Neobanks operate on tighter margins and may lack the strong reserve funds which is required to insulate against economic downturns, unlike traditional banks, which are often backed by established financial institution. Customers may find their accounts frozen, which leaves them unable to access their funds, pay bills, or conduct essential transactions.
Neobanks can face this failure due to several fraud risks and challenges that can cause them to fail. These include regulatory issues, a lack of trust from not having physical locations, limited services, strong competition, difficulties in making money, and cyber threats.
Neobanks primarily depends upon transaction fees as their source of revenue which can be their weakness. There are many neobanks that collapse due to these challenges and the Syna[pse in one of them. Synapse’s case shows how poor management and failing to follow regulations disrupted partner neobanks, preventing customers from accessing their funds or processing transactions.
Neobanks can work on their management and process through several strategies like improving customer experience with personalized AI services, diversifying revenue sources, following regulations more closely, and using strong fraud prevention methods, such as multi-factor authentication and real-time monitoring, which allows them to overcome these fraud risks.
Why Do Neobanks Fail?
Neobanks are not traditional banks, therefore they have no protection or regulations coming from the central bank, which can offer them a safe operating environment and credibility to raise finances and enter into risk-hedging contracts.
Neobanks face several challenges like inadequate market understanding, trust and perception issues, regulatory hurdles, limited services, cybersecurity risks, monetization and funding challenges, dependence on transaction fees and competition from established banks and other neobanks which lead them to failure.
1. Trust and Perception Issues
Neobanks often struggle to build trust among customers as do not have any physical branches and perceived security risks. Trust issues make it difficult for neobanks to compete with traditional banks that have a long-established presence and reputation.
2. Limited Services
Neobanks usually focus on providing basic services to customers like savings accounts and making successful payments but they neglect other critical financial services required by the customers. Their limited service range restricts their ability to cater to diverse customer needs and hinders their growth.
3. Regulatory Challenges
Neobanks face complex regulatory requirements like adherence to anti-money laundering regulations, data protection laws such as GDPR, and KYC processes that results in several operational delays and increased expenses. These regulatory challenges makes it difficult for neobanks to balance regulatory compliance while maintaining agility.
4. Intense Competition
Neobanks face intense competition with traditional banks, fintech startups that offer innovative financial solutions, and other neobanks. Differentiating themselves from others through unique features like seamless user experiences, lower fees, and personalized services and sustaining customer growth in a crowded market with the same niche can be challenging.
5. Dependence on Transaction Fees
Neobanks usually depends upon the transaction fees for their primary revenue source, unlike traditional banks which has multiple source of income streams like interest from loans, personal banking services and investment products, neobanks often face challenges in diversifying their revenue. This reliance on transaction fees can restrict their profitability, financial growth and sustainability.
6. Inadequate Market Understanding
There are many neobanks that fail to understand their target market fully, which leads to a mismatch between customers’ needs and what are they offering. This market understanding issue can result in low adoption rates and customer dissatisfaction.
7. Monetization and Funding Challenges
Many neobanks struggle to earn a steady revenue and rely heavily on initial investments, which creates financial risks for them as moving from growth to profit is difficult. If they can’t generate consistent income, they may face cash flow problems and an unsustainable business model. A lack of funding can also lead to a complete shutdown, which may affect the banks’ employees and customers.
Consequences of Neobanks’ Failure
- Loss of Consumer Funds: Consumers may face a risk of losing their savings due to the neobanks’ failure. Many neobanks are not insured by federal agencies which puts individuals and small businesses in danger of losing their money and experiencing serious financial trouble.
- Erosion of Consumer Confidence: When neobanks collapse, it can reduce consumer trust in the entire fintech sector. The collapse of Synapse can be one the example that show the lose of consumers’ trust in neobanks. People may hesitate to use digital banking services because they fear more failures, which can slow the adoption of new financial technologies.
- Job Losses and Economic Consequences: Neobanks’ failure can cause significant job lose in the fintech sectors which may increase the unemployment rate. The increase in unemployment rate may affect the overall economy as less consumer spending can lead to economic downturns.
- Market Shifts and Investment Impact: Competitors may gain market share after neobanks fail, but the fear of instability in digital banking can scare off future investments. Venture capitalists might reconsider how sustainable digital banking models are, which could lead to less funding for startups and new technologies.
- Increased Regulatory Scrutiny: Neobanks’ failure may lead regulators to impose stricter rules on other financial institutions. The impose strict regulations may cause several issues like increase in compliance, difficulty in new innovations as it slows down the process and harms the competitiveness of the fintech industry.
Overcoming Challenges in Neobanking – Importance and Strategies
Importance of Overcoming Neobanks’ Challenges
Improving the risks faced by the neobanks is important for their long-term sustainability and the stability of the financial system, as it protects customer data, prevents fraud, and ensures compliance with regulations.
If the neobanks proactively manage these risks, it can help them protect their reputation and build trust among stakeholders, including customers, employees and investors.
