Community
Kanika Hope, Chief Strategy Officer at Temenos
Challenger banks have been a growth story in banking in the last decade. Today there are ~450 challenger banks globally worth $300B in 2022 compared to 100 in 2017 worth 161B.
However only 5% of non bank-owned challengers are profitable. Despite low operational costs, the average cost income ratio of challengers is 130% compared to 62% for incumbents.
Profitable challengers are generally platform or telco owned, mostly in Asia. There are few exceptions in the rest of the world - independent profitable challengers include Greendot in the US, Nubank in Brazil, Bunq and Tinkoff in Europe and a good handful in the UK (Starling, Revolut, OakNorth, Redwood and Zopa). Interestingly, all of these acquired a banking license on their growth trajectory.
Profitability – Why not?
1. Banking license: Obtaining a banking license is so expensive and time-consuming to obtain that only a handful of challengers have been able to. This is because otherwise, they have to rely on expensive wholesale debt or private funding in order to diversify and grow. A license provides the deposits to originate loans and hence raise NIM. In the US, where challengers are reliant on BaaS partnerships and where 70% of their revenues come from debit interchange fees due to the Durbin exception, a license allows for revenue diversification beyond the debit interchange fee model.
2. Customer base: By their very nature, the customers that challengers have spent so much money to acquire are also less credit worthy and less profitable. They tend to be either underserved or unserved segments and hence financially struggling or younger demographics who are several decades away from the banking revenue peak. Typically, the average challenger bank age bracket is 20-30 years which is 40 years away from the revenue peak of 60-70 years. Also, despite rapid growth, most independent challengers remain sub-scale when compared to incumbents or the platform giants in an industry with significant margin pressures.
3. Primary relationship: Only a handful of challenger banks’ customers are true transacting customers where their primary relationship is with the challenger. 70% of accounts with challenger banks are not used on a monthly basis. Only 23% of 7.8M customers at the US challenger bank, Dave are active. These customers with low activity and low blended balances (only 5-7% those of incumbents) are difficult to cross-sell additional products to (lending, wealth, credit cards). Acquiring customers without a rise in transactional volumes is hurting these banks.
4. Incumbent advantage: Through the rise of the challengers, incumbents have continued to hold the primary relationship with clients and have been able to meet the holistic needs of their customers across a broad product portfolio, dominating profitable products such as lending where challengers typically struggle – they lack the skills for risk-based data driven loan underwriting and servicing and pricing scenario stress tests, and typically have above average charge off rates compared to incumbents. Above all, regulation-native business models and culture have proved to be formidable strengths. Challengers continue to lag incumbents in risk and compliance, KYC and onboarding. A review by the UK’s Financial Conduct Authority has found that challenger banks need to improve how they assess financial crime risk, with some failing to adequately check their customers’ income and occupation. In some instances, challenger banks did not have financial crime risk assessments in place for their customers.
The climate has changed for fintechs and challengers this year. They are entering unchartered territory in a rising interest rate and recessionary environment with tightening funding and incumbent fightback. I will dive into this more in the next post: A turning tide for challenger banks?
This content is provided by an external author without editing by Finextra. It expresses the views and opinions of the author.
Boris Bialek Vice President and Field CTO, Industry Solutions at MongoDB
11 December
Kathiravan Rajendran Associate Director of Marketing Operations at Macro Global
10 December
Barley Laing UK Managing Director at Melissa
Scott Dawson CEO at DECTA
Welcome to Finextra. We use cookies to help us to deliver our services. You may change your preferences at our Cookie Centre.
Please read our Privacy Policy.