Incumbent and challenger banks must converge to survive

The race is on for ‘everyday banks’ to reach the new ‘endgame’, writes Tom Merry, Managing Director for Banking at Accenture.

For the past decade, the notion of divergence has dominated the banking sector in the UK. Starting with the growth of traditional challengers – such as Metro Bank and Virgin Money – for years now customers have been promised something ‘different’; an opportunity to break away from the status quo of the major high street banks for a new kind of service.

More recently, changes to what customers can expect from their everyday banking service have only accelerated, with a new generation of digital-only banks. These ‘neo banks’ have sought to challenge both the major high street lenders and the traditional challengers by offering a flashy, digital-first alternative.

The likes of Monzo, Starling and Revolut were heralded as signalling the birth of a new era of banking, defined by their impressive technology and a low cost-to-serve model. However, the external environment for banks in the UK has proven trickier to navigate than these players might have hoped. Most – if not all – have struggled with the challenging margin environment, too few primary customer relationships and insufficient scale of a balance sheet, hindering their ability to thrive.

However, it has not been plain sailing for the incumbent high street banks either, which are also struggling to achieve the level of returns once seen in the past. They have the scale and product breadth that the neo banks lack, but are held back by lumbering legacy tech and sprawling real estate portfolios, resulting in a much higher cost to serve, impacts on customer experience and transformational inertia.

Endgame chase and race

It is clear that neither model is optimal. The everyday banking sector is now moving on from divergence, shifting instead to convergence, with players of all sizes fighting for the same endgame digital model.

This new endgame ideal brings together the best of both worlds – a digital-first bank powered by formidable technology that’s cheaper to run and is more engaging for customers but crucially is underpinned by some of the traditional elements which make money in everyday banking. Such as product breadth and a scale of the balance sheet which results in a foundation of strong, ‘traditional’ interest income.

We’re already seeing signs that point towards this shift in the neo bank arena. Revolut’s application for a UK banking licence earlier this year signalled that the bank sees lending as important if it is to achieve sustained profitability. Similarly, Starling’s longstanding search for a lending acquisition target is a recognition that the neo banks’ vision of a ‘new model of banking’ may not mean long-term viability.

Both these moves appear to be wise options to combine obvious strengths with a push towards a more diversified and scaled balance sheet as the bedrock of future returns.

Meanwhile, swathes of branch closures affecting the traditional banks – a trend accelerated by the COVID-19 pandemic – are a symptom of changing needs, as the major high street players seek to capitalise on the growing shift towards digital and rebalance their expensive legacy real estate portfolios.

Same endgame, different journeys

While the ultimate endgame may be similar, the journey that neo banks and the incumbents must navigate to get there is certainly not. Their different starting points, strengths and weaknesses mean their strategic imperatives, and journey through the next five years will be markedly different.

If they are to not only survive, but thrive, the neo banks must quickly broaden their product offering, diversify their balance sheet and then drive scale by shifting customer behaviour towards primary usage, multi-product take up and avoid being secondary accounts.

By contrast, the incumbents must accelerate the shift to a new ‘estate’ (notably their technology), and aggressively cut back their legacy while doubling down on customer experience.

Both sets of banks must also continue to look over their shoulders. Big Tech continues to loom large and there are highly successful financial unicorns who have focussed their efforts on areas operating dangerously close to this everyday banking arena. Both the traditional banks and their digital-first counterparts must remain vigilant of this continued threat of disruption impacting the sector if they are to truly thrive in this brave new world of banking.

The race is still on, albeit via different routes, for the new endgame model. What remains to be seen is which banks will emerge as winners and losers.

The views and opinions expressed are not necessarily those of AltFi.