In the years since the financial crash of 2008, an array of new so-called challenger banks have emerged, ready to shake up the world of banking. But, name aside, how much do these newcomers actually challenge the established players? Sanne Wass reports.
“Hi! Can we help you with anything?”
A small purple chat box pops up in the left corner of the screen as I enter the website of Starling Bank.
Albana of customer service is on the other end. She is quick to answer my numerous questions about why I should choose the digital-only bank – part of the newest wave of the so-called ‘challenger banks’ – which is soon to launch “banking in-sync with you” for mobile lovers.
“We’re building a full-stack bank from scratch,” she writes. “Nothing is being used from an already existing platform, which means that we can design our processes as we want, and we want them to match the needs of our customers.”
Her answer, as well as the slick, digital customer service, reflects the ethos of the many new challengers that have entered the banking market over the past few years: they start with a blank canvas. No brushstrokes of past misconduct or outdated and cumbersome IT systems remain.
“The main advantage is that they are starting without any legacy,” says Chris Skinner, an independent commentator on financial markets and fintech. “They are using the latest technologies, they have got a completely blank piece of paper to design their service, to make it the best it can be, and they have got the ability to hire a team which is completely dedicated to delivering a digital vision or be the best retail service it can be. All of those advantages give them a great ability to design something that is exceptional.”
The term ‘challenger banks’ has been in the spotlight over the past few years, and according to a KPMG study on challenger banks in the UK published in May 2016, the challenger sector continues “its relentless growth”.
The UK is the epicentre of the movement. The country has seen a boom in challenger banks as a result of regulatory changes following the financial crash in 2008. Since then, regulators have made it easier for start-up banks to enter the market, in a bid to create greater competition and diversity in what historically has been dominated by four or five big lenders. Dozens of new banks have already been born; more are established every year.
According to KPMG, the challenger banks continue to outperform incumbents on growth, cost-to-income as well as return on equity: in 2015, total profits for challengers increased by £294mn, against a fall of £5.6bn for the ‘big five’ – HSBC, Barclays, Lloyds, RBS and Santander.
Focused IT infrastructure, simpler business models and often simpler product sets, the report says, are some of the factors enabling the challengers to operate at a low cost. And by embracing technology, they are able to offer a more personalised service, which, together with consistently higher savings interest rates, has appealed to new customers.
Despite the shared label, there is real diversity among challenger banks. Some are small, others large. Some have branches; others are purely digital. And the challengers often have completely different focuses, targets and business models.
The KPMG report, for example, segments the challengers into a set of categories: the ‘large challengers’ are typically longer established and include the likes of TSB, Virgin Money and Handelsbanken. These often look much like the traditional banks in nature, but smaller in size.
Metro, Aldermore, OneSavings and Shawbrook fall under the category of ‘small challengers’. Banks in this category have typically been launched in the past five to 10 years, and most of them have based their business models on targeting profitable lending niches. This group in particular is outperforming the others on financial results: in 2015, the average return on equity for the small challengers reached 170% – in contrast to 4.6% for the ‘big five’.
Then there are the new kids on the block. Also known as neo-banks in the industry, or the second-generation challenger banks, they are small in size too, but stand out in that they are digital-only. Including the likes of Starling, Tandem, Atom and Fidor, these digital newbies have been surfacing in the UK market since 2015. They seek to set themselves apart by offering a personalised service, more transparency and customer involvement, as well as intelligent use of data. And they often embrace open ecosystems – platform-based models similar to Apple’s app store – partnering up with third-party fintech companies and other financial services providers to give customers more and better options.
At Fidor, for example, vice-president of European expansion Sophie Guibaud says the bank is really a “fintech company with a banking licence”. Launched in Germany in 2009, Fidor expanded to the UK in 2015. Apart from its own digital-only offerings, the bank has opened Finance Bay, an online one-stop shop where customers can access insurance, investment, financing, trading and other financial services.
“The idea is that Fidor Bank is focusing on its core banking proposition which is our current accounts, saving bonds and some credit products,” Guibaud says. “And for the rest we basically integrate those fintech partners directly onto our platform and we share the know your customer data with them. It gives a much better experience for clients, who don’t need to go and share all their data again.”
