The flashy new corporate headquarters of financial group N26 in downtown Berlin tells a story of its success as well as its growing challenges.
The newly built office block with its extensive glass facade is the seventh head office in the company’s 10 years of existence. N26 has grown so quickly that all previous ones rapidly became too small. But many desks in the new headquarters remain vacant. N26 cut 4 per cent of its workforce this year and has put the brakes on hiring.
Founded in 2013 in a tiny shared Berlin office by Max Tayenthal and Valentin Stalf, N26 was a first mover among new European digital banks. For close to a decade, the sector sent venture capital investors into overdrive, attracting billions of euros of funding. The big promise of new financial groups such as N26, Revolut and Monzo was that they would disrupt staid retail banking empires that took decades to build.
But the funding bonanza has come to a stop as interest rates have risen and doubts about the business models of these “challenger” banks started to mount. While they have attracted millions of customers, they generally struggle to turn a profit and some are bogged down by concerns about corporate culture.
They have also attracted the attention of regulators unhappy about poor know-your-customer checks and anti-money laundering controls and widespread organisational weaknesses.
“Without any doubt, neo banks are currently facing extreme challenges,” said Max Flötotto, a senior McKinsey partner who advises the sector.
In the UK, Revolut’s application for a banking licence has been in the balance since 2021. It was founded in 2015 by former Lehman Brothers derivatives trader Nik Storonsky and by 2021 had a valuation of $33bn.
Since then, worries have surfaced about its financial controls, its workplace culture and turnover, its reliance on crypto trading and the integrity of its accounts. In March, auditor BDO warned it was unable to verify three- quarters of the £636mn of revenues that Revolut reported for 2021.
Regulators have also said it must simplify its ownership structure if it wants a banking licence. Revolut is disputing how to achieve this with SoftBank, one of its largest shareholders, which is demanding significant compensation if the bank collapses its six classes of shares into one.
Storonsky, meanwhile, has criticised the UK’s “extremely bureaucratic regulator” and threatened that the company would list in New York rather than London.
In Germany, N26 is struggling because of a growth cap imposed by financial regulator BaFin two years ago, in response to organisational flaws and poor anti-money laundering controls.
The increasing regulatory oversight has coincided with a change in investor sentiment. Sky-high valuations have fallen away as these fintechs have struggled to make a profit. “Retail banking doesn’t make a tonne of money,” said Alex Barkley, managing partner at Lancero Capital. “[Digital banks] have had to turn to wealth management or lending, none of them are doing it very well.”
Even industry veterans such as Anthony Thomson — who founded digital bank Atom and UK challenger bank Metro and is a non-executive director of Australian consumer finance group Humm — have become sceptical: “Would I start a digital bank today? No I wouldn’t”, he said, adding that high street incumbents had done much to improve their technology and online services.
Earlier this year, Allianz X, the digital investment arm of the German insurer, was looking to sell its 5 per cent stake in N26 at a 68 per cent discount to the bank’s $9bn valuation in a 2021 funding round.
In June, Revolut investor Molten Ventures slashed the valuation of its £7.1mn stake by 40 per cent, following a similar move by asset manager Schroders in April.
Tumbling valuations also make it harder to attract staff. In the past, employees were wooed with shares they hoped would multiply in a later IPO. But as venture capital investors tend to insist on preferential treatment in a listing, employee shares “are often of little if any actual value”, said a former senior N26 manager.
Revolut and N26 also have some self-inflicted wounds. Both have had a string of senior executives leave, alienated by the leadership style of founders. In 2022, the six most senior executives of N26 accused Stalf and Tayenthal of creating a “culture of fear” that threatened to drive the group into a “downward spiral”. Four of the managers have since left.
At Revolut, a number of senior compliance staff left last year, and this year the group chief financial officer and both the banking CEO and chief of staff of its UK business have gone.
Its financial crime controls have faced scrutiny on multiple occasions, most recently after the Financial Times revealed fraudsters stole more than $20mn from its US entity because of a problem with its payment system.
Its reliance on crypto trading, which accounted for a third of its revenues in 2021, is also under scrutiny as the value of digital assets has tumbled. Revolut said in March that despite diminishing crypto activity, revenues for 2022 rose 30 per cent year on year to more than £850mn. It declined to comment for this story.
Despite the challenges, these new banks are being wooed by policymakers across Europe. UK Chancellor Jeremy Hunt has called Revolut and its rival Monzo “shining examples from our world-beating fintech sector”.
In an attempt to up the pressure on UK regulators over the delayed banking licence, senior figures at Revolut said they are being courted by French and Spanish ministers keen to have one of Europe’s most valuable fintechs in Paris or Madrid.
The optimistic case for these new banks partly hinges on rising interest rates pushing up the interest income they can earn on client deposits.
Tayenthal said new banks can take particular advantage because of their lower cost base, and tech infrastructure that is easy to scale up. “If you build your systems properly, it should not matter if you have 50 new customers tomorrow or 50,000,” he said.
Customer numbers are also very encouraging. Last year, challenger banks accounted for about 17 per cent of all new account openings in Germany, compared with just about 2 per cent in 2016, according to McKinsey data.
“There is a massive shift in clients from incumbents to challenger banks, which I think will be a permanent change,” said Flötotto.
Ricardo Schäfer, a partner at Target Global — which took part in Revolut’s latest $800mn fundraising — argued that the new digital banks have proved “that the market is there” and that “many people were unhappily banked with incumbents”.
The optimists hope that some short-term issues will turn into assets as time goes by. Revolut and N26 have been successful in wooing twenty-somethings. At the moment, they are not a very profitable client group. But this should change as their careers progress and incomes grow. “As a rule of thumb, banks stop making losses with clients who are older than 30. With customers younger than 40, they don’t earn a lot either. Above 50, it becomes really interesting,” said Andreas Pratz, a partner at PwC’s consulting arm Strategy&.
Challenger banks will have to continue to invest heavily in broadening their product range to keep their customers and to keep making money out of them. A crucial challenge will be to convince more people to use them as their main bank. “This requires having a wide product range that satisfies the basic needs of 80 per cent of clients,” said Pratz, citing brokerage, consumer lending and mortgage services.
But the biggest challenge might be to reconcile a founder-centric start-up culture with the needs of a highly regulated industry.
“Neobanks need to find the right balance between strong and heavily influential founders and their entrepreneurial spirit on the one hand, and the nature of a highly regulated industry,” said former BaFin president Felix Hufeld.
It also requires a rethink by investors. In the past, said one industry veteran, “no investor gave you a single euro if you had the best compliance in place, but you were not growing”.
