These last six weeks have laid bare the fact that COVID-19 is both a public health and economic crisis. As venture capital wells run dry, FinTech startups — including many burgeoning neobanks — will be forced to make difficult decisions to survive.

Richard Turrin, the international best-selling author of Innovation Lab Excellence: Digital Transformation from Within, spent two decades as an executive focusing on FinTech innovation. He now lives and works in Shanghai, where he consults clients in the AI and FinTech space.

Turrin’s position in China has given him one of the most interesting vantage points from which to see the neobank and FinTech arena, especially during COVID-19. When we talked on Sunday, he told us Shanghai was “80% back to normal” and that “funding for startups is picking up again.” But that didn’t mean he thought the United States, Europe or even China were out of the woods yet, by any means.

Turrin’s upcoming book is called China’s Digital Currency Revolution: Profit From Banking Innovation That Will Shape Our Future. We talked about the effect of COVID-19 on neobanks and what China can tell us about the future of finance.

Unifimoney: In your latest article “Neobanks Can’t Fight the COVID-19 ‘Flight to Quality’,” you explain the way that investor and consumer desire for stability during this pandemic will most likely doom many of the challenger banks. In the piece, you write: “I like neobanks and think that they have had a profoundly positive influence in making banking services better for everyone.” If COVID-19 does lead to a mass exodus from neobanks, how will that affect the average consumer’s banking experience?

Richard Turrin: Let me just change direction a little bit. I would say that the article called out the problems the neobanks are facing rather than calling for their demise. No disaster for neobanks! But it certainly is a challenge for them.

There is, today, with the COVID-19 financial crisis, a “flight to quality.” This is not new. I was an investment banker for 18+ years of my life and I’ll admit to being very close to 60. So, I’ve seen various runs on the market before. And with each one of them, people sell risky assets and move toward risk-free assets. In the statistics from the Federal Reserve, you can see that most of the money is going into the top-25 large commercial institutions.

Before COVID-19, neobanks had to displace and take money out of the incumbent institutions in order to survive. It’s not enough just to get clients; they have to get the clients plus their assets in order to be solvent. So, if we see a trend where there’s a “flight to quality” and people are putting their money in these top-25 incumbent institutions, where does that leave neobanks? It leaves them in a very challenging position because they can’t acquire the assets they need to survive.

So, that’s Problem #1: acquisition of assets. The second problem is that neobanks make their money from interbank interchange fees from credit cards. So, basically, every time you swipe with your neobank card, they’re gonna get somewhere around .02-.04% of your total swipe charge. If people are staying home and they’re not buying airline tickets and going on vacations, it’s a problem. They don’t have one of their major revenue streams. That said, I view that as a short-term problem.

Problem #3 is interest expense. In order to attract people to use the neobank, many offer 1.5–1.7% interest, which is great. Everyone wants high interest on their savings. The problem is, they’re only able to invest and get, what? The short-end of the curve is around 0.4% if you look at zero-to-five year treasuries. So, they’re investing at 0.4% and they’re paying out at 1.5% and that difference is money that they’re losing. Now, COVID-19 is going to end and Problem #2 with bank interchange fees will go away. That revenue stream will recommence, but we are in a long-term, low-interest-rate environment. The easiest way to confront Problem #3 is to reduce the amount of interest rate, but with that comes the big question: can a neobank attract customers if they’re not paying them high interest? That’s the quandary that neobanks find themselves in.

And finally, the biggest issue for neobanks is VC investors. Most neobanks are dependant on funding. Without venture-capital funding, they cannot survive because they are fundamentally operating at a loss. Some of these new neobanks are going to be fine, but there are many smaller neobanks that are going to have a real problem with the current environment and are gonna have to ask a real fundamental question: Can we get investor funding?

There are big changes in the neobank world, but I love the sector. I think that neobanks have done tremendous work by pushing incumbents to make your bank services better. Not every neobank is going to make it and it’s definitely a challenge for smaller players, but neobanks have done great work and I’m happy they’re here and I’m happy to report that it is not a disaster for all of them.

Unifimoney: In ‘Innovation Excellence: Digital Transformation from Within,’ you write about the ways in which innovation occurs within companies. How has a global crisis like COVID-19 forced companies to innovate?

Turrin: Among innovators, there’s an internet meme that’s going around right now and it asks the question: “What is driving your digital transformation program? A) CEO B) CTO C) COVID-19” So, really, what we’ve seen with COVID-19 is a major push to digital.

