Mapping out the origins of challenger banks and why incumbents are falling by the wayside
Reading Time: 9 Mins
If you’re anything like me then you have a little orange/hot coral card sitting in your pocket ready to pull out and show off. At least, that was me a couple of years ago sparking comments like ‘Oh that’s a nice colour. What’s it for?’ and ‘Is that actually a bank card?’. Nowadays those questions are moot as everyone knows it’s a Monzo card (they crowdsourced the name change which was originally Mondo). And I’m not alone in this digital banking shift. Over 3million users have Monzo accounts, they see around 200,000 new sign-ups each month and now they’re looking to crack the states!!
But it’s not just Monzo leading this banking revolution–and it IS a revolution. Aptly named Revolut, one of the starters of this uprising, as well as Starling Bank, Atom Bank, Monese, Tandem and Chip are some of the more popular names and they are only a handful of the UK ones. Fintech Futures has a great list of banking tech firms across various countries but it’ll take you a while to read through the whole list.
Viva la banking Revolut-ion!!
Looking back at the period when some of the big ‘challengers’ started out it seems that 2015 was a turning point. It’s when Revolut founders Nikolay Storonsky and Vlad Yatsenko left their jobs working at 2 different banking firms to launch the digital bank in July 2015. Revolut was essentially born out of a frustration at traditional banking firms neglecting its tech-savvy and phone loving, younger customer base. That was 4 years ago and it now has over 8 million customers (over 2 of this is in the UK alone).
Tom Blomfield, co-founder & CEO of Monzo, also launched in 2015 with his other co-founders Jonas Huckestein, Jason Bates, Paul Rippon and Gary Dolman and the origins of Monzo were pretty similar to that of Revolut. Although Monzo started as a pre-paid card rather than a fully-fledged bank account due to its lack of a full banking licence (which it now has), Tom’s vision was very much as a sympathiser for the underserved retail banking market.
“We want to help with all that stuff that no one likes doing, by using data and technology to automate it,” Blomfield said in an interview with the Mail on Sunday.
So was it just a few ambitious folks who thought banking was a bit broken that led to this revolution? Not exactly no. Factors like availability of tech resources, growing interest in innovation, London becoming a FinTech hub, the numerous financial companies in the area (mainly Canary Wharf and The City) AND incubators like Level39 in Canary Wharf, where Revolut was developed, were contributing factors.
These factors go hand in hand with the fact that making drastic changes to big companies from inside, like a Lloyds or RBS for example, is really, really hard. It’s why many of these challengers are separate new banking entities rather than new projects inside traditional banking institutes. And it’s a trend that seems to be continuing.
Why are ‘big banks’ slower to change? And how can a startup create a bank within 3 years??
So here’s an interesting question. Why is it so hard for a big, experienced company with a vast amount of resources to create a digital bank but a new startup can go from zero to 2million users in under 3 years? The answer isn’t simple but is made clearer when broken into the following categories:
It’s easier for a tech CEO to convey a message of ‘Consumer and Product first’ than it is for a seasoned banking CEO to do the same. So when a company tries to change its culture of a profit-making business to a consumer and product-based company it’s like the old analogy of trying to change the direction of a tanker. Whereas digital banks are very much about ‘MAKING THE PRODUCT GREAT AGAIN’. Ok, bad phrasing but you get the picture.
🏦-> Banking culture has traditionally been profit margin based. And it makes sense when you consider the industry. Consistent revenue streams, good profit margins and a steady share price his been the norm. And the main reason is that most big banks are PLCs so they are beholden to shareholders, who again, care about profits. For example, if you invested in a company would you be that concerned with how the consumers of that company felt or more concerned with your dividend payment at the end of the year….?
🦄 🚀-> Challengers have a very different cultural approach. They take a very ‘Users First’ approach. The cynical reason for this. Challengers need users to prove that the product and model works and also to generate revenue and gain more funding. The non-cynical reason. The founders of these companies are simply trying to create a product to solve an actual problem and help users who have been neglected. Either way, the ‘User First’ approach works if the product is in line with the things that the user needs.
NOTE: Jobs to Be Done or JTBD is a great framework for looking into and thinking about consumer activities in more detail and understanding what the users’ goals truly are.
