Digital Only: The Challengers Taking on Big Banking in the UK

In 2013, the Bank of England revealed a decision to encourage new banks to start in their banking market. The goal was to introduce competition into the industry and respond to consumer demands for greater transparency and better services.

In contrast to the United States, there were very few banks in the United Kingdom during the financial crisis. Their regulatory thinking was that the crisis was the result of light-touch financial regulation and misaligned incentives. Once the crisis hit, the impact was made much worse because of the concentrated market. The banks were "too big to fail". This result of this oligopolistic market and they wanted to encourage more banks to create a more stable system in the future.

The landmark new rules by the Bank’s Prudential Regulation Authority (PRA) stipulated a simplified two-step process for setting up new banks called “Option B”.

I frequently find that the financial technology community here in the United States is only vaguely aware of the new challenger banks in the UK, what they are doing, and the lessons to be drawn. Given that my partner Dan and I spend some of our time and capital investment in the UK, we have been tracking them quite closely. The purpose of this post is to give an overview of some of the new banks, how they are approaching the market and their innovations.

The new banks have many implications for the continually growing fintech market in the UK and point the direction for some of the innovations we hope to see in the United States if new technology-first banks are ever chartered (For example, I’m hopeful for Varo and some other unannounced new banks in the US).

The new age of banking

With the change in the rules, the regulation enabled the authorization of more than a dozen new banks between 2013 and 2016, which has led to a visible change in the market. About 8 or 10 new banks are basically savings-and-loans companies targeting older people who have a lot of savings (e.g. Oak North, Paragon, Charter Court, etc). They raise fix-term deposits competing solely on price and then lend into interesting niche markets.

Then there are a few banks really focussed on transactional accounts, targeting millennials via a smartphone app. These are a new breed of banks: built for a mobile, primarily millennial, market and designed for customer service and user experience. Their offering includes personalized products and intelligent services that are accessible at the touch of a button, and genuinely useful to users.

The Bank of England noted the positive impact and innovation of these new banks, "whether it be the service they provide, the customers they target, the products they sell or the technology they use." These new banks were able to avoid the legacy brand and technology debt of established institutions. Untarnished by the financial crash and negative consumer perception, they were able to start afresh from both a reputational and technological standpoint.

The banks have designed a delivery strategy that centered around consumer expectations, and purpose-built their technological infrastructures from scratch (or at least their user experiences and user interfaces). They provide an entirely digital banking experience, which saves them the costs of maintaining inefficient legacy systems and expensive brick and mortar branches.

Not only do they deliver powerful capabilities like spending analytics, instant transfers and overdrafts, and intelligent money management, they do so in a way that’s intuitive, visual and immensely user-friendly.

Who are some of the challengers?

I’m going to go over who I think are the five most interesting new entrants to the market.

There are four new digital-first consumer banks -- Monzo, Starling, Tandem, and Atom banks. At the highest level, it's interesting to compare and contrast here. Monzo and Starling build core systems from scratch and were able to launch current accounts relatively early. Atom and Tandem chose to outsource, which appears to have slowed down their product launches. Monzo, Starling, and Tandem are all aiming to be "transactional hubs", while Atom is savings-and-loans.

The fifth bank is ClearBank, which is the first new clearing bank in the UK in more than two centuries.

1. Monzo: a focus on user acquisition and growth in consumer accounts

Arguably the most trendy of the digital-only challengers, Monzo is designed for “people who live life on their mobiles” and targeted to millennials: half of its users are under 30, and a further quarter are under 40.

Monzo was launched in 2015 and made history with its first round of crowdfunding in March 2016: the company raised £1m in 96 seconds, the fastest crowdfunding campaign ever. In 2017, it received another £71m in funding and was granted its full banking license. As of December 2017, it had almost half a million UK customers, who have spent more than £800m on the platform. They recently passported to Ireland as well.

Monzo’s offering is a current account with a contactless debit card and a mobile banking app. They started their offering with a bank account (originally just a prepaid card built on someone else’s infrastructure) and are now working on ways to monetize their customer base through lending products and cross-selling.

Users don’t receive interest, there’s no cash incentive or offer to join, and although it offers attractive savings on spending abroad, as Monzo’s CEO and Founder Tom Blomfield acknowledges, “For something like 90% of our customers, the free foreign exchange is nice, but they might go on holiday once or twice a year”. So, what’s driving all the user acquisition: as Blomfield points out, it is not about the tangible offering. It’s about “the feeling of visibility and control”. The app’s standout features include intelligent spending notifications, real-time balance updates, and clear, dynamic budgeting and financial management.

