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Lightweight versus Heavyweight – will it always be a foregone conclusion in the ring?

[fa icon="calendar"] 16-Apr-2020 09:17:58 / by David Woolcock

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Since the Global Financial Crisis (GFC) the banking industry, especially in the UK, has experienced significant growth with the advent of the “Digital Challenger”. These lightweight contestants in the banking market have harnessed new technologies and processes to deliver a better customer experience. In the early rounds, they have positively disrupted the established heavyweights with their innovative digital financial solutions. Social media, and subsequent news coverage, has all conspired to make them a popular choice. However, they have not landed a knock-out blow to incumbent heavyweights who continue to dominate the banking and payments industry. Traditional banks are raising their guard and hitting back with their own developments and enhanced digital propositions; however, some are lumbering around the ring and so far, not successfully rising to the challenge with nimble fancy footwork! 

Many cite the rules favouring the challenger and this is misleading. A UK Challenger Bank is regulated by the Prudential Regulation Authority (PRA) which is a requisite to be called a “bank" and It probably follows that after the GFC the PRA instigated a new application process. A “New Bank Start-up Unit” was formed which guides firms in a journey from an expression of interest, through the application process. This culminates in an “authorisation with restrictions” if appropriate, and finally to those restrictions being lifted and the firm being granted a full banking license. Therefore, it is a levelling of the playing field to encourage competition. 

In the same way, another type of challenger “Neo Banks has emerged operating exclusively online without a traditional physical branch network. Neos are either regulated by the PRA or partner with another bank for regulatory purposes. The rest of the challengers tend to be Authorised Payment Institutions (API) or E-Money Institutions (EMI) and can only offer restricted banking services mainly in the payment's arena. The main difference between the two is EMIcan issue electronic money or digital currency and are thus required to have more capital than an API. However, both require significantly less capital than a bank. This is a common structure found in most jurisdictions, especially those in Europe. 

This fintech revolution has been predicated on other recent changes in the regulatory landscape that has in Europe been evidenced by the introduction of the Payment Services Directive (PSD2). PSD2 has led to a dramatic increase of open banking, with more challengers deploying new initiatives such as mobile payments, mobile wallets, specialised payment accounts focused on budgeting, faster payments and peer to peer (P2P) payments. All this is giving greater competition to the incumbent heavyweight banks by providing a wider range of payment services based on customer needs and demands. In short, the challenging fintech companies are offering new faster and more user-friendly payment solutions. 

Therefore, we have a good fight on our hands in the payments space between the heavyweight banks and the lightweight challengers. Though no Challenger Bank has emerged to rival the traditional banks for size, services offered and reach, the fintech’s are giving a good account of themselves in the payments sphere. This is leading some of them to collaborating with banks who decide they want to offer enhanced services to their clients without building the capability themselves. Recent deals have involved a private bank and a fintech by way of example. In a recent paper “Payments Policy for Europe: Direction for the Next Five Years” from various banking associations it was stated – 

“The European payments landscape is at a crossroads. Payments are the bloodline of the European economy and are thus important for the sovereignty of the European Union. For an ambitious and unprecedented shared vision to materialise, an extensive investment from the banking sector is required but also unprecedented and concrete support from public authorities will be needed. A key success factor is a long-term sustainable business model that is beneficial to all stakeholders and will enable banks to finance the considerable investments to set-up new payment solutions. The relevant public authorities should assist the market players in finding the appropriate tools to create a strong business model that works from both an economic and competition perspective, and that matches the expectations of all stakeholders involved.” 

The fightback by the heavyweights has thus begun in earnest, and they have significant advantages. Unless, or perhaps until, we see Central Bank Digital Currencies (CBDC – see my blog) most of these new fintech initiatives rely on the banking system to operate. At the heart of the banking payment system is a bank-owned cooperative called SWIFT which recently made the following statement – 

SWIFT will enable instant and frictionless payments from account-to-account anywhere in the world, with an end-to-end solution that combines international and domestic capabilities. This ambitious platform expansion means SWIFT will support financial institutions to strengthen their positions in B2B payments and capture new volume in SME and consumer segments.” 

This comes at a time when the combatants need to be at their fittest. The current pandemic crisis is leading to an implosion of payments, especially cross-border. This is drastically reducing the amount of fees being earned on payments and comes at a time when many of the challengers have been concentrating on customer growth rather than profitability. As has been noted by numerous marketing surveys, we trust the traditional banks with our money (deposits are guaranteed unlike the case with APIs and EMIs) but we want the “tech” of the challengers. This means we are going to see many more rounds as we go the distance and it will be interesting to see what the landscape looks like in 5 years’ time! 

Topics: Banking, Payments, PSD2, Banking Regulation, APIs, SWIFT, PRA, challenger banks, Growth

David Woolcock

Written by David Woolcock

David Woolcock is an independent consultant and Director, Business Consulting at Eurobase. In addition, David is Chair of the Committee for Professionalism at ACI – The Financial Markets Association as well as Vice-Chairing the ACI FX Committee. He is also a member of the Market Practitioners Group for the Bank of International Settlement's FXWG that wrote the FX Global Code.