Rise of virtual banks – revolutionizing the future of banking

By Harold Kwabena FEARON

In the not-so-distant past, banking often meant enduring long queues, paperwork, and rigid operating hours just to perform basic transactions like transferring money or checking balances.

Today, however, the digital revolution has fundamentally reshaped our relationship with banking. Armed with nothing more than a connected smartphone or computer, individuals can effortlessly navigate their financial affairs from virtually anywhere.

Whether it is paying bills, transferring funds between accounts, or monitoring investments, the barriers of physical branches and fixed schedules have been shattered. This newfound freedom and ease of access have redefined how we interact with our money, empowering us to take control of our finances on our own terms.

At the heart of this digital revolution is the emergence of financial institutions known as virtual banks. These banks operate entirely online, offering a range of financial services through digital platforms.

As more people become comfortable with online transactions, virtual banking is continuing to take the banking world by storm. Therefore, this article intends to discuss what exactly a virtual bank is, its distinction from other related innovative banking solutions, and its associated benefits and challenges.

What are virtual banks?

A virtual bank, also known as a direct bank, neobank, branchless bank, digital bank, or online bank, operates exclusively through digital platforms such as the web, email, mobile apps for check deposits, and ATM machines without physically setting foot in a physical banking hall. Unlike traditional banks that maintain physical branches, virtual banks leverage technology to deliver banking services efficiently and conveniently to customers. The concept of virtual banking dates back to 1989 in the UK when First Direct introduced telephone banking, marking the inception of banking without physical branches.

However, the proliferation of the internet and mobile technology in the mid-2000s accelerated the growth of virtual banks worldwide. These banks have gained popularity for their accessibility, ease of use, and ability to provide a wide range of financial services online, from basic transactions like transferring money to complex activities such as investment management and loan applications.

Rather ironically, traditional banks have also entered the virtual banking space by establishing virtual banking subsidiaries or separate entities focused solely on online banking services. This hybrid approach allows traditional banks to leverage their brand reputation and existing customer base while capitalizing on the operational efficiencies and customer-centric innovations inherent in virtual banking models.

The difference between mobile banking, digital banking and virtual banking

Virtual banking by its model inherently differs from traditional banking and digital banking services typically offered by traditional banks. The following elucidates the distinctions between the respective traditional banking, digital banking, and virtual banking models.

1. Traditional banking: Traditional banks operate through physical branches and have a long-established presence in the banking sector. They offer face-to-face customer service and a wide range of financial products, but often come with higher fees and slower service delivery compared to virtual banks.
2. Digital banking: Digital banking refers to the online services offered by traditional banks, accessible through their websites or mobile apps. While digital banking shares similarities with virtual banking in terms of online accessibility, digital banks are still tied to traditional banking infrastructure and may not offer the same level of agility and cost-effectiveness as virtual banks.
3. Virtual banking: Virtual banks are standalone entities that exist entirely in the digital space. They provide banking services exclusively through online platforms, offering advantages such as lower fees, faster transaction processing, and enhanced user experience. Virtual banks are often at the forefront of innovation, leveraging technology to streamline operations and cater to the digital-first preferences of modern consumers.

Different types of neobanks

1. Front-end virtual bank: A front-end-focused virtual bank does not have an operating banking license. It usually relies on the backing of a traditional financial institution and functions in partnership with them to provide services to its customers. Such a neobank often piggybacks on the traditional bank’s balance sheets for operating.
2. Digital banks: Standalone or independent digital banks are the digital arms of an established bank. Marcus by Goldman Sachs is a popular example. Digital banks act as an extension or online-only arm of traditional banks. They do not just back traditional banks but also offer adequate digital services such as savings accounts, loans, payments, and investments entirely online.
3. Full-stack digital banks: Full-stack digital banks have the required bank regulatory approvals and provide a broad selection of services. They issue deposits and loans and maintain their independent brand and balance sheets. In an increasingly digital environment, these banks are not burdened by the costly networks of physical branches.
4. Mobile-first banks: These banks prioritize mobile app accessibility, providing seamless banking experiences primarily through smartphones. They may offer innovative features like mobile check deposits, instant payments, and personalized financial management tools. Examples include ‘Revolut’ and ‘Monzo’.
5. Challenger banks: These are new entrants into the banking sector, challenging traditional banking norms with customer-centric approaches, innovative technology, and agile operations. Challenger banks often target specific demographics or niche markets, offering tailored products and services. Examples include Chime in the U.S. and Starling Bank in the UK.
6. Platform banks: These banks integrate financial services and products into existing third-party digital platforms, such as e-commerce or social media platforms through the use of Application Programing Interfaces. They leverage large user bases to offer banking services as an additional feature, enhancing customer engagement and loyalty. Examples include BBVA Open Platform, Solaris bank, Starling Bank and Bankable.
7. Embedded finance providers: These are non-bank companies that embed financial services into their core offerings, expanding beyond traditional banking roles. They provide seamless financial transactions within their ecosystems, integrating banking services with everyday activities. Examples include fintech startups like Square and Stripe.