2. Starling: searching for a niche

Like Monzo, Starling Bank specializes in current accounts. Like Monzo, it’s built for the “millions of people who live their lives on their mobile phone”. The similarities are undeniable - and they’re not incidental.

Founded in 2014 by Anne Boden, the former chief operating officer of Allied Irish Bank, Starling went through a major management change in 2015/6 when members of the founding team left to set up rival Monzo.This included former Starling CTO, and current Monzo CEO, Tom Blomfield.

Harald McPike, an American quantitative trader, agreed to a tiered fundraise with Starling from their earliest days. A year after the major management change, the company received its banking license and the bulk of the $70 million in funding from McPike. The bank received a restricted license in July 2016 and started allowing current accounts in March 2017. In 2017, it also announced the expansion to Ireland.

Despite similarities with Monzo, Starling claims to offers a different focus and unique value proposition: personalized services with intelligent analytics. In addition to consumer current accounts, they are testing the waters on a number of other products, including a business current account. They’re partnering with lots of early-stage financial technology companies, and working on credit card processing to compete with the likes of Stripe (and potentially mirror Chase Paymentech at scale). All of this would be impressive but it seems to have led to relatively little customer uptake --  I've yet to meet someone who actually has a Starling account whereas I see Monzo cards everywhere in London.

3. Atom Bank: focused on savings and mortgage without a current account

Atom Bank was the first of the digital-only banks to start offering products.

Atom Bank was founded by Anthony Thomson, who also launched Metro Bank, the first high street bank in a century when it opened six years ago. Atom was authorized to take customer deposits in November 2015 and launched in full offering and mobile app after the lifting of regulatory restrictions in 2016. The challenger is backed by the veteran City investor Neil Woodford while Spanish bank BBVA has a 29.9% stake.

Atom’s first products were a one-year fixed saver offering an interest rate of 2% and a two-year savings product with a 2.2% rate. In 2017, it announced it was suspending the planned launch of current (i.e. checking) accounts for at least a year. Their decision to postpone the checking accounts was because of high growth in the savings and mortgage products (and because of IT problems with their outsourced core banking system supplier) despite the lack of a checking account.

Their big investment in brand, early marketing (the "AI future of banking") and channel (primarily through a smartphone app) is totally at odds with their main product -- a fixed term savings account. They're much more like the other savings-and-loans banks like OakNorth and Paragon. Their biggest depositors will be 55+ years old, but all their marketing choices seem like they're going after young people.

This raises interesting questions about whether a checking product is necessary for a consumer bank or whether it can offer a more a la carte menu without it, and focus (like many non-bank financial technology companies) on offering a niche, focused product, although with a cheaper cost of capital off the balance sheet. I find the approach pretty interesting: raise a lot of money and start lending immediately, making your business stable without necessarily having to worry about acquiring massive amounts of customer deposits.

Later last year, it partnered with Deposit Solutions to offer retail deposits in Germany.

4. Tandem: smart savings

Although less well established than its rival Monzo, Tandem bank is designed with similar goals in mind:  to help users manage their finances and save money in an easy and intuitive way.

Tandem was founded in 2013 and received its license in 2015, becoming the second digital-only bank after Atom Bank to get approval from the UK financial authorities. In 2017, Tandem lost their banking license due to the collapse of a deal that would have seen them gain £29 million in funding, and regained it in early 2018, after taking over Harrods Bank.

Ricky Knox, Tandem’s CEO, claims that the app’s aim is designed to find ways for users to save money on services and providers, and “ figure out how we can get you a better deal on all the stuff you're buying, whether it's your utility bill, whether it’s a credit card or your mobile bill.”

According to Knox, Tandem is different as it is “not designed for finance geeks” but for people "who are a bit rubbish with their money and can’t be bothered to spend Saturday afternoon budgeting.”

The company’s products reflect this. A bare-bones approach means that their app and credit card are simple to use and conditions are transparently presented. In early 2018, Tandem launched the credit card, which offers holders 0.5% cashback on purchases above £1 and access to borrowing services. As with Monzo, a part of the card’s appeal is the fact that it doesn’t charge fees abroad.

Unlike its competitors, Tandem’s app doesn’t just track spending on its own card. Instead, users can add any bank account on to an app that lets users track their spending, gives them updates on their bills, and enables them to switch service-providers if a better deal exists elsewhere.

5. ClearBank: UK’s first new clearing bank in 250 years

The UK’s first new clearing back in 250 years is the new venture of Nick Ogden, founder and former CEO of WorldPay. The bank was set up in 2015 with an investment of £25 million from PPF Group and CFFI Ventures in addition to investments from the founding management team. The bank was granted a license at the end of 2016 and launched in 2017.

