Can Challenger Banks break the massive bank concentration in the UK?


The UK has one of the most concentrated/ consolidated banking markets in the world with the top 5 banks accounting for 85%market share.

By contrast, the big banks only account for about 44% in America and 25% in Germany.

The question is, does this level of concentration & consolidation make it harder or easier for challenger banks? This post seeks to find out which of these two theories is correct:

  • Theory 1: Big banks will remain dominant. Their size enables them to crush any attacker
  • Theory 2: The digital only challenger banks will win because the game has changed.

We segment the market into:

The Big 5 universal banks

The big traditional challengers

The new digital only challengers

The challenge from retail players

Current account innovators

Altfi Lenders moving into Deposits

SME Banks

Niche challengers

The Big 5 universal banks in their castles

Everybody knows them – a walk down any UK high street shows their dominance. These are the barons in their big castles, with huge moats populated with crocodiles and plenty of boiling oil to pour on attackers. They seem impregnable. Consumers may grumble, but maybe they will always need a big solid bank to fall back upon.

Approximately 27% market share goes to Lloyds and a further 18% each to Barclays and RBS with HSBC and Santander taking 12% and 10% respectively.

The other narrative goes like this –  the barons in their castles have lost the plot and suffer from bunker mentality and are “too big to manage”.  Their innovation teams report back from sponsored hackathons and innovation challenges to business units that then get back to business as usual. Their business reality is about managing dividend cover ratios, buybacks and stress tests, not delighting customers.

Investors also know these Big 5 very well. Apart from crashes around various crises, such as the Global Financial Crisis in 2008, the Eurozone Debt Crisis in 2011 and Brexit in 2016, their stock holds up as long as they keep paying high dividends and passing stress tests. There is no sign as yet of investors viewing the challengers as a serious threat.

The big traditional challengers

These are the landed gentry in their manor houses. They are minor compared to the Big 5 but 3 of them have meaningful market share, more than 1%:

  • Nationwide
  • TSB
  • Coop Bank

Virgin Money has the new brand, but is really Northern Rock under the skin. Clydesdale and Yorkshire are innovating with the B account, but this article in the Telegraph shows how hard it is to win over new customers.

They all seem like smaller versions of the big guys, which is not a game-changer.

In this category, Metro Bank is the one to watch. When Metro Bank opened for business in spring 2010, created by a US entrepreneur called Vernon Hill, it became Britain’s first new high street bank in over 150 years. It has retail branches – called stores – open 7 days a week and outside normal banking hours. The model was largely based on a similar venture created by Hill in the US, Commerce Bancorp (acquired by TD Bank in 2007), which gained the nickname of “McBank” as Hill applied his knowledge of the fast-food chain business to the bank. Metro Bank has also been a talent incubator; Metro Bank’s co-founder Anthony Thomson left in 2012 to set up rival Atom Bank.

During 2015 it looked like the game was turning to the challengers as per this report from KPMG:

“Britain’s challenger banks outperformed the Big Five lenders by notching up an 18% hike in profits in 2015, but new research warned the “tide is turning” in a tougher year for smaller players.

Total pre-tax profits for so-called challenger banks – such as – rose by £194 million to £1.28 billion in 2015, while the Big Five were left nursing a combined profits drop of £5.6 billion.”

The new digital only challengers

These are the insurgent “neobanks” using ladders & tunnel & battering rams to break into the mighty castles.

In 2013, the Bank of England created a simplified two-step process with lower capital requirements, in order to introduce more competition.

The digital challenger strategy is mostly to appeal to mainstream but younger consumers – the Millennial strategy.

We sorted these challengers by amount raised:

Bank Total ($m)
Atom 166
Starling 70
Tandem 35
Monzo 18

Atom’s last round was from BBVA which pioneered buying Fintech Neobanks with Simple. So we can expect a big challenge into the top 5 from “the other big Spanish bank in the UK”.

We see two distinct strategies. One is to build a new tech stack from scratch. The idea is to be able to offer a genuinely new service rather than a new UX on top of an old core banking system.

The other is to outsource the back end to proven banking software vendors. The idea is to focus on the UX layer, so that they can innovate faster. Most digital only banks adopt this approach; you see surprisingly Traditional Fintech below the hood.

Monzo is the biggest proponent of the DIY from scratch strategy.  The technology used is classic for a digital startup. It is mainly open source: Linux, Apache Cassandra, Golang and PostgreSQL relational database. There is a team of 16 people working on this.

