Challenger banks: the good, the bad and the different
In the past few years new players have been arriving on the bank- ing scene, allegedly to shake up the market and bring innovation, competition and more choice for you and me. But how much difference can two men in a canoe make amongst a fleet of dreadnoughts?
Enter the challenger banks.
It's hard to write about challenger banks without using the word complacency a great many times: the big banks have become complacent and overly comfortable with their massive market share and the way they do things, and customers have become complacent about what they expect from their banks.
Yet a challenger could offer the moon but people might just not care. Why go through the pain of switching for a marginally better savings rate or better online banking facilities?
Challenger banking expert Andrew Hagger says: "These challenger banks are fighting back against the old stuffy high street names with a fresh approach to win over customers.
"Extra choice, better service, longer opening hours, more convenience and best-buy rates are just a few of the weapons that the challenger banks are using to make people sit up and take notice."
Many challenger banks - Metro Bank and Virgin Money being notable exceptions – operate solely over the phone and online. Not having branches means lower overheads, which in theory means thicker margins, which in turn means they can offer better rates. Couple those with state-of-the-art technology as opposed to the haphazard legacy systems of the old guard, and you've potentially got a killer combination of better service and better products.
Even the branch operators have some pretty nifty ideas – Metro will print your debit card on the premises the minute you open your account, not to mention opening on Sundays.
"Some of the elements offered are good value if they suit the way you run your account," says Hagger. "TSB and Tesco both offer good credit interest deals on their current accounts, whilst Metro Bank has a cheap overdraft rate and low-cost debit card when used abroad – in fact it's free in Europe."
But why haven't more people switched over? Challenger banks would presumably be shouting from the rooftops if they were enjoying a torrent of new customers switching in from the big bad banks, but Hagger says he's been surprised how cagey most have been about numbers.
"I'm surprised that they don't want to show their hand and let the industry see just how much of a slice of new business they're actually taking in the ultra-competitive current account market."
Some have come forward: Metro Bank claimed last summer to have 360,000 customers. But compared to Barclays' 16.7 million that isn't much. You also have to question whether that number will be enough to cover the cost of running 34 branches.
Challenger banks are very popular in theory: even the government's Treasury Committee, usually ultra-sceptical of the banking sector, has called for more entrants to the banking market to increase competition. The Financial Conduct Authority, the regulator, is also all
for increasing competition as the best way to keep banks focused on their customers' best interests.
The Treasury also acknowledged in a report recently that "inadequate competition in bank- ing is a long-standing problem."
But it's slow going. Outside of current accounts, new banks are having problems lending money to small and medium-sized enterprises. The government's Competition and Markets Authority found that in 2014,
the market share of banks outside the top five players was less than 5%. It concluded that the evidence indicates newcomers are not yet powerful enough to really live up to the name 'challenger'.
Andrew Tyrie, chairman of the Treasury Select Committee, says: "Millions of consumers and small businesses have been getting a poor deal for decades because of a lack of effective competition and genuine choice in banking."
But now there is innovation out there. Metro offers a very low overdraft rate, long opening hours, and a debit card that is printed on-demand and free to use in Europe; Shawbrook consistently has among the best savings rates; and Tesco Bank – which has admittedly been around for years but is included here because of its innovative stance – offers competitive rates for mortgages, personal loans and credit cards and even gives customers Tesco Clubcard reward points (see the six challenger banks below).
But challenger banks also face a number of hefty obstacles, despite a government and a regulator that both want to encourage new entrants to liven up competition.
Six challenger banks at a glance
Age: Four years eight months. Delivery method: Store, online, mobile app, telephone.
Best savings rate: 2.25% on a five-year fixed-rate Isa.
Star product: Personal current account opened in 20 minutes with debit card, PIN, cheque book and internet banking set up.
Aimed at: Branch lovers – the only bank open seven days a week, 362 days a year, from early to late.
Contact: 0345 080 8500
Age: Seven years (preceded by Tesco Personal Finance from 1997).
Delivery method: Online, phone and in Tesco stores.
Best savings rate: 3% Junior cash Isa and 2.6% five-year fixed-rate saver.
Star product: Tesco Bank current account.
Aimed at: Tesco customers.