ClearBank does not offer retail banking services. It is a bank for banks and (FCA-regulated) financial technology companies, offering open access to payment, current account, and transactional clearing services for all UK Financial service organizations including both incumbent and challenger banks.

ClearBank claims that “the improved efficiency delivered by [its] built-for-purpose technology” can save users £2-3 billion on their transactional banking, annually. It has a custom-built, integrated core banking system, known as ClearBank Core, and APIs that allow it to offer services free from the constraints of legacy technology.

What lessons do we learn from these and other challenge banks?

1. A mobile market: banking branchless

It’s no surprise these neobanks choose to operate on a digital-only platform and mobile-focused approach. They’re building their platforms to capitalize on a seismic market shift from banking at branches to banking through digital channels. The British Bankers Association (BBA) reported 19.6 million U.K. consumers used banking apps in 2017, an 11 percent increase from 2016. These numbers are set to reach 32.6 million by 2020. In addition, the use of banking apps rose 356% between 2012 and 2017, as a result of customers using apps more frequently, and for a greater number of transactions and tasks.

Prior usage for banking apps had focused on simply checking balance and bills, while as of 2017, 62% of U.K. adults prefer to conduct all of their banking activity online instead of at a branch.

2. Digital delivery: built for a better consumer experience

Monzo CEO Tom Blomfeld is candid about the philosophy behind Monzo’s intuitive design and user interface: “[Monzo is] built for the way we live today… it’s an app that’s designed in the same way that WhatsApp, Citymapper, Uber and Amazon are. It just works the way they expect” Atom Bank has a similar design philosophy, promising to make banking “easier, intuitive and there whenever you need it, all on your mobile.”

Like most in-demand apps, Monzo, Atom Banks, and other digital banks have designed their delivery channels with customer engagement and seamless user experience in mind.

Their front-end interfaces are designed to be intuitive, enhancing both functionality and usability.

Opening bank accounts in the United Kingdom has historically been very difficult. Unless you're dealing with Metro Bank it can take weeks to get an appointment (to open a current account, say), and then you have to present tons of paperwork and spend hours getting grilled by bankers. Business current accounts are even worse - generally takes months to open an account.

By contrast, you can open a challenger account in about five minutes on your phone and get a debit card in the mail a week later. The degree to which customer experience is awful really inspires a potent distaste for banks and bankers here and young people want something new.

The intuitive interface bely the complexity of powerful back-end platforms that offer artificial intelligence layering, predictive analytics, cash flow forecasting, biometric security, and open API integrations. The focus on user interfaces and consumer experiences are certainly paying off: these digital-only newcomers outperform traditional banks in customer service, customer loyalty, and referrals.

3. Leaving behind legacy architectures: the advantages of modern software development methodologies

As challenger banks are the first to acknowledge, it’s their lack of legacy architecture that allows them to deliver their innovative technology and customer-centric approach. According to Stewart Bromley, Atom Bank COO, big banks have “tied themselves up in knots” with their sprawling, often patchwork technological structures. He notes that “The technology [big banks] use is typically 50 to 60 years old, and that in itself is a massive inhibitor to changing anything.”

Nick Ogden, ClearBank Executive Chairman, echoes this concern. He believes “the industry will never truly move forward while it’s constrained by the challenges of legacy operational structures” Banks typically spend 80% of their IT budgets on maintaining outdated, inefficient, and aging systems, as opposed to investing in innovation, which gives a real opportunity

When banks do innovate or make expensive updates in order to meet regulatory requirements, they usually add more technology to their stack, further adding to the complexity of the outdated systems they will one day need to replace. As Bromley points out, “Most banks have layered technology onto technology onto technology, [making it] very difficult for them to move off of those legacy platforms.”

Due to the sheer volume of customers at big banks and their huge bureaucracies, it is difficult for these institutions to make disruptive changes to their technology environments, which can take as long as 18 months.

With legacy-free modern architectures that are already modular digital-only banks have been built like startups. They’re are designed for innovation, with agile operating models and technical architectures in place for rapid scaling.This allows them to choose a niche in the value chain to specialize and excel in while integrating offerings and data from third parties.

4. Open platforms and marketplaces

Starling, for example, is emphatic about its chosen niche: “current accounts - nothing else”, according to Anne Boden. “We are going to give the best current account in the world, and when they want the best mortgage in the world we are going to offer it, but through somebody else, not us". This vision is made manifest in Starling’s Marketplace platform.

