Digital-first banks and fintech services may be bringing an ‘Uber moment’ to retail banking but new banking entrants are more than a few clicks away from toppling the incumbents.
Since 2010 more than 25 companies have either obtained banking permissions or are applying to operate in various parts of the retail banking market. These ‘new entrants’ comprise a range of institutions offering anything from the full suite of banking products through to start-ups offering a single product via a single distribution channel. In many cases they are entering the market without any existing customer base: Metro Bank being a good example.
The retail banking status quo is yet to be upset, with the 'Big Five' banks (RBS, Lloyds, HSBC, Santander and Barclays) holding more than 80% of current accounts. The growth in the number of new entrant banks into the market means that 2016 could be a watershed in the competitive landscape. Five new entrants launched in 2015 and a further four are expected to launch this year.
Customer experience and engagement are at the forefront of their thinking. The focus on digital and their strategy of targeting specific customer segments (for example, the SME market) means new entrants pose a growing threat to incumbent banks, especially those with an entrepreneurial customer-first approach ingrained into their culture. Monzo, Starling Bank and Atom Bank for example, have all emphasised their desire to break new ground in banking.
If customer service is driving strategy, the tool used for realising its potential is the advancement of fintech (financial technology), and specifically the importance of digital distribution channels. Out of 25 new entrants analysed by Grant Thornton, 85% are planning a predominantly online or mobile-only route to market.
Four challenges for new entrant banks
1. Ever-increasing cost of regulation
This puts pressure on return on capital and often forces entrants to employ higher-risk strategies than the Big Five banks. Indeed OneSavings CEO Andy Golding said recently that current regulations "force small banks to target higher-risk business, as it’s the only way we can compete on price".
2. Customer inertia on switching
Despite regulatory attempts to increase competition for banking, the 2015 figures released by Bacs Payment Schemes show that, while switching banks has never been easier, the amount of people who actually move between them is currently on average 80,000 per month. This has decreased from 95,000 per month in 2014. Therefore, the lethargy of the public at large could stifle competition. Either way, large-scale movement of current account holders between banks has yet to be seen, and this stifles the ability of new entrants to grow.
3. Operational and technical barriers to scaling up
New entrants will have to overcome the operational and technical implications associated with an increase in the scale of their operations, assuming they are able to increase their market share. One of the big advantages the new entrants have over incumbents is a low-cost operating model and agile responses to change, from which financial gains can be passed on to the customer. The challenge is therefore to keep these costs down even as their scale of operations increases.
4. Fightback against new competition
Incumbents may aggressively mount a defence of their market by leveraging current strengths to their advantage, as seen when Santander launched the 123 account. These counter-actions that incumbents take will continually shift the norms of banking practice, with a continuing need for the new entrants to have a voice and maintain a unique and differentiated position in the market, which customers recognise and support.
Moving through 2016 and beyond
Incumbent banks already have an advantage over the new entrants in terms of their investment capital, regulatory rating, distribution channels, and existing customer base, while their size gives them opportunities in investment capital.
However they also have legacy operating models, reputational damage and historic issues that may impede their progress and provide an opportunity for the new entrants to increase their market share.
Left unchecked, the new entrants’ focus on digital distribution channels and limited product offerings means they should continue to grow and potentially eat away at the market share of the larger banks. Indeed, our analysis shows that 50% of new entrant banks are targeting specific customer groups, 60% are offering only one or two product types, while 35% are focused on business banking services, most of which appear to be underserved by the incumbent banks.
Clearly, the new entrants are not competing on all aspects of banking. Aldermore is a good example of this, stating clearly on their website: "We deliver award-winning commercial finance, mortgages and savings to Britain’s small and medium-sized enterprises (SMEs), homeowners and savers." However the challenge will be to continually provide the best customer experience as the scale of their operation grows in an increasingly competitive environment.
While we do not believe the increased number of new entrant banks entering the market is going to radically alter the status quo in 2016, it should ensure that innovation and customer experience remain high on the agenda for retail banking.
Words: Neil Furnivall and Ben Coyne, Financial Services