Challenges for Challenger Banks

News the Australian retailer Coles have moved further ahead with plans to expand financial services, first revealed by BlueNotes editor Andrew Cornell last year, comes just as UK retailer Tesco is about to formally become a bank.

Tesco Bank will offer a current or transaction account in the United Kingdom in what will be the latest example of the entry by the so-called 'Challenger Banks' into the provision of financial services, in direct competition to the 'Traditional' banks. 

Tesco Bank will target its existing seven million customers plus Tesco’s regular shoppers who are members of its Clubcard loyalty rewards scheme. The online transaction account will reward users with Clubcard points. 

For these challenger banks, the transaction account has become a key focus in winning market share. The theory is it is easier to market mortgages, savings accounts, personal loans and credit cards to customers if they already have a transaction account relationship with their retail financial services provider. 

The Australian market is very similar to the UK market in this respect, with four big banks who currently dominate the transaction account market (in the UK the Big Four hold around 38 million of the 50 million existing transaction accounts) and there are challengers who are seeking to break into this market, such as retailers (Coles); mutuals (Credit Unions and Building Societies) and challenger brands such as Virgin Money, all of whom have growth aspirations. 

However all of these Challengers themselves face huge challenges in getting customers to switch their banking transaction accounts to a new provider. 

There are lessons from the UK experience in this. Tesco, for example, has invested heavily in technology infrastructure since taking full control of its personal finance joint venture from former partner Royal Bank of Scotland in 2008. 

The new Tesco Bank account can only be opened online and offers free banking to customers who deposit more than 750 Pounds a month (there will be a 5 pound monthly fee for those who do not). 

The account has a contactless Visa debit card, the spending on which will earn Clubcard points wherever it is used with the ability to make deposits into the account at over 300 Tesco stores. The account pays annual interest of 3 per cent, well above the average for a transaction account. 

Tesco Bank already offers term savings accounts, personal loans, credit cards and mortgages and reported pre-tax profits of 15.3 million pounds in the year to the end of February 2014. 

The retailer concedes the new transaction account will be a slow burn and it may even negatively affect profit growth at the bank but the hope is an industry wide, seven day account switching service system, in place in the UK since September 2013, will encourage switching behaviour from banking customers, an activity which had previously been characterised by customer inertia. 

Another UK retailer to recently enter the transaction account market is Marks and Spencer whose M&S Bank launched a no-fee account in May 2014. To encourage 'switchers' it offers a 100 pounds M&S gift card, to those who switch from their current provider, by using the UK's current account switch service.

As explained in this BlueNotes story, this is a free service which guarantees all existing payments into and out of a transaction account will be transferred to a new account within seven working days. 

New M&S Bank account holders can also earn loyalty points by spending on their MasterCard debit card. Prior to the launch of the switching service, fewer than 3 per cent of transaction account holders switched provider in the year to September 2013, so expectations are high that switching in the UK will become more popular. 

Mutuals in the UK have also been aggressively chasing new customers via transaction accounts, led by the Nationwide Building Society. It already has a large share of mortgage lending and savings accounts, but is underweight in transaction accounts, so it too has been targeting 'switchers' and is reported to have gained just under half a million new accounts in the year to April 2014. 

Challenger banks from entrepreneurial backgrounds have also been active in gaining new customers. Virgin Money, which bought out Northern Rock from the UK Government at the start of 2012, now has more than 4 million existing customers and is rumoured to be launching its new transaction account by the end of 2014. 

However, Metro Bank, launched in 2000, exemplifies the challenge for the challenger banks to gain traction in the market for transaction accounts, as its total customer base was by April 2014 only 318,000, despite its strong emphasis on customer service - its 26 branches being open seven days a week, early and late hours, for 362 days of the year. 

So these are some of the questions that the Challengers’ experience in the UK pose for their Australian counterparts. Presumably they are the sorts of issues Coles’ task force is assessing. Is a transaction account really the vital building block for the retailing of financial service products, such as insurances and mortgages? 

Coles appears to believe so judging by Cornell’s story last year the retailer was investigating obtaining a licence from the Australian Prudential Regulation Authority to take deposits and recent news of the task force being sequestered away at head office. 

But can wholly online accounts offer both better rates/lower fees to customers and better returns to providers? And will Australian customers overcome their seeming inertia to switching their bank accounts? 

With the Financial System Inquiry due to produce its interim report on July 15th and with its Terms of Reference including, 'Recommending policy options that will promote a competitive and stable financial system that contributes to Australia’s productivity growth, as well as create an environment conductive to dynamic and innovative financial service providers', it will be interesting to see what, if any, encouragement is given to the Challenger Banks in Australia in their quest to provide more competition and deliver customer centric financial services to the Australian market.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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