Major banks have long held all the cards, operating in closed environments and keeping their customer data under lock and key – but no more. In the new opening banking landscape, banks must establish open application programming interfaces (APIs) to enable third parties to access customer account information for gathering data or the initiation of payments.
It doesn’t sound like much, but this has led to the emergence of digital banks.
One of the fastest growing digital banking alternatives is UK-based Revolut. In April, the bank raised $250m via a Series C investment round, led by late-stage venture capital firm DST Global. The capital injection helped the bank become one of the fastest tech companies in Europe to obtain the coveted unicorn accolade with the bank’s valuation increasing 5x in a little under a year to $1.7bn.
Its rivals in Europe include UK-based Monzo and Starling Bank. The former is looking to raise £30m in crowdfunding this, after securing £71m from Silicon Valley venture capital firm Goodwater Capital and US-based payments provider Stripe. Meanwhile, Starling Bank has hired Quayle Munro to help it raise up to £80m this year and is also looking to secure a £120m “Pool A” grant from a Royal Bank of Scotland established fund.
Despite their success in attracting investment, there are doubts over the long-term sustainability of their respective business models. Many of these digital banks are trying to compete in the retail deposit space, which is “doomed to fail”, a sector banker said. To have success with this strategy, interest rates need normalise which is not looking likely to happen anytime soon, the banker added.
For long-term success, digital banks must have more than their marketplace model and cutting-edge technology, according to Luvleen Sidhu, President and Chief Strategy Officer at US-based BankMobile.
Technology is merely a commodity, so no matter how unique it is, the rest of the market can catch up in less than a couple of years, Sidhu explained. In her opinion, the key differentiator that determines success or failure is banks’ strategy for acquiring customers. BankMobile is acquiring 400,000 new customers each year by partnering with colleges and universities to deliver disbursements.
In the UK, Revolut targeted currency exchange over current accounts, homing in on frequent travellers, a traditionally underserved segment of the market. What’s more, all the start-up needed to start doing business was an e-money license from the UK Financial Conduct Authority (FCA), rather than waiting to receive a bank charter which rivals Tandem, Starling and Atom had to wait up to two years to obtain before launching their respective products.
Other non-conventional products like its cryptocurrency exchange, helped Revolut outpace its rivals on customer acquisition, with the company reporting 1.5m customers as of February 2018. Compare this with the 52,000+ customers that rivals Tandem, Starling and Atom have accumulated collectively.
Earlier this year, Santander announced its plan to launch a stand-alone digital bank in the UK, a move likely in response to RBS’ own mobile bank initiative that will enter beta in 3Q this year. Then there is Goldman Sachs’ major foray into fintech and consumer lending named Marcus. The online platform offers no-fee personal loans and high-yield savings accounts aimed at retail customers and was recently bolstered after it acquired personal finance start-up Clarity Money, adding more than a million new customers and tools to help improve its customer experience.
New digital challengers are not worried about incumbents’ decision to launch their own challenger brands, according to Chad West, Head of Global Brand & Communications at Revolut. “Tier 1 banks can’t do anything with their antiquated legacy systems, so they start from scratch,” he said. “They’re losing the millennial audience to digital challengers like us.”
Not all the major banks are looking to go head-to-head with these new digital challengers though.
Spain-based BBVA has led several investment rounds in UK-based Atom Bank. The Spanish lender now controls a 39% stake in the mobile-only bank after investing £167m and has until April 2019 to decide on whether it will acquire the business outright or forego its veto powers over the bank’s strategic decisions. In 2014, BBVA acquired US-based digital bank Simple for $117m.
Combine this with the fact that big tech companies like Alipay have invested heavily in Germany-based N26; PayPal’s acquisition of P2P-payment app Venmo and more recently its $2.2bn takeover of iZettle and Amazon’s seemingly limitless appetite to enter new markets, the case for market consolidation is building.
Aaran Fronda is a financial services reporter at Mergermarket