The familiarity of brick and mortar banks can make us feel like they’re infallible, in a league of their own. But every so often, we’re reminded that the unthinkable can happen, as was the case as recently as March 2023, where the collapse of Silicon Valley Bank marked the second-largest bank failure in U.S. history.
In these moments, as depositors scramble to protect their funds, the resounding question is: Where’s the safest place to hold my money? And in the age of digital banking and neobanks, a quick follow-up might be: Am I better off with a big bank, or is a neobank just as safe? The answer, in fact, requires us to rethink the question...
Are traditional banks safer than neobanks?
The fact of the matter is that pitting fintechs and neobanks against traditional banks overlooks the interesting relationship between the two. In actuality, it’s usually not an “either or,” but an “and.” Many leading banking fintechs, or neobanks, are — as the disclaimers on their websites and email footers will frequently remind you — not banks. Instead, they are service providers that sit between traditional banks and depositors (whether consumers or businesses) — the goal being to offer a powerful user interface that creates a more streamlined, tech-enabled banking experience where there’s less need for manual busywork, less room for human error, and more room to excel at greater fraud prevention and security.
In the end, the case for a lot of neobanks — including Mercury — is that banking services pass through government-regulated, FDIC-insured banks, removing the need for depositors to deal directly with those banks and making it so that deposits aren’t actually held at a neobank, but rather at a regulated partner bank. The neobank then manages the bank relationship on behalf of a client while delivering the most seamless user experience possible.
Looking at the differences between a traditional bank and a neobank, Casey Jennings, attorney at Seward & Kissel specializing in financial service regulation, notes that there’s no fundamental difference between the two when it comes to certain key functions, like the availability of deposit insurance, for example. “With a neobank, it’s a two-party arrangement — the neobank is the customer-facing entity, but they aren’t providing banking services,” says Casey. “All the banking services — whether that be deposit products, check writing, debit card, credit card issuance, etc. — are handled by a bank. With the neobank, you're layering an interface on top of an existing traditional bank.”
Addressing common critiques around neobank safety
With this relationship in mind, we can shift our attention from comparing neobanks and traditional banks, and instead hone in more specifically on neobanks to better understand how they operate. Here, we tackle some of the common critiques that typically surface regarding the safety of neobanks:
Critique #1: Neobanks are more exposed to security risks
On the security front, a lot of the concerns that typically surface regarding neobanks and digital-first banking platforms are around access. There’s often a question of whether going fully digital creates an increased security concern by making funds and information more susceptible to cyber attacks, like phishing and online hacking.
The reality, though, is that a lot of banking in today’s world is happening digitally anyway — whether through a neobank or a legacy bank. Most legacy banks have implemented digital banking solutions, including online banking dashboards and mobile apps, to cater to an increasingly digital-first world. The difference is that neobanks, unlike their standalone traditional bank counterparts, aren’t simply layering a digital component onto a clunky banking framework. Instead, they are built as digital-first platforms from the ground up, pouring their resources into creating an optimized digital experience with layered security, including robust authentication and access protocols like multi-factor authentication.
Did you know?
Mercury’s partnership with trusted partner banks allows us to facilitate smoother banking
Critique #2: Neobanks aren’t safe because they aren’t regulated in the same way as banks
As Casey notes, the reality is that neobanks are not inherently less safe than closely regulated financial institutions — they’re just subject to different requirements because of their unique relationship with their banking partners. Actually, because of that relationship, neobanks sometimes have two layers of safety measures: those that they might voluntarily undertake to mirror regulatory requirements imposed on banks and protect their customers, and those that their banking partners impose on them contractually
“From the perspective of some bank regulators, the neobank isn’t the main party — the banks are,” says Casey. “Legally, the neobank is a banking service provider — providing services on behalf of a regulated bank. The partner banks are then fully regulated in compliance with federal law.”
In this way, while the neobank might not be subject to direct regulation like a traditional bank, it can only offer the banking services that it does with a government-regulated banking partner behind it. To that end, a neobank is still reliant on banking regulation in order to offer customers banking services.
Critique #3: Neobanks don’t offer reliable protection or insurance for cash
There is a notion, likely stemming from the novelty and subsequent misunderstanding of neobanks, that cash is inherently safer with a traditional bank because of guarantees like FDIC insurance. But again, this school of thought misses a key fact: neobanks work with traditional banks to provide banking services to their customers. As a result, when the relationship is set up and documented correctly, depositors are able to access FDIC insurance with just as much reliability at a neobank as if they were to go directly to a traditional bank.
“Again, all the [neobank’s] banking services are handled by a bank — and that bank is going to be chartered under either state or federal law, and deposits will be insured by the FDIC up to the insurable limit,” says Casey. “If you're an FDIC-insured bank, you're an FDIC-insured bank. There are no caveats or situations where some banks get certain deposit insurance and other banks don’t. It’s one-size-fits-all.”
