The digital banking revolution - will digital banks save the mainstream bank?

More than £1.7 billion is now transferred each week using mobile phones or tablets at the major UK banks. Consumers’ demands of their bank are changing at an increasing rate as internet and mobile banking enable them to access banking when and how it suits their lives.

• Halifax has just reported a 100% increase in the number of logins via mobile over the last 12 months, with the total number of logins hitting 40 million.
• Towards the end of last year RBS announced a 30% reduction in branch footfall, as use of internet banking surged 232%.
• Lloyds Bank’s app has been downloaded more than 7.2 million times and at peak times it is being used some 138 times per second.

These are just some examples from a growing number of evidence-based statements made by leading banking brands in recent months. So, realistically, who has the appetite to visit a bank branch these days?

Years ago, the banking sector faced a similar crisis; how to counter the emergence of the non-branch based banking, and compete with the first mover in First Direct, as phone–banking was the order the day. Then, as now (as RBS knows to its cost), the cost and effort associated with modifying existing bank legacy systems was so large that no-one dared commission such a risky project.

Back then a number of new start brands, such as Egg, If, Cahoot and Smile, were created to service the new proposition, tempt customers from other banks and, for the banks, facilitate a swift and safe launch. 

These businesses were able to deploy new technology and operate virtually autonomously from the parent’s systems and infrastructure. Apart from some initial challenges, as most failed to estimate the number of internet users that wanted to open and access accounts, the businesses worked well and gained reasonable customer adoption. But only until such time as their parent worked out how to bring phone banking back into the core brand and slowly, but surely, a number of the new brands first closed to new customers and then started to migrate customers back to the parent. 

Fast forward 10 years and we’re here again. This time though, it’s a different delivery channel that is causing the banks’ frustration; the internet and digital banking. The situation is further complicated by new start ‘traditional’ banks such as Metro Bank and Virgin Money disrupting the service proposition and others focusing on specific niches, such as Aldermore on business banking.

Following the plethora of failed new start bank attempts a number of years ago, the relaxation of rules by the PRA/FCA has given rise to a number of specialist banks with others, such as Paragon and S&U having declared intent to become licenced, though perhaps it’s the prospective digital banks such as Atom and Starling that will cause the most excitement. 

With the ability to leverage a completely new infrastructure which is fully digitally enabled from day one and with no legacy of compliance headaches and / or costly branches, they present a viable threat to the mainstream banks.

The fixed cost for launching a digital bank is reasonably high as the whole process needs to be driven by robust, scalable technology, though the marginal cost for serving a new customer is incredibly low. Beyond the initial investment, so long as the businesses can recruit more customers, they should be able to get to profitability reasonably swiftly.

Recruiting these customers won’t be easy of course, but the cost and risk associated with migrating a core banking system to a digital platform is too difficult for most existing banks to contemplate. They need to find a way though, especially as according to KPMG’s Banking Industry Outlook Survey late last year, a third of bank executives believe upgrading and simplifying core technology platforms is the single most important IT investment to improve customer experience.

Arguably it is this conundrum that has brought about the legacy issues that banks currently have with their existing platforms and which leaves them vulnerable to the new entrants. 

So, what will the future look like for the new digital banks? Nostrum's view is that they will shine bright for a number of years and attract an increasing customer base that is tech savvy and is perhaps willing to pay for an improved service. Ultimately though, they will need to get scale or niche and as mainstream banks manage to sort their propositions out, I’d suggest that the future will involve the mainstream banks acquiring the digital banks (or even doing white label JVs with them) and slowly migrating their customers across to the new platform, ultimately being able to decommission their legacy systems. 

In some ways the new start competitors could end up being a lifeboat for the mainstream.