What Is a Neobank?

Key takeaways about neobanks

• A neobank is a nonbank financial tech firm that partners with a bank to offer digital banking services, but they have risks that banks don’t.

• Neobanks tend to have lower fees and more competitive rates than traditional banks, but so do online banks.

• Since they provide internet-only banking services, in-person customer support isn’t available.

What is a neobank?

A neobank is a nonbank financial technology company that provides digital banking services through a partner bank. A neobank is not a bank, so it partners with one or more banks to offer checking or savings accounts. Accounts at neobanks are technically insured by the Federal Deposit Insurance Corp. through the partner bank, though how insurance works at a neobank is different than at a traditional bank. Popular examples of neobanks include Chime®, Revolut and Current.

» SEE: 16 neobanks and what they offer

Neobanks, sometimes called “challenger banks,” generally focus on a limited range of financial services and can offer perks often not available at traditional banks. Banking options usually include the ability to transfer money electronically, pay bills and receive direct deposit or mobile check deposits. Additional perks may include early direct deposit, fee-free overdraft coverage, as well as tools to help with budgeting and saving.

» Learn more: What happens if a neobank fails?

Providers typically emphasize their mobile apps, but many also let consumers access accounts via website and offer a physical debit card.

Here’s a look at neobank upsides, as well as some drawbacks.

Pros of neobanks

Easy access

Neobanks let consumers manage most of their banking on a smartphone app or computer, 24/7, without having to visit a branch. Some of the best neobanks have apps that are highly rated in app stores.

Applying for an account through a neobank could also be easier than opening one at a traditional institution. Some neobanks don’t check banking histories, for example, meaning your account is more likely to be approved if you’ve had accounts closed in the past.

Lower fees, competitive rates

Like online banks, neobank providers don’t have to pay to maintain branches, and some providers pass on the savings to customers. The savings can take the form of low or no monthly service charges and the ability to earn strong interest rates. If you’re paying a $10 monthly fee at a traditional bank, switching to a neobank with a fee-free account could save you $120 a year.

Make sure you understand the provider’s policies, however. Some neobanks do charge fees for premium services or require that you make a certain number of transactions each month to get the best interest rates. Before signing up, consider whether the offer matches your spending habits and savings goals.

» Looking for a high-interest account? Check out NerdWallet’s best savings rates

Cons of neobanks

FDIC insurance does not always apply

Many neobanks don’t have long track records. They may have opened only within the last few years, and they could fail, like any other startup or company. If that happens, recovering your funds is not guaranteed.

That's because FDIC insurance works differently for neobanks. Though they might advertise that the account you open with them is FDIC insured, FDIC insurance only kicks in if the partner bank fails, not the neobank itself. A neobank must also maintain accurate records of customer accounts for FDIC insurance to work.

If a neobank itself fails, its customers will have to recover funds through a bankruptcy process, not through FDIC insurance. But there’s no guarantee that customers will get all of their money or will have continuous access to their money during the bankruptcy proceedings. Historically, some neobank closures such as Simple resulted in customers who were temporarily unable to access their money. If a bank fails, in contrast, the FDIC typically provides prompt assistance to ensure customers don’t lose access to their money.

Note: Credit unions, the not-for-profit equivalent of banks, are traditional banking institutions with deposit insurance through the National Credit Union Administration. NCUA insurance is the credit union version of FDIC insurance.

Limited customer service

With no branches, expect limited personal help. Some providers offer customer service through social media accounts or by phone. They may also have online chat options.

Those options can be helpful for basic banking questions. But if your account is frozen or closed because of suspected fraud, for example, you may have a tough time reaching someone who is authorized to help resolve the situation.

» Learn more: 5 things to know before opening a neobank account

Fewer account services

Neobanks offer some digital banking services but many lack broader banking options, such as the ability to send wire transfers or easily accept cash deposits. In addition, they may offer fewer accounts. As mentioned above, a neobank might offer a spending account, but they might not offer certificates of deposit, investment options or loans.

» Compare to: What is a bank?

Neobanks vs. online banks

While neobanks and online banks offer online banking services, they're not the same. Online banks are licensed as banks and have FDIC insurance directly. While these banks can choose to have a limited selection such as only savings accounts, many online banks offer a range of traditional products, such as checking, savings, certificates of deposit, investments and loans. Unlike traditional banks, most online banks don’t operate branches, which has an upside: saving on operational costs so that they can offer high-yield savings accounts and CDs.

Online banks should not be confused with the term “online banking,” which is the ability to manage money via the website or mobile app of a bank or other institution. Nonbanks, online banks, traditional brick-and-mortar banks, and credit unions often provide online banking services to their customers.

Former neobanks that became banks

Fintech firms have blurred the line between nonbank and bank entities within the past decade, but knowing what is a bank and what is not matters. Several fintech companies have either acquired a bank or received a bank charter, and these companies are now officially banks:

• GO2bank.

• LendingClub Bank.

• SoFi.

• Varo.

Neobanks may work for some

If you’re looking for banking convenience and prefer doing most of your financial tasks online and don’t mind the risks of an nonbank platform, a neobank could be a good choice. You could save on fees and even earn interest. But a neobank account is best for people whose accounts are mostly on autopilot and who don’t need to deposit cash, send wire transfers or use expanded account services. In addition, compare offerings at online banks, especially if your goal is to find a combination of low fees and competitive savings rates.

» ALSO SEE: What is a commercial bank?