Strategies to Overcome Neobanks’ Challenges
There are several practices that can help you to overcome the challenges faced by the neobanks:
Enhanced Differentiation and Customer Experience
Using AI and machine learning in banking can greatly improve customer loyalty and attract new customers.
Overcoming Market Competition
Personalized financial advice, predicting spending habits, and offering customized deals help banks stand out in a competitive market.
Diverse Monetization Strategies
Neobanks need to shift their focus from simply acquiring new customers to actually generating profits. There are various strategies they can adopt to increase their revenue by providing a wider range of services, like introducing premium subscriptions, increasing their lending income, and exploring more opportunities to sell additional products to their existing customers.
Managing Regulatory Compliances and Building Trust
Using agile and secure technology can help neobanks to stay competitive. It allows them to grow, address security concerns, and build trust with their customers by following global financial rules and protecting customer data.
Case Study: Synapse, A Neobank Failure
Synapse was a neobank founded in 2014 that acted as a middleware company that connected the neobanks with traditional banks, including Evolve Bank & Trust, to offer modern banking services like easy account openings, appealing interest rates, virtual debit cards, and budgeting features.
Several neobanks like Yotta and Juno relied on Synapse to manage customer accounts and transactions, which utilizes the FDIC insurance provided by partner banks.
Recently, Synapse collapsed due to a significant crisis that highlighted the vulnerabilities in the fintech ecosystem, particularly in the partnership model between neobanks and traditional banks. This case study examines the causes and consequences of Synapse’s failure on neobanks as well as the broader implications for the fintech industry.
Main Reasons Behind Synapse’s Collapse
Synapse’s collapse took place due to several key factors that cumulatively led to its downfall:
- Regulatory and Compliance Issues:
- Synapse found it difficult to keep up with regulatory standards, which are very important in the tightly controlled banking industry.
- The collapse of Synapse highlighted the limited authority of federal regulators over fintech intermediaries.
- Operational Struggles and Mismanagement:
- Synapse faced significant discrepancies in its account balances, with a reported shortfall of up to $95 million between bank-held funds and amounts that are owed to its customers.
- The company experienced internal strife, including technical product defects and accusations against its leadership.
- Complex Operational Structure:
- Synapse complicates its financial management and oversight due to its operation through multiple entities and accounts.
- Weaknesses in the BaaS Model:
- The BaaS model, which relies on intermediaries like Synapse, exposed vulnerabilities in accountability and oversight.
- The reliance on Synapse as a critical intermediary created a single point of failure, impacting numerous fintech partners and their customers.
Synapse’s Collapse Leads to Neobanks’ Failure
The Synapse collapse (2024) demonstrates the systemic risks that lead to neobanks’ failure. Its bankruptcy revealed a $65–96 million shortfall between customer deposits and actual funds at partner banks like Evolve Bank. Though the partnered banks themselves (FDIC-insured) remained solvent, this incident highlights how neobank-dependent tech failures can disrupt consumer access even when deposits are technically protected.
Neobanks relying on Synapse suddenly lost:
| Transaction Processing Systems | Customer Balance Tracking Tools | Bank Partnership Coordination |
|---|---|---|
| Synapse allows neobanks to manage transactions and connect with partner banks. However, after Synapse suddenly declared bankruptcy in April 2024, this functionality ceased and left several neobanks, including Juno and Yotta unable to process payments or access customer funds. | Neobanks were unable to track accurate customer balances or release funds when synapse ledgering systems could not handle the large number and complexity of transaction, which makes the records irreconcilable. | The partner banks of Synapse, such as Evolve Bank & Trust, lost access to their records following Synapse’s failure in its role as an intermediary between the neobank and traditional banks. This disruption resulted in account freezes for hundreds of thousands of customers. |
Types of Frauds Affecting Neobanks
There are several types of fraud like identity theft, new account fraud or account opening fraud, account takeover (ATO) fraud and many other that put neobanks at risk and can be one the reasons for their failure.
