Can challenger banks climb the mountain?

I’m going to shut up about challenger banks soon, but noted that even the regulator is getting worried about them. After Monzo’s admittance that it may not continue as a going concern if the pandemic continues through 2021, N26 admitting that profit is not their focus, Revolut’s tripling of losses, and more issues out there, it is interesting to see the UK’s Prudential Regulatory Authority (PRA) issuing a warning note.

The PRA drafts the regulatory structure of financial services for the UK. It does not oversee day-to-day operations of financial providers. That’s the job of the FCA, the Financial Conduct Authority.

However, having seen a wave of new entrants into the UK banking scene – Monzo, Starling, Tide, Tandem, Shawbrook, Oaknorth, Aldermore, Monese, Atom, Hammock … – they  are now worried. In a consultation paper issued in July 2020, the PRA states that is appears the neobanks and challenger banks: “are focused on the ambition of becoming authorised and lose the longer term focus of becoming a sustainable business, or fail to appreciate the ongoing need to invest in systems and controls to ensure they remain commensurate with the evolving needs of the business.”

This is interesting. In other words, the fact that a new entrant can get a banking license from the regulator is often seen as the aim and goal in and of itself, but it’s not. The aim should be to create a sustainable business, not just get a license to do business. It’s like doing all the training to be 007 and then sitting at a desk in the office. You’ve got a license to kill, but can’t be bothered killing anything.

This Consultation Paper does not come as a surprise. Over a year ago, the Bank of England was expressing concerns about the new banks. A confidential BoE stress test in June 2019 reviewed 20 of the fastest growing, new UK banks and found that the banks were underestimating potential loan losses in a downturn, lulled by the “relatively benign credit conditions” that existed back then.

“Most fast-growing firms were overly optimistic about the potential impact of a stress scenario on their business,” wrote Melanie Beaman, the BoE’s senior supervisor, in the letter. “We expect all firms to demonstrate effective engagement and challenge by senior management and boards, with stress testing integrated into the business.”

Now we are in that stress scenario, and the regulators are obviously worried. For example, Sarah Breeden, Executive Director of UK Deposit Takers Supervision at the Bank of England, delivered a speech on 22 July 2020 to introduce the Consultation Paper stating:

“We recognise that the winding path up the mountain to become a large player can seem arduous, and strewn with rock faces that appear difficult if not impossible to scale. Barriers to growth are in many ways the inevitable corollary of our lowering the barriers to getting onto the mountain in the first place and of us introducing proportionality into the regime. So ironically our actions to support competition risk creating the very barriers that firms then find it hard to overcome …

“Over the past few years, our focus has been on getting more banks onto the mountain at base camp. But as our next step, our focus has turned to ascending the mountain. And I hope the draft Supervisory Statement we have issued today goes some way to making the path up the mountain easier for you all to navigate.”

Fascinating stuff and a space we are all watching closely.

Climb the mountain safely guys!