FIS Blog

Challenger banks: the new kids on the block


Andrew Woods | Thursday, October 8, 2015

In the U.K. banking market, there are plenty of new faces in town: the “challenger banks.”

Over the past seven or so years, since the global financial crisis and through increased encouragement from Europe, there has been an influx of firms applying for banking licenses in order to launch retail banks in the U.K., and no wonder. Competition, monetary and policy incentives, customer demand, margin and yield pressures plus innovative technology enhancements have all fueled the increased appetite for banking services. Firms looking to launch banks are faced by daunting challenges, starting with the regulatory approval process of sustainable business models.

In addition, other challenges include investor appetite, a demanding customer base, human resource factors and system selection. Recent launches have differed hugely, ranging from private equity, non-bank financial institution (NBFI) investment and EC-driven mandates. Business models are also diverse, ranging among branch, digital and hybrid delivery channels. The trend is set to continue, with equal numbers annually submitting bank license applications, making the U.K. financial market attractive to investors and, under current regulatory supervision, a heightened risk sensitive community.

Since the launch of the first “challengers” and their subsequent success, it would appear that launching a bank is now not such a big issue; business model – check, staff – check, systems – check, signed certificate – check. After all, the regulatory application process has been revised to target a smoother launch path. Investors are given the ease of access, proof of success and risk-based governance. Systems and technology are adapting to provide a service (SaaS/cloud) and meet continued demands for lower technology costs. In essence, and as expected, the landscape appears to be improving in order to reduce overall costs and increase success rates in launching banks.

Insights show a welcomed appetite to introducing banking competition: a recent KPMG report, The game changers (May 2015), notes “five challenger banks listed on the London Stock Exchange in 2014, raising over £350 million of new capital to fund growth and strengthen balance sheets. In the group categorized as ‘smaller challengers’, return on equity (RoE) reached a staggering 18.2 percent in 2014, which contrasts starkly with a market where single digit – or even negative – RoEs are the norm.”

Banking licenses will not be granted to firms that do not show a robust approach to technology, systems and controls; this is clear. Key areas of consideration include:
  • Engagement model: It is essential that the bank sees its service providers as partners and not simply vendors. Through a partnership approach, the complexity of proving technology expertise and credibility is eased both with the regulator and the investor base. Building a partnership with your service providers ensures predictability of costs and ultimately reduces total cost of ownership.
  • Business strategy: Understanding a clear five-year business plan is essential to building out the roadmap across treasury, risk and finance. A collaborative approach to the roadmap ensures that systems and controls are in place prior to product launch, reducing cost to market. This is especially important given the continued data onboarding through the bank’s strategy. Aligning the business plan to the onboarding of data is fundamental to successful product launch and ongoing reduced costs.
  • Operations: Operations need to be efficient, do more with less and provide fast, reliable results. Users, management information and executive committees need to be enabled by operational activities, not hindered, confused or challenged. Having automated, integrated systems among treasury, finance and risk enables bank operations to meet KPIs. With the pressures exerted by regulation, senior managers, investors, audit, compliance and more, having robust systems across the bank helps retain staff, fuel organic growth and reduce operational cost.
  • Technology: It is safe to say the FinTech market is alive with suitors. However, are they all eligible? System selection is about credibility, underpinned by expertise and proven delivery. New entrants will need to prove that the target operating model can deliver the proposed and future business plans. Delivery models vary from SaaS, on premises, hosted and others to meet branch, digital, hybrid and other service channels.
  • Launch costs: Capital is a scarce resource. Efficient capital allocation is paramount, and therefore plans, roadmaps and investments need to be aligned. Close understanding and a collaborative approach between the bank and its technology provider can help reduce risk and the costs of launch. Shared goals ensure all parties remain incentivized and therefore benefit from success.

The good news for all is that competition will intensify.

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