When faced with disruptive competition – the now classic example is taxi companies and Uber – a firm at risk of disruption has effectively got three options:

-          Adapt; use the facilities available to you today to try and stay competitive. For example, offer discounts or change pricing;

-          Add; create new capabilities, either by yourself or in partnership with others, to offer competition at or above the level of the new challenger;

-          Acquire; buy the disruptive competitor and integrate their capabilities into your own.

Incumbent banks have been successfully disrupted over the last five or so years by a small stable of innovative challengers, Monzo, Starling, Revolut, N26 etc. Following the financial crisis of 2007/2008, regulators sought to lower the risk of future bank failures by stimulating competition. EMI licenses to offer ‘entry-level’ financial services – such as prepaid cards – were made available, and in the UK in particular, an efficient and well-supported application process drew in entrepreneurs who saw the chance to disrupt. The disruption from challengers was, and is, based on customer-focused experience design and a more modern tech stack to support those experiences. A simple example is real-time spend analytics; a highly valued service, which is impossible to deliver if you are using a legacy banking platform that batch process debit account transactions once or twice per day. 

A recent survey from the Economist Intelligence Unit looking at preferred innovation strategies from major banks shows that the ‘Add’ and ‘Acquire’ options are overwhelmingly favoured.  36% declared an intention to create their own ‘green-field’ challenger banks, and as recently as the 28th of November, Lloyds openly declared an interest to acquire Starling. The decision whether to build or buy is a challenging one for any large company looking to add capability, but in this case, the stakes are especially high.

• Successful challenger banks are quite rare, and their valuations reflect it. Revolut’s series D valued them at $5.5bn and even after a down round, Monzo is still worth over $1.5bn. For a bank to acquire a challenger is a serious investment.
• Successful green-field challengers are rarer still. In fact, all we have so far is some high-profile closures, including RBS and JP Morgan.

This leaves our bank’s preferred innovation strategies looking rather bleak. Either make a large and incredibly high profile acquisition and hope to leverage the brand, UX and tech of a challenger bank through what will likely be a complex merger, or try to make a success of their own greenfield challenger when they have just seen their competition fail to do so.

While this is a real challenge for the banks, it is an incredible opportunity for those who sell relevant services to banks, specifically issuer-processors.

Payment processing and the software that supports banking operations are two essential functions for a challenger, and most of them buy these in from a growing body of suppliers. Companies like GPS, Marqeta, Galileo, TietoEVRY and Paymentology provide processing to a host of challenger banks. These ‘challenger processors’ are especially well placed to help the banks crack the formula for the successful greenfield challenger bank as they’re the very companies that helped support the challenger banks in the first place.

The challenger processors have underserved this opportunity so far – instead focusing on creating developer-first API-enabled platforms to support the typical ‘Fintech CTO’. A lot of work will be needed to create a proposition that will support the banks and help them avoid the pitfalls of Finn and Bo.

The potential prize, however, is huge. While the challenger banks have expanded in many ways quite rapidly, they still represent a small proportion of processed payments in many markets, and a successful greenfield challenger rollout could  become larger than all the challengers put together. This is obviously great from a revenue perspective, but also gives the successful challenger processor a route in to working with tier 1 and tier 2 banks and a way to challenge the incumbent processors who have dominated this space for so long