In the beginning, digital challengers presented themselves as a kind of anti-bank proposition. This initially served them well, especially in the wake of the 2008 financial crisis – which eroded peoples’ confidence in high street lenders so severely that ten years on two thirds of Brits still do not trust banks, according to a YouGov poll.
But to diversify their product offering, reach profitability and attract a different type of customer, the line between these digital disruptors and their incumbent rivals has blurred, with the more mature challengers becoming fully-fledged banks.
In January, Revolut announced that it had applied for a full UK banking license – following in the footsteps of rivals Monzo and Starling Bank.
The license will enable Revolut to offer customers overdrafts, loans and deposit accounts. It will also ensure the company is covered by the UK’s Financial Services Compensation Scheme (FSCS), which protects customers deposits up to £85,000 if the business goes bust.
“In the future, we want to offer many more innovative products to our UK customers and we are excited to continue driving innovation and competition in the banking industry,” Revolut CEO and founder Nik Storonsky said in a statement. “Becoming a fully licensed bank in the UK is a central pillar of that ambition.”
Another upshot of challenger banks obtaining a banking license is greater consumer confidence and trust, according to Mark O’Keefe, founding director of Optima Consultancy.
“I think they probably need the banking license for credibility and to address key hygiene factors,” he says. “And if they really want to get customers to close their Lloyd’s or Barclays accounts, then they probably want to be called a bank. And they probably want to offer customers the reassurance that comes with the FSCS scheme.”
A banking license is also a major steppingstone – although no guarantee – towards profitability for challenger banks. After all, new market entrants have been urged by the Bank of England to find a “clear path to profitability (whilst meeting full capital requirements)”.
To their credit, all three challenger banks have shown signs that they are beginning to shift their focus towards profitability, with Revolut quietly breaking even in November, despite the firm recording a 40 percent dip in revenue during the early days of the pandemic.
“Despite the pandemic, we’ve grown margins, reduced costs, launched in new markets such as the US, Singapore, Japan and Australia, operationalised Revolut Bank in Lithuania and Poland, and also begun the process towards becoming a bank in the UK with our application for a UK banking licence,” a Revolut spokesperson told bobsguide in an email.
“While the coronavirus is reshaping the business landscape, it has accelerated things we wanted to do anyway, and we are concentrating on offering our customers more products and services that they can use every day to manage their money.”
In October, Starling Bank reached a major milestone; becoming the first challenger to make a profit (£800,000) amid an exceptionally challenging backdrop that has applied significant pressure on lenders both old and new.
“The pandemic has accelerated the shift to digital channels and as an app-based bank, Starling has seen robust customer acquisition since the start of the first lockdown,” a spokesperson for Starling Bank told bobsguide in an email. “We’ve doubled our customer base in the last year, to more than two million accounts and have increased our headcount in our London, Southampton and Cardiff offices by more than 300 to top 1,000.”
“Thanks to this growth we hit our target set in the summer of 2019 to hit breakeven before the end of 2020. The challenge going forward will be to help our customers whose finances have been adversely affected by the pandemic to bounce back with all the right kinds of support.”
But while Revolut looks to obtain a banking license this year and Starling kicked off 2021 by announcing that it is actively searching for non-bank lenders to acquire, the future of Monzo looks uncertain after its pre-tax losses doubled, according to its latest 2019/20 annual report.
“There are material uncertainties that cast significant doubt upon the Group’s ability to continue as a going concern,” the company said in a statement. “Our revenue streams have been significantly impacted by the pandemic and resulting macro-economic uncertainty.”
The bank raised an additional £60m in December to bolster its balance sheet, taking its total raised in 2020 to £125m following the completion of a £65m funding round in June that valued the company at £1.25bn – representing a 40 percent discount to the £2bn valuation it secured a year prior.
So, while the pandemic has boosted adoption of challenger banks, a trend that will likely continue into 2021, the disappearance of regular everyday spending due to tighter lockdown restrictions did hit revenues hard and highlighted underlying issues with how they monetise their customers.
Monzo declined to comment.
Trust trumps tech
The pandemic has forced consumers to rely on digital banking. With that, the user experience and the overall design of mobile banking apps is facing increased scrutiny and becoming an increasingly crucial component in determining who consumers choose to bank with.
In response, high street banks have upped their game, issuing a myriad of software updates over the past 12 months, adding additional functionality to their mobile banking apps in a bid to address a growing disparity in terms of feature support compared to their digital-only rivals, according to Optima Consultancy’s 2020 Mobile Banking App Review.
