2 February 2017
Do we need Challenger Banks?
It’s time to look local rather than global.
by Frank O’Nomics
Another week – another two banking scandals. News that two former HBOS bankers had been involved in a £245 million loan scam, and a £500 million fine for Deutsche Bank for allowing clients to transfer $10 billion out of Russia, will have done nothing to improve trust in banks.
It used to be said that you are more likely to change your wife than your bank account. Historically people opened a bank account when they got their first job, used that bank for their savings and mortgage with the account only being closed on the account holder’s death. It is still the case that the average account holder stays with his bank for 17 years and the average marriage lasts for 11 ½ – but there is a change developing. Online facilities have made it much easier to change banks and levels of dissatisfaction and/or mistrust have prompted many to do so. The rise of Fintech, and the 2013 reduction in capital requirements from the Bank of England, has helped new “challenger” banks to launch services designed to lure away the long standing customers of established banks, without the overhead of a huge branch network and balance sheet. The Current Account Switch Service, launched in 2013, has helped over 3 million people to change banks. However, the movement seems to be largely based on people seeking the best deals and has been more to the benefit of some established banks, such as Santander, than to the new banks. Should Customers now review the new challenger banks with a view to getting a better service? The answer, sadly, is that most of the new banks are just high tech smaller versions of the old, without the reputational baggage. What seem to be missing are banks able to build relationships rather than relying on a purely transactional model, banks acknowledging that people need help with their money and will be loyal as a result.
That there is a huge, and increasing array of alternatives is not to be doubted. The Banking Technology website lists 49 new banks, ranging from the tiny to UK subsidiaries of the Chinese leviathan ICBC. Many of the banks only offer services online and chiefly exist to provide loans to the Small and Medium Enterprises (SME) sector. However, there are plenty that are seeking to provide a full banking service, with the likes of Metrobank becoming the first new high street bank in 150 years. These banks have been created by using a technological edge to give them a competitive advantage. They can make more money than established banks because they have no legacy bad loan book to service, and they have a branding benefit of not being associated with any of the banking scandals of the last 10 years. So what’s not to like? Well, the problem is that (with the possible exception of Metrobank) most suffer from an even greater lack of customer engagement, the very issue that has led to dissatisfaction with the major clearers closing so many local branches. There may be an attractive online efficiency, but most of these banks do not have the resource for personal interaction. Secondly, while lower capital requirements mean it is easier for them to set up, this is not that reassuring if we go into a sharp recession. Ultimately, a lot of banking inertia must be put down to wanting your assets to be safe.
Established banks are making efforts to get their houses in order. The separation of their businesses into a good and bad bank is allowing a run-off of the more toxic assets, helping them to compete more actively for traditional business. There has also been a significant move to improve their reputations with the like of the Barclays RISES initiative. This acronym stands for – Respect, Integrity, Service, Excellence and Stewardship. Note the lack of words like “profit” and “return on capital employed”. Logic suggests that a large bank with integrity and economies of scale should be the home for our money or mortgages. Sadly, the reality is that large banks are still scaling back customer facing operations and becoming ever more transaction focused, steering us towards communication with robots. Big banks serve shareholders first, the regulators second, with customers a very distant third.
There is a more deep-seated issue with banks in that they really don’t do what it says on the tin. On one side they don’t really take in deposits – they are just getting you to lend them your money, offering no return, just safety. On the other side it is hard to see that banks are lending much money to help in the generation of economic growth, merely lending money to people who are very solid risks, at levels that generate a healthy return on the money borrowed from “depositors”. To a large extent this explains the development of many challenger entities, who are targeting the SME’s that banks are not prepared to take a risk on, or are too small for them to expend resources on appropriate due diligence.
This may all sound a little disappointing, with consumers yet again having a product forced upon them rather than adapted to their needs. There is, however, a model within the new challenger banks that may give a pointer to a better future. In Germany there are some 1,700 locally controlled small banks, which lend mainly to SMEs, and there are moves in the UK to set up similar, not-for-profit community banks, owned by a charity and run for the benefit of local people. Local First CIC is promoting community banks here, with the Hampshire Community bank already getting ready for launch. This bank will not pay bonuses to staff and will be run “for the benefit of the people in the county of Hampshire”.
For now, the top 7 banks account for over 90% of deposits and 94% of total loans. Cartels in banking have led to some bad habits and generally operate for the benefit of noone other than their members. In view of this, the development of challengers to the cartel in the UK is to be encouraged. It could provide the opportunity for customers to seek a personal and local relationship with a bank that operates in their, and their communities interest. Maybe small is beautiful after all.
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