Challenger banks have struck a chord with customers and investors alike as the tech-savvy and more nimble alternative to traditional financial institutions. Also known as neo banks and upstarts, challenger banks are a product of the financial technology (fintech) revolution born from the financial crisis, and no single group poses more of a threat to their legacy bank counterparts.
Young customers are among those flocking to upstarts but they’re not alone. Challenger banks also cater to workers in the gig economy who sometimes get left out in the cold by the big banks, offering features such as credit, bill tracking, and income tools that support the freelance lifestyle. Other customers are simply those who have “lost faith with institutional firms” on the heels of the global recession.
Upstart banks have disrupted traditional finance for good reason. They offer all of the familiar products that consumers have come to expect, such as checking, savings, credit and debit cards, insurance, and more, while streamlining the products in a convenient mobile package.
In some cases, challenger banks are also providing greater fee transparency or cutting out fees altogether. One way they can avoid charging fees is to instead take a cut of the Visa interchange fee on a debit card.
Big investors, meanwhile, including venture capitalist are increasingly choosing to back challenger banks, valuing them as unicorns in the billions of dollars for their popularity and ballooning number of new accounts. According to CBInsights, “startups disrupting retail and commercial banking” attracted $1.72 billion to their coffers in the 10-month period through October 2018, which is more than half of the total raised over the last five years.
However, high street banks tend to not do themselves any favors when it comes to competing with challenger banks. For instance, a recent all-day outage at Wells Fargo was a better marketing campaign for their smaller and mobile-friendly competitors than anything challenger banks seemingly could have designed themselves. On the heels of the outage, digital upstart bank Chime reportedly welcomed close to 10,000 new accounts, which set a new record for the challenger bank.
This lesson is not lost on traditional banks. According to a recent study by Fraedom, more than three-quarters, or 86 percent, of bankers consider challenger banks a threat to their business. In fact, more than 40 percent of bankers polled identify challenger banks as the single biggest competitive threat to their business. Challenger banks continue to fill a void in the market that has been left by their larger banking counterparts, mostly due to the former’s ability to adopt digital technologies while traditional banks’ growth is stifled by legacy systems whose maintenance alone eats up most of the tech budget.
Now that financial services has been disrupted by fintech, legacy banks realize they must invest millions of dollars in technology to remain relevant. One way they are doing this is to partner with challenger banks, which is an emerging trend that could catch on.
N26, which is a Germany-based upstart mobile bank, wants to become the “Netflix of banking.” This means that they have a global expansion in their sights including the U.S., where they plan to make a mobile banking push. N26 is reportedly teaming up with an undisclosed U.S. bank for the expansion in the second half of this year, though the details are sparse. Their U.S. offering will revolve around an app that aggregates all services—from peer-to-peer payments to checking to debit.
Regulatory Headwinds and Tailwinds
Challenger banks first took the U.K. by storm after the financial crisis and they have since expanded into other jurisdictions. One of the reasons for their growth is said to be a friendly regulatory environment around the world that is making it easier for them to set up shop. But that doesn’t mean that challenger banks are not facing any growing pains.
While research suggests that it has become easier to launch a challenger bank since the financial crisis, newcomers continue to face an unlevel playing field, particularly in the U.K. Reports suggest that challenger banks face a “glass ceiling”, one that is a function of rising costs and a higher concentration of the region’s biggest lenders today versus before the financial crisis. These dynamics have given legacy banks an advantage and in the U.K. ”barriers to entry” have reportedly been replaced by “barriers to growth.”
Despite the headwinds, challenger banks have already succeeded in disrupting the financial services landscape, andnd they are lightyears ahead of their incumbent banking counterparts with technology. While the playing field is still taking shape, challenger banks are sure to be considered players to watch for the foreseeable future.