Neobanks are regulated via Anti-Money Laundering (AML), Know Your Customer (KYC), and indirect regulations to which traditional banks are subjected.
Neobanks operate in a highly technological environment and often include international money transfers, payment systems, and specialised services, making them operate in multiple jurisdictions and regulatory environments.
Since neobanks (also known as challenger banks) are fintech companies and not banks in the traditional sense, many of the rules and regulations like Basel Norms and capital adequacy rules are not applicable directly.
The rising popularity of neobanks has led to an evolving policy and regulatory response from regulators. The European Union (EU) is leading the adoption of neobanks, followed by the USA and the UK. NuBank (Brazil) and Robinhood (USA) have attracted capital investments to expand their operations.
In terms of the percentage of people having Neobank accounts, the top grosser is India at(rank 1), followed by UAE and Mexico (rank 2) and Portugal (at rank 3) (Neobanking regulation).
Recent regulatory changes impacting neobanks include the EU’s MiCAR framework, which now regulates crypto-assets across the region. At the same time, eIDAS 2.0 introduces a unified European Digital Identity to enhance financial security and efficiency. Also, in the UK, the FCA proposed replacing the existing e-money safeguarding regime (EMRs) with new rules under CASS.
Obtaining legitimacy alongside financial stability and consumer protection relies on the successful implementation of regulatory requirements by neobanks. When neobanks fail to comply with regulations, their business faces severe penalties, operating license loss, and damage to its reputation.
Licensing & Regulatory Framework for Neobanks
To legally operate, neobanks need to secure the relevant license according to their service type:
- Full Banking License: Allows for extensive banking activities, including lending and deposits.
- Electronic Money Institution (EMI) License: This license permits digital payments and e-wallet services but does not allow lending operations.
- Banking-as-a-Service (BaaS) Model: This model functions under the partner bank’s license, thereby enabling FinTech to offer banking services without explicit regulatory permission.
| Region | Regulatory Bodies | Licensing Requirements |
|---|---|---|
| USA | Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Consumer Financial Protection Bureau (CFPB) | Neobanks can obtain a fintech charter from OCC or partner with FDIC-insured banks for deposit services. They must comply with Dodd-Frank Act consumer protection. |
| EU | European Banking Authority (EBA), European Central Bank (ECB) | Neobanks can apply for an Electronic Money Institution (EMI) license or a full banking license. Licensing requires compliance with PSD2, GDPR, and capital requirements under Basel III. |
| UK | Financial Conduct Authority (FCA), Prudential Regulation Authority (PRA) | Post-Brexit, neobanks must be FCA-authorized and meet PRA capital adequacy rules. They can operate under an EMI license or full banking license. |
| Asia-Pacific | Monetary Authority of Singapore (MAS), Australian Prudential Regulation Authority (APRA), Reserve Bank of India (RBI) | Singapore grants digital full bank & wholesale bank licenses. Australia’s neobanks must meet APRA capital requirements. In India, neobanks must partner with traditional banks due to RBI restrictions. |
| Latin America | Central Bank of Brazil, National Banking and Securities Commission (CNBV) – Mexico | Brazil issues digital banking licenses, while Mexico’s Fintech Law allows neobanks to operate under a regulated framework with capital and risk requirements. |
Key Regulatory Areas Affecting Neobanks
Neobanks need to fulfill numerous regulations to operate safely and lawfully. Financial regulations protect the banking system while protecting client interests and reducing threats, which include fraud and money laundering, together with data security breaches.
1. Anti-Money Laundering (AML) & Know Your Customer (KYC) Regulations for Neobanks
Neobanks need to follow AML/KYC regulations to combat fraud, money laundering, and financial crime. Several online banks employ AI-driven identity checks and transaction surveillance to increase compliance.
AI systems evaluate customer transaction behaviors to discover inconsistencies through analytical tools. Under SAR requirements, Neobanks need to inform FinCEN (USA) and FCA (UK) when they spot abnormal account activity.
