27 Feb 2019
In 2015 I wrote a chapter for a textbook entitled “Challenger banks! Are they for real?” The book questioned, in a UK context, whether new entrants into the banking market could really disrupt the status quo.
The Australian and UK banking markets have many similarities. Both are dominated by a ‘Big Four’ of incumbent banks whose presence was and maybe still is a challenge for those seeking major disruption.
"So where are all these so-called challenger banks now?”
In the UK, the Big Four are Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland (RBS). Collectively they hold over 70 per cent of the cheque/current accounts, mortgages and SME lending business. In 2015 their ’challengers’ were Virgin Money, Tesco Bank and Metro Bank.
The Virgin Group was a ‘disrupter’ brand, it aimed when it emerged in the mid-90s to be a ‘rebel’ and bring simplicity to the UK banking market. Virgin came to Australia in 2003 and, after several previous partnerships, it was subsequently taken over by the Bank of Queensland in 2013.
Tesco Bank also had its origins in the mid-90s and then after being in a joint venture with RBS, it became a wholly owned subsidiary of the retailer Tesco PLC in 2009. By 2013 it had 6.5 million customers and was offering savings, credit cards, personal loans, mortgages and general insurance products.
In the Australian market, both Coles and Woolworths sought to emulate Tesco by moving into the provision of a range of financial services products, some of which are provided by third parties, but marketed under the retailer’s brand.
Metro Bank was the first new UK ‘High Street’ bank in over 100 years, when it was launched in 2010, having been granted a license by the UK regulator, as part of the drive to introduce new competitors into the UK market.
Metro Bank promised to revolutionise the retail banking market by opening new ‘High Street’ branches, under banners such as ‘Open Longer, Every Day’. It initially offered savings products, credit cards, personal loans and mortgages, with personal assistance to customers in ‘switching’ their accounts from other providers. It claimed to be a disrupter, by promoting its focus on customers, with very high levels of service in branches and convenience.
The physical presence was important to Metro Bank and it claimed that originally 93 per cent of all new accounts were opened in its bank branches. Its goal was to reclaim the banking values of the past by focusing on developing personal relationships between its staff and their customers.
In Australia, the nearest current equivalent to Metro Bank is probably Judo Bank, who received their banking license from the Australian Prudential Regulation Authority (APRA) in April 2019. Their target market is small to medium-sized enterprises, in particular those with a turnover of up to $A20 million. To serve this market, Judo are recruiting bankers to build a relationship-based lending model, where each banker will have around 80 clients.
So where are all these so-called challenger banks now?
Virgin Money (UK) was bought by the Clydesdale and Yorkshire Banking Group (CYBG) in 2018, with the intention of moving all of the group’s retail customers (around 6 million) over to the Virgin brand within three years.
CYBG claimed that the takeover would, “bring together the complementary strengths of the two successful challenger banks, to create the UK’s first national competitor to the large incumbent banks”. The emphasis was to be on more lending to SMEs, to diversify both income streams and the balance sheet. The deal created the UK’s sixth largest bank, measured by assets and hence potentially a scale competitor to the Big Four. Many Australians have an interest in CYBG, as both Clydesdale and Yorkshire Banks were previously owned by National Australia Bank (NAB).
When Virgin Money Australia was sold to the Bank of Queensland (BOQ), the purchase was justified by BOQ receiving exclusive use of the Virgin brand in Australia for up to 40 years. Virgin Money has previously had partnerships with both Westpac and Macquarie Bank and both it and BOQ have ongoing ‘white label’ credit card deals with CitiBank. BOQ intends to use the Virgin Money brand to develop a cloud based digital bank, that will lead its challenge to the Big Four of ANZ, CBA, NAB and Westpac.
What then of Tesco Bank? In 2014 it launched current/cheque accounts and it is still one of only two of the so-called challenger banks to offer this product, the other being Metro Bank. By 2017 Tesco Bank had gained over 8 million customer accounts and deposits of more than 8.5 billion pounds. In 2012 it started to offer mortgages and in an attempt to scale up that business, in 2016 it started partnering with independent brokers.
However, in May 2019, Tesco Bank announced it would pull out of the UK mortgage market, blaming “challenging market conditions”. There were by then around 23,000 mortgage borrowers with Tesco and a book valued at 3.7 billion pounds but intense competition and shrinking margins proved too much to handle in a market where the top six lenders account for over 70 per cent of the market.
