The rise of the digital bank
Few industries have felt the impact of technological disruption more than the banking sector. Over the last few years several new kids on the block have emerged to take their seat at the top table and muscle in on the activities of the high street giants by specialising in areas that are being underserved.
Many of the most successful challenger banks have raised funding via investment crowdfunding platform Crowdcube (more information can be found at the bottom of this article). But who are these new ‘challenger banks’, why are they different, and how has the industry changed since their arrival? We take a closer look.
Historically, one couldn’t simply go out and set up a bank (at least not without a significant outlay). Therefore, the banking sector has traditionally been dominated by a small number of large organisations – the so-called UK ‘big four’ of Barclays, HSBC, Lloyds and RBS, for example.
However, the global financial crisis a decade ago led to significant changes in the regulatory landscape (which formed part of the 2012 Financial Services Act), which opened the market up to new players for the first time in almost a century. For example, when Metro Bank received their banking licence in 2010, it was the first issued by the UK Government in over 100 years.
“Regulators moved the needle in terms of what you could and couldn’t do,” said Tushar Chitra, VP of Product Strategy at Oracle Financial Services. “Five years ago, if you looked at regulation around the world, it was tough for startup banks to get things past the regulators - today it’s much easier.”
In addition to a significant shift in the regulatory goalposts, the industry has also been adapting to a whole raft of new and innovative technologies such as AI, the Cloud and Blockchain, that have impacted on operational processes and banks’ offering to customers.
This has enabled new fintechs to free themselves from legacy technology, that to a degree have bogged down the larger banking behemoths which take longer to change operational practices, and have brought banking into the digital age.
Conor Colleary, Vice President at Oracle Financial Services commented: “Technology is accelerating innovation. Open banking and APIs (application programming interfaces), are increasing the amount of competition in the sector with new entrants coming into the market that are very focussed.”
Tanya Andreasyan, Managing Director of banking specialists, FinTech Futures added: “The challenger banks emerged and shook-up the sector, offering services that are better, faster, more transparent and far more aligned with the tech-savvy generation.”
This combination of factors has led to huge growth in the sector, which is now incredibly vibrant. Figures from KPMG have revealed fintech investment across the world doubled to $111.8bn in 2018. In the UK alone, total investment in fintech in 2018 was almost four times higher than the previous year – further highlighting the appetite for new services in the sector.
So, what do challenger banks do differently and how do they compete? Andreasyan added that the larger incumbent banks have found it difficult to offer the same services as the challenger banks due to their legacy systems. “In some cases, the back-end technology of traditional banks is so old,” she added. “Some even date back to the 1960s. Over the years they have built around it but today the technology has become so tangled, complicated, cumbersome, and so intertwined, that it has become incredibly difficult to incorporate new services.”
In addition, due to their traditional position in the market, many of the larger banks have never been under pressure to change. “If you don’t have a lot of competition, why would you do anything to modernise or do anything different?” continued Andreasyan. “Significant change requires significant investment - not just financial, but also upskilling personnel, new processes, thinking, and company culture, and that’s a big, complicated project – it can make or break banks, and make or break careers. So, why embark on a major shift in company operations if it wasn’t absolutely necessary?
“Of course, the big banks still hold the overwhelming majority of clients and money, so the challenger banks’ market share is still tiny. However, they are making a lot of noise and they are pushing the bigger banks to be better and offer an improved customer experience, which is essentially good for the consumer.”
Indeed, these new digital banks have been fundamentally built with UX (user experience) and CX (customer experience) in mind, with a completely different mindset. They have been built specifically for mobile rather than the older banking systems that have gone through multiple iterations over many years.
And a key string to the challenger bank’s bow, is that they tend to have a fairly narrow focus – offering in some instances just one product or solution, but concentrating on delivering it very well, and these are the new entrants that have had the most success, as Chitra explained: “This narrow approach enables the challenger banks to offer direct monetary value and keep their operating costs low.
“Throwing new technologies into the mix means that they have also been able to scale their model across geographies, markets, and achieve much deeper penetration. There is one bank (which unfortunately I cannot name), who are only focussing on deposits, with just one product. In a period of six months they received €6bn in deposits!”
UX trumps innovation
When we write about startups the buzzword is often innovation. However, what is key in the finance sector, and is setting fintech startups apart, is actually customer experience. A recent joint survey between London Research and Trustpilot has shown that it is the most important differentiating factor for emerging fintech brands, as it makes them more investable. Customer experience in the sector is also seen as significantly more important than brand awareness, online reputation, and price.
“All the big banks are improving their mobile banking offerings for the consumer, in line with what the challenger banks are doing,” Andreasyan added. “They are also far more focussed on the customer rather than the product. Traditionally, the big banks focused everything around the product (i.e. savings accounts, or current accounts). Now, the new mantra is to build everything around the customer, and that is a major shift in culture, thinking and how the technology is created – it’s called human-centric design, where it’s the customer, rather than the product, at the heart of the process.”
