Encouraged by a progressive regulatory stance, UK challenger banks have emerged as significant disruptors in high street retail and SME banking. However, not all challengers is guaranteed to flourish given an increasingly competitive environment evidenced by declining mortgage yields and compressed net interest margins. Moreover, the regulator has recently challenged the risk controls and stress test assumptions in a "Dear CEO" letter to a number of challenger bank industry CEOs (FT Advisor, June 2019).
In a furthcoming study, Dr Yacine Belghitar of Cranfield University and myself examine these emerging de novo banks in thier formative years of development using an empirical framework. Our findings indicate that the best in class challengers scale up quickly (to not run out of start-up capital) without compromising thier risk appetite or regulatory constraints.
Using a variety of statistical techniques, we provide early evidence (in a previously under-researched domain) about this sector and the determinants of accounting performance and risk-taking measures. We show that banks that scale well exhibit higher returns, better net interest margins and have lower NPLs. They also use thier capital and leverage effectively within the regulatory constraint advocated by Basel III. Our research further considers the channels of this outperformance to be linked to several underlying performance drivers such as interest expense, compensation and operating margins.
The hard part is fully appreciating how these winners practically do this. There is early evidence that a combination of risk governance practices, such as risk committees and risk appetite frameworks contribute, as well as the use of securitizations to provide an alternative source of funding as government led programs are slowly wound-down. Not all challengers are alike. But some appear effective at scalling thier de novo banking licences without suffering excessive NPLs or requiring excessive capital levels as they mature. This discpline in part appears linked to disciplined (or lucky) credit risk appetite decisions taken in thier formative years.
Photo credits: Vector Stock and FinanceMonthly 2019.