The New Banks on the Block

Apr 09, 2019

Written By David Carnes

Is mobile banking the wave of the future? If so, what legal challenges do they pose?

Challenger banks are small financial companies, mostly founded during the past five years, that compete with the UK’s traditional banks. They appeal to entrepreneurs and small business owners by skillfully exploiting the digital revolution and by specialising in services that have been ignored by the major banks. These “challenger banks” are characterised by their reliance on mobile apps, online-only operations and intense consumer focus.

Challenger banks can be divided into four categories:

Companies with full banking licences such as Monzo and Revolut;

‘Neobanks’ such as WeBank, that operate through partners who have banking licenses;

Beta banks, which are subsidiaries of existing banks that operate under their parent company’s licence; and

Non-banks that operate on e-money licences or other innovative business models.

Some of these challenger banks, such as TSB and Metro Bank, have established themselves as formidable players by allowing consumers to establish and fund accounts, pay bills, deposit and transfer funds, and purchase goods and services using a bank-supplied debit card—all by downloading an app onto your smartphone or tablet.

A glimpse of the future

Some analysts are predicting that after three centuries of dominance by the traditional banking industry, challenger banks will do to traditional banking what Uber and Lyft have done to the taxi industry—or what blogs have done to the mainstream media. Indeed, challenger banks have muscled their way into 14% of the UK’s banking revenue, despite focusing on some of the less lucrative sectors of the banking market.

When it comes to future trends, the statistics are ominous, at least from the point of view of the traditional banking sector. Monzo, for example, gained over 500,000 current accounts between September 2017 and March 2018, while Germany-based N26 tripled its membership to around 2.3 million between 2017 and 2018.

This trend looks to accelerate over the next few years, at least if the challenger banks continue to penetrate successfully their target markets. By 2030, self-employed workers are expected to outnumber salaried workers in the UK. Even today, sole proprietorships and micro-enterprises make up well over 90% of all UK businesses.

Apple enters the fray

It’s not just small start-ups that are entering the market—some of the big players from the non-banking sector, such as Apple, are starting to get involved. The Apple Pay app has been available in the UK since 2015 and has been activated on nearly 400 million iPhones worldwide.

The Apple app allows users to register credit and debit cards on their iPhones to make speedy transactions. New features currently in development may even allow users to manage their spending habits by notifying them when their spending exceeds pre-established budgetary limitations.

Trouble in paradise?

Although so far no major challenger bank has failed, industry watchers believe that it’s just a matter of time until it happens. Challenger banks with banking licences, of course, are ensured up to £85,000 through the Financial Services Compensation Scheme. It’s the non-bank challengers, such as those who operate under e-money licences, where failure could hit the hardest.

Rampant misconduct is also a distinct possibility, given the current “Wild West” atmosphere triggered by the failure of UK regulators to keep abreast of the rapidly evolving banking environment. The Revolut case is perhaps the first example of a potential fiasco. Revolut, which boasts millions of customers and a market capitalisation of more than a billion US dollars, has been accused of lax operating procedures. Among the accusations levelled against it are:

Falsifying advertising data;

Tolerating employee turnover rates that resemble that of a McDonald’s franchise rather than an established bank;

Financially exploiting job applicants by forcing them to recruit new customers without compensation;

Tolerating financial actictiy that evades legal sanctions through lax oversight; and

Interfering in the Lithuanian political process.

Other challenger banks have run into difficulties as well—Metro Bank, for example, committed a major mistake in how it classifies its loan book, which wiped £800 million off the value of the company in a single day of trading. Even without management errors, consumers face inherent risks such as identity theft made easier by non-secure SSL links, and vulnerability when using a mobile app on a public Wi-Fi network such as Starbucks.

Regulatory changes

In the UK, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) bears primary regulatory authority for licensing and regulating banks. A “bank” becomes subject to this regulatory authority by accepting deposits and either lending these funds to third parties or using them to finance other company activities. These authorities have maintained the traditional regulatory model for UK banks for decades now, but change is already in the air.

Challenger banks currently enjoy an increasingly friendly regulatory environment. The 2018 Revised Payment Service DIrective, for example, now allows bank customers to use third-party providers to manage their finances. Traditional banks are required to allow these providers access to their customers’ accounts, thereby permitting them to build financial services using these banks’ data. Traditional banks are facing a radically altered regulatory landscape.

Is coexistence possible?

Traditional banks are adapting to the challenge in much the same way as traditional media adapted to the challenges posed by the blogging revolution—in part, by adopting their new competitors’ business models by acquiring promising fintechs, for example. The other half of the success equation for traditional banks is to exploit their existing advantages—loyal customer bases that go back for generations, for example. But it’s simply impossible at present to predict the ultimate outcome of this seismic upheaval in the banking industry.

Commercial Insights