The rise of challenger banks has been a particular hallmark of the fintech industry over the last decade. Created to disrupt the traditional banking sector, challengers are full to the brim with innovative, often digital offerings aiming to serve customers in a variety of ways. With the customer taking centre stage and newfound co-operation with incumbents, this month we explore some of the classic attributes of challenger banks and their efforts to stay one step ahead of the industry.
Having discussed and dissected a multitude of challenger bank topics during the month of April, today we’re concluding our coverage of the industry’s biggest disruptors by posing the all-important question, ‘what is the future for challenger banks?’
According to David Royle, chief operating officer and MD of financial services consulting for SRM Europe, challenger banks must demonstrate both profitability and relevance in their services if they are to successfully compete with incumbents in the future: “The road ahead is many forked, and in some instances, yet to be built. Challenger banks must continue to develop and broaden the relevance of their service offering, so they become more relevant and trusted by more customer segments.
“They will have to compete hard against other banking segments, as well as contend with the next wave of fintechs who could redefine challenger status altogether – embedded finance, wealth management, AR, crypto and digital currencies to name but a few.
“We long anticipated there to be a natural cycle with many of the digital challengers being acquired by the banking mainstream, however inflated valuations and high street banks upping their digital game has constrained this avenue, no doubt to the disappointment of many digital bank founders.
“As such, establishing profitability becomes the defining step, and investors will back innovation and disruption for many years, but the ultimate success stories will be those who can be self-sustaining and continue to grow, which becomes even harder.
The early adopters and those attracted to a differentiated proposition will already have been tempted to open accounts, albeit most will have kept their traditional banking relationship alongside. The challenge remains how to acquire the next wave of customers and persuade them to leave their traditional banking comfort blanket.”
Doing it differently
As explored here by Mike Kraus, principal of CMFG Ventures, challenger banks must facilitate services that will be entirely new to the consumer, and that they should find a niche within the market if they are going to survive within it: “Challengers hold an advantage by having lower operational costs and speed to market. The question is whether those advantages are enough to hold off the large incumbents with seemingly endless resources. Challengers will continue to chip away at market share but may see increasing competition from non-bank consumer brands such as Amazon, Apple and others.
“As of December 2021, there were 256 challenger banks worldwide according to data by Exton Consulting. While a challenger can launch with relatively low capital requirements, scaling is an entirely different story. In the coming years, we’ll find out which challengers have a differentiated value proposition for customers and are therefore able to grow profitability.”
Embedded for better
James Butland, VP of Financial Partnerships, EMEA at Airwallex, anticipates a future of embedded finance and more personalised offerings: “The future for challenger banks will be creating a holistic experience for customers and businesses.
“This means, embedding more financial products and services into their core business models, which in turn will empower a seamless payment experience for customers.”
Philipp Buschmann, co-founder and CEO at AAZZUR, largely agrees with this opinion; adding: “I see the future where banks will still be there, but day-to-day banking will be done by challengers selected via the personalised products they offer.
“Savings and the bulk of the money will be parked in incumbent banks that are trusted and have longevity.”
A testing time
Daniel Haisley, EVP of innovation at Apiture, considers what the future of the industry will look like from both sides of the table, stating: “Challenger banks fall into two primary categories:
- “Traditional institutions working on a digital transformation. These institutions are using the challenger brand to kick the tires on new technologies, new target demographics, and new products. We expect to see the number of entrants in this space continue to rise as the path to success becomes well-trodden.”Most financial institutions are looking for a way to either get out and/or stay out of the malaise of commoditisation. Some will be successful, and you’ll see the traditional institution adopt the then-tested strategy, technology, and customer base of the challenger.
- “Non-chartered institutions who want to change banking from the outside-in. Unencumbered by existing technical debt or expectations of an already-situated customer base, these entities will continue to work to define new communities of customers who are otherwise disenfranchised by the status quo of the banking landscape.”The challenge for these entities will be whether they can establish a sustainable business model in time, particularly as it increasingly appears we’re headed for economic headwinds where capital may become less accessible, and rates will continue to increase. The winners here will be those who develop strong bank partnerships to access deposit insurance as a means of driving down the cost of capital, and then the choice few who succeed in making the move to themselves get chartered.
“We saw this with marketplace lenders in the most recent decade where a deluge of entrants results in a few winners, a few high-flyers being sold at deep discounts to their peak valuations, and most falling to the wayside.
“Overall, we anticipate seeing a continued proliferation of challenger institutions, particularly as open banking drives standards across the industry. Those spun from larger institutions will be seeking to funnel learnings back to the mothership, while those independent, non-chartered institutions will be striving to find the business model that ultimately delivers the margins needed for a sustainable institution.”
A turning point
Ahmed Karsli, the founder of Papara, closes our conversation with: “With technological efficiencies at their core, and unconstrained by the legacy systems traditional banks have built themselves on, the pandemic has been a defining moment for neobanks. From first-hand experience, our customers have valued the speed and ease with which we have been able to adapt to their quickly changing needs in comparison to incumbent providers, which we believe has been the key catalyst for our growth.
“However, as we emerge from the Covid-19 crisis with more digitally evolved consumer habits, there will be a turning point for the sector whereby challenger banks will in fact form the majority of the banking industry. Challenger banks will need to ensure they are truly at the cutting edge of technological innovation to ensure they remain just that.”