How to be a successful challenger bank
So assuming you have got the capital raised and have got
through the regulatory hurdles necessary to be a challenger bank what the
critical factors for success?
battleground. Given that the big five banks (in the UK) or the Four Pillars
(in Australia) or the equivalent in other markets are so called because they
have the scale and the established track record trying to take them head on at
their own game is a sure fire guarantee of failure. To paraphase the Chinese
general Sun Tsu in his ‘Art of War’ only attack the enemy head on if you have a
three to one advantage. A bank that
wants to take on the banks across their entire retail customer base is setting
itself up to fail. The established big players have the depth of capital and
the customer base to play the long game and can besiege the challenger bank
until they have used up all their capital and their investors patience.
For challenger banks the better strategy is to ‘fragment’ i.e.
to pick off part of the established banks’s customer base, preferably one of
the more profitable segments.
By not having a clear customer segment strategy but simply
competing for business that can be won from the established banks can end up
with the so-called challenger winning the unprofitable business that the big
five would happily like to exit.
Handelsbanken have never sought to be a replacement for the
big five banks in the UK for all their customers. They have deliberately
adopted a strategy that focuses on small businesses in largely market towns
where customers like to use branches, have face to face contact and are
prepared to pay for that service. The result has been very high customer
satisfaction along with high profitability.
First Direct (albeit owned by HSBC) set out to be a bank for
customers that weren’t interested in visiting branches, liked to be able to
talk to a person, liked a high quality of service and were prepared to pay for
it. First Direct is very rarely at the top of the price tables. Equally First
Direct has not tried to grow its customer base aggressively with its market
share relatively stable and relatively small. What they have ended up with is
the highest Net Promoter Score amongst the banks.
from a position of better insight. The established banks have the scale,
the benefits of a high margin back book and the deep pockets so competing
purely on price is not a long term strategy. Neither is competing simply on not
being one of them. Some of the legacy problems the established banks have is
their data has grown up from individual product systems, there is a culture of
not sharing data between organisational silos, their systems have often grown
from a series of acquisitions and are based on old technology. This gives the
challenger bank a real opportunity. Designing the bank from the start to be
based around the customer not the product, designing the data infrastructure
around the ability to analyse, model and forecast not only the customer, but
the risk, the external environment and the way the business performance will be
managed will give the challenger bank a significant advantage. By having better
customer insight offers can be better tailored to what the customer actually
wants (resulting in a reduced Cost Per Acquisition), pricing can be based on
individual or segment risk (not only for lending but also for deposit pricing)
and retention of customers can be significantly higher.
A good current/checking
account offering is not optional. Without it being a real challenger is
impossible. Unless you have a transactional product, one where the customer
interacts with you frequently, you are not going to be able to own the customer
relationship and whilst you might win in the short term it will only be for
that. When you ask any customer who they bank with their first response will be
the bank where their salary is paid into and which they use daily to buy goods
and services with.
If the basis of competition is around taking mortgages and savings market shares off the
established banks, then effectively regardless of the ownership structure, this
is a building society offering. Building societies have been around for over a
hundred years and their attempts to be challenger banks can be seen in the
demise of the likes of Alliance & Leicester, Bradford & Bingley and
Nationwide Building Society has shown that by having a good
current account offering that they are a real challenger to the established
banks. (Nationwide has done more than that as well but the current account has
been a key building block to their success).
What’s more the current account offering needs to be
designed to attract the customer segment that has been selected as part of the
Most customers see one current account being the same as
another. A lot of customers will also have been made more cynical because of
the ‘value-added’ or packaged current accounts that were sold in the run up to
the financial crash. These were accounts where it was questionable whether the
‘added value’ was worth the monthly fee. There are very few ways of
differentiating a current account but certainly for a challenger bank it needs
to be designed for being used on mobile devices such as smartphones and
tablets. The established banks, whilst they may have deeper pockets, have old
and under-maintained systems which should give challenger banks an advantage
(see the comments about IT below)
The danger of coming out with a simple, low function current
account is that the challenger bank ends up with the low income, highly
unprofitable customers that established banks are obliged by governments to
offer to the unbanked. While this may make the challenger bank popular with
government it will do nothing to help investors and if that is not the customer
segment being aimed for will only lead to brand confusion.
Design the business
from the outside in. One of the biggest challenges the existing banks have
is their organisation structure which is built around silos, largely
product-based and very hard to change. This brings inflexibility and high cost.
Challenger banks have a real opportunity to do something different, even if
they have come into existence by acquiring an existing player. The way that the
bank’s processes are designed should be driven by the experience that its
customers, partners (intermediaries, aggregators, suppliers) want and then
decide how it can be delivered profitably. Experience doesn’t just apply to
getting a customer to purchase a product but also what happens after that.
