Challenger banks may re-evaluate business models

Lack of sustainability threatens challenger bank longevity, according to a panel at Money 2020 Moneyfest yesterday.

“Of course companies have to be profitable, but most of all they have to be sustainable. This is the point, and to be sustainable you can’t always reach out to the market and do fundraising,” said Paola Papanicolaou, group head of innovation, Intesa Sanpaolo.

John Doran, general partner, TCV agreed, saying challenger banks should not worry about profit at this stage of their development.

“We shouldn’t be talking about profitability here, we should be talking about sustainability. I think the story probably isn’t written there and we’ll know over time … I would argue that financial services in particular, there’s an argument where from a product perspective you do want to try to offer multiple products to your consumers to understand what really sticks with them and where you can push certain winning products,” he said on the panel.

“I would bet that in the next twelve months you’re going to see some of these digital banks continue to increase valuations based on the fact that they continue to show great momentum, investors that are making investments think that there’s a sustainable business model there and it will take care of itself.”

The business model of challenger banks is being questioned as even the most popular neobanks struggle to break even. While Monzo’s customer deposits increased £930.7m in the twelve months leading to February 2020, its gross lending increase was only £124.7m, according to the challenger’s latest annual report.

Losses have caused Monzo to offer paid-for retail accounts, such as a £180 a year Monzo Premium card that premiered last week.

“It’s a different menu for each [challenger] bank, but in general what I see is that their expense bases are every very well developed and their revenue channels or their ideas for how to monetise their customers are very, very underdeveloped,” said Sergei Galperin, European head of fintech investment banking, JP Morgan during the panel.

“By far the most popular [business strategy] has been ‘we’re going to get tons of customers and we’ll figure it out later.’ And that needs to stop being the most popular business model and the concrete steps they need to take to achieve profitability is before you’re drowning in millions of customers, figure out how you’re going to monetise those customers.”

But according to Doran, challenger banks that have seen success in rapidly expanding customer bases need not worry.

“If you look at any other industry that has seen massive digital disruption, I don’t think you’ve seen profitable companies in the first two, three, four, five years which is basically where we are in the neobank, challenger bank journey. It’s very, very early. And if you look at the growth rates of these companies, they’re in the hundreds of percents growth. Being profitable is probably not the most important thing today for all of these companies.”

It is still up for debate whether challenger banks have chosen the correct business strategy, said Galperin.

“Ultimately, most challenger banks are not really profitable because they haven’t spent a minute of their lives to date focusing on profitability. We can debate whether that was the right approach or the wrong approach … If you’re going to be focused on profitability like [digital lender] Oak North, it became very profitable and with very few customers very early on. If you’re focused on growth and taking over the world and profitability has taken a back seat, you’re going to be investing in growth, spending money on marketing, spending money on investing and not going to be profitable.”

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