🏦-> Traditional banking firms often have a long and very winding road to their current position. Barclays Bank, for example, is made up of part of Lehmans failed Investment banking division + ING Direct UK + The Woolwich (an old British Building Society) + Banco Zaragozano (a Spanish bank) to name just a few. And for the majority of these big banks, they were established before the 1980s when the age of the computer (or Information Age) really started to come to life. What this means is that most banks started out with very basic technology, then when tech started to make bigger leaps, they became stale very quickly. And with acquisitions of other firms comes the inheritance of even more bad tech. It means that most big banks have been playing catch up for a while and many of them still have big programs of work on the slate to bring their tech stack into the 21st century.
🦄 🚀-> Many challengers have had a very different and much less windy story. Most digital banking founders are either pure technologists or understand that the technology is key to delivering a valuable user-centric product. This is why technology has been at the heart of most of the challengers you see today and it’s 10x easier to create a technology product with a blank slate and then scale up than have to build using a specific set of technologies within a certain set of constraints.
🏦-> Big banks like HSBC, Barclays, Santander have regulators like the FCA and specific regulations like Basel 2 to contend with. Whilst it might sound like something Gordon Ramsey would use in a pasta dish, Basel 2 is actually a regulation that requires banks to keep a certain amount of capital in reserve. This is just in case speculation and bets don’t quite go their way and we have another crash al la 2008. This is just another hoop big banks have to invest time and money into to get through.
🦄 🚀-> Challengers don’t usually have to conform to these big banking regulations so they either do not consider it at all or build it in slowly at each stage of the growth of the product. Either way, it’s not a big upheaval to conform to such regulation because the technology is in a good enough state for it to be implemented quickly and efficiently. The only real downside for challengers in this regard is obtaining the infamous holy grail. A Full Banking Licence!
Note: A Banking Licence offers additional protection to the consumers of the product who hold it, allows the holder to give users additional services like overdrafts, loans and direct debits. But it also gives a greater sense of legitimacy and validation to the challenger. Revolut’s page announcing when they obtained a banking licence shows what it meant to them.
🏦-> Big banks are absolute behemoths. No matter how big you think they are, think bigger. That’s why they’re always compared to tankers. Difficult to stop once they set off at high speed in a particular direction. And when they need to turn they need notice. A lot of notice. It’s why, when the previously mentioned regulations are enforced, banks have to spend a lot of time preparing and making changes. And because of their size, changes usually need to be made in multiple places and meticulously coordinated.
To put the employee numbers in perspective, HSBC has around 200,000 employees worldwide. Monzo has around 1,000. You don’t have to be a maths major to work out the ratio. HINT: HSBC is 200 times bigger
🦄 🚀-> As you can see from the employee numbers alone, challengers tend to be A LOT smaller than incumbent banks. This means that when things are going badly or new requirements come in, changes are quicker and easier to make. And when new market trends arise or regulation needs to be enforced, making these changes at a smaller, leaner company is much easier and much less costly.
🏦-> As you’ve probably gathered from the previous sections, but mainly the Company Culture section, incumbent banks don’t tend to work well with others. A judgemental statement maybe. But there’s actually a good reason why. The reason is, as mentioned before, that many incumbent banks are listed companies that have to answer to shareholders and therefore very profit-driven. And to be seen to work with other banks, especially in an area like the Current Account market where competition between banks is rife, collaboration is seen as sharing profits with a competitor. Which should be avoided if it can be helped.
For example, HSBC, Barclays and RBS working together to abolish unfair overdraft fees to help their customers would just never happen. In fact, the FCA (Financial Conduct Authority) had to step in and enforce reform in the overdraft fee area as it was clear that it was dysfunctional and harmful to consumers.
🦄 🚀 -> Challengers, however, are slightly different. Obviously, the ‘product and consumer-first’ approach is key to gain the trust of consumers. But also, the willingness to do this and to collaborate with companies in the same field to achieve a goal. Monzo, for example, has this year partnered with OakNorth, another fairly new outfit, who target entrepreneurs and provide lending and savings products. The reason for the partnership? Monzo wanted to provide savings products to their customer base and rather than create these products from scratch which takes a lot of time and effort, they decided to partner with a firm that already provides some of the best high-interest savings accounts on the market. In exchange for allowing Monzo customers to create a savings ‘pot’ using OakNorth’s products, Monzo receives a small revenue percentage. A small price for OakNorth considering the amount of profile and number of customers received in exchange.
This is just one high profile example of a partnership but it seems a lot more acceptable for positive partnerships with challengers than it is with incumbents.
