The banking industry has seen an intense period of regulatory change and individual bank restructuring since the financial turmoil known as the credit crunch in 2008 – but little has changed in the minds of customers.
If you ask consumers on the street to name five banks, the usual suspects will flow off the tongue. But Monzo, Starling, Atom and Fidor – some of the leading financial technology (fintech) challenger banks – are unlikely to be on many people’s lists.
It is hard to believe that so little has changed in the market share of the traditional high street banks when you consider the rage directed at them a decade ago, when they contributed to the UK’s worst recession since the 1930s.
But now it appears the high street players have survived the worst, some of them with a bit of help from UK taxpayers, and the indications are now that the banks could be about to enter a phase of growth. And rather than threatening their growth, it appears the fintech revolution will actually fuel them.
In fact, recent research from EY suggests that, after years of investing in regulatory compliance, traditional banks are now ready to put more into growth. An EY survey found that investing in digital transformation was the second-highest priority in the industry this year, with 84% of executives citing it. This was only exceeded, unsurprisingly, by cyber security, named by 89% of executives as a priority for 2018.
Banks are also planning to dig deep into their pockets to support digital. In the EY survey, 59% of the banks questioned said they expect their technology investment budgets to rise by more than 10% in 2018. It’s not too difficult to conclude where the money will go.
It also seems that the banks’ reputations were not damaged beyond repair by the financial crisis. It turns out customers actually quite rate their banks. A study of 1,000 people by marketing agency True and research company Strive found that 86% of those aged between 18 and 55 gave their current bank a score of seven out of 10 or more for satisfaction. And 59% agreed there is little to be gained by switching banks.
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So it appears the banks that found themselves in a dark place just a few years ago have emerged ready to harness the fintech revolution that has been going on all around them.
Banks have always remained close to new technology and invested in it, but have largely allowed third-party fintech companies to evolve – and now there is a strong fintech ecosystem for banks to dip into.
But where does this leave the challenger banks? Were the doubters right when they said they were unlikely to make much impact, or is there still some way to go?
Where next for fintech startups?
There appear to be three paths ahead for fintechs. The first and probably most anticipated, as with most startups, is that they will get up and running, build a reputation and customer base, and then get acquired. The second path is they will build a niche service and focus on that to build a profitable business. The final and most ambitious journey would be for a fintech business to take on the traditional banks as an end-to-end digital bank.
One fintech provider challenging the traditional banks is Fidor, a German challenger bank that was set up in 2009 and gained a UK banking licence in 2015.
Fidor has taken the first path mentioned above, and in July 2016 was acquired by French banking group BPCE, which has 35 million customers, more than 100,000 employees and about 8,000 branches in France.
Matthias Kroener, CEO and co-founder of Fidor, which now operates as a separate unit of BPCE, says it is no surprise to him that consumers are not rushing to switch banks.
“For this reason, we decided to come first as a clear secondary partner, then change gear into developing primary banking relationships,” he says. “For this, you must truly offer advantages and you must have the financial power to communicate that.”
As the boss of a company that was acquired by a traditional bank, Kroener admits he is biased when he says fintech startups will benefit from being taken over by experienced banks. “You need to have people on your investor side who understand the risk nature of your business,” he adds.
Kroener says trying to build a full-service bank outside a traditional organisation is tough because the traditional banks have a huge advantage. “The incumbent banks are not as stupid as we fintechs always tell the market,” he adds.
Sooner or later, challenger banks face the same hurdles as the incumbents, says Kroener. “You hire the same staff as the incumbents, maybe even coming directly from them, and, sooner or later, you might end up being just a normal bank.”
A senior IT professional in the banking sector says it is true that the traditional banks have had the measure of the fintechs on the rise. “I’ve seen what the banks have been doing as they picked up on the potential threat some years ago,” he says.
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The IT professional says this will inevitably lead to the big banks getting involved, either directly through acquisition or indirectly through partnerships and investment. “The banks are keeping a look-out for emerging fintechs and then invest in, or become a customer or partner with, the most promising firms,” he says. “In this way, they hope to benefit from new tech without having to create it themselves, while also preventing some fintechs from becoming competitors.”
Acquisition might be attractive to some fintechs, depending on their ambitions, he adds. “Selling out can be a nice exit for the founders, who can then go off and do something else. Their offering would then be limited to what the buying bank can do, rather than be used by many banks, so acquisition could restrict a promising idea rather than allow it to be used more widely.”
The IT professional thinks becoming a full-service bank is the least likely outcome for fintechs. “There will be a few firms that take this route, but it is very difficult to be a bank these days, both technically and economically,” he says. “A decent tech firm should outperform a bank, so I’m not sure it’s that attractive as a business idea. You can probably do better selling stuff into the banking industry rather than actually becoming a bank.”
Focusing on a niche
Becoming a niche service provider is perhaps the most likely outcome for fintechs, he says – but acquisition is then highly likely. “I think a fintech niche supplier is more likely to be bought out by one of the bigger tech firms, rather than a bank,” he adds.
But he believes big tech companies could make inroads into the traditional banks’ market share. “If big tech firms like Apple, Google, Microsoft, Paypal, Amazon and others wish to get into specific financial services, I think they have the power to beat the banks,” he says. “But increasing regulation and de-globalisation of financial services may put them off.”
Celent analyst Gareth Lodge also sees focusing on a niche as the most likely outcome for fintechs. “I think the reality is likely to be focus on a niche,” he says. “It’s hard to see how they could ever move from being niche to a top 10, for a variety of reasons.”
One reason for this is that the big banks follow the challenger banks and fintechs, learn from what they are doing, and replicate it, says Lodge. “It would be very naive to think that the big banks aren’t trying to innovate as well,” he says. “They have the resources to do so, it’s just that sometimes it’s harder for them to do so. The consequence then is that the edge that many challenger banks believe they have perhaps isn’t as big a differentiator as many think.”
Lodge says it would be interesting to know how many customers of the challenger banks have closed their previous accounts. Many customers use a challenger bank as a second account or are just trying it out.
A worthwhile challenge?
Chris Skinner, chairman of the Financial Services Club, doesn’t think the challengers will really challenge at all. “They are too similar to banks and they will end up either as niche, boutique players or be acquired by the big guys, just as Fidor has been already,” he says.
But there are some challengers that stand out, says Skinner. “These include Tandem, with the Qatari connection giving it deep pockets, and Monzo, which also seems to have a lot of support from its customer base,” he says. “Even then, I don’t see any of these guys doing better than Metro Bank, which has had billions of pounds in backing but is still struggling to challenge the big five.”
Metro Bank was the first new UK bank in more than 100 years when it was launched in 2010.
Meanwhile, the rise of Santander proves that digital banks need deep pockets to challenge the traditional players, says Skinner. “In fact, the only reason Santander has achieved its position is by acquiring three building societies and then spending over £1bn a year to bribe people to switch,” he adds. “Do any of these new guys have a billion to throw away on acquiring customers? I don’t think so.”
So it seems the advantage the fintech banks have is technology rather than finances, and the senior IT professional in the banking sector says they should probably stick to the technology focus.
“Being a bank is not as attractive as it once was, so my guess is that the fintechs will be best suited to inventing things that the banks either invest in, become a customer of, or perhaps in some cases buy out if it is suitable for one bank to own it rather than use across the industry,” he says.
“A lot of banking products are just commodity and utility offerings, so all you can do is focus on making them cheaper to run, be more reliable and faster. I don’t think we’ll be seeing ‘luxury faster payments’ selling at a premium over ‘normal faster payments’. People just want to move money around – they don’t need bells and whistles added to that.”