Challenger banks are largely a European phenomenon. There are now about a dozen top digital banks across Europe that are shunning traditional brick-and-mortar branches and developing highly user-friendly interfaces that put an end to cumbersome banking procedures.
Companies such as Revolut, Monzo and Starling Bank provide low-fee (or even no-fee) payments, foreign exchange services, and competitive interest rates. Despite the intense competition between these startups and the fact that they offer relatively similar services, each has built powerful network effects into their offerings and between them have gained hundreds of thousands of users.
However, across the pond, consumers are wary of digital banks and banking alternatives. American consumer interest is very much limited to convenience-based startups that enable users to link their bank accounts for simpler payments, such as Venmo, or money management apps such as Moven. However, Americans tend to draw a red line when it comes to making large deposits into a digital bank account.
The Profit Problem
Unlike in Europe, North American banks often charge a monthly fee for current accounts, which, in theory, should make the US ripe for digital bank disruption. Ultimately, though, the problem boils down to consumer habits. However, offering legacy financial services on a technologically-improved platform gives digital banks a comparative advantage that is just not enough of an incentive to break the cradle-to-grave relationship that most Americans have with their bank.
To an extent, challenger banks’ ability to create a strong value proposition is hampered by their business model. Out of the UK’s leading challenger banks, only Revolut has managed to break even. Last year, Monzo was losing about £50 on each customer it acquired and its losses promptly grew to £6.7m as its popularity soared. This is particularly concerning for digital banks because Monzo’s customers are middle-income millennials who, in theory, ought to be a relatively profitable demographic.
Accordingly, given the difficulty of generating a profit and the broadly similar services across the space, most digital banks are targeting higher-income users, who are more likely to have deeper relationships with their existing financial service providers. This often runs contrary to their stated aims of democratising the banking industry but ultimately the low-income demographic that will likely benefit the most from digital banks simply do not generate the revenue that these startups need in order to reach scale.
Synergy, Not Disruption
One solution to this conundrum is for challenger banks to partner with incumbent banks rather than compete with them. This way, challenger banks can get access to the cheap funding they need in order to lend to their customers at a competitive price point. Synergy, not disruption, may be one way forward for a number of US fintech startups. Failing that, legacy firms can always build their own digital systems.
Goldman Sachs has already seen enormous interest in its digital retail banking service, Marcus, which gives customers a high-yield savings account that also takes no transaction fees and offers loans of up to $40,000. However, unlike virtually all challenger banks, Marcus does not have a mobile app and ATM withdrawals are not possible. Despite these drawbacks, Marcus was named the best savings account of 2018 on NerdWallet and already boasts over $13.8bn in customer deposits. Evidently, in the US, brand names count for a lot more than impressive UX design.
UK challenger banks Revolut and Monzo are planning to bring their services to the US, which sets the stage for a bitter fight for customers. Given the saturation in the American financial services market, as well as the labyrinth of federal and state laws and regulations, breaching the US is going to be both a costly and timely operation for these startups.
Should they succeed, US customers will have access to a raft of cheaper financial services and legacy banks will be forced to adapt to a new status quo. If they fail, it will be business as usual for the incumbents.
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