On-boarding is even more important now for retention, profitability and
customer advocacy, particularly where business comes from brokers or comparison
What typically happens is that organisations where there is any
conscious design are built from the perspective of the bank and how it is
easiest to manage, not from the customer’s or strategic supplier’s perspective.
The challenger who gets this right will only be able to attract customers at a
lower cost (reduced CPA), will reduce customer attrition and achieve higher
customer referral rates.
Invest in talent and
experience. Everybody thinks they are an expert in retail banking because
everyone has a bank account. This is the equivalent of saying that everybody is
a doctor because they have a body. If retail banking was really that easy and
that profitable there would be no need for challenger banks. It is not only
since the financial crash in 2008 that people have looked down on bankers and
treated them as of less value than estate agents or tabloid journalists. Prior
to the crash many banks employed retailers because they thought bankers were
just staff who didn’t know how to sell properly. A probable consequence of the
introduction of this retail talent was the PPI (Payment Protection Insurance)
and the Structured Investments scandals, where sales techniques borrowed from
the retail industry were applied to the banking industry. There is no doubt
that the banking industry can benefit from the insights and experience of
industries that deliver better customer service and use technology more smartly
but that needs to be counterbalanced with deep experience of retail banking.
Current account-based retail banking is far from the same as simply attracting
deposits and selling mortgages. If retail banking was so easy why have the
building societies (Nationwide excepted – see comment above) been so
unsuccessful in making a significant dent in the established banks market
share? To be a successful challenger bank investment in real expertise of
current account banking is not optional.
technology can do something doesn’t mean customers want it. There are
plenty of digital gurus out there who are coming up with very imaginative ways
of doing banking whether it is different ways of making payments (at least once
a day someone somewhere in the world announces a new way of making payments),
identifying the customer, wearing technology, and interacting in branches, but
just because you can do it doesn’t mean you should. Unless it makes it more
convenient for the customer (and many of the novel ways of making payments are
cool but take longer than conventional ways of paying) then don’t do it. Being
sexy is not a requirement to be a challenger bank.
Start from the goal of
zero IT ownership – exploit the cloud, SaaS and outsourcing. The
established banks have very expensive and old IT systems which they need to
maintain. This comes from the legacy where banks were amongst the first
organisations to use IT and therefore had no option but to build up their own
expertise. With the maturity of the both the IT and the outsourcing industries
there is no reason for banks to own or manage their own IT. Given the problems
established banks have had with their legacy systems over the last few years
their competency as an IT provider has been seriously tested. Not only does
putting IT out to third parties save overall money but it also allows the
challenger banks to focus on what is important and that is the provision of
banking to their customers.
Metro Bank, one of the challenger banks in the UK, has
bought the use of its core banking service on a per transaction basis (SaaS –
Software as a Service). Its IT is outsourced. When the time it took to Metro
Bank to launch its current account is compared with Tesco Bank (which is
building its own platform based on a core banking package) then there is a
clear argument for considering SaaS.
technology and commercial approaches should give challengers a great advantage;
however it isn’t always turning out that way.
A number of challenger banks are being created by the acquisition of
assets from existing players. They would argue that by having existing proven
platforms that they can be up and running faster than starting from scratch.
This is true in the short term but rather than being able to offer a truly
differentiated service what they offer is a smaller but more expensive (due to
the smaller scale and, in some cases, having to pay one of the big 5 banks to
support the IT) version of the established banks. This is the situation that
both TSB (the former Verde Lloyds Banking Group 630 branches) and William &
Glyns (the 316 RBS branches) find themselves in. (See http://www.itsafinancialworld.net/2013/07/can-tsb-be-challenger-bank.html)
In the longer term this is not a viable solution for a challenger bank.
Challenger banks who have acquired legacy IT, need a transformational
CIO working alongside the bank’s executives, to put in place a plan to get off
the legacy and onto modern platforms enabled for mobile and digital as quickly
as possible. They also need to be experts in strategic supplier management. The
challenger banks need to educate their investors that this is not optional.
Have an exclusive
relationship with major investors and get them committed for the long haul. There
are plenty of hedge, private equity and sovereign funds who are interested in
investing in challenge banks, however a number of them have placed investments
in more than one challenger bank in the same sector in the same country. What
does that say about their commitment?
To build a sustainable challenger bank will take time
particularly given the limited availability of off the shelf banking technology
and the time it takes to implement a new business model. Equally getting a
return on these investments is not going to be quick, so investors who aren’t
in for the long haul should be politely shown the door.
This isn’t meant to be an exhaustive list of what a
challenger bank should be looking at but highlights some of the areas where the
difference can be between success and failure.