“The pandemic has accelerated digital adoption permanently and the need to enhance your app and release [updates] frequently has become a necessity, and those that continue to struggle to do this will likely find customers losing patience and looking elsewhere,” the report said.
Among the incumbent lenders, HSBC made the most progress in terms of additional functionality, issuing several software updates, allowing its customers to amend standing orders, manage overdrafts and delete direct debits. Virgin Money added two new features (update contact details and report cards lost/stolen), while NatWest and Royal Bank of Scotland (RBS) added transaction controls.
However, despite their efforts, the report noted how disappointing it was to see just how little progress was made by some providers considering customers inherent need for non-physical channels, with fintechs managing to “remain ahead in every feature category”.
But despite UK challenger banks like Revolut, Monzo and Starling boasting superior functionality and an overall better digital experience, banking relationships tend to be more resilient than other industries, with traditional lenders still used for four out of every five purchases, according to research from the open banking platform Curve.
“There have been numerous studies that have been done and when people are asked, ‘who do you trust’ customers tend to go with the traditional lenders,” says Nathalie Oestmann, chief operating officer at Curve. “The reality is that bank customers are very sticky, and people usually stay with the bank that their mum and dad signed them up with when they were teenagers.”
This has led to a scenario in which a growing number of consumers have two bank accounts: a primary account, often with a high street bank, that they deposit their salary and savings into, and a secondary account held with a challenger which they top-up to avoid fees abroad and to gain access to spending analytics tools that help improve their money management.
However, the rise of challenger banks is still a major concern for incumbents, with 16 percent of consumers banking solely with a digital challenger and 33 percent choosing to hold an account with both, according to recent report by Fujitsu. From a different angle, the research shows that only 51 percent of consumers expect to bank exclusively with a conventional lender – down from 71 percent. And things stand to get worse for incumbents over time, with the research suggesting that those loyal to incumbent banks “have their best years behind them”, while over a fifth (22 percent) of younger consumers (16 to 34-year-olds) are prepared to switch to a challenger bank by 2024.
But if the digital disruptors want to grow this trend further and truly take market share from their incumbent counterparts, challenger banks “must create solid infrastructures, underpinned by security and transparency, to reassure consumers of their longevity”, according to the Fujitsu report.
The great rebundling
As important as it is to grow their customer base, challenger banks must also retain it and find new ways to monetise it too. Digital-only banks have managed to entice millions of people to download their apps by unbundling banking.
Revolut won customers with free foreign exchange services, but they do not make the company much money. Unsurprisingly, the great unbundling is beginning to reverse, with challenger banks boasting banking licenses in pursuit of new revenue streams, greater consumer confidence and profitability.
“This ‘rebundling’ will happen to all bank brands,” says Oestmann. “Why? It’s to do with consumer mindset. A consumer goes to their bank to deal with their bank. They don’t go to their bank to deal with other banks. It’s a mindset thing, that’s not going to change.”
“The entire industry is ripe for re-bundling,” she adds.
2020 was supposed to be the year of global expansion for these digital disruptors. Instead, the pandemic has plunged the global economy into a recession that is yet to be fully realised and is likely to put plans of world domination firmly on ice for the foreseeable future. But over the long-term challenger banks are well-positioned to shakeup the banking landscape. However, consolidation in the UK banking market is likely to become a fixture, driven by deals or death.
“Certain banks won’t be able to survive this Covid thing because they are too reliant on payments and interchange, especially here in Europe,” Storonsky said in recent CNBC interview.
To not only survive, but thrive, challenger banks will need to innovate further and find new ways to differentiate themselves from the larger, established players, says John Cragg, CEO of MYHSM.
If the new products and services digital disruptors launch off the back of their banking licenses turn out to be just a remix rather than a revolution, their potential to overthrow the legacy banks that have gone unchallenged for decades could dwindle. Having said that, the challenge of how to monetise customers is a major issue for traditional players too.
In the end, both sides have a lot to learn from each other to survive. High street banks must adopt more characteristics of their digital-only rivals. But the failure of Bó, RBS’ digital bank for retail customers, highlights the incumbent players digital deficit. Meanwhile, the challengers assumed they could reinvent the wheel only to slowly adopt business models that are becoming intriguingly similar to the legacy banks they hope to topple and must navigate the same capital requirements and regulatory red tape of their established rivals.
For now the war for customers continues, but when the dust eventually settles it will be fascinating to see the which challengers manage to make the climb and the champions that fell off their perch.