It’s only in the past decade or so that challenger banks have steadily risen to prominence, responding to shifting consumer demand and the digital revolution.

While this new wave of innovation in banking presents an exciting time for consumers, the classification of such businesses remains a widely misunderstood concept for many. So, what are challenger banks and why are they becoming increasingly appealing for the consumers of today?

A new breed of banking

A universal definition of challenger banks hasn’t been provided by the industry. In simple terms, however, it refers to new banks looking to compete with those that have an established physical presence in the retail banking market. Specifically describing the UK banking landscape, PwC1 believes that they can be broken down into four distinct groups:

  • Mid-sized full-service banks: generally banks with well-known brands, with a physical presence as part of a blended model.
    Examples: Co-operative Bank, CYGB, TSB
  • Specialist banks: provide specialist and niche lending services (e.g. for small- and medium-sized enterprises). Limited physical presence, using the likes of third-party distribution and digital channels.
    Examples: Aldermore, Secure Trust, Shawbrook
  • Non-bank brands: linked to parent companies with strong brands in other industries (e.g. major supermarket chains). Generally focused on digital channels with a limited physical presence.
    Examples: Tesco Bank, Sainsbury’s Bank, Virgin Money
  • Digital-only banks: start-ups with a small, but growing scale aimed at catering to the tech-savvy and digital converts. No physical presence.
    Examples: Monzo, Revolut, Starling Bank

It’s the last group that is arguably the fastest-growing – and most disruptive – segment of the banking industry and warrants further discussion.

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What do digital-only banks offer?

In today’s digital age, such banks have the benefit of creating their products from scratch without the legacy issues experienced by many traditional banks, and can therefore create a highly personalised service. Also, many recognise the need for a more open ecosystem, primarily through partnerships, to provide their customers with access to best-in-class products, while generating additional revenue for themselves. A further differentiator lies in its approach towards transparency, with banks such as Monzo publishing its total number of customers on their website, along with future development plans.

Gaining traction worldwide

While the UK digital banking market has noticeably grown in recent times, online-only challenger banks have gained traction elsewhere in Europe too. This includes German-based firms N26, which is looking to potentially expand in the US2, and Fidor Bank, with the latter actively partnering with fintech businesses. Italian-based Fineco Bank offers its customers current accounts in multiple currencies, and recently announced the expansion of its global platform for UK-based clients3.

Meanwhile, firms in China are leveraging their stronghold in technology, with the likes of established tech companies Tencent Holdings and Alibaba (with its affiliate firm, Ant Financial) both launching challenger banks – WeBank4 and MYbank5 – in 2015.

Source: Beyond North Star Gazing, Accenture 2018

The US will likely see the launch of more challenger banks in the coming years, especially since the US Office for the Comptroller of the Currency opened up national bank charters to fintech firms in 2018. Interestingly, multi-national tech companies such as Amazon are also looking at broadening their offering to include banking6.

Lastly, the launch of banQi in June 2019 by Boston-based startup Airfox marks the first (and only) mobile-only bank in Brazil7, and illustrates the growing reach of fintech to markets, which currently do not have access to traditional banking services.

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What obstacles do challenger banks face?

While such firms offer attractive solutions for customers in a world where we are becoming more reliant on tech innovation, digital challenger banks face a number of hurdles. The main one centres around the high level of competition from established banks, with many customers more inclined to stick with who they know, rather than being open to change. Secondly, trust and security remain at the forefront of most customers’ minds, especially after cybersecurity breaches experienced by established banks. Thirdly, stringent regulatory requirements over how much capital can be held against certain assets may have implications on growth prospects.

Huge potential in an increasingly digital world

Digital challenger banks are likely to continue their upward growth trajectory, with such firms simplifying banking for today’s consumers and being nimble enough to adapt to new technology.

In the short term, newcomers are more likely to focus on less competitive – and less capital intensive – areas to begin with (currency transfers have been a popular target market of choice), and broadening their offering over time. Collaborating with established financial players or other challengers could be key to unlocking their full growth potential.

For established retail banks, investing more in their own technology will be crucial in order to overcome legacy IT issues and deliver digitally-friendly solutions for their customers, to keep pace with the digital transformation and these digital disruptors.

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1 Who are you calling a ‘challenger’?, PwC 2017
2 Kahl Stephan, Peter Thiel and Li Ka-shing Have a Banking App for America’s Generation Z, Bloomberg, 1 April 2019
3 Fineco Bank expands multi-currency platform for UK clients, International Investment, 22 May 2019
4 Wildau, Gabriel, Tencent launches China’s first online-only bank, Financial Times, 5 January 2015
5 Wildau, Gabriel, Alibaba finance arm launches online bank, Financial Times, 25 June 2015
6 Shevlin, Ron, An Amazon Checking Account Could Displace $100 Billion in Bank Deposits (But It Won’t), Forbes, 21 January 2019
7 Mello, Gabriella, Brazil retailer Via Varejo launches digital bank targeting low-income clients, Reuters, 5 June 2019