Are challenger banks challenging banking?

No longer new entities in the banking space, challenger and neo banks are now acquiring significant market share in the banking world. In fact, the Compound Annual Growth Rate (CAGR) of these banking sectors currently stands at 46.5% - a not so insignificant portion of the market. And with this set to increase further – to over $394m by 2026, no less – traditional banks can no longer deny that challenger banks are here to stay.

But with that said, what sets challenger banks apart from the traditional banks that are suddenly feeling the heat?

The differences between challengers and traditional banks

Firstly, the biggest difference between neo and challenger banks and their incumbent competitors is their physical presence. Neo and challenger banks tend to be entirely digital, cloud-based enterprises that utilise web platforms and mobile applications as their main points of customer contact.

In direct opposition to this, traditional banks are burdened with legacy technology and infrastructure and still take up significant space on the high street. But while this was once an advantage, the coronavirus crisis has proven how these kinds of physical structures are more prohibitive these days than beneficial.

For example, as the pandemic caused lockdowns across the world, challenger banks were relatively unaffected, as their customers were already used to managing their finances with an entirely digital first experience. As a result, challengers can be defined by their flexibility, scalability, and customer centric approach, in that their customers have a method of banking that fits entirely around their lifestyle. 

The rise and growth of challenger banks

The challenger banks currently leading the way include the likes of NuBank, a Latin American start-up that acquired 15 million customers in 2019, Chime, a US neobank which quadrupled it’s valuation in less than a year to $5.8 billion from $1 billion in March 2019 and Revolut, one of the first challenger banks to launch and arguably one of the most well-known challenger brands in Europe which is now valued at $5.5 billion.

However, in the last decade there has been an enormous influx into the market, with other challengers rising in the ranks, including Monzo Starling, N26, Monese and SoFi to name but a few.

With their flexibility, accessibility and digital nature having ensured that their presence is here to stay, challenger banks have gradually won over swathes of customers from traditional banks by offering a wide range of value added services and add-ons in addition to un-rivalled customer service.

Furthermore, challengers don’t just provide a current account for users, but they also offer features that help customers with money management, often homing in on specific needs of customers that are self-employed, or like or need to travel extensively. As well as this, they tend to target the certain financial challenges facing SMEs, utilising open banking, banking as a service and PSD2 to provide solutions that far outstretch their traditional banking counterparts.

How has Covid affected these nimble entities?

Despite their digital first approach, challenger banks since the beginning of the pandemic have witnessed declining app downloads. Conversely, traditional banks like Lloyds and TSB have seen the opposite and have gained greater interaction with their online banking platforms, not necessarily because customers want to interact with their banks digitally but rather needed to during the pandemic. And with the convenience of online banking being experienced first had, this trend is set to continue.

Moreover, there is still a perceived level of safety associated with incumbents which challenger banks have yet to conquer. Customers of challenger banks tend not to deposit large sums of money into their accounts but rather use their card abroad due to the very competitive exchange rates and for smaller purchase with their ‘spare change’ transferred from their main bank account. The likes of Monzo, Startling and Revolut rely on card transactions to generate revenue and the global lockdown has abruptly stalled travel plans and small purchases such as eating out, subsequently pausing their growth momentum.

Are challenger banks really acquiring significant market share away from incumbents?

There are currently an estimated 100 challenger banks in operation globally, and it’s clear to see that traditional banks are feeling the pressure. As such, there is a rising need for traditional banks to develop strategies to minimise the erosion of their place in the market they once dominated. However, for the moment, legacy banks are relying on there being certain challenges to inhibit the challenger banks becoming the primary bank account and financial provider of choice.  

For example, certain customers who have always used legacy banks will be harder to persuade to switch. And while legacy banks already have their roots firmly planted, challengers don’t just need to convince customers to switch, but they need to implement a differentiated growth strategy while simultaneously not overstretching themselves. Not only this, but they also need to consider how to become financially viable on the trajectory from start up to scale up and beyond.

What is the future for challenger banks?

It’s clear then that challengers and neo banks have set certain expectations and standards which are well and truly here to stay and will continue to be expected within the banking industry. Not only this, but they have the potential to become a formidable presence in the banking space, if they can gain the required confidence, trust and market share which expands beyond millennials and early adopters. If this can be achieved they have the potential to overshadow the legacy banks that have stood their ground unchallenged for decades.  

All this to say, it’s no longer a question as to whether digital banking will one day be the norm. However, whether traditional banks crumble under the pressure that challenger banks are continuing to place on them, or hold their own and maintain their market share…  only time will tell.