Nick White explores the challenges facing startups and neobanks disrupting consumer banking with digital-only services and business models.

Attempts to shake up the stagnant consumer banking sector come in waves, it seems. In the 2000s, brands such as Virgin Money and Metro Bank emerged to challenge the big four banks by providing customers with more innovative products, better customer service, and a branch experience that broke the mould in terms of accessibility. The 2010s have seen a second batch of new, digitally-focused banks arrive on the scene with the aim of disrupting established players whose products and services have remained to all intents and purposes unchanged for decades. Even online banking has so far amounted to little more than transplanting generic services into the digital environment, with little thought as to how that environment might facilitate the delivery of new, more useful services.

London has emerged as the epicentre of this second wave of challenger banks, as a raft of startups have been emboldened by a progressive regulator’s efforts to encourage greater competition in consumer banking. Increasing numbers of companies are applying for banking licences, which have become easier to obtain – 15 have been granted since 2013, and a further 20 companies are understood to be in talks or are going through the process. Even organisations from outside of banking and financial services are weighing up potential opportunities arising from the CMA’s recent recommendations concerning open banking.

Increasing numbers of companies are applying for banking licences, which have become easier to obtain Click To Tweet

Four British banking startups, their business model characterised by a digital-only approach to consumer banking, have been given the label ‘neobanks’. These companies have attracted particular attention in recent time, held up as examples of the wholesale digital transformation that will disrupt consumer banking. Yet, despite their popularity among early adopters of digital services, and some considerable media hype, how much of a disruptive impact are Atom, Monzo, Tandem and Starling really having on the market?

Disillusioned customers

Consumer uptake to date has been very limited: in a market of 70 million current accounts – 70% of which are provided by the big four banks – Atom has fewer than 2,000 users (from 40,000 people to have registered their interest in an account) and total deposits of just £18m), while Monzo has issued just 50,000 of its prepaid debit cards (albeit with a waiting list of 250,000), loaded by customers with a total of £45m. The signs from the previous wave of high street challenger banks are not promising: founded in 2010, Metro Bank still has a customer base of just 780,000, and expected to start making a profit only in the second half of 2016.

One explanation is that banking is a sector in which it is notoriously difficult to persuade customers to switch provider. In the 12 months following the launch of a government-backed account-switching service in September 2013, just 3% of UK bank customers changed current account provider. Mostly, customers are disillusioned, feeling that there’s little differentiation between banks’ offerings, and that switching is just too much hassle for too little reward. But when neobanks such as Atom and Monzo promise such a radically different, customer-centric service – with extra focus on helping individuals manage and understand their relationship with money – and spend so much on marketing, one might think that inertia would be less of a problem for them.

Another part of the problem may be, then, that – to borrow an idea from politics – the different neobanks are ‘splitting the vote’, with early adopters divided among them to such an extent that none is able to reach the critical mass required to give them a chance of cracking the mainstream. Neither have the neobanks been helped by what may be thought of as sibling rivalry. Atom has seen competitors publicly question the decision to build its banking service’s mobile app front-end on a game design platform best known as the foundation of Pokémon Go, while Tandem has been subject to speculation as to why it still hasn’t launched a consumer product months after winning its banking licence. Meanwhile, Monzo and Starling have a storied – and public – rivalry dating back to a split between their founders when both working on the former.

Customer inertia

The suspicion remains that, while the underlying ideas behind their services, and their experimentation, and iteration-driven approach, undeniably reflect consumer needs and preferences, and the direction that banking services should be heading in, the neobanks will remain little more than small-time proof-of-concept exercises unless those ideas can be scaled effectively. And that’s another challenge facing the neobanks. Thanks in large part to customer inertia, the cost of customer acquisition is – in comparison to that of the big four, who, in something of a Catch-22 situation, benefit from economies of scale – astronomically high. It’s very unlikely that they will be able to absorb such costs for long enough to gain sufficient traction, even with the significant venture capital backing they’ve secured.

This combination of factors has led many commentators to conclude that the neobanks are doomed to be copied or absorbed by the established players, their early successes showing the way for bigger, better-resourced banks to replicate their innovative approach, products and services at scale. But this simplistic conclusion overlooks one crucial point: traditional banks have so far proved dreadful environments for delivering innovation. For all the hot air and ‘innovation theatre’ that has swirled around about labs, they have shown precious little appetite or aptitude for delivering genuine innovation into the hands of customers. It would take a brave commentator to predict success for a neobank going down this path.

Traditional banks have so far proved dreadful environments for delivering innovation Click To Tweet

My colleague Lee Cameron has written elsewhere about the parallels between the brand concession model employed by department stores and the integration of fintechs’ capabilities into traditional banks’ offerings. While this approach works when a fintech is providing part of the service that a bank provides, and doing so in a better way, it’s much less likely that banks would integrate a neobank – which is challenging their core current account business, the bedrock of their customer relationship – in the same way.

It has been suggested that, rather than acquire and absorb neobanks, the big players might instead use their resources to launch their own, independent from their existing brand. Such ‘greenfield’ banks could serve as a testing ground for innovation, with customers gradually migrated from old services to new if they prove successful. But, as Chris Skinner notes, this idea is every bit as liable to fall foul of banks’ innovation aversion as the acquire-and-absorb approach.

More realistic is that neobanks – with the backing of investors and enthusiastic customers as advocates – survive and continue to influence the direction that their traditional counterparts take their product and service development in, without emerging as major threats over the short- or medium-term. They may establish themselves as the primary financial services providers to today’s digital native generation as it grows up, but staying around long enough to see this evolve into mass market adoption will require more investment in scale than some newer players will be able to afford.

READ NEXT: The rise of the neobank

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About the author

Nick White

Nick White is senior vice president, group product marketing, at monitise. He's globally responsible for all aspects of product marketing and propositions development for clients and partners, including Santander, Visa, Mastercard and RBS group. He started his career with Barclays as a business and product development manager, responsible for a range of early web-based services including Barclaycard's first online account management services and BarclaySquare, the UK's first online shopping mall.

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