The world’s major banking institutions have had a tough time of late. In the aftermath of 2008’s financial crisis, there has been a concerted effort by politicians throughout the world to rein in the influence of the established banking sector. At the same time, public opinion of the industry has never been worse.
With regulators looking at increasing competition within the industry, and bigger banks trying to cope with the aftermath of the crisis, an opportunity has arisen for a wave of new entrants into the market. So-called challenger banks have emerged in recent years, with a number of innovative approaches to banking that are posing a serious threat to the established order.
Challenger banks can position themselves as champions of consumers and small enterprises, using cleaner reputations, greater transparency and innovative use of technology, to distinguish themselves
In the UK in particular, challenger banks like Metro Bank – which in 2010 was the first organisation in the country to get a new license in more than 100 years – have begun to offer alternatives to the traditional ‘big four’ banks of Barclays, Lloyds, HSBC and Royal Bank of Scotland. Since Metro’s launch, UK regulators have issued an additional six licenses to new banks. Other markets across the EU are also seeing an increase in new banks, eager to take advantage of the industry shake-up and regulatory changes to occur after the crisis of 2008.
Sage advice
According to John Harvie, Director at global consulting firm Protiviti, challenger banks have emerged because of a number of regulatory and technological changes in the industry in the years following the financial crisis. “Challenger banks have emerged in the years following the financial crisis, aspiring to capitalise on the rapid development and adoption of new technology by consumers, the removal of regulatory barriers and the efforts of government to increase competition.” He added that because of “years of scandals within well-established banks, the market and consumers may be more likely to shop around for new banks”.
However, while these banks may offer something new, it is unclear yet whether customers are willing to turn their backs on their existing banks. “It remains to be seen whether the disbelief and disillusion of consumers with established high street banks can be turned into customers for challenger banks”, said Harvie.
The way these new banks can position themselves is to be a genuine, consumer-friendly alternative to the established order. “Challenger banks have the opportunity to position themselves as the champions of consumers and small enterprises, using their cleaner reputations, greater transparency and innovative use of technology as a means of distinguishing themselves from the prevailing established banks.”
In order for these banks to compete successfully, they need to be clear about what part of the market they are targeting and be clear about the cost of their products, noted Harvie. “For challenger banks to effectively compete with the established players and build a strong customer base, they need to identify what segment of the banking value chain to target and look beyond products to the full customer experience.”
In order to entice customers away from the established providers, they need to ensure they offer both technological incentives and a service that is, at least on the face of it, more in-tune with customers’ needs than those of the bank. “The key to attracting customers revolves around making the true cost of the product transparent, incentivising consumers through improved service, delivered to the consumer in an easily consumed way, usually involving mobile technology, and being recognised to support consumers in managing their finances to their benefit rather than the bank’s. All while operating a low cost and agile business model”, noted Harvie.
Some of the things challenger banks could do to differentiate themselves from the rest of the market include targeting specific consumer segments, such as people with niche requirements for services. They can also target areas of the market that have, until now, been run inefficiently, such as money transfers and cross-border payments. Harvie cited M-Pesa as an organisation that is helping to reduce costs in the money transfer space, as well as Holvi, which is making it easier to make standardised payments across EU borders. He added that there is also considerable opportunity for cross-selling products to customers.
Considerable hurdles
While challenger banks are certainly making waves within the industry, Harvie believes it may still take some time before they pose a genuine threat to the established order. “It will take time for the emerging landscape of challenger banks to genuinely threaten the established market, but it is clear that this process has begun. If new competitors are able to deliver and demonstrate delivery of improved outcomes for consumers, then the process will undoubtedly accelerate. However, data available from the UK Competition and Markets Authority illustrates the scale of the challenge. Interim findings suggest a low level of customer engagement with today’s market”, he said.
According to the report, as much as 73 percent of customers in the UK have not looked to change banks in the last three years, while 81 percent haven’t tried to change in the last 12 months. Most seem to be generally satisfied with their banks, with 52 percent of respondents claiming to be very satisfied.
Nonetheless, there remain significant opportunities for new entrants in the banking market, not least through trying to offer a different service to traditional business models. “Traditional business models rely, to some extent, on profitability derived from those consumers that are overdrawn or fail to deal with high interest bearing credit. There is an in-built disincentive to act in the best interests of customers. Challenger banks have the opportunity to reinvent the business model, generating profits more transparently and being seen to be acting in their customers’ best interests”, Harvie explained.
Challenger banks have an advantage over their bigger rivals because of the relatively low cost base they can operate from, while also ensuring customer service is at the heart of the business. “The traditional banking business model has a branch-based architecture at its core. Each layer of subsequent innovation – call centres, ATMs, digital channels – has been tacked onto this underlying architecture, adding cost and complexity. Challenger banks have the opportunity to do away with this and place customers at the core.”
The empire strikes back
The dominance of the major banks is still likely to remain for the foreseeable future, with their considerable reach and infrastructure, as well as reticence from customers to go through the hassle of changing banks, helping to solidify their position. However, with concerns from many regulatory bodies that there is a lack of competition in the market, further opportunities for new entrants might well emerge. How the big banks respond to these new challenges will be key to their continued dominance. “There are clear indications that the pace of change is accelerating, and they would be wise to address their points of vulnerability and start establishing an approach to their customers that is more modern, customer-friendly and transparent”, advised Harvie.
He believes that one way bigger banks could face off these threats is by establishing ‘new banks’ within their existing operations. One leading provider, HSBC, has even announced plans to create a new high street bank that may be called Midland, after the British banking institution it previously purchased and subsequently closed down. One way or another, the banking landscape is set to change. It is in the hands of the old guard to adapt.