New banks shed ‘challenger’ label and target specific customer needs using data treasure trove - PwC

So-called ‘challenger’ banks are casting off that tag as they continue building their market share by focusing on customers who prefer multiple accounts in order to get the best deals, fresh analysis from accountants PwC has revealed.

The “Who are you calling a challenger?” report, produced in collaboration with the BBA, revealed some CEOs of these organisations said being their customers’ primary bank was not their main focus. Neither were they trying to replace the main high street banks as current account providers- rather they were looking to pinpoint customer needs currently being underserved.

Challenger banks can range from new ‘digital’ banks offering specific online services, to banks that have emerged from players in other industries, such as major supermarket chains with strong and trusted brands and an extensive archive of customer data.

These organisations have a significant presence in Scotland, including CYBG, TSB, Virgin Money, Sainsbury’s Bank, Tesco Bank and Hampden & Co.

PwC also surveyed more than 2000 consumers.

When asked to choose, 54 per cent said they would prefer to bank with multiple providers in return for the best deal on products they offer. This was compared to only three in 1o (30 per cent) who would bank with just one provider even if it meant they might not always get the best deal.

Branches are still important for the majority of customers across products – 68 per cent of customers think a branch is essential for them to open a new current account vs only 25 per cent of customers who think a mobile app is essential.

Many of the digital players are offering a different type of current account that helps customers control their finances and also access the best value non-banking products from third parties.

The survey evidence forms part of PwC’s analysis, which focused on those organisations typically described as ‘challenger banks’, dispelling some of the assumptions made about this market segment. Alongside the consumer poll, interviews were conducted with CEOs of more than 20 banks in the wake of continuing economic and political uncertainty as the UK prepares for Brexit.

These ‘challenger ’ banks are driving innovation and improving customer service levels in the market, and this has translated into steadily growing market share in retail and commercial lending, the report finds.

Allan McGrath, head of Assurance Financial Services for PwC in Scotland, said: “It’s not necessarily the case that these so-called challenger banks are challenging the incumbents on all fronts but they have enough USPs – either by geography, product specialism or other needs – that they are filling in gaps left by other banks.

“There’s also an acceptance by the challengers that many people don’t want all their banking in one place – they are comfortable with one bank for savings, another for a mortgage and another for a current account. In fact, our survey showed more than half of British consumers surveyed preferred to use a range of banks for different products and services, according to which is best placed to serve them.

“The choice in the UK marketplace is set to grow as well. At least eight new licences are also currently being processed, reflecting the attractiveness of the sector. Additionally PwC is also working with close to 15 firms who are preparing to apply for a banking authorisation. ”

The consumer survey revealed only 11 per cent of customers who switched banking provider in the last three years did so because they were dissatisfied with the level of customer service. 57 per cent of consumers who changed their bank switched due to financial incentives such as better rates, cash incentive, cashbacks and discounts.

A significant number of customers surveyed (39 per cent) would consider opening a financial account with a bank that would share their financial data with other banks and third parties (e.g. Amazon, Apple, etc). In return they would receive benefits such as an overall view of all accounts in a single app, or being able to compare product offers from third parties which are tailored for them (e.g. savings accounts with better rates, cheaper utilities providers, credit card offers, personal loans when getting close to becoming overdrawn).

Ian Logan, head of valuations at PwC in Scotland, said: “While the older banks are dealing with legacy issues a lot of the growth and value creation opportunities lie with the new challenger banks who are jockeying for position in the constantly evolving banking landscape.

“Challenger banks who can tailor their strategies and focus on the following areas, will be best placed to increase their value and deliver strong returns on equity in a low interest rate environment:

“So often value is driven by the strength of intangible assets and this ever expanding part of the financial services sector is no different. A strategy that focuses on aspects of customer loyalty, strong and secure technology and a trusted brand, can deliver increasing value for those players who achieve the greatest success in these areas.”

The ‘catch-all’ idea of a challenger bank masks the very significant differences between many of the banks it attempts to describe, the report finds. These banks can be split more accurately into four broad groups with varying target markets and service models:

Mid-sized high street banks tend to be the banks with well-known brands, with single-digit millions of customers and between 2,000 and 9,000 employees.

Specialist banks have propositions anchored around lending and saving for customers who they believe are underserved by others in the market, eg certain types of SMEs and the buy-to-let market. They normally employ 500-1000 staff and serve hundreds of thousands of customers.

Digital only banks, which recognise the trend of customers shifting to digital channels and are building their business to serve both digital natives and converts. They typically have fewer than 150 employees and fewer than 100,000 users.

Non-bank brands have parent companies that are strong players in other industries, such as major supermarket chains. They have strong and trusted brands and as a result of their established banking lineage- some started as a joint venture with main high street banks ) can have a significant number of customers (between 1 million and 8 million) and 1,000-3,000 employees.

Bank CEOs surveyed appreciated regulatory efforts to open the market to new entrants and foster further competition, for instance through the recent investigation by the Competition and Markets Authority (CMA) into the retail banking market.

However, they highlighted a number of areas that could drive progress, specifically: 1) less disparity in capital treatment; 2) more regulatory proportionality; 3) increased access to payments systems; and 4) increased transparency of products to improve customer understanding of product value.

By far the most commonly cited structural challenge in our CEO interviews was the regulatory approach to capital requirements, particularly in the mortgage market. For example, regarding a less than 50 per cent loan-to-value buy-to-let mortgage, average internal ratings based (IRB) weighting is 7.8 per cent and current standardised approach (SA) weighting is 35 per cent.

Some banks using the SA model must (relatively) hold up to five times the capital of main high street banks using the IRB model. It is currently difficult for challenger banks to become IRB approved because of the data requirements and significant costs of obtaining and maintaining approval.

Other examples highlighted included proportionality issues around Know Your Customer (KYC) and Anti-Money Laundering (AML) regulation. Currently, the same rules apply whether customers open an account with £200 or £20,000.

Newer banks in particular believe they have performed more KYC/AML checks than they feel are productive. Others argue that the pace of regulation has not kept up with the way in which challenger banks operate.

In terms of the future, Open Banking is set to drive a fundamental change in the banking landscape, giving rise to new business models, with some providers choosing to specialise in narrow areas rather than offer a traditional suite of products or attempt to manage the customer’s end-to-end experience. Some may compete by making it possible to integrate niche offerings from a number of different companies in a seamless way.

John Lyons, head of retail and commercial banking at PwC, added: “To be successful, each bank needs to overcome specific -and not insignificant- challenges. For example, mid-tier high street banks face pressure to transform their operating models and differentiate their propositions, while digital-only players seek to build awareness with customers and attract them with distinctive service offerings.

“Open Banking is set to drive a fundamental change in the banking landscape. If the regulators take action to further develop competition, the future market will be increasingly varied resulting in a very different banking experience for customers. While new players must work hard to prosper, we believe there will be room in the market for many different banks and non-banks to succeed.”