| Region | Regulatory Bodies | Key AML/KYC Regulations |
|---|---|---|
| USA | Financial Crimes Enforcement Network (FinCEN), OCC, FDIC | The Bank Secrecy Act (BSA) and Patriot Act require neobanks to implement KYC, Suspicious Activity Reports (SARs), and transaction monitoring. |
| EU | European Banking Authority (EBA), ECB | AML Directive (AMLD 5 & 6) mandates customer due diligence (CDD), enhanced due diligence (EDD), and risk-based AML measures. |
| UK | Financial Conduct Authority (FCA) | Neobanks must follow Money Laundering Regulations 2017, requiring identity verification and ongoing monitoring. |
| Asia-Pacific | MAS (Singapore), APRA (Australia), RBI (India) | Singapore follows MAS AML rules; Australia aligns with AUSTRAC AML laws; India enforces RBI KYC norms for digital banking for Neobank. |
| Latin America | Central Banks, Financial Intelligence Units (FIUs) | Brazil’s AML Law and Mexico’s Fintech Law AML framework require strict KYC onboarding and reporting of suspicious transactions. |
2. Consumer Data Protection & Privacy Regulations for Neobanks
Neobanks deal with significant volumes of sensitive customer information and are subject to strong data protection regulations. Measures for compliance are encryption, constant mechanisms for customers, and breach reporting.
Users have the opportunity to see their information and demand its destruction. Non-compliance with GDPR and similar laws can lead to major financial penalties that reach up to 4% of global revenue.
| Region | Regulatory Bodies | Key Data Protection Regulations |
|---|---|---|
| USA | Federal Trade Commission (FTC), Consumer Financial Protection Bureau (CFPB) | The California Consumer Privacy Act (CCPA) grants consumers rights over personal data. New federal regulations are under consideration. |
| EU | European Data Protection Board (EDPB), National Regulators | General Data Protection Regulation (GDPR) requires user consent, data minimization, and the right to be forgotten. |
| UK | Information Commissioner’s Office (ICO) | UK GDPR (post-Brexit) follows GDPR principles but allows for domestic amendments. |
| Asia-Pacific | MAS (Singapore), Australian Prudential Regulation Authority (APRA), RBI (India) | Singapore’s PDPA, Australia’s Privacy Act 1988, and India’s Digital Personal Data Protection (DPDP) Act set data protection standards. |
| Latin America | National Data Protection Authorities | Brazil’s LGPD (Lei Geral de Proteção de Dados) is modeled after GDPR; Mexico also has strong data protection laws. |
3. Payment & Open Banking Regulations for Neobanks
Payment security and open banking regulations mandate neobanks to uphold standards when processing digital payments through third-party applications. Open Banking defines an obligation for banks to provide secure access to financial data through APIs to external third-party providers.
| Region | Regulatory Bodies | Key Payment & Open Banking Regulations |
|---|---|---|
| USA | Consumer Financial Protection Bureau (CFPB), Federal Reserve | CFPB is developing open banking rules; banks follow Real-Time Payments (RTP) system standards. |
| EU | EBA, ECB | Payment Services Directive 2 (PSD2) requires Secure Customer Authentication (SCA) and open API access. |
| UK | FCA, Open Banking Implementation Entity (OBIE) | Open Banking Regulations mandate secure API access for third-party financial providers. |
| Asia-Pacific | MAS (Singapore), APRA (Australia), RBI (India) | Australia’s Consumer Data Right (CDR), India’s Account Aggregator Framework, and Singapore’s open banking policies promote financial innovation. |
| Latin America | Central Banks, National Regulators | Brazil’s Open Banking Framework and Mexico’s Fintech Law encourage digital payments and data sharing. |
4. Capital Adequacy & Liquidity Regulations for Neobanks
To maintain financial stability, neobanks need to fulfill minimum capital and liquidity standards. Such rules enable neobanks to deal with both withdrawals and financial instability. Following Basel III standards assists digital banks in managing risks and liquidity buffers efficiently.
| Region | Regulatory Bodies | Key Capital & Liquidity Requirements |
|---|---|---|
| USA | Federal Reserve, FDIC, OCC | Neobanks must meet Basel III capital ratios and liquidity coverage rules. |
| EU | EBA, ECB | The Capital Requirements Directive (CRD V) and Capital Requirements Regulation (CRR II) impose capital buffers. |
| UK | PRA, FCA | Neobanks must follow PRA capital adequacy rules and meet liquidity stress tests. |
| Asia-Pacific | MAS (Singapore), APRA (Australia), RBI (India) | MAS sets capital adequacy norms; Australia enforces APRA liquidity requirements; India follows RBI’s Basel III framework. |
| Latin America | Central Banks | Brazil and Mexico impose Basel III capital requirements on neobanks. |
5. Fintech-Specific Regulations & Digital Assets Compliance for Neobanks
Fintech-specific regulations are highly diverse, especially for neobanks that offer cryptocurrency services. Compliance mechanisms ensure that digital assets function according to legal frameworks.