The challenge from retailers

Asda, Tesco, Marks & Spencer and Sainsbury’s have all launched banks. The logic makes sense as they have brand recognition and physical high street coverage, yet without a major presence they don’t suffer from innovators dilemma.

Like all banks, they suffer from cyber attacks.

The Post Office also has the brand recognition and physical high street coverage.

These retail store challengers use traditional old school technology. Their advantage is simply being able to monetize their real estate in multiple ways – and that is a big deal.

Current account innovators

While most challenger banks focus on deposits and loans, which is highly regulated, many other ventures focus on the current account (checking account for American readers). This is a big area for innovation and there is no reason why in the digital realm a current account must be bundled with deposits and loans. The innovators we see in this category are:

  • Tide. Tide focusses on SMEs. They offer a fully featured current account and business MasterCard, plus SME-oriented finance apps, accounting capabilities and and online community.
  • Think money. They also offer MasterCard as part of their current account. They differentiate via tools to help  customers manage cash flow (ego tracking incoming like salary, benefits, pension so that there is enough pay all the regular bills. Once the bills are taken care of, the rest of the money is moved over to the customer’s “card account” for discretionary spending.
  • Soldo. They also offer prepaid debit card (MasterCard) and a mobile app. They focus on family spending, budgets and cash flow. The company says it does not intend to compete with banks, but will rather complement their services. It plans to seek formal partnerships with banks and co-branded arrangements. Soldo holds an electronic money licence and is regulated by the FCA.
  • Loot. Loot is a  mobile banking service aimed at students or what it calls “generation Snapchat”. They also offer a prepaid Mastercard account. The card is linked to a money management app that lets people track their spending and gives them insight into where their money is going.
  • Pockit. They also offer a prepaid MasterCard and focus on the underbanked, who rely on cash in the absence of bank accounts.  Pocket says it takes two minutes to open an account – without any credit checks.
  • Ffrees. It offers a no-frills account (and a debit card) and does not carry out credit checks. Ffrees describes itself as an “Unbank”, with their November 2016 launch of their new U Account. They claim to have opened 10,000 accounts in 3 months from a young demographic. We covered them in their earlier incarnation here.
  • Lintel Bank. They do position as a full service bank and are still waiting for a licence. They focus on migrant workers and students via prepaid current accounts, money transfers, personal and SME loans, and mortgages.

AltFi Lenders moving into Deposits

Our thesis at Daily Fintech is that the P2P Lending is the new Deposit Account. As an investor, you put in more work, take a bit more risk (less if you put in the work) and get a much higher return than you would from a deposit account. This is still only for early adopters – such as Hector Nunez who we profiled here – so there is still a lot of room for intermediaries to package it up for consumers in a way that is easily accessible.

Funding Circle raising $100m signals that P2P Lending is alive and well.

Zopa, which claims to be the world’s first P2P Lender is taking this thesis to a logical conclusion by applying to become a bank. This gives them a big interest rate arbitrage opportunity. They can borrow via deposit accounts from investors and lend via overdraft alternatives, while laying off most of the balance sheet risk to the market. This will be worth watching.

Other AltFi Lenders moving into Deposits include:

  • Together Money. This was created by Jerrold Holdings Group, which unites Auction Finance, Blemain Finance, Cheshire Mortgage Corporation and Lancashire Mortgage Corporation.Their focus is on residential and commercial mortgage loans to niche market segments underserved by mainstream lenders. They have applied for a banking license.
  • Paragon Bank. This banking subsidiary of a well-established specialist finance provider, Paragon Group, was launched in early 2014.
  • OneSavings Bank. This is a rollup and rebranding of a number of financial services businesses owned by US-based private equity firm JC Flowers. Constituent companies include Kent Reliance (residential mortgages and savings products), Interbay Commercial (commercial mortgages), Prestige Finance (secured loans), Reliance Property Loans (property financing) and Heritable Partners (development finance).
  • Masthaven. This mortgage specialist recently received a banking licence.
  • Coombs Bank. They are still waiting for a licence (site is “coming soon”. It is backed by S&U plc, a provider of consumer credit and motor finance created by Derek Coombs.

