The UK market is the most fertile for the development of challenger banks; however, the Polish economy is not lagging behind. From your point of view, how is the banking sector being formed on these markets?
Peter McElwaine-Johnn: The retail banking industry in the UK dates back to the formation of the Bank of England in 1694 and has experienced little innovation for much of its history. Over the last 50 years, many smaller institutions have been acquired by larger ones, leading to the creation of a small number of very large banks whose balance sheets dwarf those of the next tier, and this concentration has tended to reduce competition, along with the incentive to innovate. New banking licenses were issued rarely during this period, but the global financial crisis, which in part caused the failure of some leading UK banking institutions, triggered a change in our regulators’ approach.
New banking licenses are now easier to obtain, and our competition authorities have investigated ways in which to increase competition as one mechanism to avoid having banks that are “too big to fail.” Regulators have even created a ‘sandbox’ where new ideas can be trialled safely. And all of this has taken place just at the time that digital technology has really matured and created the conditions for Fin Techs to develop new propositions and take them to market quickly and cheaply. So the emergence of our ‘challenger’ banks is taking place against this backdrop.
Łukasz Koszela: Exactly, and I would like to add that up until the great financial crisis of 2007 – 2008, the biggest ‘Wall Street’ banks designated the direction of development of the world economy. Significant changes came along with the bursting of the financial bubble – when the US sneezes, Europe catches a cold. These words perfectly describe the situation in the past when the biggest financial institutions were failing. In this empty space, Fin Techs found an opportunity to change current rules and set up a new banking business. The UK’s financial market was the most fertile ground for Fin Techs because of a strong need to change the outdated financial system marked by the long history of banking.
So how does the situation of the banking sector present itself in Poland?
Peter McElwaine-Johnn: The banking industry in Poland is much younger than that in the UK in that it has mostly sprung up since 1990. Polish banks have not had enough time to evolve the complex decision-making structures, nor to acquire the huge legacy technology estates that are both typical of large UK banks. This lack of complexity, and the higher agility that it promotes means that innovation in Polish banking is able to take place within its core as well as externally, which in turn means that successful innovation reaches more people faster than in the UK, because the innovators often already have millions of customers. This intensifies competition and spurs further innovation, with the result that the Polish market has moved ahead of the UK market in most aspects of customer-facing innovation.
Łukasz Koszela: As Peter said, the Polish financial market is quite young because of its political and historical context, so from the very beginning the bulk of financial institutions created their products and services basing on newer technological solutions and took particular care of the user experience and user needs. Compared to other economies characterized by a long banking history, the Polish financial area is very well-developed – advanced data-security systems, online transactions, standards for secure login or virtual offers are the order of the day. The banking system is more straightforward for customers than in the UK. For instance, to open a bank account we need just a few minutes, with a minimum of documents or we are able to do it online. In the United Kingdom you need to stand in a long queue at the desk, and formal matters take a million years.
Challenger banks exploit a similar business model and generate incomes based on the same financial products that traditional banks offer. Nonetheless, the competitive advantage is significant – so where is the crux of success?
Łukasz Koszela: Challengers build their offer on the same products as traditional banks and generate earnings in the same way. The difference is in the specific approach to customer needs and focusing on selected functionalities which are constantly improving. The strategy of challenger banks is distinguished of course by more transparent terms of agreements and advantageous rates of interest, but a really crucial aspect is the use of advanced technology.
Peter McElwaine-Johnn: On the other hand, challenger banks, despite their lower cost bases and higher agility, lack the market presence and reach of the established banks. The digital-only banks self-evidently lack presence on the ‘High Street’ and they cannot afford to advertise as widely as the incumbents. Crucially, they score lower for trust than their larger competitors, and this presents a barrier to entry that the regulators can do little to lower.
To thrive they need to focus their efforts. Those that have succeeded in the last few years have targeted market niches that for various reasons have been neglected by the larger banks. For example, Metro Bank has focussed on re-inventing the branch banking experience, and has attracted customers who still value that banking option. Aldermore and others have targeted small and medium enterprises (SMEs) with their lending efforts during a period when overall lending to this sector was contracting. Monzo and others have worked hard to appeal to the younger generation.
Even the most successful of these banks still has a balance sheet that is of the order of 1 - 2 percent of that of the largest UK bank, which highlights the gap between the top few banks and the remainder.
