My article – It’s time for fintech fight club – underlined major structural and cultural problems with fintech; the big barriers blocking new banks and trammelling true competition. One place where the cards seem especially stacked to prevent incumbents losing is the UK mortgage market. If the fintech fight club metaphor introduced the overarching problem, let’s this time dive deeper into some gritty detail.
First, there are the capital requirement constraints. New banks are automatically granted permissions on a standardised approach to capital requirements. This creates an instant competitive disadvantage when supplying lower risk residential mortgages compared to the established banks, who have internal-ratings-based (IRB) requirements. This is compounded for new banks who are building a balance sheet from scratch, as they tend to be competing for investor capital, which has a higher demand for returns in shorter timescales (hence the reason most new lenders start in higher risk/specialist sectors, or focus on unsecured lending rather than the mainstream residential market).
Then we have the frustrations of funding favouritism. The established banks have enjoyed access to Bank of England funding schemes (Funding for Lending, and now TFS) since 2012, to boost their lending volumes. So, not only do they have lower capital requirements, they have also enjoyed access to cheaper funding lines. Meanwhile, new banks are more reliant on retail deposits for funding while they wait for assets to complete. Smaller players tend to have to offer headline rates in order to build brand awareness and encourage new customers to come to them. This all equals higher costs.
The knock-on effect is that the biggest incumbents can price more aggressively than startups. It presents challenger brands, customers and intermediaries with a nightmare to navigate, while the biggest players keep moving ahead. If it costs a new bank 50 basis points more to price the same mortgage product as a big bank, that equates to £700 a year more for a customer with a £150k mortgage. Not something that could ever be classed as best advice.
Risk management regulations can spark a spiral. If new entrants want to break out of niche sector markets and move to the mainstream, they need to tackle some tough terrain. Specifically, providers need to invest energy and money in securing a higher proportion of low-risk mortgage applications, despite these being the most aggressively priced with the least room to manoeuvre on interest margin. The result creates a less diversified asset profile with a lower return on equity. This in turn, doesn’t help present an attractive proposition to ratings agencies, and further funding lines become more expensive – a perfect storm.
Despite the barriers, new brands such as Atom Bank are using their digital advantage to battle their way to some success. I sat down with Maria Harris recently, Atom’s mortgages director, who explained how to approach an unfair fight:
“With no back book of customers sitting on standard variable rate (which tend to have a much higher net interest margin), the only way for new banks to effectively compete is to be quicker, slicker and more cost-effective using digital technology to automate large parts of the process,” she said. “It’s important to deliver a self-service model to the customer, not having an expensive branch network, and keep overheads to a minimum.”
Everyone can see that the fight isn’t fair. Listening to the incumbent lobby is a habit regulators can’t break. Yet, despite what amounts to a mortgage market misfeasance, digital brands are learning how to fight, and some of them are getting rather good. The low-cost, highly automated competitors are coming.
So perhaps it isn’t all bad news? When you’re forced to learn your craft fighting with one hand tied behind your back, while your opponents get fat hiding behind their friends, perhaps digital brands will emerge fitter and more focused for when the rules of the fight finally become fairer.
LISTEN TO: Guy Shone and Shaun Weston discuss the ‘fintech fight club’ …
Image by Suat Gursozlu, Shutterstock.com