Monzo takes a similar approach, writing that “the bank of the future is a marketplace”. By offering APIs that allow partners and third parties to integrate their services within the Monzo app, it’s positioning itself to capitalize on that future.

An open approach is clearly supported by consumer demand: as of 2017, 39% of customers are willing to share financial data in order to receive benefits such as an integrated view of all their accounts, and tailored offerings from third-party providers.

Platforms and marketplaces also face uncertain monetization paths, as no one has quite figured out the right path to sustaining revenue in the space.

The challenges faced by challenger banks

Ultimately, the success of the challenger banking model depends on the trust banks are able to build with their customers. Challenger banks are quick to empathize with and address consumers loss of trust and dissatisfaction with big banking: it’s what helped build their business model and brand position.

Their brand philosophy is built on the insistence that they’re not like those banks.They’re making a fresh start.

Monzo, addresses the issue head-on, acknowledging that “banking has been obtuse, complex and opaque” and that they aim to be radically different and “build a new kind of bank.” Anne Boden of Starling is a little blunter: “banking is broken… and the only way to fix it is to start from scratch.”

However, when it comes to the question of storing, sharing, and securing highly sensitive personal and financial data, these new banks face a greater disadvantage than established institutions. While starting from scratch may mean a fresh beginning, this lack of legacy proves a double-edged sword for these revolutionary new banks.

Although established banks are mired in the morass of their reputational and technological legacies, they also have centuries of history, billions of capital, and lifetime relationships with millions of legacy customers: before the introduction of a switching service in 2013, consumers would, on average, stay with ‘their’ bank for 17 years. Even with the switching service, very few customers switch their primary banking relationship every year.

Challenger banks lack history, trust, and the loyalty of customers -- critical factors that take a long time to develop. This means that despite the meteoric rise of the challengers, established banks still dominate the market today. For example, although Starling and Monzo both specialize in current accounts- with arguably better service and delivery - more than 80% of the UK current accounts market is ‘owned’ by the five big banks: Lloyds, Barclays, HSBC, the UK arm of Santander and Royal Bank of Scotland. It not clear how much that is changing -- I have been unable to find any data on how well the challenges have done in getting people to use them a primary checking account rather than as something to try on the side or only use for particular value like free foreign ATM withdrawals. ( ran into the same problem in the US -- many people signed up for novelty, not to replace their primary bank relationship).

Challenger banks will need to demonstrate sustained long-term growth, prove that their technologies are secure, remain committed to their current level of service and innovation, and, by the way, prove they can get real revenue. Many are focused on low-value customers and they need to prove out how their customer value will grow over time (and the impact that interest rates will have on their businesses). Challenger banks also struggle to acquire and build awareness with customers, and typically lack the capital required to build brand visibility or incentivize acquisition with loss-making offers.

In addition, like with any entrepreneurial venture and emergent business model, there are no guarantees. As Tom Blomfield acknowledges, “The investors who put their money in Monzo know they’re taking a big risk for an outsized return. But - there’s a really big chance you’ll lose everything.”

That thought is one that venture investors are quite comfortable with, but when it comes to where consumer put their money, it can be a challenge even though the Financial Services Compensation Scheme protects every dollar.

The future of finance: APIs and the move to Open Banking

Having said that all banks can no longer delay major reform of legacy architectures. Financial services in the United Kingdom as an industry is fast moving towards an increasingly open structure and API-based modular architectures as it evolves to meet consumer demands for a personalized, integrated, and seamless customer experiences.

In 2018, two key pieces of regulation come into effect that will mandate banks to make the move to “opening” their APIs to third parties. Open Banking rules have forced the UK’s nine largest banks to open APIs to share their data with licensed startups. While the Second Payment Services Directive (PSD2) will require all banks to allow third parties access to their payments infrastructure and customer data assets by opening their APIs.

To me, the future of challenger banks is uncertain in the United Kingdom. The market becoming more open is great -- and will allow more financial innovation. Customers historically have not switched primary banks at all easily, the 2003 attempts to promote bank switching in the UK - including allowing customers to port their routing and account numbers to new banks, achieved very little. Almost no one switched. So, the more focus these banks on lending and payment products, the better. Getting people to switch their primary checking account has proven very difficult.

Having said that, as the majority of these banks are now licensed, they’re attractive targets for partnerships, investments, and acquisitions. Investments by legacy banks, like BBVA with Atom, are likely to continue. As the financial services industry becomes more open, these challengers can attract many partners to their platform, and perhaps create lasting brands at the center of consumer’s financial lives.