Łukasz Koszela: Yes, I agree with your opinion, the gap between the top few banks and the rest is significant but it is worth mentioning the engagement of people who believe in the idea of challenger banks. We can see that for a specific group of people, new Fin Techs are the right direction for the development of the finance sector. For instance, Tandem – one of our clients - raised over £1 million in around 15 minutes and has a wide network of co-founders who participate in the process of creation and decide on a vision for this investment. Traditional banks are not able to offer that possibility; relations between them and their clients may be described as dependent. Banks are growing because of their clients’ money, but the usual client can do nothing to influence or decide on strategy and vision. As in the Pink Floyd song – ‘All in all, you’re just another brick in the wall.’
From my backyard, another great example is the case of Suits Me, in which we are taking part as a technology solution provider. Suits Me has helped thousands of temporary workers in the UK to become financially independent, as well as recruitment agencies nationwide to support these people in employment, ensuring they are paid smoothly and securely. Currently over 90% of their members are from the EU. Without a bank account, people often must rely on cash and cheque payments, which can be open to fraud and costly to process, consequentially leaving them in a hand-to-mouth situation and unable to securely access their wages. Suits Me is helping recruitment agencies to champion financial inclusion – addressing these issues and attracting this overlooked and under-banked talent pool of temporary workers.
Not all challenger banks run their business using only mobile solutions. Some of them possess stationary agencies and build business networks. What does this mean for their business and is it important for them?
Peter McElwaine-Johnn: Predictions of the disappearance of UK banks’ branch networks have been made for at least the last 25 years, and have partially come true. The majority of UK banks believe that the transactional role of the branch will continue to decline, but the rate at which this will happen and the nature of the future role for branches are still the subject of debate. Research shows that tomorrow’s banking customers, the millennials, have a noticeably greater bias towards physical interaction, pointing to their need for face-to-face contact, advice and reassurance in their financial journey. What cannot be denied is that some customers still like to be able to visit bank branches, whereas other customers are happy to conduct all of their banking business using digital channels.
Łukasz Koszela: Additionally, I would like to interject that challenger banks are able to adapt to customer needs and are distinguished by their flexibility and the necessity to meet their target expectations, so if necessary they can open branches to be closer to their target or remain merely in a virtual reality.
Peter McElwaine-Johnn: Right, that is a fact. It may sound a little obvious, but the upshot of this is that, for any given bank then, they will attract the kind of customers they appeal to. So if they have branches they will attract customers who like branches, and if they are purely digital then they will attract customers who like digital banking. So if a bank has branches, then the branches are important because they are important to their customers. Metro Bank is the only completely new UK bank to open branches this century, and its branches are core to its customer proposition.
Could Fin Tech start-ups be a real danger for traditional banks? Do they perhaps offer a chance for development and change in the current strategy of traditional banking?
Peter McElwaine-Johnn: Positioning Fin Techs and traditional banks as rivals belies the reality that most traditional banks need Fin Techs to provide a ready source of innovation, and most Fin Tech start-ups need traditional banks to give them the market reach to be successful. There are some exceptions, such as in the area of alternative finance where lending volume reached £5 billion (€6 billion) in 2015 in the UK. Even this level, however, represents a tiny fraction of overall UK retail lending. Though they can barely be still referred to as start-ups, global technology companies such as Google, Apple and PayPal may present a more significant threat to the established banking industry because they have the capital, the market reach, the expertise in customer experience and the demonstrated inclination to disrupt at least the unregulated areas of retail banking. Should these ‘incursions’ become deeper, then the established banks will have no option but to alter their strategies to respond.
Łukasz Koszela: Definitely, Fin Tech start-ups constitute a great change for traditional banking and motivate them to change their current working style; however, they still make up a too small part of the financial sector to become a real rival.
The relationship network between Fin Techs and traditional banks is a significant trend and may change the current rules of the game in a financial world which is evolving, along with business in general, towards consumer to business (C2B) relations. Thanks to this structure, new players like Google, Apple, Facebook and Amazon (GAFA) could move into the territory of banking. Google launched Android Pay, with contactless payments via mobile phone with the Android system, Apple offers a cyber-wallet called Apple Pay; with Facebook Messenger we can transfer money from their platform, and last but not least, Amazon Lending offers loans for selected sellers.
In my opinion, Fin Techs may have a meaningful impact as a motivator for bigger banks and they will more or less determine the way of development for banking. Bigger institutions should cooperate with smaller and smarter start-ups to get to know their know-how and pick up some good practices. Unfortunately, such cooperation could be unrealistic because of two reasons: it would be a drastic change in the way of thinking and acceptance of innovation, like the launch of ATMs. The second point which could slow down or stop all changes results from the current regulations and banking standards.
To conclude, Fin Techs are valuable providers of innovation, while traditional banks attain the market reach and enjoy the trust of their customers, and time will tell if their wide cooperation will come true and will be successful. Maybe we will be witnesses of a great fulfilment of the chance to develop the financial world.