Challenging times for challenger banks

May 11, 2021 • 5 minute read

When was the last time you switched energy supplier? A year ago, maybe two? What about your current account provider? Almost certainly not for ages, if ever.

That’s one of the more sobering findings from the excellent Social Market Foundation report Banking and competition in the UK economy.

The SMF found that the market for personal current accounts– the cornerstone product in retail banking – remains more concentrated now than before the 2008 financial crisis.

Worse, levels of switching between banks actually fell again last year, though the coronavirus pandemic saw customers shop around less in general, to the benefit of incumbents in most other sectors as well.

But the big banks have also effectively cornered the market in government-backed lending schemes to SMEs brought in during the pandemic.

On one level then, this represents a monumental failure of competition policy.

‘Too big to fail’ banks were meant to be broken up and competition encouraged – or, in the case of Lloyds and RBS, ordered by the European Union – so that customers would get a better deal.

Instead, despite new entrants to the sector, there’s been little change to market concentration in current accounts and mortgages since the separation of Lloyds and TSB in 2013.

Life is undoubtedly tough for the challengers and their fintech digital cousins. Lacking scale, they face falling profit margins because of lower-for-longer interest rates, rising regulatory costs and the prospect of surging loan defaults once government-support schemes are withdrawn.

The report explores the many barriers new, challenger banks face. They include:

  • big banks have more data on more customer types, which makes for better risk-profiling
  • big banks can make more money because they have more assets to lend against
  • product complexity makes it difficult for households and businesses to compare banking products
  • perceived risk of “something going wrong” can decrease customer willingness to switch bank – particularly to relatively new challenger brands.

The SMF proposes a number of possible remedies. For example, it suggests higher deposit protection limits for challenger bank customers. This, however, may have the unintended consequence of merely encouraging more reputationally damaging risk-taking with customers’ money. And asking for regulatory carves-out like this always looks a bit self-serving, not to say confusing.

Challenger banks and fintechs like Revolut and Monzo have deservedly earned a good reputation for innovation and providing excellent levels of customer service and satisfaction. They’ve also forced big banks to improve their own mobile and digital offers, to the benefit of millions of customers.

In terms of communications, though, perhaps expectations have become over-inflated. There are limits to how far new technology can disrupt any one sector.

And in the case of food retail, where levels of market concentration have fallen fastest in recent years, the biggest disruptors have been the traditional bricks-and-mortar discount retailers Aldi and Lidl, rather than tech-enabled platforms.

So if the stubbornly low rates of switching are anything to go by, the challengers still have a long way to go if they are to truly shake up the UK banking market.

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