Opinion

From Metro Bank to Mondo: A look at the prospects of Britain's challenger banks

16 min read

08 July 2015

When Metro Bank became the first new high street bank in 100 years in 2010, it reflected that an arguably stagnant sector was getting a much-needed wake up call. More and more names have since entered the industry, but which are succeeding and what's on the horizon for the newcomers?

We’ve seen 11 new banking licences approved in the last two years, and many new banks keep cropping up, so it’s fair to say the space has had something of a shake up. At the same time, these upcoming names are mostly focused on particular areas and certain offerings – so aren’t posing a challenge to the established bank’s standings. Nevertheless, is there enough space for all of these so-called challengers, and where can they fit into the banking landscape? 

KPMG recently released a report assessing what has been a significant year for challenger banks, with five being listed on the LSE and raising over £350m of new capital. It also pointed to the fact that during that year, lending assets for these banks increased by 16 per cent, set against a decline of 2.1 per cent for the Big Five (Barclays, HSBC, Lloyds, RBS and Santander).

If we consider the landscape as it stands, KPMG branches the challengers into different groups. First, there are the larger, typically longer established ones, such as TSB, Virgin, NAB and Post Office. Then the smaller challengers, which have been incorporated in the past five years and were private equity backed through initial phases. It mentioned Metro Bank, OneSavings, Aldermore, Shawbrook, Handelsbanken and STB as examples.

Finally, there are the large retailers, which have entered the financial services market offering unsecured products and savings accounts. Those like Tesco and M&S, Asda and Sainsbury’s.

Theories of competitive advantage indicate that banks need to develop a cost advantage or differentiate to compete effectively. KPMG’s report concludes the scale benefits that should be gained by the Big Five have been somewhat affected by regulatory change, compliance troubles among other problems. For 2014, despite being significantly smaller, the challengers reported only slightly higher costs – an average cost to income (CTI) ratio of 64 per cent as opposed to 63 per cent for the Big Five. The smaller challengers produced a CTI ratio of 53 per cent in 2014 – significantly better than the market, while the larger ones track more closely to the market.

In terms of differentiation, KPMG’s report cited resources (driven by the brand, distribution and product set) and capabilities (driven predominantly by culture) as what helps a bank distinguish itself. The challengers have an interesting array of prospects here – the report indicated that the mobile functionality of the challengers is at best equal to, but often worse than, the Big Five.

Unsurprisingly, the upcoming banks have looked to slip into cracks left by the established banks and provide better, or more tailored, offerings.

Furthermore, the climate seems to have shifted more positively in the direction of challenger banks. Applying for a banking licence was a lengthy, complicated process. Anthony Thompson founded the digital-only Atom Bank, which recently got its licence. He was also part of the founding team for Metro Bank, which received its licence a few years back, and said there had been a big improvement. “Our original application for Metro Bank was about 38 pages back in 2008,” he explained.

The issue of loyalty and trust has become more fluid due to the reputational damage major banks suffered after the financial crisis. Additionally, while people may be worried about saving with an unknown bank – particularly one that doesn’t have branches – most providers are covered by the Financial Services Compensation Scheme, the same system as the high street mainstays. Savings of £85,000 per person are guaranteed by the government should the bank go bust – though this is set to be cut to £75,000 from January 2016 due to euro weakness against the pound.

This isn’t totally cut and dry though – some would say their branch staff were highly reliable and trustworthy, meaning customers are happy with their provider. The banking sector as a whole has been hit by trust issues, which could also mean a wariness at new providers. At the same time, challengers have the opportunity to create a new brand from scratch – and don’t have the unenviable task of patching up a tattered reputation.

Considering some of the challengers it’s clear some in particular have excelled, by pinpointing gaps where better service could be delivered. Aldermore, for example, was formed from a merger of Ruffler Bank and Base Mortgages in 2009. It offers savings and loans to small businesses and homeowners but not current accounts or other banking services. It deals mostly in asset finance, invoice finance and buy-to-let mortgages. Simon Healy, managing director of savings, said: “We like to think we offer traditional values with modern execution.”

It doesn’t have branches, but by focusing on lending to small businesses it has tapped into an areas which had been a concern for those worried about lack of business investment in the UK. In March, it got away a second attempt at its £650m float, at 192p a share, and by the end of that first week shares were up 18 per cent. The chief executive, former Barclays veteran Phillip Monks, had to pull its initial plans when the stock market hit troubled waters amid fears of a triple-dip recession in the euro zone.

It followed OneSavingsBank, which listed in June 2014 – the first new bank to list on the main market in London for over a decade. The move quickly sparked others to follow suit, including TSB, Virgin Money, then Aldermore and Shawbrook. Metro Bank looks to be preparing for a potential listing in 2016, and some digital-only banks may follow suit in the future.

