The short answer is yes…. sometimes to both. However, there is a huge change underway and enough evidence to suggest that customer and competitive pressure alone will drive more change, even without further regulatory updates.

Globally, and in the UK, margins in the lending market are feeling the pressure. Slow credit growth (currently at 2.5% in the UK), and low interest rates are the primary drivers. This has fuelled competition, especially for lending products with higher margins, such as mortgages.

Established banks are choosing to deal with this problem by being far more aggressive in retention efforts and attempting to steal their competition’s customers. None of this is surprising, in fact some are doing a very good job at differentiating on service and personalised offers.

Following the financial crisis, some customers seeking loans looked to challenger brands as a vital source of cash. This included the growth of a range of alternative funding, such as crowdfunding and peer-to-peer lending with brands like Zopa and Funding Circle. More recently, in August 2018 Starling in the UK launched its first personal loan products, with Monzo announcing their full loan offering a year later. Also, in 2018, Atom bank launched first time buyer mortgages and has since expanded its product offering. A number of challengers have also moved into small business banking usually covering secured and unsecured lending up to £250k. These companies are already succeeding by providing slicker technology, often cheaper rates or lower fees.

The newer challengers are clearly focused on delivering a different experience and seeking to target low risk customers who are more reliable in terms of repayment. The most recent current account switching data in the UK showed that whilst the largest net gain went to Nationwide, the second largest was to challenger bank Monzo. So, how are the new fintech organisations succeeding in differentiating?

On trust, newer brands are seeking to differentiate by the very fact they have not been associated with issues in the past such as poor lending practices. They are also differentiating in the way they use technology to help customers. A great example of this is 86 400, a new bank in Australia that sends a push reminder to customers of how close they are to getting their bonus saver rate by depositing or saving a certain amount that month. This is not something you would typically expect from a financial organisation, but this behaviour is becoming expected.

The larger banks are taking action to improve both in terms of digitisation and branding/market positioning. For example, NatWest has launched brands such as Bó and Mettle which are built on a new more modern technology stack, to enable the same service as the challengers and aim to appeal to the same at-risk customer base. Setting up a new brand means they avoid the constraints of their existing systems and can develop innovative technology in the same way a nimble start-up would. All while having the security of being connected to a long-standing organisation that can provide vital resources.  

The real threat will come from the impending generational wealth movement. A majority of new loans will soon be offered mainly to people who are now in the 20-30 year-old range. If they can access a mortgage through a challenger, they will do so because they will favour these brands and the expected trust advantage is either not there anymore or needs to be regained.  

Challenger banks lent a record £115bn in the 12 months to September 2019, according to BDO. However, this was just 3 percent more than a year earlier, a significant fall from 19 percent, the previous growth rate. Much of this will have been linked to lower levels of lending with Brexit uncertainty, so you would expect this to recover.

The main barrier that will hold back the challenger brands in lending is their relatively small balance sheets. But there is no shortage of money looking for a return and if they can find an appropriate backer or partner who is willing to fund the money to support, there is nothing stopping them from taking the charge.

Ultimately the future of lending will continue to come down to a battle of two key differentiators: ‘time to yes’ and the overall customer service experience (including the service post-lending). If customers don’t perceive a difference, their choice will ultimately go back to the very basic criteria of price and any limited product differences.

Challenger banks have already had a big impact on how technology is being used, and in some cases how service is being provided. As they scale, and as the existing banks make improvements, lending will become the new battleground, if it is not already…