Point of View

As challenger banks’ profits fail to match their growth, incumbents must continue to invest in digital

February 26, 2020

Incumbent banks, the traditional and often brick-and-mortar brands that have dominated banking for decades, have been threatened for some time that they’ll fall at the hands of challenger banks. The emergence of Monzo, Revolut, Starling Bank, and many more have made the threat real. However, while disruptors have gained rapid traction in the market, they’re struggling to turn a profit, and incumbents aren’t faring much better, as their own digital brands, such as JP Morgan Chase’s Finn, have had limited success. The difference is that incumbents have a significant advantage in their brands, capital reserves, and existing customer bases; they can use these to outlast challengers. In the meantime, they must continue to develop digital offerings—when they outlast the competition, they can swoop in with ready-to-go platforms or merge and acquire the more promising challengers.



A handful of banks have developed digital banking platforms to combat challengers—but they haven’t all been successful


While we can date branchless banking back decades to the inception of First Direct, a telephone and internet-based bank, some early-movers in the digital-banking age include HelloBank, Moven, and Simple. Not every digital banking effort has been a success. JP Morgan Chase launched Finn in June 2018, then closed it the following year. Ultimately, JP Morgan took a step in the right direction, but it failed to differentiate its existing offerings for customers to deem it worth making the switch. Finn customers could still visit Chase branches, and it built Finn on the same infrastructure as the firm’s regular banking app.


More recently, HSBC and RBS have both announced efforts to tackle the threat from the challenger banks in the form of Kinetic and Bó, respectively. HSBC’s Kinetic targets businesses, but it is currently only in the piloting stage, while Bó hopes to facilitate financial stability for its customers.


A key advantage for ventures like Bó and Kinetic is the financial stability and established customer base of their established bank parents—a lack of which is concerning for potential digital-bank consumers who aren’t willing to risk their wealth with an unknown. Furthermore, in contrast to Finn, both Bó and Kinetic are entirely digital offerings developed independently of their parents’ legacy tech stacks.


Challenger banks may not be profitable yet—but they are making a dent in the market


Challenger banks are growing. Monzo boasts that one in every twenty adults in the UK are using its platform, and they are spending £49,653 every minute. The firm is now exploring overseas expansion as it sets its sights on the US market, which will likely accelerate its already impressive growth. But Monzo isn’t alone in its rapidly growing market share: Starling Bank, another digital-only bank, reports it doubled the number of customers from 385,000 in November 2018 to over 775,000 in August 2019.


Customer demands are quickly evolving, and incumbent banks’ customers are willing to seek alternative options if their current provider is unable to adapt. The disruptors might not be showing the profits, yet, but this should not lull incumbents into a false sense of security.


The constant growth in the challengers’ customer base may be deceiving, as their financial reports reveal they’re still struggling to make profit


Exhibit 1 shows data from the most recent annual reports of four well-known UK challenger banks. Spoiler alert: profit is impossible to spot. Challenger banks’ losses have been clear to see for several years now, which leaves them looking to alternative sources of finance.


This year alone, Starling Bank announced that it raised £60 million in a Series C funding round, as well as a further £15 million investment from an existing investor, while Monzo announced new funding totaling £113 million. Ultimately, time is running out for challenger banks. They need to cross over to profitability before their funding dries up, they’re out-competed, or they go out of business—for some, being acquired by an incumbent bank will be the best they can hope for.


Exhibit 1: Profit still eludes challenger banks, with four key players posting losses in their most recent publications



Source: Annual Reports from Monzo, Atom, Starling and a Telegraph article on Revolut



Profit’s not the only problem for challenger banks—the Bank of England recently announced that they are not managing risk effectively


With their customer base continuing to grow, it’s entirely possible that challenger banks can turn their profit problem around and match long-hailed expectations, but that wouldn’t be the end of all of their problems. The Bank of England (BoE) recently ran stress tests on 20 of the fastest growing new banks in the UK and found that they had been overly optimistic about the potential impact of an economic downturn to help accelerate their growth. For incumbent banks, this represents yet another sign that challenger banks might not be able to compete in the long run.


The Bottom Line: Incumbent banks must continue to leverage their capital reserves, brand loyalty, and proven business models alongside developing all-digital offerings, which might just outlast unprofitable upstarts.


Incumbent banks’ digital projects might not attract the same level of hype and customer-luring that some challenger banks might, but the inherent barriers to entry of the BFS market (such as capital and reporting and risk management requirements) mean that many challengers may not be able to cut it in the long term. Amid the hype surrounding challenger banks, incumbents must continue to build up their digital competitiveness so that they’re ready to swoop in once they’ve outmuscled or bought-out the challengers.

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