Challenger banks step forward

Originally published on bobsguide.

When Tom Blomfield, CEO of Monzo, told bobsguide “If we do our job right, we’ll make some of the high street banks extinct”, it sounded like a gutsy gauntlet to throw.

Similar sentiment can be found with the likes of other challengers in the retail banking sphere: Atom, Starling, Revolut and Metro Bank are all looking to shake-up the banking landscape. But the UK’s retail banking sector has long been a hypercompetitive market, and established players have recently been shedding their restrictive legacy systems and creating agile new innovation departments, such as Barclays’ Open Innovation incubator on Silicon Roundabout.

That said, the next few years could provide a window of opportunity for the challengers. The new legislations (PSD2, Open Banking, GDPR) are working in their favour, and they have faster and more agile tech deployments built and developed by a new wave of bright technicians inspired by disruption and frustrated by legacy obstacles. And these challengers are savvy to the market, appealing in large part to the wealthy and tech-friendly millennial generation.

All of that is working. Monzo recently announced that 362,000 customers had upgraded to its current account, suggesting a committed client base that could be with them for the long term.

As the banks mature into the market, both Atom Bank1 and Starling2 expect to break even by 2020. Monzo hopes to be making a profit by 2019. OakNorth, another challenger bank of recent years, reported successfully turning a pre-tax profit of £10.6m for the 2017 calendar year, having repaid 2016’s accrued losses in full.

OakNorth offers personal and business savings, and structured lending, but is also targeting middle market SMEs with its technology platform, the ACORN machine – an analytics platform offering fast and bespoke business loans. A white label product, it is being marketed to other financial service providers on a software as a service basis. Like many of the new generation of financial services providers, the bank is trying to step out from the crowd by diversifying it’s offering while utilising in-house talent.

“We’re competing with everyone and no one,” Cristina Alba-Ochoa, the bank’s CFO says, recalling a time she’d witnessed Goldman Sachs analysts deliberating the UK’s challenger bank landscape and placing OakNorth as rather detached from the other challengers along the spectrum.

“We’re bucking the challenger bank trend,” says Valentina Kristensen, who heads up the bank’s Growth and Communications department. “Monzo, Starling, Revolut, N26 and Fidor are all taking the approach of trying to scale by obtaining licenses in multiple markets and setting up operations there, whereas we feel the most effective way to scale our proposition is by licensing out our technology, enabling banks to replicate what OakNorth does with SME lending in the UK, in their own markets.”


SME lending rife from disruption

The lending market has been a target of disruption of late, with advanced AI analytics as well as PSD2 making the sector attractive to a range of fintechs. Alba-Ochoa, however, says OakNorth spotted a gap in the market: she says at the top end of the spectrum institutional investors won’t lend unless it’s worth the cost while the bottom end is financed by the fast and agile Kabbage and iwocas of the world. The middle-ground SMEs are caught between the two, satisfied by neither, and underserved.

“That’s the gap that OakNorth is filling,” she says. “By trying to adapt to the client’s needs and looking at the cash flow and collateral without being specifically discount financing of invoices and giving you a proposal that makes sense in terms of repayments, interest and end product.”

Carving out a market within that middle ground is where OakNorth hopes to make an impact greater than other challengers, and the bank is leaning on what it sees as its expertise to do so. “It’s the best of both worlds; technology meets entrepreneurial intuition. Our ACORN machine helps inform credit decisions but it’s ultimately the Credit Committee (the decision makers) who decide whether to grant the loan, so the ability for borrowers to meet them directly and make a real case for themselves is pretty special.”

If OakNorth is not intent on expanding in the same way as the other challengers, it raises the question as to how scalable operations may be and how they ensure future profitability as a result.

“Focus on delivering and executing profitable growth and ensuring that no credit decision compromises on credit quality whilst also retaining that ability to lend fast and flexibly”, says Alba-Ochoa. She also points out that OakNorth has plenty of headroom to grow into a market worth £220bn in the UK, even in the event of future economic stagnation.

Thus far OakNorth’s impact has been felt, with the bank lending a total of £1.2bn to the likes of Brasserie Blanc and LEON, as well as into a range of other sectors (healthcare, education, private equity, art, tech, and property). The bank says that’s lead to the creation of 4,000 new jobs and 5,100 new homes.


Mental gap

But within the highly competitive consumer and business banking sector, technological skills and identifying a market gap may not be enough. Both Alba-Ochoa and Kristensen agree that the real differentiator is in OakNorth’s mentality. “We’ve got a good balance on the board between a traditional banking perspective and a slightly different perspective that doesn’t stray too far into the pure fintech mentality,” Alba-Ochoa says in response to the appointments of Navtej S. Nandra, formerly Morgan Stanley, and Ted Berk, formerly of Bain Capital and Harvard Business School.

Kristensen goes a step further to suggest that one of the greatest motivators for staff at OakNorth, is the unique opportunity to buy into the bank. “The founders get asked a lot at conferences, how do you make your employees care as much as you do about the business? Let them be a part of it.” she says.

“I have part of my life-savings in the bank, and that makes me work and negotiate that extra bit harder so, ultimately, I think the people will ensure the long-term survival of OakNorth,” Kristensen concludes.


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