Challenger banks rally to meet the coronavirus call
Gavin Brown (MBA, 2007) & Richard Whittle (Manchester Metropolitan University)
Following a generally stellar year in 2019, challenger banks looked to 2020 with anticipation. In fact, lending to customers by UK challenger banks reached a staggering £115bn in 2019, up twofold over the previous five years according to BDO LLP. Then came COVID-19 and our world changed, probably forever. However, the change and disruption wrought on society so far in 2020 has yielded both opportunities and threats to these banks in equal measure. The world has indeed changed and the cumbersome banking behemoths we generally use are lagging further behind the challenger and neo banks in key areas.
Challenger banks boast a full banking license unlike their neo bank contemporaries, allowing them to operate in all key areas of banking operations. These relatively new but complete challenger banks offer much needed flexibility, usually over and above online banking options offered by traditional banks. For instance, typical challenger bank apps will interact with the various technologies on your smartphone to deliver a highly convenient banking experience. Whether it is paying in cheques by photo, provision of disposable virtual cards for increased security or easy interaction with bill sharing apps for convenience, a challenger bank experience is designed to be one of seamless convenience tailored to your individual needs. A trend often described in the industry as hyperpersonalisation.
This convenience disappears in the face of traditional cash and banking services. Yet cash use is rapidly diminishing of late thereby delivering a headwind to the momentum behind such new banking services and their providers. This has been evidenced by LINK who recently reported an almost two thirds reduction year-on-year for ATM transaction volumes in the UK. Not restricted to these shores, The Financial Times highlighted in May this year that cash volumes also fell in Spain, albeit more markedly, down some 90 percent. In contrast, the U.S. and Russia saw increases in cash withdrawals perhaps due in part to Government issued stimulus cheques or likely cash hoarding owing to concerns over the ability of their banks to weather this economic shock.
From the early beginnings for challenger banks in the wake of the 2007-09 Financial Crisis, they have progressed rapidly. Their initial toehold then was servicing the underserviced, some said ‘broken’, small business banking sector. However, challenger banks are now presented with a new opportunity. Their unique customer demographic and digital competencies has not gone unnoticed or unused during the pandemic. In April this year, the state owned British Business Bank (BBB) approved three challenger banks including Starling to deliver business loans as part of the Coronavirus Business Interruption Loan Scheme (CBILS). The BBB’s CEO Keith Morgan explained in The Daily Telegraph that, ‘these new lenders (challenger banks) will be able to deploy vital funding and get additional finance flowing to smaller businesses across the UK as quickly as possible.’ The challenge is a logistical one of delivering relief funds to the correct people and businesses in a targeted, robust and crucially timely manner to mitigate economic failure. Enter the challenger banks…
However, what seems like an opportunistic strategic move by Staling et al may be more defensive in nature once we dig a little deeper. By example, Starling Bank has a 2.6% market share of the UK small business banking market comprising over 155,000 business accounts. Despite being voted Best British Bank 2019 and having raised €110million in investment in 2020 alone, Starling’s disproportionate reliance on small-businesses perhaps leaves it exposed during this pandemic should those same small businesses fail to access sources of critical funding such as CBILS and Bounce Bank Loans. This is corroborated by head of Regulatory Affairs at OakNorth challenger bank, Nick Lee, who said early in the coronavirus crisis that, ‘time is of the essence if we’re to preserve as many small and medium sized businesses as we possibly can.’
Notwithstanding the strategic thinking of the challenger bank sector we have seen even more upheaval in our personal use, storage and psychological contract with cash in these COVID-19 times. For instance, it is now extremely likely that the shops and services which you use on a daily basis no longer take cash. Without the requirement for cash, businesses no longer need change and the need to deposit cash with your retail bank branch vanishes. The previous advantage of the traditional banks with an infrastructure oriented around cash is becoming increasingly undermined. Couple this degradation in cash usage with A.I. enabled real-time lending decisions along with the growth of robo-advisors and the trend for open banking and we have the makings for a paradigm shift away from relationship led branch banking and toward the challenger bank business model.
However, it is this very change which appears to strengthen the appeal of the challenger banks which may ultimately be to their cost. The traditional big four retail banks in the UK, (Barclays, HSBC, Lloyds and RBS Group), have been institutionally slow in their response to financial technology, such as Paytech and the financial convenience promised by technological change. This is unsurprising, as they have established infrastructure and systems, which will be costly, time-consuming and potentially futile to change. Technology is moving so quickly in this area that a two year change agenda, if implemented well and on time leaves an institution already lagging behind.
Furthermore, the big four banks generally have large, established and for want of a better word, ‘traditional’ customer bases with ‘traditional’ banking needs. If we consider how we have changed as a society over the last few months, cash use has rapidly declined, bank branches have been closed or inaccessible, customers who have previously never shopped or banked online have embraced or at least grudgingly used these technologies. The sunk costs of updating infrastructure and consumer attitude have thus far prevented traditional banks from justifying the improvement of their technology to meet the rising challenge. The step-change by society discussed above may now flip such investment decisions from no to yes. The legacy systems, outdated technology and inefficient customer processes may soon be a thing of the past leaving the traditional banks able to quickly catch up, close the gap and then better meet the competition from the challenger banks head on.