The business of banking is changing rapidly. Products and services rendered and built on disruptive technologies are increasingly being placed in the hands of end customers, and the behaviors of banks are changing in terms of customer convenience, transparency, pricing and customer service. As costumers’ behaviors and expectations change, so do the business and operational models. One such change is the introduction of neobanks in the banking sector, which has a great potential of its own. According to a Vidhi Centre for Legal Policy report, Digital-only banks, or neobanks, have the potential to meet the financing needs of small businesses and help digitize and formalize their operations.

Access to formal credit has been a key challenge for India’s micro, small, and medium enterprises (MSMEs), which employ about 111 million people. Digital banks can support underserved market segments as access to credit from traditional banks have been limited due to the informal nature of businesses, low turnover, and inability to provide collateral.

“One common customer segment that seems to have gained popularity with such digital-only banking models (both in India and globally) is the MSME segment. Through their technology focused operations, these banks are able to offer a range of services to meet the varied banking and business needs of such establishments,” the report said.

India’s neobanking sector is at a nascent stage and at present there are 17 neo-banking platforms, including Niyo, RazorpayX, Instantpay, Jupiter, and Nupay, the Vidhi report said. Digital-only banking functions as a partnership between a licensed bank and fintech companies, as Indian laws do not allow digital banks.

Digital banks can support underserved market segments as access to credit from traditional banks have been limited due to the informal nature of businesses, low turnover, and inability to provide collateral

The non-banks provide the tech platform through which banking and value-added services, including opening and operating savings or current accounts with licensed banks, applying for loans, generating invoices, accounting, and ensuring compliance with goods and services tax norms, are accessed. Such platforms typically target millennials, startups and MSMEs.

However, in countries such as South Korea, China, and the UK, digital-only banks are licensed to provide all banking services. “Licensed digital banks that allow end-to-end banking operations to take place have emerged in certain jurisdictions. The digital-only banking model may play an important role in providing critical banking services and contributing to the growth of a robust and competitive banking sector,” the report noted.

A digital bank and a neobank aren’t quite the same, even though they appear to be based on the mobile-first approach and emphasis on digital operating models. While the terms are sometimes used mutually, digital banks are often the online-only subsidiary of an established and regulated player in the banking sector, A neobank, on the other hand, exists solely online - without any physical branches and independently or in partnership with traditional banks. This enables them to navigate and comply with the regulatory environment.

Neobanking can work as an extension of measures undertaken to solve the challenges of financial inclusion and bundling banking services with other financial services such as opening of bank accounts for immigrants, facilitated through new onboarding procedures not based on traditional documentation of identification. With narrow targets initially, neobanks could expand by adding more functionalities and services over time.