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Bigger banks may have to set up their own 'challengers' to take on new entrants

22 May 2015  |  10428 views  |  8 London skyline - old Natwest tower and gherkin

The UK's established high street banks may have to set up greenfield operations free of legacy tech to take on the better-performing small challenger banks nipping at their heels, according to a report from KPMG.

KPMG's study, 'The Game Changers', analyses the full-year results of newer entrants to the UK's banking sector and finds that while challenger banks are outperforming the country's 'Big Five' banks, it is the smaller, more focussed entrants who are enjoying stellar returns.

For larger challengers, such as Metro and Virgin Money, key financial indicators, such as return on equity, are becoming very similar to the establishment.

Warren Mead, head of challenger banking and alternative finance at KPMG, says: “Financially, the large challengers are looking very similar to those of the traditional banks. To ensure they remain differentiated, they must review their brand, distribution, products, culture and customer service."

The greater threat appears to lie with smaller new entrants, which have much lower cost bases than their bigger compatriots.

“Small Challengers are securing high returns and have better cost optimisation," says Mead. "If this trend were to continue, as the challengers grow and benefit from economies of scale, it poses an interesting question for the Big Five as to whether too big to fail, becomes too big to compete?"

While they appear unable to match the technological prowess and big budgets of the UK's largest banks, KPMG's figures paint a picture of the challenger banks picking-up the whitespace left behind following the financial crisis. This includes areas such as small business lending, second charge mortgages, invoice financing and unsecured lending.

Mead says that the main point of difference between the new market entrants and old-line banks lies in their culture.

"Being largely free of the legacy problems of the past contributes to a sense of social purpose that puts fire in the bellies of their executives and frontline staff alike," he says. "Only time will tell whether the big banks will combat that fire with fire of their own. Creating a ‘bank within a bank’ - a new challenger brand free from legacy conduct, technology and culture - might be the best start.”

Comments: (8)

Denis Wicking
Denis Wicking - F C Consultants - Stowmarket | 22 May, 2015, 10:52 interesting model, but I don't think it is just about the technical or pure service delivery infrastructure that holds back the big banks. The balance between prudence and risk control is different and it is very difficult to shift those within a large corporation. Mini bank can do something wrong and will get a fine proportionate to its earnings; the mini brand of a mega corp would expect to be fined in proportion to mega corps earning, with all the associated media and governement attention. All the advice given to mega corp's directors would be that they cannot distance themselves far enough away. I have seen this cultural and regulatory uncertainty within non-bank offering payment services worldwide and it is a challnge to get some entrepreneurial umph to get the challenges into context.
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A Finextra member
A Finextra member | 22 May, 2015, 11:49

There is an other element to this: In small groups of people you can build up trust and give feedback far cheaper than in big, multilocation organisations.

this results in better and cheaper customer contacts and also in more effective risk management with less procedural mess.

So the lesson might be that for trustbased dealing the smaller organisations have an intrinsically better position.

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A Finextra member
A Finextra member | 22 May, 2015, 12:08

Maybe the larger players will look to acquire the challengers, rather than compete.

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A Finextra member
A Finextra member | 22 May, 2015, 13:17

The big banks have far more to worry about that the small banks that are grabbing a share of the market. The trend towards marketplace and peer-to-peer lending is on the rise. It's hard to believe that the p2p lending platforms like Zopa and the rest won't continue consuming market share.

As far as the small banks go, I agree with James, they are the little fish likely to get eaten by the big fish eventually.

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A Finextra member
A Finextra member | 23 May, 2015, 09:11

The big 5 have to stay central to the action what ever they decide to do, well positioned for inevitable buy outs.  Like the tech giants routinely do with start ups.  Whether big banks can be as agile as the likes of Amazon and Facebook is yet to be seen

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Arunangshu Dutta
Arunangshu Dutta - Standard Chartered Bank - Dhaka | 23 May, 2015, 11:58 It looks the big challengers may need to go for purely franchise style . Multi location branches will be responsible for each of their respective loss & profits under certain broad guidelines from the mothership .
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A Finextra member
A Finextra member | 26 May, 2015, 09:27

I do agree with Warren - all the major banks and FI's lack the infrastucture to build out digital propositions. Most are wedded to legacy mainframes that are expensive and were built in the 80's. /90's - where's the innovation? To build out digital you need a core platform that is capable of delivering applications and servicing data in an agile and elegant way. Its the likes of Metro who have scale and new technology that are stealing a march on the market, whilst everybody else talks about their digital strategies..#digitallending

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A Finextra member
A Finextra member | 26 May, 2015, 11:30

This is hardly a new thing.  Look at first direct (HSBC), egg (Prudential), smile (co-op)...even other industries...GO (BA), etc.  Even the big energy companies are spinning up "smaller" companies to compete for shale gas in the States.  My question is...are the challengers really that different, or better?  Virgin doesn't even offer a current account, so it can't really call itself a bank!

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