From retail to corporate banking
Many of the new banks promote themselves in the retail banking space, targeting the young, digital generation with smart mobile tools, instant notifications on spending habits and intelligent management of personal finances. Other challengers are seeing opportunities to grow elsewhere in the market, especially in the corporate banking sector, including the trade finance space. They may not be big players, but they perform an increasingly important role in covering gaps that were previously underserved by the traditional banks.
“We see a lot of them moving into the SME space particularly,” says Richard Iferenta, head of challenger banks at KPMG. “And I think they are making a lot of good inroads especially by focusing on some of the SMEs that perhaps the larger banks have not been very focused on. And they try to make their lives much easier, by, for instance, turning around loans much more quickly, and by having a team of people who engage with them and are much more responsive to their needs.”
Shawbrook, Aldermore, OakNorth and Tide are some of the challengers that have targeted their services toward SMEs, with offerings ranging from digital accounts with automated bookkeeping and easy invoicing to structured lending solutions delivered in days.
“Small business capital investment and lending in particular is one service that I would definitely watch,” Skinner says. “There are a number of new start-up banks that are really focused on developing services towards businesses that were underserved in the past, small businesses in particular. Those are the ones that will see the most activity and opportunities to get access to trade finance services that they never had access to before.”
Bababing, a baby products designer and retailer, is one of the many SMEs in the UK that have seen new opportunities with a challenger bank. The company has been importing and exporting for the past 11 years, but decided last year to use Aldermore’s trade finance offering. Managing director Nick Robinson explains that while the company has its normal account with Lloyds, Aldermore could simply meet their financing and service needs better.
“One thing was the charges,” he says. “It was just cheaper going down the Aldermore route rather than our own banking route. Secondly we wouldn’t have the same level of service on a day-to-day basis. We’re a small business, we do everything ourselves, so I don’t want to spend half an hour on the phone waiting because the call centre is busy or the trade finance manager is away from his desk. Aldermore gives me immediate service and a personal touch. It’s been fantastic in terms of the client relationship.”
In contrast to his traditional bank, he adds, Aldermore was prepared to give him the support he needed as a small business-owner. “The problem is that the big banks want the big businesses, the multi-million pound businesses. Not the smaller companies: I don’t think they are that bothered with those to be honest.”
Founded in 2009, Aldermore was amongst the first wave of challenger banks launched after the financial crisis. “We launched for a very simple reason,” says Andrew Dixon, director of specialist finance at Aldermore. “We saw areas where customers were not getting what they needed from the established banks and we believed that we could provide a credible alternative. This is probably the essence of what it means to be a challenger bank.”
Aldermore has no branches, but houses nine offices across the UK, as well as an online and mobile app. The challenger introduced its trade finance offering at the end of 2014, and the demand is, according to Dixon, constantly growing amongst businesses as they become aware of what the bank can offer. The facilities provided by Aldermore typically range from £250,000 to £750,000.
“Because we are a relatively new company, we have been able to build Aldermore around our customers’ needs,” Dixon says. “This means that we have the flexibility to adapt our products and processes to them, rather than asking them to fit in with our requirements. We also take the time to fully understand customer needs before providing a bespoke solution.”
Boutique or challenger?
But the challenger banks aren’t immune to challenges themselves. For a start, any newcomer has to acquire a licence, gain trust and – probably the most pressing challenge – attract customers away from their current banks.
Despite the introduction of a seven-day current account switching service in the UK in 2013, aimed at easing the process of changing banks, the number of customers making the move remains low.
“The downside is that they have no customers, no history, no trust, no brand and limited capital,” Skinner says about the new banks in the market. “So in challenging the incumbent banks who have billions in capital, many millions of customers and centuries of history, they have to do something radically better.”
Skinner actually argues it’s simply wrong to label many of the newcomers ‘challenger banks’; he prefers labels such as ‘different banks’, ‘niche boutique banks’ or ‘neo-banks’.
