What Happens to Your Money If a Neobank Fails
Neobanks often partner with licensed banks to offer deposit protection up to government limits. If a neobank fails, your money is still safe if held with a protected partner. Learn the key differences and how to verify coverage.
Neobanks vs Traditional Banks: A Key Difference
Neobanks operate entirely online and often hold an electronic money institution (EMI) license rather than a full banking license. This distinction is crucial because it affects how your deposits are protected. Unlike traditional banks, neobanks typically partner with one or more licensed banks to hold customer funds. Your money is usually placed in pooled accounts at those partner banks, which means the actual custodian of your cash is a regulated bank.
However, not all neobanks are the same. Some have obtained full banking licenses and are directly covered by deposit protection schemes. Others rely on partnerships, and a few may not offer any formal protection at all. Understanding your neobank's structure is the first step in knowing what happens if it fails.
Deposit Protection Schemes Around the World
Deposit protection schemes exist to reimburse savers up to a certain limit if a bank fails. The limits vary by country:
- European Union: €100,000 per depositor per bank, under the Deposit Guarantee Schemes Directive (DGSD).
- United Kingdom: £85,000 per depositor per bank, via the Financial Services Compensation Scheme (FSCS).
- United States: $250,000 per depositor per bank, backed by the Federal Deposit Insurance Corporation (FDIC).
- Other countries: Many have their own schemes, e.g., Canada (CDIC) covers up to CAD 100,000, Australia (FCS) up to AUD 250,000.
Note that these protections apply only to banks, not to e-money institutions. If your neobank is an EMI, your money may not be covered by any deposit guarantee.
The Role of Partner Banks
Most neobanks that lack a full banking license place your funds in a partner bank. In that case, your money is covered by the partner bank's deposit protection scheme, but only if the partner bank fails. If the neobank itself fails (without the partner bank failing), you can still access your funds because they are held separately in the partner bank. However, if the neobank mismanages funds or commingles them, recovery could be complicated.
What Actually Happens When a Neobank Fails?
When a neobank fails, the first step is usually a suspension of withdrawals as administrators assess the situation. If your neobank is a fully licensed bank, the relevant deposit protection scheme will step in and reimburse you up to the limit within a few weeks. For example, in the UK, FSCS aims to pay out within 7 days for most claims.
If your neobank is an EMI, the process is different. EMIs are not covered by deposit protection. Instead, customer funds should be ring-fenced in segregated accounts. If the EMI becomes insolvent, those funds are legally yours and should be returned to you, but this can take months as the insolvency process unfolds. In some cases, you may only receive a portion of your money if the ring-fencing was not properly maintained.
Potential Delays and Limits
Even with robust schemes, delays can occur. For instance, if a neobank has multiple partner banks, determining which bank holds your specific deposit may take time. Additionally, coverage limits apply per person per institution. If you hold accounts with multiple neobanks or with the same partner bank under different brands, your total coverage might be capped at the scheme limit.
It's also important to consider foreign exchange risk. If you hold deposits in a currency different from your home country, the payout may be converted at an unfavorable rate, or the protection limit might apply in the local currency.
How to Protect Yourself and Verify Your Neobank's Safety
To ensure your money is safe, take these steps before depositing substantial sums:
- Check the neobank's license type: Is it a full bank or an EMI? This information is usually on their website or regulatory filings.
- Identify the partner bank(s) and verify they are covered by a deposit protection scheme. Use official regulators' websites to confirm the partner bank's status.
- Read the terms and conditions regarding fund custody. Look for clear language about segregation and ring-fencing.
- Monitor your total deposits across all accounts to stay within the protection limit for each institution.
- Consider spreading your money across multiple neobanks or traditional banks to maximize coverage.
By understanding these fundamentals, you can confidently use neobanks while knowing what safety nets are in place. A failed neobank does not necessarily mean lost money, but the outcome depends on the type of license, the partner bank, and the jurisdiction's protection laws.