Challenger banks are about to be handed a windfall by the high street incumbents as the likes of HSBC, NatWest and RBS actively shed accounts with measures designed to keep them profitable. This makes for an interesting period of change as the old starts to give way to the new. Can the incumbents beat off the challenger banks?
In a LinkedIn post, accountant Jason Holden says:
Well so far this week, RBS told a client they are not opening anymore business account's, he already has an existing business with them...and yesterday HSBC told a client they are giving 2 month's notice of closing their business account, all these clients have money in the accounts and no overdraft, so as well as Brexit the banks are also trying to put UK small business out of business, what is going on....
A rolling thunder of failure
What's going on is a combination of things.
First, in the case of HSBC - and I have seen this from personal experience - the fact they were slapped with a $1.9 billion fine in the U.S. for drug money laundering in Mexico was a wake-up call for their compliance unit which went into overdrive with overly aggressive KYC requests in the 2015 timeframe. It didn't end there. In 2017, HSBC got slapped with a €300 million fine in France for its work in helping customers evade tax. Anyone surprised then that the weight of compliance is both driving customers away and seeing them being 'fired?' Locally, I heard from Nationwide that HSBC has been 'sending' them many accounts. As a mutual kind of bank, Nationwide doesn't operate business accounts but they're gearing up for it.
Second, in the case of RBS, the financial crisis of 2008 brought home the incredibly fragile state of RBS's balance sheet and its need for a massive bailout as the UK government's answer to a possible financial meltdown. It's taken 10 years but the bank finally got back into profit in early 2018. You can be sure that in its case, the bank is micro-analyzing for profitability as it attempts to recreate past glories. If that means SMBs get dropped - well that's the price of proppping up a share price.
Third, the rise of the challenger, and, in some cases, quasi-banks has created an entirely new landscape for the next generation of business people. No longer is it a case of 'pick from one of HSBC, NatWest, Barclays, Santander, Lloyds.' Now small businesses can think about Metro, Monzo, Tide, Starling and possibly Revolut. Or all of them.
What do these banks offer that is so hard for the incumbents?
There's a combination of things on offer. For a start, and with the exception of Metro Bank, they are mobile-only which plays directly to the next generation of business owners who live on their iPhone or Android device.
Next, these banks make it remarkably easy to set up and operate an account, even for business users where UK bank regulations tend to be more stringent.
Crucially, the challenger banks are not wallet fracking at every turn. Instead, they are using their low-cost technology base to ensure that the cost of providing services is incredibly low, if not free. I was surprised to discover for example that while Monzo has attracted more than 1.1 million customers, its technology base cost is only some £22 million. Its annual stated cost of customer support has fallen from £50 in 2017 to £15 by June 2018. Compare that to the £10, 12, 15 per month or more that's typically charged by the high street banks.
The new class of bank understands that customers have a pent-up sense of resentment at being charged bank fees for holding money from which the banks already make a turn through leveraged lending. This is equally true for forex transactions where the high street bank vig can be upwards of 7%. The new banks often offer rates that are very close to the forex mid-rate on any day. In our case, this facility has allowed us to save thousands of dollars/pounds/euros in fees when traveling or buying U.S. based subscription services.
These challenger banks are bringing forms of innovation that the incumbents simply can't match. As a result, they are not so much creating customer portfolios but fans who love what they do. In the case of Monzo (sorry to keep mentioning them), this week they opened up a £20 million crowdfunding raise. It sold out in under 3 hours. On its community forums, even those who missed out were quick to praise the company for the extraordinary success it achieved.
The challenger banks are making a critical move towards transparency in operations that is not typical among the high street incumbents. This comes with risks. Screw up and everyone knows. But the upside is that customers feel like they have a sense of ownership in a venture that is working for them and not for nameless institutional shareholders. How long that continues is anyone's guess but it is a proven method of keeping customers onside.
What they may not be aware of though is the potential for influence among professionals that will drive customer acquisition. The LinkedIn post referenced at the top of this story provides a clue. Among the comments, Millie Hunter, partnership manager at Tide said:
Small businesses are more and more poorly served by the high street banks, but this is where the challenger banks come in! At Tide we focus solely on the small business space, offering business owners a current account (usually) within 5 minutes, and without any monthly fees. I also saw your comment about FSCS protection. As we're not a bank, we don't actually need this; the money is held in a ring fenced current account, which means that if anything were to happen to us, your clients money would be protected to 100% of the value. I work in the partnerships team, partnering with Accountants to save their clients time and money with their banking. I've sent you a connection request, happy to answer any questions about Tide and how we might be able to help with these accounts :-)
Recommendation by a trusted advisor, in this case, the accountant, is going to figure heavily for business growth. Those challenger banks who rediscover the relationship model which existed up until the early 1980s will win out handsomely.
Are these banks flawless? Nope. In the case of Revolut, which operates as a prepaid card, it can take up to two weeks to refund hotel deposit costs. They say it's a function of how the hotels operate but that's hard to believe. In the case of Atom Bank, if you change your device then you have to dump the app and reinstall to re-register a new device. Some of the banks have hooks to services like Xero but not all. To my mind, that should be a priority for any bank seeking business customers.
These are early days in the next stage of banking evolution and there are many unanswered questions. For instance, I recently participated in a conversation where it was posited that at least one of the challenger banks might be too expensive for an incumbent to acquire. Unicorn status by value might sound expensive but then when you consider that HSBC holds £1.8 TRILLION in assets at the last count and with a market cap of £127 billion as of today, it doesn't take a genius to figure that HSBC, along with its peers, could easily take out any of the challengers. And don't be fooled by the 'We're not for sale' rhetoric. Everything has a price.
In many senses, what we're seeing is a modern version of what used to happen but with a twist that reflects technology advances and the needs of the next generation of business users. The incumbents won't die out any time soon. Their global reach and sheer bulk combined with a dizzying array of services will keep them in business for years to come. But quite how that impacts them for the long haul in relation to small business is hard to know. In the tech space, who'd have thought that little more than 10 years after arriving on the UK shores, Xero would attract more than 3,000 people to its 2018 UK user event and pass 1 million customers on its home turf of New Zealand and Australia? Will the same kind of growth trajectory hold true for the challenger banks? Of one thing I am sure, 2019 will be a year to watch carefully as both incumbents make increased fintech investments while challenger banks roll out ever more innovative features.