In my book, I talk a lot about the resistance that innovators face. Often times, you can have a great solution, you can have an innovative product idea that makes perfect sense, but your problem is not necessarily with the idea’s conception or ability to deliver; it’s with humanity’s resistance to change. During World War II and during other times of national crisis, including COVID-19, we look and we say, ‘Well, the barriers to entry for innovation are reduced.’ We look to solutions. We look to try something new because what we have isn’t working, needs to be modified, or otherwise is failing. And that’s really where we find ourselves now.

There’s been a tremendous amount of companies who have been, what I call, laggards in digital transformation. These companies are finding out that that was a bad strategy, because now everything is digital. If you want to access your client and your clients are staying home, and you can’t access them through digital channels, what do you do? Right now, they’re playing catchup while those who are sophisticated digital players are actually launching more than ever. So, this is a time for great digital transformation and for really bold moves from a lot of companies. Innovation is huge in our current COVID-19-affected workplace.

Unifimoney: You’re based in China — how does the Chinese financial startup scene compare to and inform your view of the neobank/FinTech startups in the States?

Turrin: That’s a great question. I’ve lived and worked in China now for ten years and it gives me a very different view on financial technology. Most experts say that China is somewhere around seven years ahead of the U.S. and Europe in financial technology, which is a substantial lead. Living here while having one foot in the United States, that’s very clear to me. We’re cashless here in China. We have digital services that the West can only dream of right now. So, when we look at the startup scene here, it’s also very different because it’s evolving along very different lines. Let me explain.

Post 2008 Financial Crisis, the Big Banks mostly took their eye off the ball of digitization. They were facing solvency issues and licking their wounds following a major profound crisis. Digitization was not top of their agenda, so that fell to a different set of companies. When we think of FinTechs, we think of small companies who have spurred digital transformation within large incumbent banks. But we think of the little guys; these are small companies who sometimes make it big.

The difference in the China market is that back in the 2010–2014 period, it was not just little companies that got into the FinTech. Big Tech entered the FinTech game. When you look at WeChat Pay and Alipay, you’re looking at the Google and the Amazon of China; in 2014, they were both granted banking licenses. This was a Big Tech-led charge on incumbent banks and it completely transformed what money is, how we pay, how we invest, how we buy insurance. Every segment — Insurtech, investment technology, and FinTech — have all been changed and revolutionized here in China.

Now, where does that leave startups? There are many, many startups in China who are trying to change the FinTech world. But they do it from a different perspective. Whereas American companies have to launch a platform and start from scratch, what you’re seeing in the startup FinTechs in China is that they are starting on a platform. They’re bringing financial services to platforms where there is already a tremendously large number of users, like WeChat Pay or Alipay or Douyin. It’s up to the users of that platform to decide whether their idea is going to sink or swim. So, the startups are there in both places, but how the startups are framing and pitching their business is remarkably different.

Unifimoney: You have one of the best understandings of the entire neobank movement. What one key thing do you think the challenger banks have missed so far? If you were starting a neobank, what would your value proposition be?

Turrin: Some of the better players I’ve seen that have launched in the last year are focused immediately on profitability and profitability through servicing the very, very specific needs of a limited clientele. If there’s one thing that the neos have to do, it’s figure out how to get profitable and how to get profitable with a distinct or unique niche of business rather than saying, ‘I’m a bank. I’m going to get everyone.’ You have to be very focused on where profits are coming from.

But, the big thing is: what have the incumbent banks missed in all this? Many detractors of neobanks say, ‘Well, look. If you look at deposits of the incumbent banks and you compare them with neobanks, there’s no comparison. It’s a drop in the ocean.’ And that’s true. There’s no way to argue that. Incumbent banks have tremendous amounts of money. And I am not one to say that incumbents are going to be slain at the hands of neobanks. That’s just not gonna happen.

But what incumbents are missing is that there’s a slow drip, drip, drip. If you’re a banker and you’re in an area that’s successful and you have good numbers, it’s very easy to ignore the fact that there’s a dripping sound coming from somewhere. Because it’s small relative to your overall business. But there is a new language of how neobanks are treating and talking with their clients that is decidedly light on fine print. That works. People respond to it. And the clients like it.

Neobanks are not going away. They’re here to stay and some of them are going to become the next big banks. Ten years from now, you’ll look back and you’ll say, ‘I remember when they were struggling and they’re big guys now.’ Incumbent banks are also changing, because they were spurred to do so. It’s going to be interesting to watch as neobanks and incumbent banks fight and change how we relate to money. If you look where China is today, that’s where the United States will be in ten years, and it’ll be the neobanks and the FinTech startups that pushed us there. Because, sadly, incumbents are in no rush to get there. It changes their profitability; they are quite happy with everything staying the way it is.

‍