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.
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