Over the last few years, digital banks have enjoyed a remarkable boom. Also referred to as “neobanks” or “challenger banks”, they have deeply disrupted the retail banking sector, leveraging technology to streamline their customers’ entire experience. They ushered in a whole new era for the industry, much like Airbnb did in hospitality and Uber in transportation. But it is now becoming increasingly clear that this transition wasn’t entirely frictionless.

By offering their services via smartphone and without the need to maintain a physical branch network, neobanks like Chime in the US or Revolut in Europe managed to cut all fees and costs dramatically, even down to absolute zero in many cases. The same goes for transaction times, while the product range they offer keeps expanding. Apart from a basic current or savings account, neobank customers now have access to the stock market, insurance products, cryptocurrencies, and much more.

Most importantly, however, challenger banks succeeded in massively simplifying all the onboarding, account opening, and identity verification processes. Opening an account takes just a few minutes and the documentation required is minimal, often simply a photo of the customer’s ID or passport will suffice. This seamless signup experience has been a powerful selling point, especially for the younger generation, while it also made retail banking a lot more inclusive.

Without the need for thorough credit checks or demands for paperwork and documents that many low-income customers may not have access to, neobanks have filled a very big gap and provided access to basic financial services to millions of previously unbanked and underbanked people.

However, over the last two years, it has become obvious that this “inclusiveness” came at a price: Having opened the door to all the customers those traditional banks had turned away, they also let in many of the bad actors that were shut out of the banking system for a good reason.

"Companies used to build financial products starting with the risk. Everything today is built starting with marketing, and risk often times comes way further down the funnel.”

~ fraud expert and executive at a San Francisco fintech company

Fraud cases, identity theft incidents, and account takeovers have been piling up, costing millions to retailers, and leaving customers with emptied accounts. While most neobanks tried to mitigate those issues by tightening up their security and verification processes, the problem persisted. Eventually, this year, many merchants decided to take matters into their own hands. A growing number of rental car agencies and hotels in the US and elsewhere are no longer accepting digital bank cards. In March, Avis stopped accepting Chime cards, while Enterprise and Hertz also put in place their own bans for neobank cards.

To make matters worse, the way many of the challenger banks choose to respond to the fraud problem often backfired. Freezing or even summarily closing accounts en masse in an effort to kick the bad actors out of their platforms, often results in totally innocent customers getting caught up in the "purge”. In these cases, customers can lose access to their funds without a warning or explanation, and it can take weeks, or even months, before it is restored. This can cause serious problems for financially vulnerable customers and for those living paycheck-to-paycheck, the very segment that the neobanks initially targeted and tried to cater to.

Of course, it is not at all surprising that a new, innovative, and rapidly expanding industry has some growing pains. As the underlying technology advances even further and as these companies learn from their mistakes, we can expect to see many of these risks mitigated.

Nevertheless, at this point, the neobanks’ troubles still serve as an important reminder to bank customers and to investors alike: being too quick to jump on the bandwagon can be very risky.

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