“Conditions for start-ups in the UK are good but it is difficult for them to scale in a way where they can challenge established institutions,” according to Karen Bradley MP and chair of the All-Party Parliamentary Group on Challenger Banks and Building Societies, which produced the report.
There are inadvertent consequences of regulation which disadvantage smaller players, such as minimum fund requirements and leverage ratios.
“The problem with banks and regulation is you need to be a bank on day one,” says Anthony Thomson, co-founder of Metro Bank, Atom Bank and 86 400.
“Everything needs to be in place – your capital, your risks, risk strategies, your fraud strategies, your products, services, everything. Otherwise the regulator says no whether you have one customer or a million,” says Thomson.
Thomson says it costs around £75m to build a bank and gain UK authorisation. “Banks need to fund their loses as well as build more capital to fund their growth.”
“When you start a bank for the first two or three years, you’re going to lose money because you’ve had to build all this infrastructure in place and put everything in place from day one.”
Starling Bank announced in November it was the first challenger bank to break even, four years after receiving its banking license in 2016.
Monzo and other challenger banks have chosen “capital light models”. “They used the model very successfully. They went from no customers to three million customers with a relatively modest amount of capital,” says Thomson.
Despite success with the model, Monzo’s valuation reportedly dropped by 40 percent in May, from £2bn to £1.25bn year on year, as reported by The Financial Times. The article said venture capital funds were becoming cautious about backing lossmaking companies during the pandemic which put capital light models under scrutiny.
At the time, Monzo had only recently started building its lending book which meant it hadn’t had much exposure or been able to build it substantially enough.
“Other banks chose to build a lending book, which gives you a path to profitability, but that does mean you need more capital,” says Thomson.
The report also found innovation was being stifled by “one-size-fits-all” regulation. The regulatory system places a “disproportionate burden on smaller firms”, said Bradley, in an email.
Some regulations should be “more appropriate” to smaller start-ups, according to Thomson. “They favour big banks over new entrants which makes it harder for them to succeed.”
“The yardstick they use for new entrants is the same yardstick used to measure bigger banks. If you’ve got a big bank worth hundreds of billions, and a new bank worth hundreds of millions, they shouldn’t be treated both the same.”
Challenger banks have had a huge impact on the sector, transforming costs and the way services are delivered.
“Challenger banks have forced bigger banks to change some of their actions, and to become more consumer centric. It has made the bigger banks change more quickly than they would have done had been the new entrants not existed” says Thomson.
New banks should be considered a driver for innovation in the industry, says Marco Mottadelli, head of global brokerage at Fineco Bank.
“They play a strong role in the entire industry because others, especially traditional banks, can use them as an example to discover how the market reacts to innovation before they do the same.”
“The use of technology has allowed banks to offer consumers outstanding quality products at lower fees compared to what is normally applied from traditional banks.”