No doubt Coles, Woolworths and other Australian retailers with aspirations to enter the financial services market will be keeping an eye on the ongoing fortunes of Tesco Bank.
Metro Bank? Well now, that’s a story! It opened the doors of its first branch in London in 2010, with a parade of jugglers, dancers on stilts and a Dixieland band. Its flamboyant founder was Vernon Hill, an American entrepreneur, who had in 2007 had left Commerce Bank, the New Jersey lender he’d set up in the 1970s, following regulatory issues.
Metro was the first of the challenger banks actively encouraged into the UK market by the British Government to take on the Big Four. The business model was to build customer relationships, both business and consumer, through a bank branch network. By 2019 Metro Bank had 66 branches, mostly located in the South of England. The branches were open long hours, 7 days a week and claimed to be strong on customer service.
Critics argued this was an outdated, even redundant, business model and evidence of this is Metro’s cost to income ratio of 86 per cent - way higher than any of the Big Four and Metro Bank has lower net interest margins to boot!
In early 2019, Metro Bank revealed it had put some 900 million pounds of loans into the wrong risk bracket and hence did not have enough capital to meet the Bank of England’s rules. The UK bank regulators, the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA), have both launched investigations, which extend to senior managers at Metro. Vernon Hill was replaced as Chairman in October 2019 and he will leave Metro Bank in December 2019. The bank has said publicly being taken over is one possible future.
The experiences of Virgin Money, Tesco Bank and Metro Bank are examples of just how challenging it is to enter a mature financial services market with established players and claim a sustainable position. Their challenge has been based on offering a physical presence in the market, often personified by a bricks and mortar network.
Other challengers could be classified as digital – or indeed ‘neo’ - banks whose business model is based on delivering financial services digitally via say mobile apps or online platforms.
The Big Four in Australia are already facing this new 21st century world of digital disruption. APRA has granted full authorised deposit-taking institutions (ADI) licenses to this type of new entrants, such as Xinja, 86 400, Volt and Judo Bank. Their target markets are customers who want near real-time updates on their spending and savings, and/or small-to-medium enterprises who want personalised lending services.
However even APRA concedes not all digital banks it has or will license, will survive. APRA’s observation is that in order to be successful, new entrants to the Australian banking market need to grow and grow quickly, to build scale rapidly.
So, what are the impediments that will inhibit customers from ‘switching’ from the incumbents to the new entrants? Be they branch or digital challengers? Yes, there is customer inertia, where it is perceived as being just too much hassle to bother changing financial suppliers. According to some reports, 40 per cent of Australian adults have never switched from the bank they first joined as a young person.
The UK’s Competition and Markets Authority (CMA) found in 2016 just 3 per cent of current/cheque account customers had moved their account in the past year. The UK’s Big Four still have a 70 per cent share of the 70 million current retail accounts, despite the challengers from Virgin Money, Tesco Bank and Metro Bank.
Things are even more focused in the SME market where the Big Four have an 80 per cent share of the 5.5 million accounts and even dissatisfied customers are reluctant to move, as it is just too much aggravation. SME owners and their advisors argue along the lines of ‘don’t change your bank if you’re doing well (it’s not broken)’ and ‘certainly don’t if you are doing badly (you might be frozen out)’.
The Australian Securities and Investments Commission (ASIC) is keen to promote switching under its Money Smart banner and it offers comprehensive guidelines on how to get your new bank to assist with switching or how to do it yourself.
However, experience suggests most customers still perceive switching as too complex and not worth the effort.
The latest wave to wash into traditional financial services is the shift in advanced economies to open data and open banking regimes where the customer is given control of their own data. In theory, this should make switching easier and allow consumers to access a greater range of competitive offers – given rival institutions can use the data to offer competitive deals.
This wave though is still building and in the UK, where open banking is in wide operation, there are yet to be significant shifts.
There are lessons from behavioural economics as well. From my experience and ongoing observations since writing that chapter going on five years ago, the key issues remain scale and trust.
While banking as an industry may have lost “trust”, most customers still trust their bank to keep their money and privacy safe. They also “trust” the solidity of existing banks.
Challenger banks, fintechs, neo-banks all face this challenge: they don’t have the history or scale or government backing (real or implied). Many are joining with incumbents to get that brand recognition and scale. What they do may well disrupt the market – but they themselves haven’t. To date.
Steve Worthington is a Professor at Swinburne University Business School
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
27 Feb 2019
23 Oct 2019