So Culture, Tech, Regulation, Size and Collaboration were clearly factors but Trust was also a big one. It was certainly tested around the time of the 2008 financial crisis and was something of a klaxon for people to start thinking about new ways of banking. All of these factors together created a perfect storm of innovation, opportunity and ambition in the FinTech sector, specifically with personal finances, and has contributed to the myriad of firms we see today.
So what’s next for the ‘challengers’? And also the incumbents?
The challengers, or contestants for the purposes of this Gladiators analogy, don’t really need to drastically change course. They seem to be doing everything right including taking their time with initiatives. What is clear is that popular UK based challengers are starting to go global. Monzo (and yes there are other challengers other than Monzo) have started their US expansion to take advantage of what looks like an underserved digital banking market. And other digital banks like Starling are ramping up their UK presence by launching formal ad campaigns using their previously great word of mouth promotion as a launchpad into the mainstream.
Gamifying the Model 🎮
As most mobile gamers will know, the most popular games work on a freemium model. Think Angry Birds and Wordscapes. This is a model that has been proven to lure users in with the attractive prospect of playing a fun game that’s free and then allowing the user to choose to pay for additional benefits. As most challengers are digital the same model applies.
Although Monzo’s Plus account has now been scrapped and reviewed, the likes of Revolut and N26 are continuing to push a successful premium version of their free account. They’re offering additional features like an increase in the amount of cash that can be withdrawn abroad, free travel insurance and even exclusive airport Lounge access via LoungeKey.
Bulking and Strengthening 💪🏽
As user adoption for challengers continues to grow the challengers must also grow with it. Monzo, for example, has gone from 400 to 1300 employees in the last year alone and with around 55,000 users signing up per month, the firm will have to continue to grow.
It doesn’t just mean building a bigger company though. It also means strengthening their existing positioning and continuing to be relevant for its user base. This includes increasing security measures, offering more features and generally creating an all-round better product that doesn’t become stale.
Honourable Mention: Having a banking licence very much helps with the strengthening process and most of the larger challengers already have a licence safely stored in their vault.
Trimming Down 🍏
It’s not necessarily a direct response to challengers but the dramatic spate of redundancies could be partly down to challengers demonstrating that building and running a bank doesn’t require millions of employees. HSBC is the latest to announce redundancies after Deutsche, Citi and Barclays. Whilst these redundancies aren’t specifically in their retail banking division it’s a clear indicator that all banks are looking to lean down to reduce overheads.
Going Digital 💻
Companies have decided that, rather be left behind by the digital challenger revolution, they’ll get on board. And whilst most banks DO have apps that allow you to manage your account in the palm of your hand, most of these apps are pretty basic when compared to the challengers.
Take RBS for example. Although they already have an app for their existing customers they are also launching Bó, a new digital-only bank they hope will rival the likes of Revolut and Monzo. And this is after news came out recently that they actually tried to buy Monzo back in 2017 but stood down after being told how much they’d have to stump up. Hindsight eh.
So why are they still called Challengers then?
With all this being said why are challengers still called challengers? Well despite their popularity, challengers still don’t have the numbers that incumbent traditional banking firms have or the brand awareness of a Barclays or Santander. Statistically, Lloyds is the UK’s largest in terms of retail customers with around 22 million and the closest challenger is Revolut with 7 million customers. But are user numbers a fair comparison? Lloyds has been around a lot longer than the likes of Revolut, N26 and Monzo and even though Lloyds is the largest traditional bank in terms of numbers, Revolut and Monzo are snapping at the heels of the likes of Santander and HSBC who have 14 million and 8 million customers respectively. So when they catch up, will they no longer be considered challengers? And will they then be considered part of the ‘big banking crew’ and drop the label of ‘challenger’?
I asked Simon Taylor, co-founder and Head of Ventures at 11FS about the ‘challenger’ label and here’s what he had to say:
“I guess in 10 years it doesn’t matter if we call them challengers or not. Has the industry changed and do customers have better outcomes? If that answer is yes then they have been effective. You can already see incumbents copying challenger features.”
The Age of the Digital Bank
What’s clear from all of this is that digital challengers are not going away and if anything their popularity is increasing. Revolut is targeting another 2million+ customers by the end of next year and that’s with a very little spent on marketing (which will change in the next couple of years). And with investment in digital banks from venture capital firms only becoming more prevalent, mainly because of the popularity of Monzo, Starling, Revolut, et al, the position of these new banks is only going to solidify.
So watch out because this is just the beginning and with the high street going the way of the Betamax and VHS, the age of high street banking is dead. And the age of the digital bank is here. 🚀🚀🚀🚀🚀🚀