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It is time now for neo banks to enter the Matrix

By Alistair Kellie
26 August 2020

By Alistair Kellie, Managing Partner

After the Global Financial Crisis (‘GFC’) in 2008/2009, there was a flurry of neo or challenger banks which were established off the back of policymaker demand for greater competition and more flexible finance, both to individuals and businesses.  We’re all familiar with names like Metro, Starling, Revolut and Monzo which all launched with great fanfare and slightly different business models.  But are they capable of competing with the incumbent banks as we enter another period of economic uncertainty, or are CV-19 related policies unintentionally working against them?

Ahead of the pandemic, the neo banks were claiming to be sweeping-up customers (particularly millennials) and businesses which were weary of their existing bank.  Dynamic marketing, ease of access and genuine mobile banking made them attractive to many.  So with lockdown preventing people from visiting branches and a surge in remote working, it would follow that CV-19 has accelerated the move away from the incumbents to these new offerings.  After all, in most other walks of life experts have spoken of anywhere from a three to ten-year leap forward over the last six months in terms of technology and digitalisation.  But it’s not yet clear if this is the case.  

Pre-pandemic many customers have been happy to open an account alongside their existing high street account, but few have placed deposits of any significance with the newcomers.  It’s difficult to see how this might change in the next economy.  Meanwhile, lending levels have been lower and often regarded as being higher risk than the high street banks.  At the same time, brand awareness of these neo banks is tiny (despite significant spend in some cases) when compared to incumbents which have been around for centuries. Added to that are a number of unfortunate governance and funding issues which have done little to build public trust and confidence in neo banks.  What hope for them during the stormy waters after the Global Health Crisis?

First Monzo.  It reported a loss of £113.8 million - significant by any measure and of such magnitude that the chief executive stated that there were now questions as to whether it would stay afloat.  It reported that lending amounted to just seven percent of its asset base, principally in overdrafts, and this is despite sitting on deposits of some £1.4bn from three million customers.  Indeed, it only started lending properly in 2019. 

The Monzo news came months after Metro Bank had some widely publicised issues. Even pre-CV-19, Metro had a number of problems and then a tough start to 2020 when in January it was investigated after it was revealed that it had misclassified the risk of around 10 per cent of its loan book, which left it needing to raise £375million from investors. It then lost its Chief Executive and Vernon Hill, its co-founder and chairman.  At a time when branch banking has been in decline, Metro’s stated aim of 200 branches by 2020 rings a little hollow.  The health crisis will only accelerate bank branch closures…with some 3,500 bank branches already closed in the UK market over the last five years. 

Revolut has not yet provided an update of its financial performance during the pandemic, but has already cut 60 staff and offered a share swap scheme for employees to trade in part of their pay packets in exchange for a stake in the company. 

In contrast, Starling Bank appears to have dodged the coronavirus meltdown and is on the verge of profitability and international expansion.  It now has over 1.5 million accounts in total, with almost 200,000 SME accounts and 1.2 million retail accounts with deposits totalling £3.05 billion at the end of July. Starling says it has grown customer accounts by 130 per cent since the start of the year.  Whilst it was able to avoid furloughing staff over recent months, it saw a 15-20 per cent decline in activity, according to Anne Boden, CEO.  The company’s 2019 accounts show the bank’s losses widened from £26.8m to £53.6m, while turnover grew from £14.2m to £23.9m in the same period.

Banks have had an opportunity to expand during the crisis.  For instance, Starling was chosen by the British Business Bank to operate under the government-backed Coronavirus Business Interruption Loan Scheme (CBILS) earlier this year which has helped to drive up its revenues.  But instead it appears that the incumbent, traditional banks have made up some lost ground.  The Big Banks benefited from access to direct funding from the BoE.  Alternative lenders argued that the design of the Government loan schemes have reduced competition in the SME market. The schemes forced some companies to move their banking relationship to the incumbents where it would be easier to get this type of loans.

At a time of considerable uncertainty, the high street banks have had the brand awareness, scale and financial stability to provide greater assurance to existing and potential customers.  

As we hopefully continue to emerge from CV-19, there’s clearly going to be demand from customers for innovative, digital banking platforms and from businesses for agile and flexible finance facilities.  The opportunity then for those neo banks that survive will be to demonstrate why they are even more relevant and to continue to push the boundaries in terms of customer service and technological engagement.   The challenge is getting customers to switch, and greater use of open banking maybe the answer. Digital business banking platform, Tide is proposing that in the future, SMEs can use its banking platform and all its functionality without switching their accounts

If the neo banks fail to harness the opportunities offered by open banking, explainable AI and other innovative technology, the incumbents will continue to dominate.  I still dream of a single financial services platform where I can transact across savings, investments, pensions and loans in a dynamic Matrix-esque format.  “The answer is out there, Neo. It's looking for you, and it will find you if you want it to.”