Brexit prompting consolidation between traditional banks and challengers

By Emma Olsson | 24 February 2020

Brexit is forcing challenger banks to grapple with thin profit margins, as some experts predict greater consolidation in the market.

“Brexit definitely plays a role because of the uncertainty it brings about and the cost of future uncertainty,” says Madhur Jain, SVP & global head Solution Consulting, SunTec.

Earlier this month German challenger bank N26 announced that that they would withdraw from the UK market on April 15, citing Brexit as the reason. On February 3, the Telegraph reported that UK fintech Revolut will move its European payments base from London to Ireland and Lithuania after Brexit.

“Because if you look at it, most of these [challenger] banks are operating on thin margins; they are basing their whole strategy on customer growth and the volumes driving their revenues. However, I also believe that if you look at the UK as a market, it’s a fixed number of people, and if you look at the number of challenger banks that are in the market with similar offers to your customers, all basically premised on superior experience driven by the channels plus much lower costs than high street banks. The proposition to customers is the same, and how many can the market bear?

“Even today we’re talking of tens of challenger banks that are competing for the same fixed set of customers and somewhere some consolidation has to happen. Because you can’t have 50 banks, each with superior growth plan missions, saying ‘I want five million customers’ with the same base of max 30, 35 million customers possibly. Brexit just adds that uncertainty into the mix.”

Yet some commentators have expressed scepticism over citing Brexit as a key struggle for challengers.

“We just had N26 announce that they're allegedly because of Brexit withdrawing from the market – I don't believe that I'm honest,” says Mark O’Keefe, Payments Systems Regulator (PSR) panel member and founding director at Optima Consultancy.

“I think most industry commentators actually say when you look at it, they were too late to the party, they weren't able to put a proposition that created quite a difference between them and those who were there before them, and there are bigger fish to fry in other markets where it's not as competitive – and that's a relatively agile challenger.”

Jain says challengers will need to up their propositions in order to compete, but that market consolidation is inevitable.

“How many challengers are making money? They might be in the market, they might be valued, they might be unicorns – where market valuation is very high, but how many of them are actually making money? To run a bank, they need to make money,” says Jain.

“I believe that there are going to be two levels of consolidation. One, with many of the challenger banks either being taken on by other challenger banks, the more mature ones. But also, by some of these banks like RBS looking at launching a digital bank themselves, and if you look at the kind of budgets these people are talking about trying to launch a digital bank, they might as well be served by buying a stake or taking over a challenger bank.”

Consolidation could occur over the next year or two, according to Jain. Challenger banks’ success will depend on their abilities to provide traditional services such as lending products, as well as incumbent banks’ ability to adapt to changing customer expectations.

“I wouldn’t be surprised if there is a set of the population which could start considering [challengers] as their main bank, but again it depends on how mature they become. Also, on the other side – how much do the main banks change themselves? If the main banks become far more responsive to the customers’ needs and meet a particular standard which the challenger banks are providing the customers, then there’s no incentive for customers to necessarily change.

“These banks are constrained by a number of things: their structure, their policies, ecosystems and their internal bureaucracies, and until they fundamentally changed from the top down, [the challenger banks] not going to go anywhere.”

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