You have to hand it to the challenger banks: they have achieved some fantastic PR. It is difficult to open a newspaper or attend a financial services conference without one or more of them being lauded writes Anthony Duffy
Much of the positive PR comment relating to the challenger banks is justified. We’re talking about new companies, with new ideas, entering a competitive but stuffy market and promising to shake it up.
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And what ambition. Atom Bank has set itself the goal of “redefining what a bank should be”, while Monzo aims to build “an alternative to the banking of the past” and has ambitions to be “a bank that improves the lives of a billion people around the world”.
But how easy will it be for the newcomers to achieve their goals? The retail banking market is notoriously difficult for new competition to crack – just think of the building societies that converted into banks around the turn of the century, or the internet banks that launched in the early days of the internet.
Changing a well-established market, where some incumbents have, literally, been around for centuries will clearly take time.
It is certainly early days for challengers. The Starling Bank platform only went live in April 2017, Atom Bank launched its first product a year earlier in April 2016, while Monzo is the only one a little older, having launched in April 2015.
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By GlobalDataBut how big is the task that the challengers’ face? Let’s take a look at three key areas to try and answer this question.
How easy will it be for the challengers to demonstrate that they are different?
The newcomers see themselves as being innovators, determined to challenge the traditional banking model. And this is probably true of the way they are trying to engage with customers, through apps and underlying technology.
Monzo is proud to “own the full technology stack, giving us the flexibility to react to changes in customer behaviour and demands. Rolling out new functionality is a matter of hours and days, rather than weeks and months”. Starling has also developed its own in-house system, while Tandem Bank has turned to Fiserv and its Agiliti platform.
But are successful technological deployments a source of long-term competitive advantage, or will good ideas simply be copied by the market?
After all, the established banks – which have successfully developed and rolled-out online and mobile banking for the mass market over the last fifteen years or so – are unlikely to slow their own technology innovation programmes, despite (or because of?) the limitations of their legacy IT platforms.
With their large customer bases – although this means that innovation costs multiply – they enjoy an established market position. This provides funds for investment and, to some extent, the time to develop and deploy the best ideas, technology and products.
For example, HSBC has indicated its intent by piloting an app that will enable customers to see all of their accounts on one screen, be they current accounts, savings, personal loans and mortgages, if they are currently visible online.
And these accounts are not just limited to HSBC products, but will include those held at 21 providers including Barclays, Lloyds and Santander.
Best of both worlds: old-fashioned values and cutting-edge IT
But while the challengers’ IT might be interesting to the technology-minded, will their banking model appeal enough to win them a new, large and loyal customer base from the wider market? Or will customers have to be wooed through the provision of old-fashioned value?
The challengers, rightly, think that the answer is to provide a mixture of the two. Atom entered the market in April 2016 with two market leading Fixed Saver accounts, while Monzo’s offering is centred around a contactless prepaid Mastercard which initially offered free overseas ATM withdrawals.
But while these offerings were popular, they also proved to be expensive to provide – and that’s the challenge.
Like many banks competing in the savings market (especially at a time when affordable Bank of England funding is readily available), Atom’s savings rates for new customers was a time-bound offer.
And Monzo has ended free cash withdrawals from ATMs located overseas, after reportedly finding that the costs of providing the service in the past year rose to £16 per customer, from £6 in 2016.
Of course, it can be argued that short-term offers and promotions have always been used to build the customer base, and that many new companies, particularly those with big ambitions, would explore such options.
But is also illustrates the challenges that any new entrant with limited resources might face in building true and sustainable product differentiation.
What reaction might the challengers provoke from their competition?
Atom and Monzo have suggested that launching a current account is a strategic priority. Monzo sees current accounts as a way to reduce losses – its prepaid scheme loses around £50 per active customer per year – while another new entrant, Starling Bank has said that its route to making money lies in overdrafts. How might the established players respond to the newcomer’s tanks being parked on what some might see as “their” lawn?
A review of statistics supplied by the Current Account Switching Service may provide an insight. They show that the established banks are currently more than holding their own when it comes to attracting customers who are moving between suppliers.
In 2016, Halifax opened more than 111,000 new current accounts; Nationwide opened almost as many, at over 109,000; while Santander sourced nearly 83,000 new accounts.
How are they competing? Quite simply: the old-fashioned way, by buying market share. A quick look at the MoneySavingExpert.com website shows that, at October 2017, some of the established players are offering significant incentives for customers to move to them.
For example, HSBC is offering £150 for switching, plus £50 if the account is kept open for a year. First Direct is offering £125 for switching and Halifax is offering £125 for switching, pus £3 per month for customers who meet minimum pay-in and direct debit criteria.
A similar situation might arise in current account overdrafts, an area where Starling Bank has stated that it wishes to compete. The cost of borrowing £500 for one week, via an arranged overdraft, ranges widely.
As at November 2017, NatWest/RBS would charge £7.75, whereas First Direct would only charge 71p. Such a wide range suggests that, although potentially financially painful, the established banks do have room for manoeuvre if forced to compete more aggressively.
And history suggests that this is what they would. Back in the mid-1980s, industry-wide free in-credit current accounts came about as a response to smaller banks winning market share by promoting free banking, despite the financial cost that ensued for the bigger players
So, incentives, together with the free-in-credit model that characterises UK current account banking may prove a further hurdle for newcomers to overcome. If the challengers were forced to enter an incentive war to win new current account customers, or if, in the future, they encounter credit-related issues, this may make the market a particularly expensive, and thus difficult, nut to crack.
A challenge for the challengers
While the challengers may be showing that they can master technology, it’s too early to tell if their overall propositions are just as eye-catching. That may only become clear later, once it has become evident whether the new IT platforms can underpin a fundamental change in the nature of banking; whether sufficient numbers of new customers can be attracted to open and regularly use their accounts; and whether the cost, credit and risk profiles associated with the propositions can be managed so as to deliver financial success.
Of course, some challengers may be satisfied with establishing themselves as custodians of second and third banking relationships, perhaps in such sufficient numbers that some of the established banks, or other market participants with deeper pockets, step forward to buy the most successful.
However, many have bigger ambitions than that. But, however the newcomers choose to define success, retail banking might yet prove to be a challenge for the challengers.
Anthony Duffy is Director of Retail Banking at Fujitsu UK& Ireland
