WORKWEEK

Last month, Aspiration laid off 180 employees as part of an ongoing restructuring:

Climate-conscious neobank Aspiration is laying off more than 180 workers as part of a companywide restructuring, the fintech disclosed in a Worker Adjustment and Retraining Notification letter it filed with California last month.

The recent restructuring also follows the firm’s leadership change last fall, in which former CEO Andrei Cherny, who co-founded the neobank in 2013, was replaced by Albrecht, previously the firm’s chief sustainability officer. 

Under Albrecht, Aspiration shifted its focus to selling carbon credits to corporations, and has paused the rollout of new digital banking products, a former employee told Forbes.

Earlier this month, Kinly was acquired by its competitor Greenwood:

Greenwood, a fintech that provides banking services to Black and Latinx communities, acquired fellow affinity neobank Kinly for an undisclosed amount, Greenwood announced Tuesday.

Greenwood said the deal adds 300,000 Kinly community members to the Atlanta-based firm’s platform. Greenwood, which last month ended its waitlist for the first time since its launch three years ago, has 150,000 banking customers

And earlier this week, Daylight announced that it was shutting down:

Daylight, an LGBTQ+ banking platform, is shutting down. Its operations will cease on June 30, according to embattled co-founder and CEO Rob Curtis.

The announcement comes months after NY Magazine published an explosive feature on the neobank. … NY Mag’s piece detailed a lawsuit brought on by three former employees as well as alleged fabrications and inappropriate behavior on the part of Curtis.

Taken all together, these developments paint a rather bleak picture of the future of a trend that was all the rage in 2020 – niche neobanks.

Quick refresher. Niche neobanks are B2C fintech companies focused on providing banking services (checking accounts and debit cards, most commonly) to specific segments of the market that have been, arguably, underserved by traditional banks. They are basically the fintech equivalent to a community bank, except that the ‘community’ in question isn’t defined geographically, but rather by some other shared characteristic – identity (race, ethnicity, gender, sexual orientation), occupation (there are neobanks for doctors, musicians, and content creators, among many others), affinity (my favorite example – pet owners), or values (climate-focused neobanks like Aspiration and Atmos fit into this category).

The basic argument for this niche neobank model is that in a post-branch, digital-first world banks have the ability to define and acquire whatever segment of customers they want and that by focusing on better serving a segment built around identity or occupation or affinity or a shared value, a bank can build a deeper, more profitable relationship within that segment.

Essentially, deep & narrow > shallow & broad.

That was the theory back in 2020 when this idea (and every other fintech idea) was attracting a lot of investment and enthusiasm.

Fast forward to today, however, and the available data suggest that this model may not work so well in practice.

So that’s the question I want to answer – is the niche neobank model viable?

And in typical Fintech Takes fashion, I’m going to try to answer this question with a bunch more questions!

Seven questions, to be precise.

1.) Do consumers select banking providers based on their identity/occupation/affinity/values?

It doesn’t really seem so.

I haven’t seen any good consumer survey data on this question, but honestly, even if I had, I’m not sure I’d trust it. Consumer survey data on bank switching behavior isn’t very reliable, nor, to the degree that it is reliable, is it that relevant anymore.

Consumers don’t switch banks like they used to. In the age of digital banking, most consumers will simply accessorize their core banking accounts with new accounts and banking tools, which they will acquire to fill in specific functionality gaps.

And this is where the niche neobanking model has failed (so far). Most of these niche neobanking products aren’t meaningfully differentiated. They don’t fill in functionality gaps for consumers. They mostly just rely on brand affinity and surface-level differentiation, like offering a debit card that is brightly colored or made out of wood.

It reminds me of hybrid and all-electric cars. 

Early adopters of hybrids and EVs were buying those vehicles because they were aligned with their values. You bought a Prius because of what owning a Prius said about who you were and what you believed.

The mass-market buyers of hybrids and EVs, who are just entering the market now, are different. Buying an electric vehicle today is less about signaling your values and much more about realizing the practical benefits of the more advanced and refined generations of these products (fuel economy, performance, coolness, etc.)

You can get a few early adopters based on brand affinity and values alignment, but the mass market requires more.  

2.) Can niche neobanks build non-bank products that consumers would be willing to pay for?

I think the opportunity for niche neobanks to grab significant market share within their target segments is to build products to solve money-adjacent problems. In the world of B2C financial services, a lot of these problems revolve around relationships, as I wrote about in a prior essay:

Money plays a foundationally important role in many different types of relationships. It causes couples to fight. It stresses out parents who don’t feel that they’re adequately preparing their children to go out into the world. And it creates a lot of awkward silences between adults and their elderly parents.