Cryptocurrency, together with digital assets, forms an essential part of many neobank services since they need to follow new regulatory guidelines on crypto. Certain regulators establish regulatory frameworks by issuing special fintech licensing technology for digital banking operations.
| Region | Regulatory Bodies | Key Fintech & Crypto Regulations |
|---|---|---|
| USA | SEC, OCC, FinCEN, FDIC | OCC’s Fintech Charter, SEC oversight of crypto assets, FinCEN AML rules for crypto transactions. |
| EU | ESMA, EBA, ECB | Markets in Crypto-Assets (MiCA) regulate stablecoins, crypto exchanges, and digital banking. |
| UK | FCA | FCA requires crypto firms to register and follow AML laws. |
| Asia-Pacific | MAS (Singapore), APRA (Australia), RBI (India) | MAS Payment Services Act governs crypto services; Australia’s crypto framework is under review; India restricts crypto banking services. |
| Latin America | Central Banks, Local Regulators | Brazil and Mexico are regulating fintech and digital banking, with Brazil recognizing some crypto assets. |
Compliance Challenges for Neobanks
Regulatory procedures, together with operational challenges, limit Neobanks from expanding their stability and market growth.
1. Regulatory Uncertainty
Fintech laws that change regularly create regulatory uncertainties that affect Fintech firms most in open banking implementations and crypto integration projects.
2. Cross-Border Compliance
The implementation of GDPR, AMLD, and other regional regulations complicates global expansion because neobanks need to follow multiple compliance standards.
3. High Operational Costs
Operational expenses rise substantially when financial organizations implement AML standards, KYC requirements, and cybersecurity measures that require expensive technologies and trained staff.
4. Cybersecurity Risks
Strong real-time monitoring, together with encryption and fraud detection systems, are necessary for neobanks because cyberattacks remain constant threats.
Best Practices for Ensuring Compliance
Neo-banks should use these strategies to control regulatory risks:
1. RegTech Integration
AI-powered compliance tools streamline transaction monitoring and fraud detection.
2. Regulatory Engagement
A crucial practice for neobanks to stay compliant involves maintaining direct communication with regulatory bodies, which enables advanced knowledge of changes.
3. CyberSecurity Investments
Neobanks should protect themselves through investments in strong encryption and multi-factor authentication, supplemented by periodic security audits to reduce risks.
4. Cross-Border Strategies
To facilitate international business operations effortlessly, neobanks should work with local experts who comply with regional standards.
Conclusion
Regulations of neobanks are shifting to harmonize with financial innovation while maintaining security and stability. Compliance is still the linchpin of viable growth, allowing neobanks to grow while complying with the law. As the fintech environment advances, neobanks need to find a balance between innovation and compliance with the strict regulatory bodies.
FAQs
What are the limitations of neobanks?
Neobanks usually do not have physical branches, which restricts face-to-face services. Some neobanks are licensed under EMI licenses, which limit lending and deposit insurance coverage. Furthermore, adherence to several juridictional regulations can be complicated and expensive.
Do neobanks need a banking license?
Not necessarily. Some neobanks have full banking licenses, while others utilize EMI licenses or BaaS collaborations with licensed banks to offer financial services. Neither loans nor customer deposit services are available to neobanks operating under an Electronic Money Institution (EMI) license, though payment and e-wallet operations remain possible.
What are the regulations for neobanks in the US, UK, and EU?
In the us, neobanks are regulated by OCC, FDIC, and FinCen. In the UK, neobank licensing and compliance are regulated by the FCA and PRA. In the EU, digital banks adhere to EBA guidelines, such as PSD2 for open banking and GDPR for data protection.
Are Neobanks FDIC-Insured?
Not all neobanks are FDIC-insured. Deposits remain insured by the FDIC only when neobanks have their licensing or work with an FDIC-insured banking institution. The majority of neobanks establish partnerships with traditional banking institutions to extend FDIC deposit insurance coverage to their customers.
How do neobanks handle KYC & AML?
Neobanks use AI together with biometric verification methods to perform digital identity checks that ensure adherence to AML and KYC regulatory requirements. Neobanks need to follow regional Anti-Money Laundering laws, including the Bank Secrecy Act (BSA) in the US, the Anti-Money Laundering Directive (AMLD) in the EU, and the FCA AML Rulebook in the UK.