The coming of age of challenger banks

October 24, 2014

By Andrew Wingfield, Partner in the Financial Institutions Group at law firm King & Wood Mallesons. The opinions expressed are his own.

With Metro Bank and the soon-to-be-launched Atom Bank offering exciting blueprints for multi-platform banking, and other new entrants making headway into the UK banking market, it seems an appropriate time to ask whether so-called “challenger banks” are finally coming of age.

There is certainly cause for optimism. Virgin Money has swung back into profit following several years of reorganisation and OneSavings Bank, the private equity-backed re-vamp of Kent Reliance, has performed well on its stock market debut. But these are both retail-focused lenders and, whilst challenger banks are enjoying isolated successes in individual markets, a key question for policy-makers is whether challenger banks can truly mature by breaking into the UK’s under-competitive SME-lending space. This market is already subject to a Competition and Markets Authority (CMA) investigation and has long been regarded as the toughest nut for new banking brands to crack.

Significant barriers standing in the way of these new players becoming established business lenders include the incumbent players’ control of the bank payments system, Vocalink, which levies high usage fees against challenger banks, clawing at their bottom line.  A new Payment Systems Regulator has been tasked with reforming Vocalink with a view to opening up the market to the newer players, and will be judged on the results.

Policy makers’ attempts to nurture challenger banks can be both a help and a hindrance. Vince Cable’s recent proposal that the government should underwrite challenger banks’ lending to otherwise un-creditworthy SMEs is bold, but could threaten to pollute the banks’ burgeoning balance sheets and erode public trust in new lenders. This is particularly damaging as challenger banks seek to distance themselves from the pre-crash days during which the wrong products were sold to the wrong borrowers.

These issues relate to a more engrained problem that continues to stunt the growth of challenger banks: that the regulators’ grip is still too firm, and poorly-focused. Regulators, within reason, should not fear the failure of individual banks, but rather help protect against the market-debilitating overspill of toxicity between overly dominant lenders.

Whilst challenger banks are still operating on a relatively small scale, they should be given a far freer rein to develop as they see fit. Some will flourish and others may fail, but the potential prizes of innovation and genuine competition in all lending spaces should appeal to banking stakeholders. Individual failures of small banks do not threaten the system, and they can be risked to allow competition to return to the UK banking market.


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