Another interesting challenger is Handelsbanken – a bank with Scandinavian roots that has attracted many British customers, resulting in full-year operating profits rising 41 per cent to £143m

Britain has become the bank’s second biggest market and it has 178 branches in the UK, with 11 more on the horizon. Handelsbanken utilises a traditional model, meaning customers have a direct relationship with their branch manager. Each branch is run like a small business and the manager is often local to that town, so there’s an important awareness of the demographic. 

Handelsbanken doesn’t advertise rates in branch or online, instead tailoring them to individual customers. 

Elsewhere, according to SavingsChampion, about 22 of the 25 best buy fixed rate bonds are now offered by challenger banks. There’s both a high awareness of what others are doing, and a flexibility about many of these newcomers, which helps in each institution’s efforts to position at the forefront of the sector. Vanquis Bank recently increased some of its savings rates to leave it included in the top five best buys across one to five year terms, and Charter Savings Bank increased the rate on its one year fixed bond to match the market-leading rate from Punjab National Bank. As an example of the Big Five, Lloyds offered 1.2 per cent on a three year fixed deal, which stood at 50 per cent less than the best offering from a challenger bank.

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In terms of growth, smaller challengers have built loan books from relatively low bases, and have achieved significant year-on-year growth. Shawbrook and Aldermore grew loans and advances to customers at CAGRs of 82.8 per cent and 52.7 per cent respectively between 2012 and 2014. Each have tended to focus growth on niche retail lending and SME markets which are felt to be underserved by the traditional lenders.

While progress can be made by the challengers – KPMG’s report indicated that the larger new banks needed to further differentiate themselves from competition – a seemingly every trickier task considering the ongoing influx of new offerings looking to get in on the action. The future for challengers, unsurprisingly, lies in making use of technology.

The rise of digital-only banks suggests this is already very much on the mind of those looking to crack the banking industry. Mondo, which has just been looking into a banking licence, is another all-digital bank. Recent stats from the industry lobby group indicate that 2015 will be the tipping point year where customers use online technology more often than branches to access their accounts.

The more unusual Metro Bank, which has sought to establish a physical presence as well as a digital one, has done particularly well in creating a culture that sets out exactly how it distinguishes itself from others. It currently services more than 500,000 customer accounts and has 35 branches across London and the South East. 

It has aligned branch design, hiring practices along with leadership behaviour and HR policies to the culture. Selectively picking the best retail experiences from the US, Metro Bank has aimed to establish a fresh banking setting – aiming to win fans as opposed to customers. An HR policy of hiring those passionate about supporting their local communities has helped here.

Metro Bank’s CEO, Craig Donaldson, told Real Business that the company’s policy of putting “customers at the heart of everything we do” meant “we’re open for their convenience rather than our own”, which he feels sets the bank apart.

He added: “We’re unmatched in in offering seven days a week banking. We open our stores early until late, including bank holidays, for 362 days of the year.”

Forward-thinking services are alongside a traditional commitment to the value of human presence. “All of our call centres are UK-based and manned by real people, not machines,” Donaldson explained. “We know that our customers value being able to talk to a person – be it in store or over the phone”, and that is offered alongside “top class online and mobile banking experiences”.

In an industry which had often been considered slow to change, and often tedious for prospective customers, Donaldson said another concern had been operating “a fast account opening process” whereby customers can walk into a store without an appointment and open an account. They leave with one set up, a printed card and access to mobile and online banking. “No waiting for days and weeks to receive a card and PIN number,” as Donaldson pointed out.

Looking forward at the long-term prospects for challenger banks, there seems a need to reassess the regulatory regime – notably the regulatory capital regime. It often works out that challenger banks have to hold more capital in comparison to the established names, due to perceived risk. The bigger banks often have advanced model status so benefit from lower risk weightings than those with a standard one.

Attaining the advanced model as opposed to the standard designation requires access to data that few challenger banks have as KPMG’s report pointed out – along with significant time and financial investment. When the regulator applies the same tests across the board, challenger banks are at a distinct disadvantage – even though they aren’t by default riskier propositions.

The British Bankers’ Association has become aware of this and urged the regulator to adopt a more flexible approach to risk.

Obviously, the majority of these challengers aren’t out to decidedly overturn the Big Five banks – most are focused on particular markets or products. The five largest challengers combined have total loans of just five per cent of the Big Five’s loan books. What they are doing is serving to freshen up a stale industry, encouraging incremental innovation, making sure underserved markets are provided for and simply giving people more options.

The raft of digital-focused newcomers – Atom, Starling, CivilisedBank and OakNorth – is likely to bring further progress across the highly-touted area of mobile. As each do, the new kids on the block may encroach further into the Big Five’s space. It looks likely to spell if not a challenger takeover, then a spate of innovative developments that bode well for the sector regardless.

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