In today’s Exponential Investor

  • What is a neobank?
  • Why is Revolut breaking ESG?
  • Where to invest next?

“Neobank”

It’s a term used to describe the new-breed of players who are quite unlike the traditional high street banks such as Lloyds, NatWest, HSBC, Barclays – the big boys of the banking world.

These neobanks don’t have a branch in the high street. Nor ATMs, either. And they certainly do not provide tellers who can cash a cheque for you.

They are digital-only. They exist in an app. They deliver a whole host of financial products and services you’d expect from a bank, but their apps are easy to use, easy to set up, and easy to manage through your phone.

The rise of the neobank has been nothing short of astronomical.

And rightly so.

These entrepreneurs saw an opening, and burst through, disrupting the traditional retail banking market.

Today you will know them as banks such as Starling Bank, Monzo or Revolut.

There are more, but those three are hugely popular in the UK. They’re also massive in terms of size and valuations.

In March this year, Starling brought on £272 million in funding, giving it a rough valuation of £1.1 billion. That is not bad for a company that’s only seven years old.

Monzo, even younger, launching in 2015, brought in fresh capital at the end of 2020 giving it a valuation of around £1.25 billion. Admittedly, it had previously been valued at as much as £2 billion.

And then there’s Revolut.

Also founded in 2015, Revolut now carries a notional valuation of around £24 billion.

That makes Revolut as big (comparing its notional valuation with the market caps of the big listed banks) as NatWest, and within touching distance of both Lloyds and Barclays (both at £30 billion).

That is incredible for a six-year-old bank.

But things might be about to change for Revolut. Some might say that this is for the better – I would say that the change is for the worse.

Pay me now, I’ll pay you later

I’m sure you’ve heard of payday lending.

It’s a practice of lending that advances an applicant a typically small sum of money in advance of their payday.

For example, let’s say it’s a week before your pay is scheduled to hit your bank account. But you desperately need a few hundred pounds for a purchase.

You don’t quite have enough savings to do it, you don’t have enough on your (or you don’t want to use your) credit card. So you can get a payday loan to cover the cost, with the expectation that when your pay hits your account, the amount of the loan is removed and paid off.

Debt paid, job done.

It sounds great in theory.

But then you’re short in your pay by that amount until you get paid next time.

This actually can often lead to a never-ending cycle of debt and repayment every payday where debts can eventually spiral out of control.

These small loans seem innocuous to begin with, but often come with fees and charges and repayment interest rates that are absurd.

Meanwhile, the Financial Conduct Authority (FCA – the key financial regulator) has implemented caps on interest on payday loans. However, according to MoneyHelper.org, “Over a year, the average annual percentage interest rate of charge (APR) could be up to 1,500% compared with 22.8% APR for a typical credit card.”

The organisations that typically get into this type of lending know exactly who they’re aiming to get as customers. We’ve also seen some operators in this space provide loans that aren’t suitable, aren’t affordable and are simply not conscionable.

Sometimes the market can weed out predatory practices in this space. We saw this with the failure of Wonga, a notorious payday lender here in the UK.

But like the mythical Hydra, you cut off one head in the payday lending industry and, it appears, two more reappear.

What makes this story baffling is that the fastest growing, most valuable UK start-up in history, Revolut, is heading down the Wonga path… providing payday lending to customers.

Revolut is offering a new service it calls “Payday” which will unlock a portion of your wage early – up to 50%, charging a small flat fee to users.

Now Revolut will dress this up as a benefit for the customer. The company may even find a way to explain away the fact it’s really payday lending.

But let’s call a horse a horse here – this is an extension of credit in anticipation of repayment. It is payday lending if I’ve ever seen it.

This may bring Revolut a new breed of customer.

But in my view, it’s going to damage its reputation. It’s definitely going to hit its ESG (environmental, social and governance) credentials, and it’s likely going to pull down its valuation.

It’s the social responsibility aspect that I find most concerning here. No doubt there’s a market for payday lending. But should there be? I don’t think so. And it seems Revolut simply doesn’t care about the kind of debt spirals that this may kick off.

While Revolut has been a darling of the UK business world till now, my take is that this is a turning point.

And should the company even actually access the public markets for funding, these are all factors you’d want to consider before you made an investment…

If not the start-up unicorn Revolut, then where?

Of course, luckily – for now – Revolut isn’t a publicly listed stock.

But the banking and finance industry is absolutely an area of focus for investors. If it isn’t one of yours, it should be.

Companies like Revolut, while perhaps heading off the rails now, still demonstrate the huge wealth-creation opportunity that disruption in banking and finance can deliver.

My view is that a company like Revolut now has a nasty taste about it.

But the big high street banks also have a similar smell about them.

So as an investor, where should you look if you want to invest in banking and finance, but the names you know and hear about are a bit “on the nose”?

Well my view is that where neobanks have gone some way to replacing the high street bank, it’s the decentralised banks that will disrupt them all in the next wave.

They’re not like the banks you’ve known. They’re not like these neobanks. They are new, risky, and borderline experimental. But in my view, they’re the next multi-billion-pound banks that will take us through this decade. We may well look more closely at them in a coming edition of Exponential Investor.

Until next time…

Sam Volkering
Editor, Exponential Investor