| Types of Fraud | How They Affect Neobanks | How to Overcome Fraud |
|---|---|---|
| Phishing Scam | Fraudsters impersonate neobanks to steal login credentials/OTPs via fake emails or websites. | Implement multi-factor authentication (MFA), educate users about phishing tactics, and deploy email filtering tools to detect spoofed domains. |
| Identity Theft | Criminals steal or use fake identities to open accounts or take loans, which leads to unauthorized transactions and compliance risks. | Use AI-powered identity verification tools (e.g., document liveness checks, biometric authentication) and cross-reference data with global watchlists. |
| New Account/Account Opening Fraud | Fraudsters exploit remote onboarding to create fake accounts for money laundering or promotional abuse. | Strengthen KYC processes with real-time document verification and behavioral biometrics during signup. |
| Account Takeover (ATO) Fraud | Hackers use stolen credentials (from phishing/dark web) to drain accounts. | Monitor for unusual login patterns (e.g., new devices/locations) and require step-up authentication for high-risk transactions. |
| Social Engineering/APP Scam | Scammers manipulate users into authorizing fraudulent payments via fake customer support calls or urgent payment requests. | Train customers to recognize social engineering tactics and implement transaction confirmation delays for large transfers. |
| Chargeback Fraud | Customers falsely dispute legitimate transactions to receive refunds while retaining goods/services. | Use detailed transaction evidence (IP logs, delivery confirmations) to contest invalid disputes and employ machine learning to identify habitual offenders. |
| Fraud Rings | Organized groups use coordinated fake accounts to launder money or exploit promotions. | Detect linked accounts through device fingerprinting and network analysis tools to identify suspicious clusters. |
| Funds Transfer/Wire Transfer Fraud | Fraudsters exploit neobanks’ fast payment systems to move illicit funds anonymously. | Set transaction limits for new accounts and use real-time anomaly detection to flag unusual transfer patterns. |
| Loan Application Fraud | Criminals use stolen identities to secure loans with no repayment intent. | Integrate income verification APIs and credit risk assessment models that analyze applicant behavior patterns. |
Partner Bank Responsibilities in Case of Neobank’s Failure
The partner bank’s responsibilities primarily revolve around ensuring the safety and security of customer funds held at the partner bank which are FDIC insured and provides a smooth transition for customers.
Partner banks are responsible for several factors in case of a neobank’s failure:
1. Pre-Failure Due Deligence
Partner banks must carefully examine the financial health and stability of neobanks before they work together. This includes examining their capital, investor commitments, profit plans, and ability to shut down operations if necessary.
Regulatory guidance from the OCC emphasizes examining risk management, compliance, and operational resilience.
2. Fund Disbursement Processes
Partner banks are responsible for reconciling the account records of the customers and releasing their funds.
For example, Evolve Bank & Trust established a dedicated portal and call line to distribute funds after Synapse’s bankruptcy, with timelines for ACH transfers and check issuance. Delays often arise from mismatched records between neobanks and banks which highlights the need for accurate data management.
3. Monitoring and Early Detection
Partner banks are required to monitor neobanks’ financial health closely in case of neobanks’ failure. This includes tracking cash reserves, burn rates and transaction activity to spot risks early. It is also essential to conduct regular audits and reconcile customer accounts like FBO balances which helps to avoid discrepancies that could slow down fund recovery.
4. Customer Communication and Access
- Provide clear timelines and instructions for customers to transfer funds via ACH, wire, or check.
- Offer extended support like live customer service which will assist users who are unfamiliar with the partner bank’s role.
- Ensure uninterrupted access to funds, even if the neobank’s app or services cease functioning.
5. Regulatory and Legal Obligations
FDIC insurance covers your money only if the partner bank fails, not the neobank. Partner banks must keep accurate records of deposits to qualify for this insurance.
It is also important for banks to follow state and federal laws, like rules for handling unclaimed funds.
How to detect Neobanks risks before it harms consumers?
Detecting risks in neobanks before they harm consumers involves several key strategies:
- Transaction Monitoring: Utilize AI-native transaction monitoring systems to identify suspicious activities in real time. You can also focus on high-risk transactions and customers by implementing risk-based approaches.
- Device Intelligence: Use device fingerprinting to spot suspicious devices like emulators or rooted phones. Watch for multiple account creations from the same devices as this can indicate potential fraud rings.
- Risk Intelligence Systems: Use the risk intelligence feature to check applicants and find fake identities. Regularly update risk profiles based on customer actions and outside information.
- Multi-Factor Authentication: By implementing the multi-factor authentication (MFA), neobanks can detect if someone is trying to access the consumers account and they can secure customer and employee access, combining passwords, devices, and biometrics.
Bottom Line
Neobanks’ failure can be a problematic issue for the consumers as it affects their funds, cretas trust issues and neobanks may may face several issues such as regulatory issues, cybersecurity risks. This highlights the urgent need for stronger risk management, regulatory compliance, and diversified business models. To survive, neobanks must build trust, enhance security, and ensure operational resilience.
FAQs
Why do neobanks fail?
Neobanks often fail due to fragile business models, intense competition, inadequate risk management, and overwhelming regulatory hurdles that they struggle to navigate effectively.
What happens if a neobank fails?
When a neobank collapses, customers may suddenly lose access to their funds, face frozen accounts, and suffer through painfully slow fund recovery processes—creating chaos and deep distrust.
What is the difference between a neobank and a digital bank?
A neobank operates entirely online without any physical branches and typically partners with traditional banks, while a digital bank is usually a tech-savvy extension of a traditional, licensed bank with a broader service portfolio.
What are the risks of a neobank?
Neobanks face serious risks including cyber threats, regulatory non-compliance, limited financial services, trust issues, and a precarious overdependence on transaction-based revenue.