How to Build a Digital Bank in 2024

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Introduction

As digitalisation progresses across markets, anew generation of banks is becoming increasingly popular. We are talking about digital banks, or neobanks, if you will. These banks operate entirely online, offering a suite of financial services without the need for physical branches. APIs, like those from the TapiX team, have been playing a major role in this shift, enabling seamless integration and functionality that enhance user experience and operational efficiency. Let's dive deeper into the process of building a digital bank in 2024.

What is a Digital Bank?

A digital bank is a financial institution that operates completely in the online environment, providing banking services through digital platforms such as mobile apps and websites. Unlike traditional banks, digital banks do not have physical branches and usually don't require any kind of physical interaction. Their features typically include:

- Online account opening and management

- Mobile banking apps (super-apps) with advanced features

- Instant money transfers and payments

- Integrated budgeting tools and financial planning services (with AI algorithms)

- Enhanced security through biometrics and two-factor authentication

Must read: 7 KPIs every digital bank should focus on

Traditional banks vs. Neobanks

As digital banks are gaining traction, it’s important to understand key differences, pros and cons and unique features for both traditional and neobanks. For neobanks, it’s about paving the way for a new generation of banking. For traditional banks, it’s about trying to keep up with constant evolution.

Neobanks: Neobanks, also known as challenger banks, are digital-first companies that operate exclusively online. They leverage cutting-edge technology to provide a seamless, user-friendly banking experience through mobile apps and web platforms. Their approach is tech-savvy, flexible, and highly innovative.

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Thanks to operating through the cloud with minimal overhead costs, neobanks can offer lower fees or even fee-free services. With a constant drive for innovation at their core, they rapidly adopt new technologies, enabling them to introduce unique features quickly and avoid the constraints of a traditional corporate environment.

According to Optima Consultancy, the average number of features in German neobank apps is 71, nearly double that of traditional banks. Revolut, a leading neobank, frequently releases innovative features such as advanced budgeting tools, instant transaction notifications, and customizable user experiences. Personalisation is a significant strength, with options to customize backgrounds, cards, and account names, alongside delivering tailored financial insights. It’s here where the need for accurate transactional data from providers like TapiX becomes particularly noticeable.

Traditional Banks: Traditional banks, or incumbents, are well-established financial institutions with a long history. They maintain extensive branch networks and provide a wide range of financial services, from savings accounts to mortgages and investment products. Their approach is more conservative, focusing on stability and trust built over decades.

Did you know? The number of bank branches in the U.S. has declined from nearly 100,000 in 2009 to fewer than 80,000 today.

While this means there is less room for the quick adoption of new features or the ability to pivot swiftly in a changing banking environment, traditional banks stand out with certain advantages.

They excel in providing comprehensive financial services. Their features include detailed in-person financial advice, extensive loan and mortgage options not available for neobanks, and robust security measures with extensive experience in adhering to regulatory requirements. However, they are increasingly pressured to innovate, with some beginning to incorporate digital banking features to remain competitive.

While traditional banks have a very stable revenue stream, according to a Forbes article, only a handful of neobanks achieve profitability despite their number continuously growing. For instance, Monzo and Revolut, despite their rapid growth and large user bases, have faced significant financial losses. Research indicates that less than 5% of the world’s neobanks are profitable, with many struggling to balance growth and sustainable revenue models.

How Do Banks and Neobanks Make Money?

Both traditional banks and neobanks generate revenue through various channels, including:

- Interest Income: Traditional banks earn primarily from interest on loans and mortgages. Neobanks also offer loans but often focus more on short-term, high-interest products.

- Fees: Both charge fees for services such as account maintenance, overdrafts, and international transactions. Neobanks typically offer lower fees or no fees on basic services to attract customers.

- Interchange Fees: Neobanks often rely heavily on interchange fees from card transactions.

- Value-Added Services: Offering premium accounts, financial advisory services, or partnership-driven products like insurance and investment services.

