Avoid the upstart banks – wait for the real innovators to come to market

The City is used to handling the float of just about any kind of company. A Kazakh minerals miner? Just tick this box. Smartphone apps? Sign right here. The developer ofa wonder drug that has yet to go through any trials?

No problem. It takes them all in its stride, even if the underlying business is poorly understood. But in the next few months, it will see a series of floats of the one kind of business it does genuinely understand banks.

Lloyds has lined up an initial public offering (IPO) of its former subsidiary TSB. OneSavings has announced that it plans to float this month. Over the rest of the year, we may well see Virgin Money and Williams & Glyn make their debut on the market. And they could be followed by the British unit of Santander, and eventually by the new Metro Bank as well.

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These are the so-called challenger' banks, and within a year there could well be enough of them on the stock market to be a sector all of their own. It wouldn't be surprising to see a challenger bank exchange-traded fund' available soon.

Each challenger will make the samepitch that it can chip away at the dominance of the 'big five'. The trouble is, none of them are really challenging enough.

In fact, the real challenge to the traditional high-street banks is not coming from these new players at all. It is coming from completely new ways of handling financial transactions on the internet and it's those IPOs that will be really exciting.

It is not hard to see why a group of challenger banks has evolved overthe last few years. Some have resultedfrom the wave of consolidation that followed the financial crash of 2008. Lloyds is being forced to divest itself of TSB by the regulators. Likewise, RBS has to unload its Williams & Glyn unit.

Virgin Money took over the remains of Northern Rock, which gave it the size to become a serious bank. OneSavings arose out of the old Kent Reliance Building Society. Others, such as Metro,were explicitly set up to take advantage of the unhappiness among customers with the old, bailed-out banks.

There should be a big market to tap in to. There is more chance of finding an England fan who thinks they can actually win the World Cup than there is of finding a customer who is actuallyhappy with their traditional bank.

Operated with remote, inefficient call centres, addicted to mis-selling, and paying their senior staff huge bonuses while providing rotten service, they are probably the worst run major businesses in the UK. If any sector was ever ripe for a blast of innovation and competition it is this one.

The trouble is, most of the so-called 'challengers' are basically running traditional banking businesses, butwith a niche twist. It might be that they have better customer service, or they are more ethical, or they open on Sundays,or that they serve a particular region.

But they are still banks, just smaller and with a slightly different way of operating. That is an improvement on the likes of Lloyds or Barclays, but it is hardly revolutionary.

In fact, the real challenge tobanking is coming from somewhere completely different: the internet. A traditional bank does a number of things. It collects deposits and makes loans. It offers payment processing. It stores money for you. And it provides financial advice. As they have in other industries, the new web players are taking that model apart.

The impact has been most dramatic in deposits and lending. The new breed of peer-to-peer lenders is turning that part of the industry upside down, connecting depositors and lenders directly over the web and offering much better deals to both sides in the transaction than any traditional bank. They still have a relatively small market share, but they are growing all the time as confidence in them grows.

But that is just one part of the story. Money transfers are changing as well. Companies such as PayPal are able to send cash from place to place far more efficiently than a bank can and at far lower cost as well. You can also make plenty of payments on your smartphone so it can't be long before Apple and Google get in to that business too.

A bank is still probably where you would go to store money, particularly if you are a retailer paying in lots of notes every day. But as cash declines and it is becoming more irrelevant all the time it is hard to see how that can survive much longer either.

As for financial advice, there are lots of online firms springing up, including automated ones, which can provide far better basic guidance on how to plan for your financial future than any local bank branch can.

This is the real future of finance.Most of the challenger banks just havea niche within a declining industry and that's not a great place to be. Their IPOs should be avoided it will be better to wait until the real challengers come to the market.