This article was published first in Global Banking and Finance Review.
New challenger banks have transformed a sector once dominated by the Big Five banks. More than 50 banks now operate in the UK and over 20 banking licences have been awarded in the last three years alone.
The challengers come in many guises: mid-sized, full-service banks like Virgin Money and Tesco Bank; specialist lenders like Oaknorth and Aldermore; and digital-only businesses like Starling and Monzo. In fact, some of the businesses targeting younger, digital-savvy customers don’t even have a banking licence. They see themselves as technology companies rather than banks.
Right now, the challengers are quicker and more innovative. But that doesn’t mean their advantage will last forever. The big banks still retain the majority of customers, and they are working hard to be more innovative, simplifying and digitalising their customer journeys and building their own fintech ecosystems. In fact, there are several areas where today’s rising stars need to be on their guard.
Cyber security – the biggest threat
Cyber security is the biggest threat to the challenger banks. Especially those whose offerings are primarily digital. I’m pretty sure at least one will fail because of a major cyber security event with the potential to destroy their customer base overnight.
The biggest banks still have the upper hand in this area. They have the brand, the money, the systems, the business continuity plans and the firepower to withstand such shocks. To minimise the threat, challenger banks need to build cyber security into the DNA of their businesses right from the start and keep it as a number one Board priority.
Regulation – where scale is still an advantage
Complying with a raft of regulations is a headache for new and established banks alike. But nimble newcomers can be at a disadvantage. ‘One size fits all’ regulation creates an uneven playing field for challengers when they’re pitted against the enormous scale of the universal banks.
Regulators are trying to make things easier. The regulatory sandbox – a safe space where banks can test innovative products and services – is a great example, and something we helped design and implement. There has also been some movement on capital requirements for the smaller banks. But to thrive, challenger banks need to find a way to comply efficiently and effectively so that regulation doesn’t become a stumbling block.
Open Banking – opportunity tempered by risk
The Open Banking initiative to encourage innovation gives digitally focused challengers a great opportunity. Letting customers add new ways of managing their money to their accounts, via tools developed by third parties, is a powerful selling point. Digital-only newcomer Starling already have several third parties bolted into the Starling world.
But it’s not all plain sailing. A key risk in this arena is the General Data Protection Regulation (GDPR). Being adept at capturing, analysing and processing customer data from many sources gives a major competitive advantage. But handling this expanded data set in compliance with GDPR, and establishing the processes and controls required to remove data upon request, could be a big headache for some challengers. With the countdown to GDPR now on, challenger banks should be taking the issue seriously.
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Will they all survive?
Cyber security, regulation and GDPR are the three big threats – but others abound. Consolidation will take out some of today’s challengers as they succumb to the need for scale or are bought up for their technology by bigger banks.
Others challengers will fail because they just can’t get the customer base their business plans require, either because their products aren’t differentiated enough or their systems don’t perform as expected.
I’m also very confident that a good many challengers will continue to grow and to thrive. Ones that both grasp the opportunities ahead, whilst managing the risks around them most effectively.
Meanwhile technology giants like Apple and Amazon are dipping their toes in the water too. It’s a dangerous world out there and only one thing is certain. The banking landscape in five years’ time will look radically different to the way it looks today.
Jason Hill is a financial services expert at PA Consulting Group