For instance, according to a report by CodeBtech, profitable neobanks like Chime and Revolut have successfully leveraged these models to achieve profitability.

What can be done to turn the tides?

Customer Retention and Engagement: Offer personalised services that keep the clients engaged and loyal. By focusing on increasing the lifetime value of customers through enriched data insights, neobanks can drive sustained profitability.

Diversified Revenue Streams: Create variety of financial products—subscription models, lending, investment services. Diversifying revenue streams helps reduce reliance oninterchange fees and creates more stable income.

Cost Efficiency: Leverage technology to streamline operations and reduce costs, maintaining a lean business model. This efficiency is crucial for profitability, allowing neobanks to scale without exorbitant expenses.

Strategic Partnerships: Consider strategic partnerships between banks and other fintech companies, which enable neobanks to expand their service offerings without significant capital expenditure. 

In any case, a bank’s profitability will also be directly connected to the type of licence that is chosen.

Licence as a key element

Obtaining the appropriate banking license is a fundamental step in establishing a digital bank. Licensing requirements vary by country but generally involve strict regulatory processes that you simply cannot avoid. There are, however, some core steps you can take:

Full Banking License: Allows banks to offer a complete range of services, including deposits, loans, and mortgages. With this, key revenue streams like mortgages and personal loans are available.

EMI (Electronic Money Institution) License: Enables the issuance of electronic money and provision of payment services, but not traditional banking activities like offering loans or mortgages.

Specialized Licenses: These may cover specific financial products or services, such as investment or savings accounts.

A critical distinction is whether a bank operates as a full-stack bank or merely a front-end interface. Full-stack banks hold their own licenses, allowing them to offer a wide array of banking services independently, while front-end operate through partnerships with licensed banks, utilizing their licenses to provide services.

As such, the next step is ensuring you choose the right licensing to meet your business objectives and customer needs.

Banking as a Service

There is, however, another way. BaaS (Banking as a Service) is a transformative concept where traditional banking services are outsourced via APIs. This model allows new neobanks to quickly enter the market without needing their own licenses, significantly reducing the time and costs associated with setting up a bank.

Did you know? Revolut initially launched using a BaaS platform before acquiring its own licenses, now serving over 18 million customers. 

Whatever path you choose, the digital bank structure requires a multi-layered architecture that ensures seamless functionality, security, and scalability.

User Interface (UI) Layer: Traditionally, the UI is a representation of any bank, interacting with users through mobile apps, web interfaces, and intuitive chatbots. The design needs to be responsive, ensuring users can easily navigate and access services across all devices.

Client-Side Layer: Behind the scenes, the client-side layer secures user interactions with authentication processes and encryption techniques. This layer ensures that user data is safe, and communication is secure. 

API Gateway Layer: The API gateway acts like a middleman, processing API calls between client-side applications and backend services. It manages API usage, ensuring smooth and secure data flow. 

Microservices Layer: A proper way to split a bank’s operations is to create modular, independent services like account management and transaction processing. This microservices layer allows the bank to scale efficiently and remain resilient, with each service operating and updating independently.

Core Banking System Layer: At the heart of a digital bank lies the core banking system. It handles crucial tasks like transaction processing, account management, and compliance. This backbone ensures that all fundamental banking operations run smoothly.

Data Management and Analytics Layer: Enriched data from providers like TapiX are a cornerstone for an accurate representation of a bank’s operations. This layer manages data storage, processing, and analysis, transforming raw data into valuable insights.

Security Layer: Finally, the security layer protects the bank's data and systems from cyber threats.Equipped with firewalls, intrusion detection systems, and compliance with industry standards, it ensures the bank's integrity and trustworthiness.

By understanding and implementing these architectural layers, you can build a resilient, scalable, and customer-centric digital banking platform for 2024 and beyond. For our next article, we will dive deeper into the importance of APIs and their role in banking.