What’s stopping challenger banks growing up?

The new banking brands, from Metro to Monzo, are still under ten years old. Every one of them seems to be going through their own growing pains. Ian Henderson tries to work out what’s stopping them joining the big boys.

The UK banking sector is the largest in Europe, and the fourth largest in the world. It is also one of the world’s most competitive and technology-driven – only the US and China have more billion-dollar ‘unicorn’ fintech startups. So it’s not surprising the big four High Street brands – Barclays, HSBC, Lloyds and RBS – have been feeling the pressure from digital ‘neobanks’ like Monzo, Starling, Revolut and N26 as well as more conventional newcomers like Metro and Atom.

And yet the rise of these challengers seems to be stalling. The Big Four still control over 70% of personal bank accounts (down from 92% a decade ago) and 85% of business accounts. In lending their dominance is even more solid. Optimistic forecasts from new banks which continue to make significant losses have spooked investors. Many analysts are predicting, if not collapses, a period of consolidation with mergers and takeovers by the bigger firms.

Customer numbers overall have plateaued. High-profile reverses like controversial Metro founder Vernon Hill’s ejection after a serious accounting error, Monzo’s ‘fluffed’ (according to CEO Tom Blomfield) launch of its Prime service and a 50% share price slump following a profit warning from Virgin Money owner CYBG haven’t reassured investors. And there’s still the small matter of making money – almost all neobanks worldwide (not just in the UK) have still to show a profit.

That’s to be expected in a new and highly competitive space; rivals are competing for customer numbers before converting them to valuable account holders. This has produced plenty of experimentation with different models such as Nubank in Brazil, Revolut across Europe and of course Metro’s contrarian branch-building extravaganza. It’s led to some brilliant marketing, like Monzo’s ‘movement-based’ approach to building a loyal fanbase, and to levels of tech-enabled service which have transformed customer expectations.

The banking revolution has been great for consumers. But in such an intensely competitive environment, costs of customer acquisition are high. And at the current stage of development, more growth actually tends to mean bigger losses. Which isn’t especially helpful.

And while the neobanks may not always be helping themselves, they are also having to contend with outside factors like regulation – the UK leads the global banking sector here too, which may be good news for consumers but less so for banking entrepreneurs. There are distinctly mixed messages from the Bank of England, which has been dishing out banking licences but (to quote the FT) “it has also introduced uniquely stringent regulations that banks say make it difficult for them to grow”.

In the UK, one such self-imposed barrier to growth is MREL, the BoE’s requirement for banks to raise loss-absorbing debt when assets reach just £15bn; in the Eurozone the threshold is much higher at €100bn, and in the US it’s $250bn. Another hurdle is ringfencing to protect against investment bank losses, which has hit larger market entrants like Santander. And of course, political uncertainty has made investment decision-making as difficult for banks as for any other growth business.

So can the challenger banks stand on their own feet and join the grown-ups? Only some of them, seems to be the answer – only the fittest will survive the coming cull. They will thrive – and continue to redefine the banking sector in ways that benefit the customer – only if the UK business environment shifts in their favour. As well as a more certain political future, that means lighter-touch regulation and continued investment in growth. And of course, a steady stream of inventive, motivated and confident entrepreneurs.


Originally appeared in Chartered Banker.

By Ian Henderson, CEO of AML Group.