“A challenger bank should be a bank that can take significant market share away from the existing large incumbent banks. So ideally to be a challenger bank, you have got to be looking at getting 5% of the UK deposit account marketplace. And at the moment I don’t see many who are in that position,” he says.
The likes of OakNorth, OneSavings and Metro Bank, Skinner adds, are some of the new banks that could perform as challengers. But others stand little chance of changing the dynamics of the market.
“Metro to me is probably the most challenging bank of all the start-ups in the UK right now,” Skinner says. “And the big difference is that they have branches. Metro bank is not a digital bank, but it is a challenger bank. To me, to really challenge the incumbent banks, you need to have a physical presence. A pure digital play is a boutique play, it’s not a challenger bank.”
Challenger banks may never become a threat to conventional banks in terms of market share, but they will prompt them to change certain processes, says Iferenta at KPMG.
“These [challenger] banks are in essence not big, they probably will never get to the size of the big traditional banks, but they can challenge what they do. That challenge can be in the context of price, but also in the context of customer service and doing things differently, and in particular segments of the market,” he says.
GTR approached a number of established banks to gauge their take on the challenge from the newcomers, but none wished to give an interview on the matter.
“The big banks have all been involved in things like Apple Pay and Android Pay, so they obviously have geared up to be able to do those sort of things,” says Andrew Hagger, a financial researcher at MoneyComms with more than 30 years of experience working for personal finance brands including Barclays and Virgin Money. “And hopefully that will kick-start them into doing more innovative things in the future. They know they have to smarten up. But at the same time they don’t have to do it overnight.”
He continues: “Behind the scenes they probably are taking it seriously; they realise that they need to get up to date with their IT. But product-wise there hasn’t really been any change – the rates that the main banks offer on savings, for example, are very poor, whereas some of the challengers are offering much better deals. But that could all change.”
Fidor is one example of how the future incumbent-challenger relationship could look like. The neo-bank is going so far as to actively engage and collaborate with traditional banks, selling its technology and helping them launch their online platforms. Its customers already include O2 Banking in Germany and Abu Dhabi Islamic Bank (ADIB), and it is in negotiations with established international banks too.
“The demand is crazy,” Guibaud says. “The initial plan was not to sell the technology, but a lot of people came to us, so we structured our operations to actually be able to sell it.”
The experts who spoke to GTR for this article all agree that as the challengers, especially the digital-only, develop a broader footprint, they will likely merge or be acquired by the bigger financial institutions.
“It’s not unreasonable to expect that as challenger banks evolve, we will see some form of consolidation in that space,” says Iferenta.
“As soon as they are challenging enough, they will get acquired, or they will be squeezed out,” Skinner says. “If you look at Atom offering 1% more interest on savings than the incumbent banks, if they get big enough, one of the incumbent banks is going to try and buy it, or they are going to offer interest rates that are as, if not more, attractive to get those customers back.”
Some established banks have in fact already taken steps to acquire the most promising neo-banks: in late 2015, Spanish bank BBVA obtained an almost 30% stake in Atom. And last year, Fidor was bought by France’s second-largest bank Groupe BPCE.
This development may raise the question of how the challengers can avoid falling into the negative stigmas that surround the traditional players. But for Guibaud at Fidor, the acquisition is a positive, and crucial, move for the start-up.
“Getting acquired by them gave us a power shot to grow much faster,” she says. “The idea of buying Fidor is not to merge us in what they do, but to help them expand towards new areas that they haven’t addressed. They didn’t have any online retail and SME position, so they capitalise on our experience and our vision to do that.”
While some customers may decide to divorce their old bank for a younger one, for the challengers themselves, it’s not as much about challenging as it is about simply filling gaps in the market and providing better services for the customers.
“In terms of the markets we operate in, they are of a size and maturity that the established banks and challenger banks can co-exist,” says Aldermore’s Dixon. ”Our ethos is less about challenging the incumbent banks and more about serving those customers who feel that they cannot get the products, services or attention they deserve from the traditional high street lenders.”
Guibaud at Fidor Bank agrees. “We just have different propositions,” she says. “So I think we can co-exist.”