Soon a challenger bank will fail – here’s why we should let it go belly up
The banking sector is ripe for a shake-up, says Matthew Lynn. But for that to happen, we have to be prepared to let the odd challenger bank fail.
Another day, another challenger bank arrives to shake up the high-street giants. Mondo, an ambitious app venture, has raised £6m from investors in a funding round that saw it valued at £30m. It is applying for a banking licence and aims to launch later this year.
It is far from the only challenger. Atom Bank was valued at £150m last year. Starling Bank, which is also focusing on mobile banking, raised £48m last month, while Tandem Bank, which already has a banking licence, is reportedly in talks to raise a similar sum. And quite a few challengers are already making their presence felt. Metro Bank is probably the most advanced it is now preparing to list in London with an expected valuation in the region of £2bn. Aldermore is already in business, as are OneSavings and Shawbrook.
It's no great surprise that venture-capital funds are falling over each other to back the challengers. It is hard to think of another sector that is both so lucrative and so ripe for disruption. High-street banks are incredibly badly run their fantastically expensive branch networks are about as relevant to the 21st century as a high-street travel agency, while a series of mis-selling scandals, from payment protection insurance (PPI) to small business loans, show that they mainly regard customers as idiots to be fleeced, rather than as people who deserve any kind of service.
If there is anyone out there who has any affection for their bank, I have yet to meet them. Only the complex licensing rules, coupled with the hassle involved in switching account, have protected the banks this long. But as the high barriers to entry start to tumble, the big four could be turned to toast very quickly. So it's a great industry to go after. If you can offer better service and lower costs, you could do brilliantly well. However, if we want to change the way that we bank for the better, there's a significant problem that we have to get over first.
We have to tackle our pathological fear of banks going down. There is space in the market for new banks, certainly but not all the challengers will succeed. Most start-ups fail and challenger banks will be no different. Like any start-up, they will have to get the alchemy of management, the market, and financing precisely right, and they will probably need a good dose of luck as well.
Although the incumbents are pretty useless, at some point they will wake up and try to fight back. On top of that, the likes of Apple, Google and Facebook are all sniffing around the finance market and thinking about how they can take a slice of it. Those are formidable companies, with a lot of spare cash. If they want to take the industry on, they will represent stiff competition.
So the challenge facing the challengers is a daunting one. One or two will do fantastically well and may well become the UK's market leaders. Three or four will do OK, but not that well, and may get taken out by the big winners. Several more will probably fail either because they aren't up to it, or because they get the timing or the product offering wrong.
That means we have to change our attitude towards banking failure. We bailed out the banks in the 2008 crash and we might be tempted to doso again if a challenger goes down. Yet if the banking sector is to become more competitive, we will have to get over that. Depositors should be bailed out up to Bank of England compensation limits which everyone should be aware of now, following the 2008 disaster. But beyond that we should be willing to let challenger banks fail. It will be messy. But occasional failures go with having a more open, competitive market, and we will all benefit from that.
The challengers: who are they?
The 2008 financial crisis caused an explosion of interest in so-called challenger banks, as the existing big four (Lloyds, Barclays, RBS and HSBC) reined in lending and spent time grappling with creaking IT systems and a string of mis-selling scandals. Metro, Virgin Money and Sweden's Handelsbanken (which has been in the UK since 1982, but expanded rapidly since the crash) have all focused on winning current accounts; Atom Bank is online only; while Shawbrook, Aldermore and Paragon have broken into buy-to-let.
Oak North, another new bank, lends to entrepreneurs. Price-comparison sites show that challengers typically offer the cheapest mortgages and the highest interest rates for savers. But their combined market share is still below 5%. Only two million people have switched bank in the UK in the last two years, compared to five million originally forecast and most have switched to Santander or Lloyds-owned Halifax.