive profitable quarter in April.

SoFi’s adjusted net revenue increased 26% year-over-year to $580.7m in Q1 2024, while diluted earnings per share (EPS) of $0.02 beat a loss of $0.05 per share in the year-ago quarter. The company expects 2024 to be SoFi’s first profitable year, and estimates EPS could reach $0.09.

Nubank likewise posted its first profitable year in GAAP terms in 2023. Between the two of them, Nu and SoFi are demonstrating that both growth and profitability are within reach for neobanks.

European Unicorns

According to Benton, “Europe was the birthplace of neobanks, with the first players emerging in the UK and Germany during the late 2000s, including Atom Bank, Monzo, N26, Revolut and Starling Bank. 72% of the European neobanks tracked in Omdia’s Neobank Activity Tracker are start-ups, considerably higher than the global average of 56%.”

These companies are proving the viability of the neobanking business model, and several could be poised to go public.

Starling’s revenue rose approximately 50% to £682.2m for the year ending 31 March. Its pre-tax profit surged 55% to £301.1m, marking the company’s third profitable year and reviving interest in its rumoured IPO, which CEO John Mountain this month told journalists is being “extensively discussed”, Bloomberg reported.

Starling is also reported to be eyeing an expansion of its Engine service, a banking software platform that the UK challenger bank offers to companies across Europe, southeast Asia and the Middle East, having also signed a contract with a partner in Australia.

This licensing trend “indicates that neobanks are diversifying their revenue streams, and by being able to pivot for business-to-business applications, this puts them in a stronger position to continue to grow overall revenue at a rapid rate,” said Benton.

Breaking the Bunq

UK challenger bank Monzo, meanwhile, celebrated its first profitable year in June, swinging from a pre-tax loss of £116.3m to a profit of £15.4m. It closed a funding round in May that took its total funding raised this year to $610m and valued the business at $5.2bn.

“Monzo recently announced that it had reached 9 million customers as of 2024. This makes it the seventh-largest bank in the UK,” said Benton.

While CEO TS Anil has stated Monzo’s intention to list publicly, there is as yet no clear indication of when this might happen.

Dutch neobank Bunq is seeking a banking license that would enable a UK return, according to PYMNTS. In an interview at the Viva Tech conference in Paris this month, CEO Ali Niknam said that the process could take until the end of 2024 or early 2025, given the complexity of the UK’s process. However, he added that “I have little reason to believe that we won’t be successful”.

Bunq originally launched in the UK in 2019 but was forced to leave when the country left the EU the following year. Bunq is reportedly targeting the country’s 2.8 million digital nomads.

A Troubled Adolescence

Merging technology and banking can be a recipe for regulatory challenges.

SoFi was fined $1.1m in May after flaws in its ID verification system enabled fraudsters to steal $8.1m from the accounts of customers at other banks between December 2018 and April 2019.

The third-party process SoFi uses to automate identity verification “allowed opening of SoFi Money accounts without a reasonable review of potential red flags associated with some applicants”, said the Financial Industry Regulatory Authority.

SoFi says that it has enhanced its verification services in response to the volume of fraud alerts generated since it launched SoFi Money in February 2019.

German neobank N26 has also been facing regulatory oversight, which Co-founder Valentin Stalf told the Financial Times has cost the company billions of euros in lost growth over the years.

N26 was told by financial regulator BaFin in 2021 to limit new client sign-ups to 50,000 per month — less than a third of its average at the time — upon discovering its poor anti-money laundering controls.

Two fines issued in 2021 and 2022 totalled €13.45m, though N26 said in May that, in addition to other direct costs such as investment in control functions and monitoring systems, the total cost came to €100m. Stalf claims that the impact on the company’s valuation, and thus its ability to grow, “amounts to billions of euros”.

“There has been a lot of doom and gloom written around the future of neobanks, but it is easy to forget that they are only now just entering their teenage years and a handful have already matured into fully fledged adults,” according to Benton.

How to Invest in Neobank Stocks

Given that the theme is still maturing, there are no dedicated neobank ETFs. However, the small number of publicly listed stocks can be found in more generalist fintech ETFs.

For example, the ARK Fintech Innovation ETF [ARKF] holds both SoFi and Nu as of 27 June, at weightings of 3.37% and 1.98% respectively. ARKF gained 33.5% in the 12 months to 26 June, but is flat year-to-date.

Nu is up 65.8% in the past 12 months and up 52.2% year-to-date, while SoFi is down 25.2% and down 35.1% in the respective periods.