The concept of challenger banks, as they are currently understood, was largely born out of the financial crisis of 2007/8 and the popular and political pressure that shock produced to open up the sector to more competition.
A useful example of the new entrants to the sector so far is Metro Bank. This is perhaps the most familiar, of the challenger brands thanks to its colourful high street presence and early shake-up of some traditions, such as opening hours. It was the first new institution to be issued a banking licence in 150 years.
A number of other new entrants are making their presence felt, some with an entirely online offering and no high street presence at all.
Despite their high profiles, the new arrivals still account for only five per cent of the UK retail banking market. Ironically, and perhaps inevitably, the challengers also face challenges of their own.
One of these is actually securing business, particularly with the regulatory requirements of ‘Know Your Customer’ and anti money laundering. By way of illustration, this is harder for a pure-play digital bank to achieve with no branch network where people can be met and authenticated. But innovation, of course, is everything. Several online offerings intend to require potential customers to scan in their identification material before they open an account. Others may link up with larger professional service providers to essentially outsource the work. But clearly customer on-boarding remains a hurdle.
Readers will be familiar with the requirements placed on banks to have sufficient capital reserves in case of another crisis. Challenger banks as a body feel that such requirements unfairly impact on their business model; and they may have a point. Certainly, even if the worse were to happen, the collapse of smaller financial institutions is unlikely to cause the same systemic risks to the economy that the capital requirements were brought in to mitigate against. Arguments are being made for the adoption of the American model of requiring larger capital buffers in the larger institutions to level the playing field for the smaller players.
Another area of particular concern to the challengers is the eight per cent tax surcharge on profits introduced with the 2015 Budget on any bank profits above £25m. Challengers argue that this disproportionately impacts smaller and newer entrants to the market limiting their growth potential.
New entrants to banking are, of course, not spared the rigours of operating in a highly regulated market; even creating all of the terms and conditions for their entire range of financial products from scratch can be complex and costly.
But challengers also have some advantages; including being able to avoid the legacy software issues complicating efforts by some of the bigger players to modernise.
There is still a great deal of road to travel for new entrants. But given the political and economic climate there remain exciting opportunities. Indeed, some forms of Brexit currently being discussed may in fact make it easier for UK regulators to ease capital requirements rules. This may see the UK move more towards a US model where attention is focused on the bigger banks, less on smaller ones.
Challengers are also profitable, with lower legacy cost bases than their larger rivals. Many are also focussing on smaller businesses, and niche lending areas,, which attract younger and more tech savvy savers. This is a market where some of the bigger players have largely retreated.
Whatever the future may hold, it is likely that the challengers are here to stay. Indeed many argue that the new banks are useful catalysts for innovation and opportunity; and they have become a crucial part of the change agenda in banking more generally.
Peter Richards-Gaskin is a partner at TLT