Banking of the future: up to the challenge?

Ollie Middleton looks at how the rise of challenger banks is accelerating the digitalisation of banking.

Even ten years ago, the idea of smartphone-only banks would have seemed revolutionary. For many people, however – particularly the under 40s – this is now very much the new normal, with regular trips to cash points and local bank branches increasingly few and far between.  

While traditional banks now offer customers the option to manage their money using an app, the digitalisation of banking has been accelerated in recent years by digital-only ‘challenger banks.’ Even if you don’t have an account yourself, the chances are you’re familiar with the likes of Monzo, Revolut and Starling Bank, which are very quickly becoming household names.  

These digital banks are attempting to mount a serious challenge to the dominance of the traditional high street banks, growing 32% between 2016 and 19. 

Unlike their high-street rivals, digital banks offer an app only service, which tend to provide a range of other helpful services, like budgeting tools and a messaging service to get quick and easy support and advice. Young people have been particularly drawn to the new offer, with one in four people under the age of 37 now using a challenger bank.  

Despite surges in the number of people opening accounts with one or more of the digital challengers, however, their traditional competitors still remain dominant with an 87% market share. 

But changes in behaviour as a result of the COVID-19 outbreak could accelerate the move towards an increasingly digital banking system.  

In the short-term, more people will likely transition to managing their money digitally, especially given the Government is encouraging people and businesses to avoid handling cash. Moreover, many people will be keen to avoid visiting their banks in person, even as the lockdown eases. 

Despite this, digital banking is not immune from the coronavirus downturn, with challenger banks’ collective app downloads falling by 23.38% by the end of March 2020, compared to the previous month. Questions also remain over the ability of challenger banks to overcome longer-term regulatory hurdles, such as limits on amounts they’re able to lend to their users, and attracting enough customers – a particular problem for the over 55s, who are still unlikely to use challenger banks. Traditional banks are also upping their game with their own digital services. 

Policymakers have expressed concerns about the risks of a generational or urban/rural divide and a potential increase in financial exclusion among some groups. In 2018, a row over local RBS branch closures gained significant attention among MPs, with a parliamentary inquiry launched following concerns about the impact on rural areas. One of the key factors RBS cited for the closures was that “more people are choosing to do their banking online.” This trend has only continued since then. 

The perception that the digitalisation of banking is leading to financial exclusion underlines the need for challenger banks to position themselves as part of the solution, identifying ways to increase access to banking through technology and providing tools to help people better manage their money.  

One such positive contribution has been the role challenger banks have played in helping to get money to businesses hit by COVID-19. In April, the British Business Bank – the UK’s state-owned development bank  - approved three challenger banks to administer and deliver the government’s emergency coronavirus loan scheme to small businesses. 

While a wave of challenger banks have been able to enter the market in recent years, many have highlighted concerns that the current regulatory landscape tends to favour the incumbent banks. The founder of Starling Bank, Anne Boden, has previously said regulation provided a significant “barrier to entry” for Starling, which was the first digital bank to provide a current account in the UK. Starling and others have also pointed to the challenge of securing banking licences.  

Time will tell whether the UK’s digital banks can mount a sustained challenge to their traditional rivals and whether the coronavirus pandemic will help or hinder their growth. There are clearly a number of policy challenges to overcome. But with most trends pointing towards increasingly digitalised societies and challenger banks still reporting year-on-year growth, the long-term trajectory remains positive.