Why challenger banks find it hard to challenge

I was thinking about this article in The Telegraph saying what a rotten job supermarkets have made of competing with banks.

Tesco sold its mortgage book to Lloyds two years ago owing to “challenging market conditions” and is now closing all personal current accounts.

Marks & Spencer this year decided to close all of its bank branches and current accounts. Rather than competing with the likes of Lloyds and Barclays, supermarket banking ventures have been added to the pile of challenger banks which have failed to do much challenging.

When asked for his thoughts on Sainsbury’s decision to scrap its plans to sell its bank, one top takeover banker offers only a blunt analysis: “It is crap”.

I agree.

I’ve been in this space for a long time. In fact, I chaired a conference in the 1990s where Sainsbury’s presented their bank launch on the basis of research that found most consumers thought banks were ‘complacent’, ‘arrogant’ and ‘greedy’. So how come they’ve failed?

Well, I hate to say it but most banking makes no money. Most banking not only makes no money but it also costs a lot of money. Why? Compliance, risk and regulation. So, how do banks work? Ah, that’s the bit the supermarkets didn’t understand and, tbh, most fintech challengers also don’t understand.

Banks work by a weird concoction of subsidising ‘free banking’ for the retail consumer with high interest fees (punishments) for those who break the rules, supported by interest and charges made on corporate and institutional client dealings. Take away the commercial banking, payments and pension fund transactions and no one would ever have access to a bank account.

Now sure, that is changing. Retail banking is no longer that expensive. Nor is commercial or investment banking. These days, accessing finance is simple and cheap. I’ve blogged about WeBank in China that can bank people for less than half a dollar a year

.So why have supermarkets failed? What did they do wrong? Why did they fail, when newer entrants seem to be succeeding?

Well, it’s all about timing and that mention of ‘newer’ entrants. The supermarket banks tried to attack incumbents in the 1990s. At that time, the cost of entry was huge. It wasn’t just the cost of entry, but the regulatory barriers and the management of supermarkets who didn’t understand how banking worked.

They failed on so many frontiers but the #1 would be: how does deposit-based banking work?

You would think they could solve that one, but they never did. They offered loans, savings and cards, but never cracked deposit-based banking. For me, that is the core issue for all challengers and entrants. If you cannot get a customer to trust you with their wages and salary, you have not got a customer. That is the issue the supermarket banks faced, and they never solved it. It’s equally the challenge that the challenger and neobanks face. Can they solve it?

If you are purely used for payments and transactions, you’re a commodity that has no ties. If you are the bank with my core deposit – my salary, my income, my main transaction – then you’re different. So why didn’t customers switch to the supermarkets? Brand? Trust? The core offer?

I guess I would tell them it was all of those things. They have a brand that is less trusted than banks? Why? Because they’re supermarkets geared up for leveraging our shopping and credit, and maximising the outlay from our wallets, rather than protecting us from those who want to  steal from our wallets. Do banks want to steal from our wallets? Yes, but they are regulated to do that in a way that ensures we don’t lose out big time (or so they say).

Supermarket banks and challengers are therefore faced with three big consumer barriers:

1. Can you give me a better offer?
2. Can I trust your offer is better and you have my core interests at heart?
3. Can I believe that you have done this with guarantees and government support?

It’s a complex thing but, for me, the biggest thing the supermarkets messed up was the product and the offer. They failed on (1). (3) is easy, but even if you do (1), (2) is not  a given. Ah well. Bye, bye, to the supermarket banks, hello to the challenger banks but, in the meantime, my money is still in the incumbent banks because they understand all of the nuances discussed above.