What does it really mean to be a challenger bank?

… and why does it matter to incumbents.

Challenger banks are the world’s hottest start-up. Banking Tech suggests there are 102 challenger banks in the U.K. alone, three of which have achieved the “unicorn” status of being valued at over USD $1 billion. So, what’s all the fuss about? In this blog we go behind the scenes to better understand what it really means to be a challenger bank.

There’s keen interest in challenger banks, but some confusion as well. Newer entrants in today’s banking landscape include a mix of challenger banks, neobanks, mobile banks, virtual banks and digital banks, all of which promise a new dawn in banking. Are these essentially different ways of describing the same type of institution, or variations on a theme? Opinions differ and agreeing on a “universal definition” is elusive.

It is perhaps more useful to define a challenger bank by what it does. Here, the clue is in the name: A challenger bank challenges traditional banking. How so? Challengers do things differently, they often specialize in areas underserved by incumbents, and they offer a tech-first and innovative approach to banking.

Innovation Born out of Crisis

The genesis of challenger banks can be traced to the 2008 financial crisis. Many blamed the crisis on bad behavior by banks that were too big in size and too few in number. Customers not only lost money, they lost faith in the established banking sector.

Banking authorities responded with a plethora of new banking licenses to expand the playing field, and established new bodies – such as the New Bank Start-up Unit in the U.K. – to guide new firms through the process of becoming a bank quickly and cost effectively. Likewise, legislation (such as PSD2 in Europe) ushered in a new era of open banking, and technology advancements continue to amaze. This confluence of factors revolutionized banking: Challengers were born.

Banking – a Technology Business

Challenger banks harness the power of modern technology to give customers the financial services they want, where and when they need them. In theory this isn’t about technology alone, but in practice banking has largely become a technology business. Technology has been elevated from the back office to be at the heart of everything a modern bank does. Banks have evolved to become technology companies operating within the constraints of a banking license, so a bank’s technology strategy is effectively its business strategy.

Increasingly it is the bank’s technology that determines the customer experience and how customers engage with a bank’s brand. This is particularly relevant for younger customers who are “digital natives” relying essentially (or entirely) on digital banking, but it applies to all demographics. Challenger banks were quick to identify these new dynamics. They use modern technologies to offer truly customer-centric banking – a lesson which incumbents should certainly learn from.

Technology – a People Business

Technology is still a people business. It is designed by people to work for people. And the value and expertise that your employees bring to your bank is integral to your bank’s identity and its outlook. One thing is for sure: The bank’s culture can literally make or break the successful use of technology as a path forward.

New Technology Brings a Cultural Shift

Most challenger banks have a different structure and culture that revolves around the customer. New methods and ways of working revolutionize how technology is developed and managed. Incumbent banks need to learn from this and adopt a fintech approach to develop better software, more quickly.

Agile methods, DevOps and Continuous Development

Unencumbered by batch-based technology, traditional branch overhead, and legacy thinking, challenger banks offer a fresh approach that appeals to many customers. Agile principles and continuous delivery mean that more can be achieved in less time. DevOps teams do not work in isolation but as part of the business, ensuring that technology is aligned with the business. This model has the flexibility to adapt.  But there’s more…

Mighty Microservices

A microservices architecture has far fewer dependencies than traditional IT and can support fast, controlled change. New releases can be deployed into the live environment with no downtime. These new methods and technologies represent a new age of software development that is characterized by delivery at pace with improved quality. This debunks the traditional view of there being an inevitable trade-off between frequent changes and platform stability.

Cloud

Many challengers also harness the power of cloud to drive customer-centricity. Cloud not only lowers the cost of entry for new entities to join the market, it also redefines the role of technology and is the gateway to becoming a data-driven bank. With unlimited computing power and storage, cloud empowers banks to adopt modern technologies, such as artificial intelligence, machine learning and advanced analytics to identify and understand what customers want in real time and to deliver innovative services in context.

Although cloud may be a source of competitive advantage today, it is fast becoming the baseline for any successful digital bank. A well-crafted cloud strategy empowers a bank to extend its reach and enter new markets quickly and cost effectively. Implemented properly, customer relationships become closer which increases engagement and builds loyalty.

Rising to the Challenge

As we’ve seen with the rise of challenger banks, healthy competition is driving the market to the benefit of customers and banks alike. There’s no room complacency in the banking industry. Let’s rise to the challenge – incumbents and challengers have a lot to learn from each other, and clearly this will be the case for some time to come.