Following guidance from regulators, banks need to ensure that their operational resilience planning continues to have focus and energy throughout 2020. Chris Laverty spotlights how this can benefit challenger banks in key areas for the sector such as customer growth, access to capital and cyber security.
Operational resilience is about how institutions address, recover and rebuild if a disruptive event happens. Policy clarifications were issued in December 2019 by the Bank of England, PRA and FCA which detail what is required by all financial services firms. In brief, banks are required to ‘map’ every process that supports the provision of a product or service to a client, identify potential failure points in each process and allocate ‘tolerances’ for each of these.
Suitable mitigations and recovery strategies must be put in place. Challenger banks need to consider which critical services are supported by third-party suppliers and ensure that these suppliers are also prepared for any failures. Regulators require a specific focus on the consumer and the end-to-end customer experience.
This is no mean feat, but in doing so challenger banks put themselves in the best position to succeed. Investing in operational resilience is more than a box-ticking exercise. It can ultimately drive value by streamlining processes and improving the consumer experience.
Operational resilience supports customer growth for challenger banks
Regulators require a strong focus on customer outcomes. This is particularly pertinent for challenger banks, for whom it is crucial to build not only customer numbers, but also customer loyalty if they are to compete with traditional banks.
Although customer figures for the challengers look encouraging, most people are still not using them for their salary or mortgage payments, but as an alternative for everyday budgeting and easy peer-to-peer transfers. Research produced by Ogury1 shows that 80% of Monzo’s customers have other banking apps – mostly with the traditional banks. This trend will not be unique to Monzo.
There has also been a concerning rise in customer complaints relating to challenger banks. Complaints to the FCA about Metro Bank rose 62% between H1 2017 and H1 2019. Resolver, an independent online complaints resolution service reported in January 2020 that it had received more than 700 complaints in just over a year relating to Monzo – the majority coming in the past six months.
These figures show it is notoriously hard for challenger banks to build up the kind of systems that are needed to properly manage millions of accounts. This is exactly what a focus on operational resilience is trying to achieve. For challengers to move into profitability, they need to convince their customer base to exclusively use their services, a conundrum when their very existence relies on it being easy for the customer to switch between banking apps. A failure could seriously affect reputation and brand. The focus on the end-to-end consumer experience required by operational resilience can only help in the race for customer growth.
Maintaining access to capital for challenger banks
With most of the challenger banks still making a loss, access to capital is vital to their survival. Challengers have evolved in an era of high liquidity and growth in the economy. So far, they have been able to fund themselves by accessing the capital markets, but what happens if they are unable to complete a funding round? Would an acquisition by a larger incumbent bank be possible? Increasingly, that looks unlikely as many banks are developing digital partnerships of their own (for example Bó by RBS). The valuations that challengers are commanding also make an acquisition seem unlikely. Revolute’s latest funding round in February 2020 valued the loss-making company at $5.5 billion.
With increased regulatory focus, we believe that operational resilience will become part of any due diligence process, and will be a powerful tool in preparing for a capital markets transaction. By having robust, documented procedures in place, challenger banks will be best placed to gain the trust and confidence of potential investors.
Operational resilience and cyber security
Cyber security is crucial for every bank, however operational resilience requirements mean entities need to look at cyber security through a slightly different lens. For example, if after an outage most technology elements of a business could be restored quickly except for one service line, that could be viewed as delivering close to business as usual. But if that line is a critical service for a customer, it now needs to be prioritised over restoring non-critical services. This may sometimes lead to conflicting priorities, but in the long run, it helps to protect consumers from financial harm and can do more to reduce reputational damage.
The regulators have stated that firms must be prepared for any failure at third-party suppliers. Recent events at Travelex demonstrate how third-party failure can severely impact a bank’s ability to service their own customers. The currency provider suffered a cyber attack on December 31 2019. More than two months later, RBS, Lloyds, Barclays and Sainsbury’s Bank were still unable to offer online currency services2.
Going forward, regulators will no longer accept the argument that it was a third party's fault if a customer is prevented from accessing one of your products. Challenger banks must ensure that they have undertaken due diligence with third-party suppliers and put mitigants and processes in place to ensure their end customers do not suffer this type of disruption.
Growing challenger banks' market share
Challenger banks face a constantly changing competitive landscape. The incumbent banks will keep fighting back with investments in technology and many believe it will only be a matter of time before GAFA (Google, Apple, Facebook, Amazon) enter the banking market.
There is no doubt that the older, more traditional banks with their legacy systems will have a greater hurdle to overcome to ensure compliance with operational resilience requirements. Herein lies an opportunity for the challengers. If they can get this right, and in a timely fashion, they will put themselves in the best possible position to gain valuable market share.
For more information and advice, contact Chris Laverty, Head of our Financial Services Restructuring team.