Investigating the Growth of Challenger Banks

The news is rife with information about ‘challenger banks’ and how they are currently overtaking the big household names in banking. We want to find out the full story and see if this growth will continue to flourish or if the big banks will swing the scales back into their favour.

What is a challenger bank and why is it important?

Challenger banks have been around for some time, but lately they’ve been growing in popularity with several even overtaking the performance of the top international banks like the ‘Big Five’: HSBC, Lloyds, Barclays, RBS and Santander – hence the name ‘challenger banks’.

It seems, then, that the big banks are slipping in popularity, and according to advisory firm, KPMG, the figures look to be backing it up:

The smaller banks in the ‘challenger’ category, which include Metro, Aldermore and OneSavings reported a 17% return on equity in 2016, as opposed to larger challenger banks like Virgin Money and TSB which reported a smaller 9.5% ROE last year.

However, both of these groups had significantly superior returns to the Big 5 banks, who delivered an ROE of just 4.6%, almost 50% less than the lowest challenger bank. This is big news for banking.

Why are people choosing challenger banks?

It’s not luck that has had these challenger banks rising up to overtake the big banks, but competitive services, low cost income ratios, as well as by offering attractive rates to consumers and small businesses, ultimately giving them more for their money.

By taking advantage of the current rates of lending growth, as well as focussing on niche financial services, these challenger banks have increased the competition and put a big dent in the current margins offered by bigger banks, meaning that these household names will eventually have to adjust their offerings if they are to keep their place at the top of the banking world.

So, what does this mean for the big banks?

Well, it’s obviously not great news for the big banks, who’ve held their position at the top of the financial lending sector for, well, forever.

But it’s no surprise really, when the big banks have been relying on their status as un-challenged household names until now. There’s clearly a reason why people have begun to switch to lesser known banks, and these challenger banks have come at a time when the economy is uncertain and consumers want to get the most for their money.

Though it’s not all bad news for the big banks and their customers. With the challenger bank shake-up in full swing, the big banks have had to change the way they work, offering new incentives to customers like Barclays’ Digital Eagles, a project aimed at customers who need help learning the ins and outs of the world wide web, and RBS’ Entrepreneurial Spark, which offers events and tools designed to help entrepreneurs meet their business goals.

It seems, then, that the big banks are finally starting to bring their ‘A game’ to compete with the challenger banks – great news for customers who could do with a little extra help from their financial providers.

But can it last forever?

While some of these challenger banks will make it in the long term, no doubt many will also struggle, particularly when the already changeable economy adjusts. Many of these new banks have emerged in a time of low interest rates, but what will happen when the rates rise again?

While these new digital banks have the upper hand when it comes to costs, they also have innovative processes and a relatively clear track record of past misselling on their side, unlike some of the nation leading banks, but the profits are still a long way behind the Big Five, who reported a gigantic £5.6bn profit increase last year, compared to just £194m from the challengers.

Will the challenger banks make it, or will they eventually be bought out by the big banks, once they close the gap on the competition and the economy levels out again? It remains to be seen.

For now, we’ll just have to wait and see what the next chapter of banking holds, whether the Big Five can keep their place at the top, or if these ‘challenger banks’ will become the next set of household names. Either way, Grovelands will let you know.

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