Published as part of the Financial Stability Review, May 2025.
Digitalisation is transforming the delivery of banking services, leading to the emergence of new digital bank business models. Digital banks do business solely in the online space, without developing bricks-and-mortar branch networks. As at year-end 2024, about 60 banks in the euro area were identified as being digital-only.[1] Seven of these banks are subsidiaries of traditional banks. The market share of digital banks increased from 3.1% of total assets in 2019 to 3.9% in 2024 thanks to the expansion of established players and the entry of new competitors. This box spotlights features of digital bank business models, contrasts them with those of traditional banks and presents the financial stability risks that may be associated with the rise of digital banks.
The funding structure of digital banks is heavily skewed towards small retail deposits. About 80% of total digital bank funding is sourced from retail depositors. The absence of physical branches reduces local anchoring, leading to an unusually large share of cross-border deposits (Chart A, panel a). Over 90% of these retail deposits are covered by deposit guarantee schemes. The average size of these deposits is smaller than at traditional banks, reflecting the low share of customers who use digital banks for their primary bank account. Corporate deposits and wholesale funding play a much less significant role for digital banks. While such a funding structure may be more stable than that of traditional banks, digital banks’ lack of diversified funding and reliance solely on online distribution channels increase their vulnerability to bank runs.
The asset composition of digital banks reveals two main types of business model (Chart A, panel b). Many digital banks have adopted the business model of a lender, transforming retail deposits collected online into loans which are often also provided through digital channels. However, the lending franchises of these banks often specialise in consumer, mortgage or non-financial corporate loans, with only a few digital banks managing diversified loan portfolios. Digital subsidiaries place a sizeable part of their assets with credit institutions within their own banking group. The second common business model is similar to that of a money market fund. Digital banks of this type do not have material lending businesses; instead, they invest deposits in high-quality liquid assets, primarily central bank reserves. All digital banks operate with unusually high liquidity buffers, possibly reflecting their preparedness for online runs and their reliance on more price-sensitive digital depositors. However, this may also be because the limited lending franchises of digital banks prevent them from deploying funds more productively.
Chart A
Digital banks follow a narrow business model, characterised by a heavy reliance on retail deposit funding and high asset-side concentration
a) Funding structures of digital banks and euro area significant institutions | b) Business model classification of digital banks based on asset portfolio |
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(Q1 2018-Q4 2024, percentages) | (End-2024, percentages) |
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Source: ECB (supervisory data).
Notes: Panel a: based on a sample of 59 digital banks. The bar on the right-hand side is the euro area funding composition based on the consolidated reporting of significant institutions (SIs), as of end-2024. Panel b: based on a sample of 54 digital banks. The classification of digital bank business models is based on the predominant asset types in portfolios. The asset composition of banks following unique business models is distorted by an online broker which reports in accordance with German accounting standards; these classify custodial deposits as assets and liabilities of the broker. Asset concentration is based on the Herfindahl-Hirschman index (HHI) and refers to the asset holding diversification in a digital bank’s portfolio: HHI > 25% indicates a concentrated portfolio. NFC stands for non-financial corporation; CB stands for central bank; HH stands for household; HH cons stands for household consumer; MMF stands for money market fund; SI stands for significant institution.
Digital banks remain less profitable than traditional banks due to their higher cost of deposits and high fixed expenses. Digital banks have proven to be less profitable than traditional banks and the dispersion of their profitability has been very wide (Chart B, panel a). Digital banks have faced a steep increase in their cost of deposits, reflecting higher interest rate pass-through (Chart B, panel b). This has been particularly pronounced for independent banks, given their drive to expand market share and a customer base that is generally more price-sensitive than that of traditional banks.[2] At the same time, their currently limited scale, relatively high fixed IT costs and substantial marketing expenses constrain their ability to achieve a similar level of profitability to that of traditional banks.[3] Digital banks also operate with significantly higher capital ratios, which mechanically reduces returns on equity.
Chart B
While digital banks are less profitable and pay higher deposit rates to customers, they are highly valued by investors
a) Return on equity of digital banks | b) Cost of household deposits | c) Equity valuations of digital banks |
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(Q1 2019-Q4 2024, percentages) | (Q1 2019-Q4 2024, basis points) | (x-axis: Jan. 2021-Mar. 2025, fundraising date; y-axis: implied price-to-tangible book value ratio, multiples, log scale) |
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Sources: Company announcements and ECB (supervisory data).
Notes: Panel a: in Q4 2024 the median return on equity of traditional banks stood at 9.9%, 2.9 percentage points higher than that of digital banks. Panel b: cost of household deposits calculated as median ratio of total interest expenses to total volumes of deposits, annualised. SI stands for significant institution. Panel c: most digital banks are privately held. Value of digital banks estimated based on announced terms of equity-raising transactions. Tangible book values calculated from company accounts and supervisory reporting. For better readability, price-to-tangible book value ratio is plotted on a logarithmic scale. The comparable ratio for a traditional bank in the euro area tends to be close to 1.
The continued growth of digital banks could bring benefits for customers but, by displacing incumbents, may also threaten financial stability. Digital banks have been successful at establishing a foothold in some banking services but remain relatively small players with limited product offerings. However, investors in digital banks seem to value their equity very highly (Chart B, panel c). Such valuations can only be justified if, in the future, digital banks achieved the kind of scale that would allow them to operate more efficiently. This would require them to acquire a substantial share of the euro area banking market. The further growth of digital banks might be good for consumers, who would benefit from more competition, and could push incumbents towards improving their service offer. It may, however, also become a threat to financial stability if the business models of traditional banks are disrupted and incumbents rapidly lose the deposit franchise that provides stable funding, which in turn backs their lending to the real economy. Furthermore, it could push traditional banks into taking on additional risks to compensate for higher funding costs. As many digital banks are based in small countries and have numerous non-exclusive customers who are more likely to move their deposits in response to idiosyncratic shocks, their expansion may create a new channel for cross-border spillovers as long as deposit insurance remains at the national level. Should digital customers lose trust in a digital bank or in its home country, they could easily transfer their funds elsewhere, leading to financial fragmentation and potentially increased spillover risks from banks to sovereigns.
The identification methodology integrates diverse data sources, including supervisory reporting, the ECB Register of Institutions and Affiliates Database (RIAD) and Orbis, to establish a ranking system that evaluates banks against a theoretical digital bank profile. Additional manual checks are then carried out to accurately identify digital-only banks. Although many euro area banks only collect deposits through online channels, not all of them meet the criteria identifying them as an online bank. For example, banks affiliated with the automobile industry are excluded from the sample because their primary focus is vehicle financing rather than a broad range of banking services.
The price elasticity of household deposit volumes, estimated using linear panel models, is significantly higher for online banks than for their traditional peers.
In the fourth quarter of 2024, online banks had administrative expenses excluding staff expenses that were twice as high as for traditional banks (1% vs 0.5% of total assets). These administrative costs were driven by substantial operating expenses in building and maintaining IT infrastructure related to their online business (2.4% vs 1.3% of total assets for traditional banks), as well as advertising, marketing and communication expenses which were three times as high as for traditional banks (0.9% vs 0.3% of total assets). In addition, while online banks do not rely on a branch network, real estate expenses relative to total assets are comparable to traditional peers due to the smaller scale at which digital banks currently operate, thus limiting any comparative advantage for these expenses.