13 May 2016
Challenger banks & the retail revolution
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As revolutions go, this one has been bloodless
In March 2010, Metro Bank was granted a banking licence by the FSA, paving the way for it to become the first new bank on the UK high street in 150 years. It trumpeted the go-ahead with a press release bearing the grandiose headline, “British Banking Revolution Starts Today”.
Fast forward six years and Metro now has 2,000 employees, 40 branches and is listed on the main market of the London Stock Exchange with a valuation well north of £1bn. Yet despite all this positive progress, the bank has not to date posted a quarterly profit – illustrating just how difficult it is for a challenger to succeed in a market dominated by the ‘Big Four’ high street banks.As revolutions go, so far this one has been bloodless.
The term ‘challenger bank’ has become a bit of a catch-all, embracing both new entrants to the market and longer-established, smaller players. Tesco and Sainsbury’s banks have been assiduously attempting to disrupt the market for almost 20 years and even Santander has tried to adopt the stance of a challenger.
From a positioning point of view, this is eminently sensible. Challenger banks can tap into a strong sentiment in favour of the upstart. Consumers and small business owners are delighted to welcome alternatives to the old guard. Even if persuading them to switch banks is another matter entirely.
Cost of entry
However, market entry does not come cheap. Licence applications, systems investment, capital injections and so forth are significant costs. Further adding to the pressure is the fact that the private equity firms and high net worth individuals backing some of these enterprises are keen to see them turn a profit within their first three years.
As a result, banks are evolving around several narrow business models. For instance, online savings and lending into higher margin niches neglected by major banks and residential mortgages, particularly Buy-to-Let. So although these banks are providing new competition – and importantly, better products for customers, such as higher rates on savings and lending to underserved markets (over-served BTL notwithstanding!) – they are not challenging the majors on core banking products like current accounts, cards and unsecured loans.
Individually these challengers are barely scratching the surface of the Big Four's dominance
Of course, there are some exceptions: Atom will deliver a mobile-only current account and related products; Tandem has a credit card based model, with data analytics to help consumers save money and access deals; newcomer Mondo, which recently raised £1m through a crowdfunding site in just 96 seconds, is developing a smartphone-based service.
In the mid ground, Virgin Money – ready to grow and diversify – is preparing to launch SME banking. Meanwhile, TSB and Williams & Glynn also have the scale to be more disruptive. That said, their ownership changes are likely to keep leadership engaged for the next year at least.
So far as the major retail banks are concerned, individually these challenges are barely scratching the surface of their dominance. But they are changing expectations and collectively have become a powerful lever in the modernisation of the UK banking industry. Higher levels of customer engagement, low cost straight-through processing systems and business models are changing the game at a market level to the extent that the major players are having to respond.
In recent years, the big beasts have focused on risk, control and financial restructuring, while also making some investment in digital capability. Going forward, they need to rethink the whole customer proposition – encompassing products and engagement. This will certainly drive demand for better commercial leadership.
Digital adoption and evolution will continue to be important. For major players, the capability to transition to new operating/business models and systems will be key. While for challengers, scaling up will bring new organisational and leadership needs.
Disintermediation by new technology players may have a massive impact on current accounts and payments. Block chain technology has the potential to transform the way we think about storing value and paying for things. It could lead to massive redundancy in legacy banking systems with the associated need to dismantle legacy operating estates while retaining data and security.
In short, while the challengers have not yet overthrown the old order, they are a strong force for change. With the emergence of block chain technology and completely new mechanisms for storing value and making payments, the established players are arguably more vulnerable than ever before. Maybe now the smell of revolution is truly in the air.