Colleary continued: “Challenger banks and fintech are being taken very seriously by the industry at large and you can see that in the level of investment the bigger banks are making in digitisation. We often talk about the fact we’re moving into the customer experience economy, where that experience is often more important than the overall product.
“Banks are recognising the need to go beyond banking and offer services that are more holistic. For example, we talk to banks about the change from offering someone a mortgage to helping them buy a house (there’s a difference), and this sort of open environment and ecosystem allows them to offer that sort of variable to their customers.”
Trust is key in a sector where you are dealing with peoples’ savings and future financial health, so for a small company entering an already competitive market, competing against globally recognisable brands, projecting that level of trust to a potential customer can be a challenge. Therefore, one of the most effective methods of conveying that message is reassurance from existing customers, thus creating a virtuous circle and evidence that the company is answering a consumer need.
Colleary added: “Challenger banks will continue to play an ever-more important role in the landscape of the industry. They are the ones pushing the boundaries of innovation and they are going to keep stretching the industry to be more customer-centric - to think about the full customer journey which will go beyond banking and offer an end-to-end service for the customer rather than just a financial solution.”
With that in mind there have been some notable challenger banks to have raised via Crowdcube. These include:
Amount raised: £1.1m
No. of investors: 433
Revolut offers banking services including a prepaid debit card (MasterCard or Visa), currency exchange, cryptocurrency exchange and peer-to-peer payments. The Revolut mobile app supports spending and ATM withdrawals in 120 currencies and sending in 29 currencies directly from the app. It also provides customers access to cryptocurrencies such as Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), Bitcoin Cash (BCH), and XRP by exchanging to or from 25 fiat currencies.
Revolut currently charges no fees for the majority of its services (but for a capped usage) and uses inter-bank exchange rates for its currency exchange on weekdays, and charge a markup from 0.5% to 1.5% on weekends.
The London-based startup was founded by Nikolay Storonsky and Vlad Yatsenko, and was originally based in Level39, a financial technology incubator in Canary Wharf, London. The Revolut platform has recently surpassed seven million users and received the Unicorn Award at the Seedrs Alumni Awards in London.
Amount raised: £20m
No. of investors: 36,000
Monzo is a digital, mobile-only bank originally operating through a mobile app and a prepaid debit card. In April 2017 their UK banking licence restrictions were lifted, enabling them to offer a current account.
The bank was founded by Tom Blomfield, Jonas Huckestein, Jason Bates, Paul Rippon and Gary Dolman, and in 2016 set the record for the quickest crowdfunding campaign in history when it raised £1m in 96 seconds on Crowdcube.
Earlier this year the bank announced ambitious intentions to enter the fragmented US market through a partnership with Ohio-based Sutton Bank. The company has expressed its intention to do away with a number of banking traditions such as physical branches and chequebooks which it regards as obsolete. Blomfield said the bank, “will not be right for everyone”, and described the company’s target demographic as those who value convenience and technical innovation.
Amount raised: £1.86m
No. of investors: 1997
Coconut is a current account that aims to take care of accounting and tax. It’s designed specifically for freelancers, the self-employed and small business owners.
Working for yourself presents a number of unique challenges, and it’s all too easy to waste valuable time on tracking expenses, getting paid on time by clients, or worrying about tax returns. Coconut Bank claim traditional products like cloud accounting packages and business bank accounts haven’t kept up with the fast-paced way we work today.
Founded by Adam Goodall and Sam O’Connor, Coconut automatically tells customers which transactions are tax deductible, provides guidance about the tax rules, forecasts their tax bill and fills out their tax return automatically.
Now with 3,000 open accounts, it’s Coconut’s mission to free millions of people from accounting and tax admin worldwide, by combining banking, payments and accounting into one product.
All three challenger banks mentioned in this article have been raising investment over the last three to four years via the Crowdcube investment platform. Crowdcube was established by Darren Westlake and Luke Lang in 2011 and was inspired by an unshakable belief in entrepreneurs that dream big, push at the edges and want to make a difference.
Individuals’ investments are pooled, allowing entrepreneurs to secure funding directly from the general public as well as angels and professional investors. The key principle of this model is that anyone can invest money in return for equity in a business.
The platform’s mission is to make funding accessible for everyone, helping to fuel the next generation of business who want to leave a mark on the world. It does this by championing the big ideas that challenge the status quo, the power of people and community, and the grit, tenacity and hard work it takes to succeed.
Referring companies to Crowdcube can help tackle one of the biggest challenges facing growing businesses - raising finance. And Crowdcube work with the likes of Grant Thornton, SeedLegals, TribeFirst, Pearlfisher and Linklaters, to support growing businesses to achieve great things.