The banking sector is undergoing major disruption.
With the recent floatation of Metro Bank, rapid expansion of online only players such as Shawbrook and Aldermore, plus the recent launch of Atom bank, there is a lot of activity amongst the new players.
What impact will they make on the UK market? Will they provide an effective challenge to the dominance of the big incumbent banks?
As a headhunter, I have the opportunity to be able to get a view from senior people in both challenger banks and the big incumbent banks – the story is an interesting one.
The emergence of the challenger banks happened as lending to the SME sector fell off a cliff in the recession. The big incumbent banks were struggling to re-build their balance sheets, plus deal with multiple scandals such as mis-selling, which hit them like a perfect storm. This created a void that a multiple of challengers, with a focus on niche areas of the market, have filled.
Given the pace of growth of technology adoption, particularly mobile, the challenger banks have a clear advantage. It is estimated that a third of us check our smart phones 50 times a day. Look around the average coffee shop and you will see it is not just millennials who are glued to their smart phones – the 50 plus age group are just as likely to be checking in.
Challenger Banks have the big advantage of being able to develop new products quickly, trial them fast and fail fast; enabling them to be very agile and respond rapidly to demands of the new economy. Their service will appeal to early adopters and millennials who are quite happy to do all their banking on smart phones. The focus is on high quality and personalised experience with cool features.
The beauty of these new banking models is low cost: no burden of costly, creaking legacy technology, or a sprawling branch network; so the potential for profitability is high. They are likely to grow very fast because they represent such a small proportion of the overall market - they have a lot of room to grow.
What about the landscape of the ‘new’ banking market?
The only new challenger that has gone down the ‘bricks and mortar’ route is Metro Bank, who have built a new consumer friendly branch network. The other ‘bricks and mortar’ players are ‘spin out’s’ from old school big banks, and include the emergence of Williams & Glyn as a standalone bank when it is spun out of RBS later this year; plus TSB (which was spun out of Lloyds, and then acquired by Sabadell, the Spanish bank) and Virgin Money.
Of the ‘online only’ challengers who are up and running, Aldermore and Shawbrook have been around for 5-6 years, and provide consumer lending and savings products, plus loans to small and medium sized (SME) business market that struggle to obtain finance from the main commercial banks. Their focus is on specialist teams working in carefully selected markets. Both Aldermore and Shawbrook are reporting strong pre tax profits - so far their approach is working.
Atom Bank launched its service this month and describes its service as designed for digital and optimised for mobile.
Fidor, the German digital bank, recently launched its service in the UK.
Of the newer entrants who are yet to launch, Starling Bank, Mondo Bank, Tandem Bank and Masthaven are at development stage, and will be pure digital (‘app’ only) banks, with no branches.
They have all raised capital to get their concepts off the ground, but are still a way off launching on the market. Testing of their apps has to be rigorous – a time consuming and cash consuming exercise.
Another issue for Starling and Mondo: they have to get a banking licence (Tandem and Masthaven already have one). This is tough to do – to jump through all the necessary regulatory hoops: thankfully for all us, as a company that is entrusted to look after our hard earned cash needs to be watertight.
The regulator expects the new banks to hold a higher capital ratio than the existing banks, which could restrict their ability to lend until they reach a critical mass of customer base. However, there is little sign of this having an impact on Shawbrook, Aldermore and Metro Bank, who are all expanding fast.
What of the big incumbent banks? You might think that they will be concerned about these upstarts stealing their lunch. The view from the big banks is that, at this stage, it is unlikely: the challengers are simply filling a gap in the market that the big banks have left open.
The big banks are focused on ‘full service’ offerings, from taking deposits, providing a wide variety of loans, foreign exchange and business banking services for SME and large corporates alike. To do this, a large banking structure is needed, including a branch network and sophisticated systems to manage complex business offerings. They also have a pre existing; and generally, a loyal customer base. Despite the deficiencies of the service levels by the big banks, customers have remained remarkably loyal. Let's face it, if you haven't had any problems with your current bank, there is little incentive to change - why go through the hassle?
Also, the big banks have not been sleepy on the digital front. Big chunks of money have been invested in a drive to give customers a good online and mobile experience. Employees trotting into work at the head offices of big banks are just as likely to be in trainers and tee shirts rather than pin stripes and cuff links, as the techies take over as the dominant force in bank expansion.
However, the big banks do have an agility problem: they all still run on large, inflexible, costly, and often very old core technology systems, which are very difficult to wean themselves off.
The common call within the challengers is that the existing bank model is broken. We have all seen how other disruptors have sneaked up and destroyed dominant players; witness Uber, Airbnb and Amazon. The leaders of major banks will be well aware of this: could Armageddon be just round the corner? Will they be left with big, expensive branch and IT estates as customers depart them in droves?
Customers are already voting with their feet. Footfall in retail branches has declined significantly in recent years as more and more people do their banking online. The big banks are struggling to make their branches pay, and more branch closures are inevitable.
Who knows where this will end up: there will be a big temptation for the big banks, whether domestic UK players or foreign banks, to snap up the challengers when their business models are more proven. The caveat is that this may be tricky to do: how to acquire and then absorb a bank with an entirely different culture would be a big challenge that will stretch the imagination of senior management and the strategy teams.
The evolution of this market has got a long way to go.