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Are Challenger Banks Disrupting Banking?

 4 min read / 

Last week Shawbrook Bank announced its intention to list on the London Stock Exchange. This move by Shawbrook came shortly after Aldermore Bank, another ‘challenger bank,’ performed strongly on its stock market debut with the share price up 12% on March 10th. These two banks are the latest of the challenger banks to seek stock market listings with OneSavings Bank, who trade as Kent Reliance Building Society, Virgin Money and TSB having listed in 2014. Furthermore, Metro Bank has plans to list in 2016. With the majority of challenger banks now listed or seeking to be listed entities, does this mean that they are forming a permanent and much more significant part of the UK’s financial landscape?

Firstly, whilst the term ‘challenger bank’ has been used to group together the banks that are looking to compete with the traditional big four banks, Barclays, Lloyds, HSBC and RBS, there is a degree of variability between the individual banks within the category. It is reported that these big four banks currently hold 77% of personal current accounts and are responsible for 85% of small business lending. A number of the challenger banks seek to compete in areas that are thought to be underserved by the major banks. Shawbrook Bank and Aldermore are a specialist savings and lending bank specialising in lending to SMEs and individuals, whilst Metro Bank and Clydesdale offer traditional high street banking services, including current accounts and credit cards.

The banks do share a number of common characteristics; a number of them have benefited from private equity backing, American private equity firm JC Flowers recapitalised Kent Reliance Building Society to form OneSavings Bank in 2011. Aldermore have had the backing of AnaCap Financial Partners who sold £185m of their shares when the company went public and Shawbrook bank are backed by Pollen Street Capital. The often-heavy involvement by private equity firms may cause some concern that these banks may have been pushed to grow their balance sheet too quickly to generate returns on investment. Aldermore have seen a compound annual growth rate in net loans of 61%. Certainly this may lead to some cautioning whether this rapid growth is sustainable.

While some of the banks have been extremely profitable, Shawbrook Bank posted a pre-tax profit of £18.6m in the first half of 2014 and Aldermore posted a profit of £50.3m for 2014, there are a number of challenges that these banks could potentially face in the near future. Most significant among these would be the effects of a tightening of monetary policy and increase in interest rates. The challenger banks have mostly been founded after the 2008 crash, Aldermore was founded in 2009, Metro Bank in 2010, and Shawbrook in 2011. Over this time period, there has been relatively steady growth and supportive monetary policy. It is yet to be shown how well these banks would operate in a more hostile business environment. The challenger banks are however generally well capitalized, Aldermore has a Core Tier 1 Capital Ratio of 10.4% and Shawbrook had Tier 1 Capital of 13.8% in 2013, both well above the regulatory minimum. With strong capital reserves and prudent lending there is no reason why these banks shouldn’t be able to weather an economic downturn well.

Some of the challenger banks do offer a number of interesting propositions that are likely to continue to help provide growth. Metro Bank, despite having yet to turn a profit, mostly due to rapid expansion, (Metro hopes to have over 200 branches by 2020), offers a very attractive customer service proposition with branches holding longer opening hours and offering services 362 days of the year. With access to equity funding hopefully these challenger banks will continue to grow and increase competition in the UK banking sector, they have certainly come a long way in the last few years.

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