I was struck by an article last year in Bank Director (April 5th, 2017 by John Maxfield) that chronicled the formation of Blue Gate Bank. Blue Gate, based in Costa Mesa CA, is only the 5th new de-novo bank established in the US since 2009! See Waupsh (2016) for his count of new bank formation as illustrated here. This is quite a change from earlier periods, when over 100 new banks were formed each year on average for the 18-year period up to 2008 (Adams & Gramlich, 2014). 

These authors map new US bank charters to the US Fed Funds rate and find strong correlation between low charter formation and interest rate levels, a driver of NIM. They also explain the impact of new regulation and reduced low growth are playing its part as well. Indeed, the reasons for the tepid growth of new bank charters are well known, including low interest rates/NIMs, growing regulatory and compliance costs that favour larger scale platforms, and of course the growth impact of FinTech. If the level of new bank formation in the US continues at this pace, it may have a significant impact on the composition of the banking sector and even the flow of credit in the economy (McCord, Prescott & Sablik, 2015). 

So new bank formation essentially has come to a halt everywhere? Well, not quite.   

Although the underlying issues of low interest rates, weaker credit demand and the growth of FinTech impacts both US and UK market dynamics, UK regulators quickly embraced the need for new bank charters post GFC, possibly given the high degree of concentration in UK banking. Today’s top six UK players (including the big four, plus Santander and Nationwide) can draw their lineage back to a less concentrated suite of over 30 banks from the early 1960s (PWC, 2017).

The FCA and PRA established a new bank licence unit, streamlined charter processing, encouraged regulatory sandboxes and the like. Successful applicants became known as challenger banks. Like other concepts in finance, this not really a good descriptor anymore and a gross generalisation of the term given the niches they operate within (KMPG, 201&). One founder/owner of a UK challenger bank that was licensed only last year told me that getting a UK bank licence was a seminal, once in a life-time opportunity, which will become increasingly more difficult to secure over time. Perhaps.

Image: Brown (2018)
By my count, there are at least 25 credible UK challenger bank groups either authorised and working towards authorisation. The former includes Atom, AXIS, Aldermore, Charter, Chetwood, Clear Bank, Fidor, Marcus, Metro Bank, Monzo, OakNorth, Paragon, Redwood, Shawbrook, Secure Trust, and Starling.  Several of these have listed, including Virgin (2014), Aldermore (2015) and CYBG (2016) where M&A activity is being mooted. Those in the wings and refining their business plans include Abacus, Amicus, Bank of Dave, City of London, Civilised, Coombs, N26, Revolut, and Zopa, to name just a few. The sheer number of current and prospective players portrays a striking difference with the environment across the pond.

UK challenger banks do not follow the same business model. Challenger banks are not all things to all people but instead target niche markets where they can compete effectively on cost and service levels. Many address perceived funding or service gaps. Some key points of differentiation include product breadth (Clear Bank focuses on disrupting the clearing arrangements of the large four bank while Metro is moving towards a broad suite of retail and SME deposit and credit products). Over 54% of challenger banks in various markets offer lending products while only 25% offer mortgages (Burnmark, 2015).

Challengers are largely on standardized capital models which probably handicaps the sector with greater capital requirements than larger rivals. Amazingly, several report healthy NIMs, such as Aldermore comfortably above 3% and thus showing no signs yet of undisciplined asset or liability pricing. A key factor supporting asset quality has been the healthy UK economy, at least during most of the previous 4 years, thus the post Brexit economy will be an important test to challenger banks.

A panel of challenger banks wrote to the House of Commons in June 2016 presenting their contribution to the UK economy and validating the sector, with SME lending growth of over 8% for challengers versus a decline in SME lending by the larger UK banks of nearly 3%. They estimated as of that period, 20% of all SME lending in the UK is provided by challenger banks, a market reportedly worth £210 billion in 2016 (Burnmark, 2016).  Overall, challenger bank growth rates are projected to grow by 46% CAGR (Brown, 2018).

Most if not all of the challengers embrace digital models and typically a combination of lower fixed costs and enhanced service/product access. Advisors to the sector identify key value streams for challengers, such as ensuring trust, offering solutions (not products), simplicity, partnerships, enticements, talent leadership, engagement with regulators, and finally current account, savings account funding or CASA funding (AT Kearney, 2014).

We are in the early days of challenger banking in the UK. While the baseline competitive framework differs in the UK (versus the US) and the need for more competition  well noted, it is clear that the UK has come a long way to realising its goal of resetting the competitive landscape for banking services.