Updated on: 08 Apr 2018
What is a challenger bank?
A challenger bank is a relatively small retail bank set up with the intention of competing for business with large, long-established national banks, be it through offering superior service, better deals, or more often than not, a combination of the two. They also tend to get specialized in and target areas underserved by the established traditional banks.
The challenger banks distinguish themselves from the historic banks by modern information technology practices, such as online-only operations, that avoid the costs and complexities of traditional banking.
There are several types of challenger banks:
- Mid-sized full service banks: that are well-known brands, with single-digit millions of customers and between 2,000 and 9,000 employees. They have been moving to digital channels, but believe that physical presence remains important and serve customers with a physical network of up to 600 branches.
- Specialist banks: that have propositions typically anchored around specialist lending and saving for customers who they believe are underserved by others in the market, such as certain types of small and medium-sized enterprises and the buy-to-let market. They generally have very limited physical presence, placing more emphasis on call centres, third party distribution channels, some regional offices and increasingly digital channels.
- Digital-only banks: that recognise the megatrend of customers shifting to digital channels and are building their business to serve both digital natives and converts. They pride themselves on innovative technology platforms that promise exceptional customer experience and engagement, primarily through mobile apps.
- Non-bank brands: that have parent companies that are strong players in other industries, such as major supermarket chains. They have strong and trusted brands, and generally seek to serve the needs of customers loyal to the parent group as a whole.
One common thread: these banks don't carry the weight of legacy technology, so they can leapfrog over traditional infrastructure and disrupt the status quo.
Challenger banks: a global movement
Most challenger banks and neobanks are in the UK, for two reasons. First, Britain isn't as saturated with big banks and their branches as a nation like the US, creating an opportunity for non-traditional financial institutions. Second, the UK was an early adopter of digital banking, dating back to the dotcom era of the late 1990s and early 2000s. That head start has probably helped it lead the shift toward challenger banks and other alternative models.
However, there's a misconception that challengers and neobanks are just a British phenomenon. In fact, they're popping up worldwide. Challenger banks now number more than 100, everywhere from South America to continental Europe to Asia. Brazil has Banco Original and Nubank. Germany is home to SolarisBank and N26; in 2017 the former announced plans to expand into Asia, while the latter is preparing for a 2018 launch in the US, where growth of challengers has been sluggish to date.
Asian players include China's MyBank, backed by e-commerce titan Alibaba Group, and WeBank, launched by conglomerate Tencent Holding; Digibank of India; Vietnam's Timo; Japanese outfit Jibun Bank; and South Korea's K Bank and Kakao Bank.
Unlike their traditional counterparts, challenger banks and neobanks aren't burdened by legacy systems and cumbersome organizational structures such as major branch operations. Because most don't offer a full suite of services, they're also less hampered by regulatory requirements. All of this means that challengers and neobanks are moving ahead faster in developing countries such as China and India, where established brick-and-mortar banks are relatively rare.
So far, most challenger banks have focused on niche products rather than the entire retail banking value chain. Customers can open a checking account with a relatively high rate of return, and may also be able to borrow, but they have to go elsewhere for services such as credit cards, mortgages and wealth management. These outfits use a variety of business models, but the majority have banking licenses, so clients get the benefit of deposit insurance.
Traditional banks vs challenger banks
Over the past year, so-called challenger banks and neobanks have been making headlines by attracting big venture capital investments. Britain's Monzo raised US$93 million in November 2017, building on a $27.5-million financing round during the first quarter. Earlier in the year, Atom Bank, a fellow UK challenger, pulled in a total of $140 million. A third British startup, digital-only Starling Bank, announced in September that it was raising $54 million in fresh funding.
Traditional financial institutions aren't asleep at the switch when it comes to these new kinds of banks. A couple of years ago, there was concern that fintechs and digital startups would replace blue-chip names, but that hasn't happened. Instead, mindful that millennials have no interest in visiting a bank branch, some legacy firms are launching nimble digital banks of their own that could pose a threat to independent challenger startups.
Take Goldman Sachs, the ultra-traditional high-end investment bank, which in 2016 rolled out a digital retail offering called Marcus by Goldman Sachs. Because Goldman is so established, this venture fits the description of a challenger bank. JPMorgan recently unveiled Finn by Chase, a completely digital play targeting younger customers and areas of the US with a shortage of brick-and-mortar banks. With their eye on millennials, who will become more lucrative clients over time, traditional banks are also working to launch digital operations whose branding doesn't include their name.
Challenger banks in Europe
Digital challenger banks have raised more capital than any other FinTech vertical in Europe, totaling nearly $500m since 2015. Mired in controversy, acquisitions, mega-rounds, and mega-write-downs, challengers are now headline news in tech/business press on a weekly basis.
These European phenomena are enabled by new regulations that make it easier than ever to start a bank. Will this emerging breed of challengers displace high street banks? Read on to learn more about:
You can also see below some of the challenger banks in Europe.
Founded in 2013, N26, formerly known as Number26, is a German digital challenger bank aimed at revolutionizing the traditional banking industry.
In July 2016, N26 received its German banking license and simultaneously announced the extension of its financial platform as well as the addition of the bank's first investment product.
The initial N26 Invest product for German customers is offered in cooperation with Frankfurt-based startup vaamo. Customers can use N26 Invest to put their money into portfolios right from the N26 app.
N26 has raised over US$50 million in funding so far.
Launched in Munich in 2009, Fidor Bank is a German digital-only challenger bank that develops banking services and solutions for the digital generation. Fidor Bank launched in the UK in September 2015 having applied for a UK banking license in January 2015.
Licensed in Germany, Fidor Bank serves over 120,000 account holders and some 350,000 registered community members.
In 2014, Fidor became one of the first banks to use the Ripple internet-based payment protocol.
The bank was acquired in July 2016 by France's second largest group for banking and finance, Groupe BPCE for an undisclosed amount.
Headquartered in London, Starling is a licensed mobile-only challenger bank founded by former Allied Irish Banks COO, Anne Boden in 2014.
In July 2016, Starling received its banking license from the Financial Conduct Authority.
Starling focuses on offering a limited selection of services, centering around current accounts. The app, which hasn’t launched yet, will offer alerts for smarter money management and real-time monitoring.
The venture has raised US$70 million in funding so far.
Monzo Bank, formerly known as Mondo, was set up in 2015 by Tom Blomfield following his exit from rival challenger Starling.
Monzo is a challenger bank based in the UK that is known for setting the record for "quickest crowdfunding campaign in history" when it raised £1 million in 96 seconds via the Crowdcube investment platform.
Monzo was granted a full banking license "with restrictions" in August.
Founded in 2013, Tandem Bank is known for being the second challenger bank to be granted a banking license in the UK in December 2015.
The company plans to offer digital services including current accounts, credit cards, and loans via its mobile app and website.
Tandem Bank hasn't launched its app and yet, the company is reportedly valued at £65 million.
Atom Bank is a UK digital challenger bank founded in 2014 by Metro Bank co-founder Anthony Thomson. It received a full license from the Bank of England in June 2015 and launched in full after its regulatory authorization restrictions were lifted in April 2016.
Atom Bank aims at offering mobile personal banking and savings as well as business banking, loans, and mortgages. The startup has raised over US$166 million in venture capital from BBVA, Toscafund Asset Management, Anthemis Group, among others.