A decade ago, the big banks were what pretty much everyone used. Yet it was clear that the finance industry was due an overhaul. Take the UK in 2010, where the four banking giants (Barclays, HSBC, Lloyds Bank and the Royal Bank of Scotland) had a 78% hold of the market with 68 million active personal accounts. Despite their near-monopoly on the market, customer service wasn't great, the fees were high and there was a focus on high-paying products over everyday needs.
In 2016, we reported that four digital-only challenger banks in the UK had obtained, or were close to obtaining, bank licenses. They were Starling Bank, Tandem, Atom bank and Monzo (named Mondo at the time). They were making big promises: smartphone-first banking, open customer feedback forums, biometric passwords, personal finance micro management, predictive spending and plug-ins with third-party services based on customer needs.
On the one hand, it seemed like the tailwinds were with them: the bureaucracy at big banks made innovation tough and their antiquated tech infrastructure made it that much harder. Plus, it seemed that open banking regulations were finally wearing away at their vice-like grip. A year later, when Monzo had around 400,000 customers and its then-CEO Tom Blomfield was regularly carrying out two media interviews per day, he told us that he expected Monzo to grow at 3.5% per week, reaching 1 billion users by 2023. ‘Blomfield's confidence is clearly compelling,’ we wrote.
On the other hand, the hurdles were clear. People were unlikely to switch banks (in 2015, just 3% of customers did so). While challenger banks offered some cool perks, there was no obvious killer feature, as digital services were increasingly being offered by incumbents. There was a sense that high-value customers would be harder to capture and challenger banks' monetization strategies were murky at best (‘There's a belief that yet unknown commercial advantages will materialize,’ we also wrote). Some believed that big banks should instead be worried about the likes of Google or Apple moving into the financial tech space.
Five years on, challenger banks have lived up to their promise of rocking antiquated banking systems – just not quite as fast or to the extent expected.
In the UK, around 8% of people hold a digital-only personal current account, up from 1% in 2018, according to the Financial Conduct Authority. Part of this growth seems to have come from chipping away at high-street banks, which now hold only 64% of personal accounts – a notable drop from 2010.
The focus on solid technology and user experience has indeed attracted attention. Free accounts, overdraft protection and slick mobile apps with easy money-tracking functions particularly drew in smartphone-first customers: a survey from personal finance portal Finder indicates that 41% of millennials and Gen Z now have a digital-only bank account. Meanwhile, high-street banks have struggled with updating fundamental tech infrastructure – for example, TSB Bank locked 1.9 million customers out of their accounts while shifting to a new IT platform in 2018.
However, it doesn't seem that people are ready to make the full shift just yet: the average number of personal accounts is now at 1.9, indicating that people tend to have multiple accounts, with challenger banks more likely to supplement the use of a traditional bank. The user base isn't representative of the full banking population: only 15% of adults in their late 50s to mid 70s currently have a digital-only account, according to Finder.
Acquiring new users is also different from making a business sustainable in the long term. Many challenger banks make money from fees on transactions – but when the pandemic hit and people weren't making small daily purchases, that revenue tanked, highlighting the need for diversified income streams. Monzo posted a net loss of £130 million in 2020 and had its valuation nearly halved that year – but it has since grown in users, has completed beta testing in the US and is exploring new product features in premium accounts, crypto currencies and the buy-now-pay-later space, and has soared in value to $4.5 billion. That said, it hit 5 million users in 2021 – pretty far off its 2017 prediction of 1 billion users worldwide by 2023.
Still, this doesn't spell the end for challenger banks. The banks that were early to diversify have seen success. Starling Bank, which offers both personal and business accounts, became profitable at the end of 2020, thanks to a boost in government-backed small business lending. Similarly, Atom bank is gearing up for an initial public offering (where shares will be sold on a stock exchange), bolstered by success in mortgages and business lending. Plus, people are now more open to change: today's young adults are 2.5 times more willing to switch banks than the generation that came before them.
There's also been a realization that challenging the big banks can take different forms. Tandem, for example, has pivoted to being a ‘green bank’, offering environmentally friendly savings accounts and loans for home energy improvements, instead of personal accounts. Nutmeg, an investing app, and Wise, a money transfer service, started around the same time as challenger banks and have found success making investing and moving money across borders more accessible than ever. Identity-focused brands such as Daylight, which focuses on the LGBTQ+ community, are creating financial products based on a community's needs, with features like the ability to choose the name on the card, built-in crowdfunding and cashback for spending at queer-owned businesses.
Challenger banks played a role in changing old-school finance, shifting the focus to customers. While traditional banks are still holding on, they'll have to boost their tech infrastructure and keep an eye on new entrants to avoid total disruption.