Not all that long ago, we thought retail banks were pretty uncomplicated. You could deposit money with them or borrow money from them, earning or paying interest respectively.
Then the global financial crisis happened. From this, we learned that though the concept of a traditional bank was simple, its underlying business could, in fact, be quite complex. Since the crisis, many new regulations and legal requirements have come into force, placing stricter limits on banks’ activities, their capital requirements and how they market themselves.
This tougher regulatory environment has not stifled innovation in banking, however. In fact, in some ways, it has been the catalyst for new ideas and methods. For example, open banking legislation is intended to improve competition in the industry.
Different types of banks have begun to emerge. Below you’ll find a quick summary of the major types of banks in the UK market, from the traditional to the most progressive.
Have traditional banks had their day?
A tried-and-tested approach?
Traditional retail banks are what tends to come to mind when we think about, well, banks… They are built around helping individuals and businesses to manage their finances. Typically, retail banks offer products like current accounts, savings accounts, credit cards, loans and mortgages. To be able to offer these services, a bank must obtain a license granted by the Financial Conduct Authority and the Prudential Regulation Authority. The process of gaining this approval is, understandably, very rigorous.
Retail banks make profits when the amount of interest they receive from borrowers exceeds that which they pay out to savers. Traditional banks have been using this model for hundreds of years. In the UK, we have the “Big Four’ group, which comprises HSBC, NatWest, Lloyds and Barclays.
We have building societies, too. While these tend to offer similar products to retail banks – they differ in one key aspect. Building societies have no external shareholders, being owned by their members instead.
Some of the country’s traditional banks and building societies spent a lot of time and money developing sophisticated digital offerings. But others lagged behind somewhat, relying on their physical branch networks instead. For some of their customers, already used to conducting other parts of their lives and businesses online, these delays were frustrating. So, a gap in the market appeared.
Rising to the challenge?
As the market opens we see the rise of Challenger and Neo banks
And in this hole-in-the-wall, a new generation has blossomed – challenger banks. Having gained banking licences after the financial crisis, these banks are small, relatively new operations with strong digital capabilities. For the most part, challenger banks do business online, but some have physical premises, too. In 2010, Metro Bank became the first new UK high-street bank to gain a licence in more than 150 years.
Without the scale, customer base and reputation of traditional banks, challengers are hungry for new business. As such, they try to offer a very appealing proposition for potential customers. As well as their online capabilities, common selling points include fuss-free approaches, lower product costs and smoother communications.
The flipside of these qualities can present some, er, challenges for customers, however. They might be less than ideal for account holders who carry out lots of cash transactions, for example. Another of the downsides of being comparatively small is a potentially limited product range. But while challenger banks tend to focus on one or two areas, their activities are not quite as defined and specific as those of neobanks.
The newest kids on the block
Neobanks and challengers have a lot in common, but there are some key differences, particularly in their respective business models. Neobanks are more closely linked to the fintech industry, and in many ways, they behave like tech start-up companies. Like a tech start-up, a neobank is likely to have a very intense focus on growing its customer base quickly. At first, generating profit may be lower down a neobank’s list of priorities. Many will use microservices and APIs to try to position themselves at the forefront of the open banking revolution.
Importantly, neobanks don’t have banking licences, which means they are limited in the types of products that they can sell. Usually, they won’t be able to offer their customers access to borrowing products like credit cards or mortgages.
As neobanks grow, however, they may come to more closely resemble challenger banks in their offerings, behaviour and aspirations. Indeed, a neobank might want to become a challenger bank. Only a few days ago, Revolut, the UK’s best-known neobank, announced its intention to join the ranks of challenger banks by trying to gain a UK banking licence in 2022. Whether or not Revolut will be successful remains to be seen.
What is certain, though, is that there’s more than small change taking place in the UK banking industry at the moment.