Advantages of virtual banks

Virtual or neo banks provide several advantages that appeal to both individuals and businesses in today’s digital age:

1. Convenience: They offer round-the-clock accessibility through web and mobile platforms, allowing customers to manage their finances anytime and from anywhere in the world. For instance, you can order your physical bank card and have it delivered to your home or request a virtual card to make online payments, all with a few taps on your phone or clicks on your computer.

1. Cost-effectiveness: With no physical branches to maintain, virtual banks typically have lower overhead costs. This translates into lower fees for account maintenance, transactions, and often higher interest rates on savings accounts compared to traditional banks.
2. Innovation: Virtual banks are pioneers in digital financial services, offering innovative tools such as budgeting apps, real-time spending analytics, automated savings features, and personalized financial advice.
3. Scalability: Virtual banks can rapidly scale their operations and introduce new services without the constraints of physical infrastructure, adapting quickly to changing customer needs and market demands.
4. Environmental Impact: By operating digitally, virtual banks contribute to reducing carbon footprints associated with traditional banking operations, aligning with sustainable business practices and ESG demands.

Challenges and concerns associated with the rise of virtual banks

Although virtual banks hold significant promise for revolutionizing the banking sector, they also come with inherent challenges and concerns that need careful consideration. One of the primary concerns associated with virtual banks is the ownership structure, often dominated by traditional banking institutions. While virtual banks tout innovation and agility, their ownership by traditional banks raises questions about their true independence and disruptive potential.

Shareholder influence from traditional banks may steer virtual banks towards maintaining status quo practices rather than fostering genuine innovation or challenging industry norms. This dynamic can potentially limit the transformative impact that virtual banks aim to achieve in the financial sector.

Also, customer trust and adoption present challenges. Many consumers may still prefer the assurance of physical branches and face-to-face interactions with bank staff. Convincing these customers of the reliability and security of virtual banking platforms requires extensive education and transparent communication about the benefits and security measures in place.

Moreover, operational resilience is crucial. Virtual banks must ensure uninterrupted service availability, especially during technological upgrades or disruptions. Dependence on digital infrastructure means any technical issues could significantly impact customer experience and trust.

Another critical concern is cybersecurity and data protection. As virtual banks rely entirely on digital platforms for their operations, they are susceptible to cyber threats such as hacking, data breaches, and identity theft. Ensuring robust cybersecurity measures becomes paramount to protect sensitive customer information and maintain trust.

Lastly, financial sustainability and profitability remain a concern. Despite lower operational costs compared to traditional banks, virtual banks must attract a critical mass of customers to achieve economies of scale and sustainable profitability. Competition from both traditional banks and other fintechs further complicates their path to profitability.

Addressing these challenges and concerns effectively will be essential for virtual banks to realize their full potential in transforming the banking landscape while ensuring the security, reliability, and trustworthiness that customers expect in their financial institutions.

Conclusion

The rise of virtual banks marks a significant shift in how we engage with banking services. Offering unparalleled convenience and accessibility, these digital institutions are reshaping the financial landscape. However, with this innovation comes the need for new regulatory approaches and careful oversight. As we move forward, collaboration between regulators, traditional banks, and virtual banks will be crucial to ensure these changes benefit everyone. The future of banking is digital, and embracing this evolution will lead to a more inclusive and efficient financial system.

>>>the writer is an Associate at SUSTINERI ATTORNEYS PRUC with its Corporate, Governance, and Transactions Practice Group, specializing in legal service provision for Startups/SMEs, Fintechs, and Innovations. He welcomes views on this article via [email protected]

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