Challenger banks face a fight for survival

For several British high street banks, 2019 is a year to be forgotten. From PPI claims to accounting flaws, IT bungles to tougher competition, the fortunes of many have been under heavy scrutiny.

But this hasn’t been the picture across all banks. Instead it has largely been confined to a specific subset – the traditional challenger bank.

Unlike the new wave of digital banks borne out of the financial crisis, Britain’s traditional challengers largely emerged in the Nineties or early 2000s, promising to be high street contenders that would give people more choice and the opportunity to break away from the big four banks.

From Metro Bank’s colourful, American-style promise of customer service more akin to a “store” than a bank branch, through to Virgin Money’s growth by acquisition to become the UK’S sixth-largest bank, these challengers have been in the market for decades hoping to disrupt the sector and loosen the hold of the incumbents.

But the last year has been a difficult one. The traditional challenger banks struggle with many of the problems that the incumbents do without the benefit of scale: they still operate on legacy infrastructure, lag behind on customer experience, and need to drive growth with tighter margins and smaller budgets.

Governance issues and increased costs have amplified these problems.

And while policymakers have set out to encourage competition, they also responded to the financial crisis with regulation that was appropriate and necessary at the time, but inevitably has inhibited growth for new entrants.

The challenger banks haven’t come close to the customer numbers or revenues to meaningfully shake-up the banking industry.

But now they themselves are being disrupted. The likes of Revolut and Monzo have hit their stride, on track to reach 35m customers over the next year, according to our research.

With soaring valuations, digital banks have been able to invest in shiny new advertising campaigns with ambitious plans for expansion in new markets and into new segments of lending.

While 2019 hasn’t been without its controversy for the digital banks, it has been largely a growth story that hasn’t been seen in banking for many years.

Meanwhile, customer growth has stagnated for traditional challengers. And while regulators have initiated more programmes to encourage switching behaviour, consumers are largely steadfast to the banks their parents banked with, or are opening new accounts with more colourful digital-only banks.

To their credit, some of the challengers have been quick off the mark in pursuing opportunities to boost innovation, with Metro Bank and Co-op Bank some of the biggest winners in the Rbs-funded competition scheme. The outcome of this funding is still yet to be seen.

And while these banks are taking steps to transform their businesses for the digital age, they haven’t been able to move with the speed and agility that their newer counterparts have.

It’s now time for these challenger banks to innovate and rethink who they are to avoid being caught between two stalls. They need to find a way of being new again. If not, in a crowded banking market such as the UK’S, they’re at risk of being squeezed out.

There’s a clear opportunity to use their smaller scale to their advantage.

As we enter a new decade, the incumbents still have the same old baggage they’ve had for the last decade – legacy infrastructure, and the cost burden of a larger, more sprawling physical footprint.

There are two paths they can take: the challengers could follow the CYBG route, consolidating to try to match the traditional banks in terms of scale and customer numbers.

Or they could embrace their challenger status and transform their business for the digital age. The RBS Remedies package has given much needed funding for some challenger banks so that they can invest for the future.

They’ll need to act quickly, and also smartly, with the spirit of their agile digital counterparts, while leveraging their decades of experience and knowledge as hallmarks of Britain’s banking sector.

It’s now more important than ever that the traditional challengers change and innovate – either as nimble digital upstarts or consolidated banking powerhouses that can match up to the incumbents.

‘It’s now time for these challenger banks to innovate and rethink who they are’