Contact: 0845 678 5678
Age: Four years.
Delivery method: Via intermediaries, online and post
Best savings rate: Five-year fixed rate bond at 2.8%.
Star product: A range of fixed- rate bonds and notice accounts
Aimed at: Savings and loan customers.
Contact: 0845 266 6611
Age: Two-and-a-half years (preceded by 30-year-old M&S Money).
Delivery method: Online, telephone and in M&S stores.
Best savings rate: 6% gross monthly savings account, available to M&S current account customers (save up to £250 a month).
Star product: the M&S current account – £100 interest-free overdraft, £100 M&S gift card on switch, M&S loyalty points scheme.
Aimed at: M&S customers.
Contact: 0345 900 0900
Age: One-and-a-half years in its current form.
Delivery method: Online, telephone or in-branch.
Best savings rate: TSB's Young Saver and Junior cash Isa both offer a 3% interest rate.
Star product: TSB's Classic Plus account pays 5% interest rate 'with none of the funny stuff'.
Aimed at: No specific target demographic.
Contact: 0345 975 8758
Age: Almost six.
Delivery method: Online, telephone and post.
Best savings rate: 2.5% on five-year fixed-rate bond.
Star product: One-year fixed-rate bond paying 1.6%.
Aimed at: Average saver age is 60 plus, but they're not picky.
Perhaps, following a couple of high-profile banking failures in recent history, customers are afraid to park their money with an unproven upstart. What if they fold? Well, fortunately this fear is not really justified: any bank that accepts deposits from consumers is covered by the Financial Services Compensation Scheme. This means that if the bank in question goes bust, up to £85,000 of your deposited money will come back to you.
Steve Davies, head of retail banking at PricewaterhouseCoopers, says there are three other major barriers to entry for baby banks.
First, there's the overbearing regulatory structure that has been beefed up since the financial crisis. The Financial Conduct Authority and its sister the Prudential Regulation Authority seem to want two different things – more banks coming to market to increase competition and 'consumer outcomes', and at the same time tighter banking regulation with more hoops to jump through and larger capital reserves.
The powers that be have admittedly lowered this last slightly in the past few years, but it remains a significant hurdle.
"You need to have the financial capital and infrastructure to manage the complex regulatory structure in the UK," says Davies, "which lends itself to running a scale business.
"The UK has a very aggressive regime around managing conduct risk, and it would appear that that regime is also starting to act as a barrier to innovation because existing banks are very focused on righting the wrongs and worried about creating trouble with the regulator; I don't think that is a good outcome for society."
The second factor is something you and I might never consider – the way transactions are completed. Some countries have a single central, publicly owned 'payments utility', a network dedicated to securely processing transactions; but in the UK this infrastructure is owned by the big banks.
"If I want to access that infrastructure I have to go to one of the big banks and say can I do this through you, and they will say of course as long as you pay us," says Davies.
However, a new authority named the Payments Systems Regulator launched on 1 April, and could potentially lead the necessary change in this respect.
Thirdly, and something of a bugbear for Davies, there's the barrier of the cultural expectation of banking being free. Of course what's free to us is not free to the banks, and who will switch from a giant to a challenger if it means paying several pounds a month?
"If I'm a challenger bank I have to offer a current account. But 80% of us don't pay anything for current accounts. You need scale, you have to get a certain critical mass of customers before you can even think about breaking even," Davies says.
These hurdles make it difficult for a new bank to challenge the big boys. But according to Davies, the next generation of banks might operate in a more fragmented sector: one perhaps concentrating on a great savings rate, another on digital payment systems, yet another on mobile technology.
The one-size fits all model of banking is powerful, but it is also unwieldy. On one hand, how can a small bank possibly compete in this cutthroat market? On the other hand, anything that puts a fire under the complacent giants and compels them to actually care about public perception and customer outcomes is something history has shown we desperately need.
This feature was written for our sister publication Money Observer
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Issued by a bank as part of a current account and, in a nutshell, serves as electronic cash. Unlike a credit or charge card, where you get an interest-free period before you have to settle the bill, the funds spent on a debit card are withdrawn immediately from your current account. Unless you’ve arranged an overdraft, if you don’t have the cash in the account, you can’t spend it.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.