When a bank’s not a bank: How fintech—and neobanks in particular—are transforming banking in Canada

The Canadian banking system is known worldwide for its strength and stability, but even so, it’s being increasingly transformed by neobanks. So, how exactly are these new, “non-bank” players disrupting the banking system? And what does that mean for Canadians?

What is a neobank? What is a challenger bank?

Neobanks and challenger banks are similar to the big banks, but they’re different in size and location. A challenger bank is a small financial institution, and many of its benefits lie in just that. Challenger banks may or may not have brick-and-mortar locations, so their fees can be low and all of their services are available online or in-app. Neobanks only offer services online or in-app, and their fees are considered low in comparison to the big banks. 

Another notable detail about fintech banks is how they’re licensed. Many of these new “banks” cannot actually be called banks. But before we dive into the ins and outs of these new companies, here’s a bit more about “traditional” banks and the evolving industry.

A brief history of banking in Canada

Traditionally, banks are defined as institutions whose core business is taking deposits and making loans. In Canada, banking services are principally provided by federally regulated banks and by the Bank of Canada, which carries out the government’s monetary policy, issues banknotes, holds deposits, and lends to governments and chartered banks.  

Before Confederation in 1867, banks were chartered by royal assent, a formal grant issued by a monarch using their royal prerogative. Since 1871, chartered banks have been licensed and supervised by Parliament through the federal Bank Act. Licensing banks allows the federal government to manage the Canadian economy by regulating the amount, availability and distribution of money and by influencing interest rates, which set the cost of accessing and distributing money. 

Beyond traditional banks, however, banking services are also available from other financial services institutions, sometimes called “near-banks.” These include credit unions and, mainly in Quebec, caisses populaires—financial institutions owned and operated by their members and generally regulated by the provinces. Trust companies, which may be regulated under provincial or federal legislation, also provide traditional banking services. 

Two centuries of evolution—and a tipping point

How Canadians access banking services has evolved over time. The first bank in Canada didn’t have a permanent location at all—the Bank of Montreal was founded in 1817 by nine men in a rented house, who moved their operations to a dedicated building the following year. 

While the intervening centuries saw the growth of banking and physical bank branches throughout the country, today, more and more banking services are conducted without using brick-and-mortar facilities. In November 2021, the Canadian Bankers Association reported that 76% of Canadians do most of their banking digitally. Only 12% say their most common bank transaction is carried out in person at a physical bank location. 

The move to online banking started in the 1990s as traditional banks responded to the explosion of home internet use and increased customer demand for access to banking services outside of physical branches. Banks adopted a “clicks and bricks” strategy, integrating both “online” (clicks) and “offline” (bricks) elements. In addition to their online presence, some Canadian banks have evolved digital-only subsidiaries to provide direct (online and mobile-only) banking services, such as Tangerine Direct Bank (owned by Scotiabank) and Simplii Financial (formerly PC Financial, and owned by CIBC).  

Innovation gains traction: The arrival of neobanks

Canadians’ adoption of digital banking has also provided a new opportunity—the provision of banking services by companies that are not banks at all. Much as video streaming disrupted both cable service and video rental stores, smartphones are replacing laptops as the primary way consumers use the internet, and peer-to-peer accommodation services are disrupting hotel chains, banking services provided by entities that aren’t banks promise to change how Canadians engage with banks and carry out banking activities. 

Because they aren’t regulated under the Bank Act, however, these new entrants can’t formally call themselves “banks.” Instead, they’re known as neobanks, digital banks or challenger banks. 

Because neobanks aren’t actually banks, they’re free from the need to offer a full suite of banking services. Instead, they can “niche down” and focus on being good at one specific thing, like savings or credit cards (for example, Koho’s spending and savings accounts work with a prepaid Visa). Here are more examples of niche services from the smaller players.

For everyday banking

Neobanks provide tons of options to meet customers’ specific needs. For example, the aptly named Neo Financial offers a cash back credit card, and Stack provides a prepaid Mastercard to help you budget yet maintain the perks of having a credit card—including no foreign-exchange fees plus the ability to earn rewards at participating retailers. 

For social exchanges 

Wealthsimple Cash is one example of how a fintech firm is making it easier for customers to use an in-demand service: cash transfers. Offered by parent company Wealthsimple, Wealthsimple Cash is an app-based money-sending service that lets users pay and get paid instantly—with no fees, holds or delays—and requires minimal sharing of personal information.  

“With the advent of the pandemic, it instantly became better and easier for Canadians to spend money digitally, capturing social interactions in a way that doesn’t exist in the Canadian market,” comments Hanna Zaidi, chief compliance officer, payments at Wealthsimple.  

Because Wealthsimple Cash is a digital-only service, its overhead costs are lower, meaning it can offer cash transfers with no fee. In addition to lowered costs, Zaidi says, “we developed Wealthsimple Cash as a new and fun way to spend, send, receive and request funds from friends and family.”  

Another niche group with specific banking needs is small business owners—and there’s a service for them, too. Benji is a “free business operating account that combines your deposits, bookkeeping and spend management—all-in-one,” with “no branch visits or headaches required,” according to its website.  

“We’re focusing on an extremely overlooked niche within the small business world which is, ironically, the largest segment of small businesses in Canada—companies with 10 employees or less,” says Benji CEO Mohammed Asaduallah, adding, “Our goal is to help Canadian entrepreneurs build resilient businesses.”

How? By solving the problems they naturally face, says Asaduallah. “Whether that’s by streamlining your accounting so you spend less time on your books, managing and matching your business receipts, establishing sub-accounts to set aside funds for taxes and payroll, or automating manual tasks in your account, at Benji, we’ve identified the pain points small businesses experience and mainstream banks don’t resolve well.”  

How do I know my money is secure in a neobank?

One of the essential reasons we use banks is to keep our money safe and secure. But if you’re banking with a digital entity, how do you know that your account won’t be hacked and that your money won’t get stolen? Or that a fintech startup company won’t go bankrupt or shut down operations? Check if your financial institution is insured by the Canada Deposit Insurance Corporation (CDIC) before you join up. This means that if your financial institution goes bankrupt, at least $100,000 of the money you hold in chequing, savings and GIC accounts is covered. (For more information on CDIC insurance, read this explainer.)

What’s on the horizon for neobanks

“If Canadian neobanks really want to shift the fintech landscape in Canada,” says startup advisor and investor Sanjeev Arora, they need to focus on “building a truly competitive and innovative product offering.” Arora’s examples include credit cards with interest rates of 4% or 5% per year, versus the 19%-plus offered by most issuers; banking products that help low-income customers grow their net worth over time; and real-time credit score mechanisms powered by consumers’ financial and behavioural data. 

Banks have a long and storied history in Canada, but a new chapter is being written as new technologies—high-speed internet and mobile—increasingly free people from the traditional bank visit. Challengers and innovators are positioning themselves to provide better service, faster integration and a greater user focus, and competition for key markets continues to drive innovation. Today’s new crop of smaller, more agile fintech ventures brings a well-thought-out approach to tackling customer needs, and that can only improve the banking experience for all customers.