What’s weird is that there aren’t any traditional bank products specifically designed to solve these money-adjacent relationship challenges.

Niche neobanks have an especially good opportunity to solve some of these money-adjacent problems because their founding teams typically are a part of the communities they are trying to serve and, thus, understand the challenges they face very intimately.

Daylight provides an interesting example.

After trying and mostly failing to get traction with the standard debit card + tailored rewards and features + community marketing niche neobanking playbook for LGBTQ+ consumers, it pivoted to Daylight Grow, a concierge-like service designed to help LGBTQ+ couples navigate the financial, legal, and logistical challenges of starting a family.

Daylight obviously failed, but my read of the situation is that this was due more to problems with execution and company culture than strategy.

The idea of creating software solutions to niche, money-adjacent problems remains intriguing to me.

Of course, building those products and convincing consumers to pay for them is easier said than done.

3.) Is BaaS compatible with the niche neobank model?

Unfortunately, I don’t think it is.

I get the appeal, especially if you choose to work with a BaaS middleware platform like Synctera or Unit. Fast speed to market. Low set-up costs. An opportunity to quickly start iterating on your brand, product, and acquisition tactics.

There are a couple of problems, however:

• You are trading product flexibility for that fast speed to market. Building on top of BaaS banks and platforms is great … as long as you are only planning to build the standard neobank stuff (debit card, two-day early paycheck access, etc.) Solving those money-adjacent problems that you were so excited about? Yeah, no. You better plan on pushing those to the bottom of your product roadmap.
• Capturing the full share of wallet within traditional banking products is tough too. It’s not just the innovative, money-adjacent software products that are hard to build in this environment. Say you just want to offer a full suite of traditional banking products to your niche. That’s tough too. I don’t know of any BaaS banks and platforms that support deposit products, lending products, and wealth management products (honestly, good luck finding a partner that can support even two of these three categories).
• The unit economics are challenging … to put it nicely. Until you reach a significant scale, be prepared to lose every revenue share negotiation you enter into (if there even is a negotiation). And if you are using a BaaS middleware platform, be ready to split up your small pie three ways.     

All of these bullet points can be filed under the heading, “Life as a neobank is tough.” Nothing revelatory here.

But the key point is that niche neobanks are a unique breed. 

The challenges of building on BaaS (lack of product flexibility, unfavorable unit economics) can, theoretically, be overcome if you are able to quickly gain a massive amount of market share and then leverage that enormous user base to renegotiate revenue shares and cross-sell your way into bigger LTVs.

That’s the hope for Chime and Varo and Current and the rest of the mass-market neobanks out there.

That doesn’t work for niche neobanks, which, by definition, don’t have massive addressable markets to go after. These companies have to mine every ounce of profit out of a much smaller vein of ore … and that’s hard to do when you’re building on top of BaaS partners.

4.) Can niche neobanks generate profit through lending?

If you’re looking to make a profit in banking, this is the classic way to do it.

It’s going to be tough for niche neobanks though.

First, as we just discussed, the infrastructure you need is complex. A lot of BaaS banks and platforms don’t support lending. And if you find one that does, you still need to be prepared to do a lot more work (underwriting, funding, servicing, collections) than your standard, deposit-only neobank.

Second, VCs (who aren’t lining up right now to throw money at any B2C neobanks) are going to be queasy about it. Most experienced fintech investors rarely back B2C lenders because they know that it’s an extremely tough business that is highly regulated and incredibly sensitive to even small changes in the macroeconomic environment.

Third, consumer lending is a ruthless market. A great brand doesn’t get you very far. To win, you usually need to outcompete the market on either price or distribution (ideally both). Large consumer lenders like Capital One and American Express have spent decades learning how to win in this arena. Competing with them isn’t for the faint of heart.

There’s a reason that traditional community banks – the closest analog to niche neobanks – make all of their money from commercial lending, where a more bespoke, relationship-focused approach is workable.

(And no, before you ask, I don’t think niche neobanks can compete in commercial lending. This is one of the only remaining areas where community banks’ geographic specialization really matters.)

5.) Is the niche neobanking model a path to stickier, more stable deposits?

This question is a bit more hypothetical, but I do wonder – if a niche neobank was able to find product-market fit and gain significant market share within its target segment, how valuable would the resulting customer portfolio be?

