While the current market is dominated by large incumbent players, new attitudes to regulation for smaller banks are likely to create more significant opportunity in the market for new and existing players to thrive.
Since the UK left the EU in January 2020, there has been gradual but continual talk of financial services reform. In this year alone, there has been discussion on issues including dual-share classes and private stock exchanges for investors, liberalising reforms to credit unions, and the relaxation of post-global financial crisis rules such as ring-fencing between retail and investment banks.
Now, however, regulators are looking to reform the entire rulebook that small banks, challengers, and building societies will have to follow.
Officials at the Bank of England have been examining ways to remove regulation, originally designed to manage the large financial institutions, from small banks and building societies.
Currently, discussions are in an early phase, but possible approaches have been considered, including identifying the minimum rules needed to maintain a bank’s resilience and smoothing the transition from small bank to big bank, which could otherwise create a two-tier banking system.
However, while this process is only in initial discussions, it represents a major landscape change for small banks, building societies, and budding digital challengers in the UK market.
Although the UK has recently seen the emergence of hundreds of new banks and financial services players, the UK market remains a challenging place to gain market share off incumbents, due mostly to mortgage lending being the main source of income for banks. And as incumbents benefit from low funding costs and competitive rates via economies of scale, it is therefore difficult for smaller banks and lenders to get a foothold in the UK market.
Helping smaller players
These rules should help to change that reality, enabling smaller players unlock new revenue-generating streams and making it more profitable to lend to niche and riskier segments of the market.
One example would be to allow smaller players to charge higher interchange fees to merchants, as with the Durbin Amendment in the US, which has allowed small banks and digital challengers such as Chime to thrive in a competitive market.
Other rule relaxations could include lower capital reserve ratios, less stringent lending rules through the introduction of alternative credit-scoring mechanisms, and raising or eliminating the ring-fencing restrictions that currently stop small retail banks like Marcus GS from expanding.
For incumbent banks, the playing field might start to become increasingly uneven as regulators try to establish greater competition in the market. For smaller players, however, the UK market might start to become a much more viable place to do business, not just start up.
By allowing these smaller firms to make the most of new and existing revenue streams, they will likely be able to grow and outcompete their larger rivals. With incumbents forced to either modernise to compete or take a chance and invest in their smaller rivals, the future will likely belong to the small UK bank.
This was written by GlobalData Associate Analyst Katherine Long.