Long reads

Challengers: True threat or paper tiger?

Paige McNamee

Paige McNamee

Junior Reporter , Finextra

It seems that the challengers really are showing their teeth. A recent report by Deposit Solutions, research found that the UK’s largest retail banking brands’ stronghold across the savings market may be under threat. The research shows that up to 20% of British consumers are considering switching their savings account provider over the next 12 months.

This is of particular concern as the loss of a savings account is considered to potentially be the first step toward losing control over the entirety of the customer relationship. What’s more concerning is that 73% of Monzo, Starling and Revolut customers are satisfied with the savings account service provided by these newcomers, compared to a more pallid 59% of customers across the UK’s six biggest retail banks.

Looking at Asia in particular, what we have seen is Big Tech players launching financial products, services or challengers themselves. Interesting moves are also being made in regions such as Hong Kong, where more and more banking licenses are being granted – a must-watch space for sure.

Banks such as Volt Bank in Australia have the potential of reaching the heights of Monzo and Starling Bank. Volt was the first of four digital banks in Australia to attain a banking licence and while Steve Weston, CEO, cited Covid-19 as cause to postpone a planned 2020 IPO until 2021, Weston remains optimistic.

Learning lessons from the past

Challengers around the globe are learning from what European challengers did well, and where they fell short in order to form a perfect product. Because of the slight loss of trust in traditional banks following the financial crisis, the Southern Hemisphere has seen a push for competition.

Covid-19 has shown appetite increase for alternative financial products, with Brazil recently introducing open banking regulations and incumbents including Banco Santander showing active interest in nurturing growth in this sector.

Drew Graham, director, digital strategy, Barclays, adds: “The challenges are mostly financial, legal and cultural. Banking remains a capital-intensive business. The conversations around compliance and risk models have been framed by the incumbents which mean applying genuinely innovative solutions is a challenging conversation.

“Banks have spent a long time making profitable products which iterate minimally on the previously profitable products. It’s understandable, but merely throwing concepts like ‘innovation’ and ‘digital’ into the existing processes won’t lead to different outcomes.”

Are incumbent old dogs struggling to learn new tricks?

Tom Graham, managing director in banking at Accenture UK highlights that at present, the problem is that new players have started to change the banking model, while legacy players continue to focus on what worked in an older environment.

“Incumbents’ investments in digitisation have focused on improving efficiency and easy wins. On average, banks spent 8.7% of revenue on IT expenses, the highest allocation to IT of any industry, but digitisation is still relatively slow.

He notes that while banks spend around 70% of their IT budgets on traditional IT services (such as maintaining core legacy systems), they only spend about 30% on non-traditional solutions related to digital transformation, such as cloud or data analytics.

So far, what banks have spent on digitisation has not yielded substantial payback, either in cost improvement or revenue growth. That said, “many banks have used the first wave of digitisation to improve the customer experience and understand customer value, which will be fundamental to successful growth strategies. Additionally, several incumbents are investing in digital challenger banks in their own markets, such as Goldman Sachs’ Marcus.”

In a DBS report entitled ‘Creating shareholder value from digitalisation’, chief financial officer Chng Sok Hui pointed to how new digital customers generate a 27% return on equity for the bank, in comparison to the 18% return the bank gets from its traditional branch-based customers.

Furthermore, DBS makes S$1,300 (£722) of revenue from each individual digital customer – double what it makes from traditional customers. However, digital customers cost more in terms of acquisition and back office administrative expenses, S$478 for digital, but S$306 for traditional customers. However, DBS are a unique case.

These newcomers have gone on to take one-third of revenue growth in Europe and UK fintech continues to lead the charge in Europe, with $6.3 billion invested in the sector in 2019.

There are five different responses that banks can take to manage the digital threat: attack, acquire, partner, diversify and join – DBS’s plan of action being grouped into the first category. Other examples that present the competition element include Goldman Sachs’ launch of its consumer digital savings and lending platform Marcus.

Marcus, perfectly positioned to capitalise on the Covid-19 pandemic, has seen $80 billion in deposits across the US and UK since its 2016 launch with such roaring success that it had to shut off its Marcus savings accounts to new customers in the UK to avoid regulatory ‘ring-fencing’ restrictions.

Imitation isn’t risk-free

But should traditional banks mimic what these new players are doing? As reported by W.UP in an article entitled ‘Digital-only banks: Traditional players copy challengers’, while digital banks are promising no physical infrastructure with customer friendly services and low fees, the business model is far from perfect, or lucrative, for that matter – but high street banks and traditional lenders are taking a page out of their book.

Alex Bannister, director of strategic partnering at Nationwide Building Society observes: “One thing to be mindful of is a potential culture clash between the more traditional, risk averse incumbents and fintechs. However, as more collaboration occurs and the value cases are proven I’m sure that this will be overcome as is already happening at Nationwide.”

As Reuters reported back in 2017, challenger banks do not want to profit from lending to customers, but from allowing other firms to access them. Steering clear of loans, overdraft fees or high foreign exchange rates, which these newcomers see as ripping off customers, their initial intention was to make money from customer data.

New doesn’t always mean better

Could that work in 2020/2021? Following drama at Revolut and Wirecard, N26 also landed itself in hot water with the regulators over lax management practices.

N26 reported that it had tripled the number of staff in its customer complaints division during 2018-19 and will respond to other issues in consultation with regulatory authorities. Other high growth startups in the fintech space have been under intense scrutiny in recently for instance AML deficiencies and - in Revolut’s case - a toxic management culture.

At time of writing, Wirecard had succumbed to insolvency following the arrest of CEO Markus Braun on suspicion of false accounting and market manipulation. Just a week prior the German payments company admitted that €1.9bn of cash was indeed ‘missing’ and with lenders owed €2bn the company’s future is no longer certain.

With its parent company entering insolvency proceedings, the FCA temporarily imposed restrictions on Wirecard’s UK arm to cease all regulated activity and froze assets and funds. This halted the operations of approximately 100 UK fintech firms relying on the payment processer for operational support, with Curve, Anna Money, Pockitt, Soldo and Holvi among those affected.

When questioned about whether the Wirecard situation served to undermine trust in the UK’s fintech sector, Fox flipped the situation. He explained that the ring fencing seemed to have been effective and while the FCA’s decision to suspend operations had caused further disruption, the FCA fulfilled its role effectively. What’s more, “the speed at which the affected companies in the UK were able to bounce back and adapt is an absolute testament to their agility and the strength of the UK regulators.”

This is a featured chapter taken from Finextra’s Future of Fintech report. For more in-depth coverage of the state of fintech, you can download the complete Future of Fintech report here.

Image credit: Devie Mohan, Burnmark

Comments: (2)

Melvin Haskins
Melvin Haskins - Haston International Limited - 15 October, 2020, 11:381 like 1 like

What people say and what people actually do are usually very different. Just because 20% of the poeple who answer a survey say that they are thinking about changing banks, in reality very few do. In addition, there is no mention of the size and demographics of the survey. So my vote is paper tiger.

Taher Tharani
Taher Tharani - Alpha Omega Project Management Ltd - London 18 October, 2020, 20:42Be the first to give this comment the thumbs up 0 likes

GenZ is and will continue to play a significant influencing factor - loyalty is no longer implied, bif is not always seen to be better. Challengers provide alignment with cultural identity which legacies often struggle with. Also, challengers - the smart ones - have the flexibility and energy to adapt and innovate swiftly.