The reason I ask this question is that we’ve just spent the last couple of months having a very stressful conversation about the stickiness of deposits in a rising-rate environment.

(If you want to understand more of the nuances of this conversation, I’d start with this podcast.)

Imagine if Atmos is actually able to gather a significant amount of consumer deposits because it offers a checking account product that appeals to climate-conscious consumers who don’t want to fund the fossil fuel industry.

Wouldn’t those deposits (which consumers are actively choosing to keep there in order to help save the planet) be unusually sticky and thus valuable to Atmos’s bank partners?  

6.) Will v2 of the ‘digital-only bank spin-off’ playbook succeed?

Here’s another hypothetical one for you – what if the niche neobanking model does end up working, but it’s traditional community banks (not fintechs) that make it successful?

A lot of the problems I’ve been talking about – building on top of BaaS, spinning up a profitable lending business – don’t apply to community banks. And the benefits (especially the ability to gather sticky consumer deposits) would be even more attractive to community banks than they would be to fintech companies.

Nymbus (one of the newer core banking providers) is trying to manifest this exact idea by partnering with community banks to launch niche, digital-only banking brands. 

One example is AlumniFi, a digital credit union for recent college graduates, launched by Michigan State University Federal Credit Union (in partnership with Nymbus) and offering tailored capabilities like debt paydown and charitable contribution management.

AlumniFi doesn’t look like the most cutting-edge digital banking product in the world, but that’s kinda the point. Maybe it doesn’t have to be. I don’t think MSUFCU is counting on AlumniFi to drive a majority of its growth or revenue, but if it can positively contribute to a couple of important metrics (growing share among younger consumers is one, I’m guessing) while drafting off of the advantages that MSUFCU already has in the market (I’d wager that MSUFCU has easy access to recent college graduates in Michigan, for instance) then it’s probably worth doing.

This is like the much smarter, more focused, and less embarrassing version of the ‘digital spinoff bank’ strategy that JPMorgan Chase tried with Finn and Wells Fargo tried with Greenhouse.

I’m significantly more bullish on this version.

7.) Have we permanently fallen below the ‘replacement rate’ for community banking in the U.S.?      

Let’s end with the most existential question.

In demography, the replacement rate is the rate at which women give birth to enough babies to sustain population levels, assuming that mortality rates remain constant and net migration is zero. In most developed countries, this rate is about 2.1 babies.

In the U.S., we’ve seen a significant increase in the ‘mortality rate’ of community banks over the last 80-90 years due largely to the accelerating pace of mergers and acquisitions (with some bank failures thrown in there, of course!) During that time, nearly 11,000 banks have disappeared.

That’s the big contributing factor to the total decline in banks in the U.S.

However, the other half of the story is the decline in the creation of new banks, as my friend Kiah Haslett wrote last year:

The Great Recession created a rift in the operating and regulatory environment: New banks no longer form at a rate fast enough to offset the number of institutions that disappear.

More than 1,000 traditional community bank de novos, or start-up banks, opened between 2000 and 2008, according to a 2016 paper from the Federal Deposit Insurance Corp. Since 2010, that number has totaled fewer than 100, according to research from the website Banking Strategist, using FDIC data. The lack of new banks has contributed to the decline of community banking in the United States. The reasons are complicated: Opening and operating a new bank profitably has gotten harder, even as technology that lowers costs and increases efficiency has proliferated. It is a radical, rare and unusual decision to open a bank these days, a leap of faith that has to be shared by regulators, investors and the executives of these new institutions.    

I thought this problem might be offset, at least somewhat, by the proliferation of new neobanks, including niche neobanks focused on serving communities and consumers who may have been left behind by the constant M&A frenzy among traditional banks.

I now think I was wrong.

It turns out that the proliferation of new neobanks that I optimistically observed in 2020 was a ZIRP-era phenomenon that VCs (and their LPs) have not been wild about continuing to support in today’s risk-off environment.

And I can’t really blame them! Neobanks, particularly the niche ones, haven’t yet demonstrated the ability to build positive unit economics or scale their way into becoming profitable businesses.

Still, it’s a shame. For all of their foibles, I think the U.S. will be worse off if community banks (both the traditional and neo varieties) disappear, as I wrote back in 2020:

The fact that community banks can’t, by definition, outgrow the communities they serve is an important counterbalance for an industry that often treats people like numbers in a spreadsheet.

When you strip financial services back to its most fundamental and important jobs, it’s difficult to make the case that smaller companies intently focused on the needs of specific customer segments aren’t vitally important.