In fact, there are some cases where the neobank will actually unlock more FDIC insurance for a depositor by facilitating a customer’s ability to opt into a partner bank’s sweep network — through which those partner banks can spread deposits across a network of FDIC-insured banks to offer a total of 4x, 10x, or even 20x the per bank FDIC insurance limit. While traditional banks could offer expanded FDIC insurance through the same methods, many choose not to purely for business reasons.
“Many banks would rather keep the money at the bank, even if it's uninsured,” says Casey, reiterating that it all comes down to how banks use customer deposits to make money, either by loaning it out or investing it. “If the bank sweeps the money off their books, they can no longer use that money in their business.” What this means is that some traditional banks have a business incentive to keep the depositor’s cash at the bank above the insurable limit.
That said, sweep networks are a proven and effective way to offer greater insurance on deposits, with neobanks being uniquely positioned and structured to offer this benefit in a way that many legacy banks simply can’t or wouldn’t want to.
Did you know?
At Mercury, rather than holding deposits with a single banking partner, we give you the choice to opt in to our partner banks’ sweep programs,
Critique #4: Neobanks are more prone to failure
There’s a general feeling in the banking space that large legacy banks, at the end of the day, are simply too big to fail. The idea isn’t unwarranted, especially considered in the context of the systemic risk exception to least-cost resolution (LCR) that went into effect as part of the Federal Deposit Insurance Improvement Act (FDICIA) of 1991. LCR created a provision authorizing the FDIC and other federal banking supervisors to resolve potential problems with banks early and quickly rather than defaulting to regulatory forbearance, which would keep a failing bank open longer — thus leading to more losses before it ultimately failed at the expense of the FDIC and taxpayers. However, LCR came with a systemic risk exception, which made it so that a bank failure that posed widespread risk to the banking system or economy — i.e., usually the big-name banks — would warrant waiving LCR in favor of open bank assistance. In such an event, the failing bank could receive emergency assistance in the form of a direct loan, assisted merger, or asset purchase.
That said, just because the failure of a big bank would warrant government intervention where that of a smaller bank wouldn’t, neobanks and their banking partners — often smaller community banks — aren’t necessarily more prone to failure. In fact, some argue that, because they can’t fall back on the promise of a government bailout, smaller community banks are inherently more focused on managing their risk and liquidity — often defaulting to more conservative behavior, healthier capital ratios, and more diversified portfolios.
Critique #5: If a neobank fails, you would lose access to your funds
When considering the safety of a potential banking partner, depositors need to go beyond just doing their due diligence to pick a bank that’s unlikely to fail — they need to consider the worst-case scenarios to make sure that their funds would be safe, even if the unthinkable should happen.
Many believe that neobank failure could be riskier to the depositor than the failure of a legacy bank because they assume the government would more likely intervene in the case of the latter.
But while a neobank might feel riskier in this aspect, it’s important to remember that neobanks don’t actually hold funds. Instead, deposits are held at a partner bank — and a depositor’s relationship with the partner bank would remain intact, even in the event of a neobank failure. And in the case of neobanks that engage in their partner banks’ sweep networks, depositors would actually have accounts at each individual bank — not only reducing the impact of a single point of failure, but, again, helping ensure that as much of a depositor’s funds are insured as possible. In this way, a lot of the friction and pain points that would evolve in the case of a neobank failure — e.g., delays in getting access to funds — are not all that different from those that would arise in the case of a bigger bank failing.
“If a neobank goes down for whatever reason, the depositor’s relationship with the banks would remain unchanged,” says Casey. “In the case of Mercury, for example, depositors have deposit accounts in their names at either Choice or Evolve. If Mercury were to fail, those relationships would remain unchanged. Nothing is fundamentally different. There’s no added risk by having a neobank involved with the depositor and the partner bank.”
As a fintech that facilitates banking services through partner banks, Mercury is frequently working to remind people that we’re not a bank. This is something that we not only feature prominently across our website in the form of a “not a bank” disclosure, but that we also reiterate by bringing transparency to exactly how Mercury works.
Rather than wearing our required disclosure as a caveat, we at Mercury see our “not a bank” status as a strength, not a weakness. For us, the unique relationship between our tech-enabled platform and the FDIC-regulated banks that we work with is one that allows us to focus more of our time and energy on delivering a streamlined, secure user experience for founders — while our banking partners deliver the reliable FDIC-backed banking services that meet our customers’ needs. The relationship is a symbiotic one — rooted in traditional banking functions and regulation, with a layer of reimagined UX that moves at lightning speed and boasts advanced security protocols.
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