Digital banking

The Ultimate Guide to Traditional and Digital Banks

In the time of a digital revolution, traditional banks are also being disrupted by their digital siblings. In recent years, many incumbents and startups started offering financial services online and pushing the limits of what financial technologies can offer.

With the emergence of fintech companies, the financial sector has completely changed. This has also led to the establishment of various online and digital-only banking structures such as neobanks, challenger banks and electronic money institutions.

One thing, however, remains an enigma – what is the difference between them? To make it clearer, let us begin with the first-ever known financial structure, the traditional bank.


What Is a Traditional Bank?

Traditional banks have been around since ancient times. They are the founders of financial services and the main source of the money flow. Traditional banks distinguish themselves with brick-and-mortar branches, where customers are personally served and can access the full range of financial products.

While in most developed countries traditional banks have digitised most of their services, in others – customers still need to visit the physical location to conduct their business. This is where the convenience of traditional banking ends, and digital banking takes its place.

However, if a fintech company or financial institution wants to function as a bank and offer advanced banking products to its customers, it must obtain a specific banking licence.

It is important to note that acquiring a banking licence is not sufficient for the licensed institution to be called a bank. To fall under the “bank” category, the provider of financial services should be able to receive deposits, grant loans and hold them in custody.


The Essence of a Banking Licence

Applying for a banking licence can be very exhaustive and requires regulatory compliance, and a lot of capital, which can be very difficult to raise, especially for small businesses and start-ups.

Fortunately, businesses do not need to have a banking licence themselves to offer some of the financial services. There are few ways that companies can do that such as getting permission from a bank to use their back-office via an API or using a core banking solution from fintech companies.

On the other hand, obtaining a banking licence has its advantages, of course. It gives companies access to more advanced banking products and offerings and helps them build trust with their customers. Above all, it opens the doors to a completely new customer segment.


What Is a Neobank?

Neobanks are a digital-only type of financial service providers. In that sense, they do not have physical branches and serve their customers entirely online via a mobile application. These structures are highly popular with millennials and younger tech-savvy users, but as technologies advance, neobanks are beginning to appeal to older generations as well.

Neobanks do not have a banking licence and therefore need to be supported by partner banks, large financial institutions, or Bank as a Service providers, which allows them to offer a full range of financial products.

The lack of physical branches and banking licence allows neobanks to lower their costs and offer more attractive financial solutions to their users. While they have access to a wide range of banking products, neobanks usually focus on a specific niche and target young consumers and small businesses.


What Is a Challenger Bank?

Challenger banks first appeared in the UK to challenge the British Big Four – HSBC, Barclays, NatWest Group and Lloyds Banking group. Their success quickly spread outside the island, and today there are more than 100 challenger banks worldwide.

In their essence, challenger banks are newly established retail banks that focus on private customers rather than business clients. What makes them more competitive is that they embrace technology, which allows them to be more flexible and offer all their services digitally.

The main differences between challenger banks and neobanks are that challenger banks own a banking licence and have physical branches, whereas neobanks do not. Therefore, challenger banks can offer a full range of banking services to their customers without the support of another financial institution.


What Is an Electronic Money Institution (EMI)?

Electronic money institutions are companies that can issue and redeem e-money. They have obtained a special EMI licence that allows them to mainly offer payment services to third parties such as money transfers, issuance and acquisition of payment instruments and execution of payment transactions.

The EMI cannot be defined as a bank as it is prohibited to take deposits. Furthermore, the transfers of funds processed through an EMI are usually limited to a certain amount, which depends on the respective jurisdiction.

It is not mandatory for the entity to be exclusively engaged in the financial industry to obtain an EMI licence. Companies already licensed Google, Facebook, Apple, and Amazon.


What Is the Difference between Traditional Banks, Neobanks, Challenger Banks and EMIs?

The technological revolution led to the disruption of traditional banking and the emergence of new financial institutions offering digitised banking products and services. Due to this change, many new terms emerged, such as neobanks, challenger banks and e-money institutions (EMIs).

Each one of them has its own business model and falls under different regulations, but at the end of the day they all offer financial services. What differentiates them from each other is the absence or presence of physical branches, the possession of a banking licence and the products and services they offer.

Understanding the difference between them might not seem so straightforward at first. That is why we have summarised the main differences in the table below.

Physical Presence Banking License Products and Services
Traditional Bank Full spectrum of banking products and services
Neobank Full spectrum of banking products and services*
Challenger Bank Full spectrum of banking products and services
EMI Payment processing and money transfers

* If the neobank is supported by a traditional bank or another licensed financial institution.


The Future of Traditional Banking

While some banks see their digital rivals as a threat, others see them as an opportunity to grow their profits by offering them access to their back-offices. Only time will tell how this love and hate relationship will develop.

One thing is for sure – technologies are here to stay, and they will keep changing the world around us as they progress. That is why companies should try to make the best use of them so that they can offer more competitive, innovative, and user-friendly products.


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