SME Banks

Our thesis at Daily Fintech is that SMEs have been like the middle child – neither Consumer nor Enterprise, so Banks did not serve them well. This leaves a big window for new ventures such as:

  • Shawbrook Bank. Formed in 2011 via the merger of Whiteaway Laidlaw Bank, Link Loans and Commercial First, Shawbrook is a publicly traded specialist lending and savings bank that focuses primarily on SMEs. You could also put them in the Altfi moving into Deposits category.
  • OakNorth. They focus on the needs of high growth ventures.
  • Hampshire Trust Bank. They were founded in 1977, but moved into the banking space in 2014, following the arrival of new owners.
  • British Business Bank. This government entity is active in encouraging lending to UK SME and has done a lot for P2P Lending.
  • CivilisedBank. They go to the SME rather than asking the SME to go to them (as they don’t have any branches). A network of local bankers working in their local communities come iPad equipped to your office. CivilisedBank hopes that this differentiated strategy will lead to a lower Customer Acquisition Costs than either retail branches or hoping for automated inbound conversion.
  • Aldermore. The company was founded in 2009 with backing from private equity company, Anacap, and did an IPO in March 2015.
  • Wyelands Bank. They were previously known as Tungsten Bank and before that as FIBI Bank. This is an example of buy & repurpose rather than build. Instead of building a bank and applying for a new license, you buy an existing bank and change it to suit your needs. The site is in coming soon status. The investor behind Wyelands Bank is Sanjeev Gupta and at the time of the acquisition from Tungsten, the planned focus was to provide funding to supply chain and trade financing firms (i.e. similar to Tungsten focus).

Niche challengers

  • Hampden & Co claims to be the first private bank to launch in the UK in the last 30 years.
  • Templewood Bank wants to be a new independent merchant bank (awaiting a banking licence).
  • Lintel Bank targets migrant workers and students (awaiting a banking licence).
  • Monese targets expatriates and immigrants. It is also in the current account innovators category, claiming a 3 minute mobile account opening and a simple a monthly charge of £4.95.
  • Monizo targets freelancers. They clain to offer real-time insight into how much tax freelancers need to pay (which is critical to financial planning for freelancers).

Daily Fintech analysis.

The two theories are:

Theory 1: Big banks will remain dominant. Their size enables them to crush any attacker

Theory 2: The digital only challenger banks will win because the game has changed.

We incline to Theory 2, but with a twist.  Consumers know they lack for choice and they lack engagement with the big banks. The traditional analog scale of the Big 5 does not help them win the digital scale game – which is about UX and network effects. Their scale makes them slow and hard to manage.

So the Big 5 are ripe for disruption by smaller and more agile competitors, but not by the current challengers. 

Our analysis is that the challenger banks will be acquired by non-bank players and new foreign entrants. They will have the deep pockets and balance sheet to enable them to win. The challenger banks will find it hard to compete as standalone entities, but via the M&A route they will be a success for investors and founders.

What could trigger a tipping point?

For all this Cambrian explosion of activity described above, all these ventures together are still a rounding error compared to the Big 5.

Most of the ventures profiled are quite happy with a small piece of the pie, as it is such a large pie. However, a tipping point matters because it is about Customer Acquisition Cost (CAC). Despite the oft repeated data about how much Millennials distrust traditional banks, it still costs a lot of money to persuade them to part with hard-earned money.

There is no magic silver bullet functionally. Everybody offers a frictionless mobile UX with personalization based on big data. That is the price of entry.

The trigger will be another catastrophic event like the Global Financial Crisis of 2008. As catastrophic event usually don’t follow the last one, the next one will be something new; the best guess currently is some form of mass cyber attack.

N26 and the German small banks

The digital challenger bank to watch in Europe is N26, from Berlin.

The German banking market is much less consolidated or concentrated than the UK.

The Grossbanken – Deutsche Bank, Commerzbank & HypoVereinsbank – mostly focus on Corporate banking and are publicly traded. Then there are about 500 independent, local “Sparkassen” or “savings banks”, with a market share around 50%. There are also about 1,450 independent, local  “Volksbanken” or “Raiffeisenbanken” (translation = Cooperative Bank) with a market share of 25%.

Yes, in Germany about 75% is from small banks, which is almost a mirror image of the UK.

The question is, does this make it harder or easier for N26?

These tiny banks must rely on outside firms for technology. The Daily Fintech prediction is that at least one digital challenger bank will switch from B2C to B2B or B2B2C and offer their capability via these locally dominant small banks. That company can come from anywhere. So our take is the N26 will have a hard time competing against lots of small local banks partnering with new neobanks that pivot to B2B or B2B2C.

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