The outlook for retail banking as the first all-digital banks are licensed in the UK
2016 has seen the first all-digital banks open for business in the UK. The advent of digital banking has the potential to revolutionise the way we bank, and also reduces some of the historical barriers to entry for new competitors in the retail banking market. The challenges for the new banks will include gaining consumers' trust and (as for the already-established banks) overcoming any data and cyber security risks.
Before the launch of Metro Bank in 2010, no new banking licences had been issued in the UK for over 100 years. Since 2008 there has been a steady stream of applications from so-called challenger banks responding to the UK financial services authorities' efforts to increase competition in the sector. Whereas most of the first wave of challenger banks targeted niche markets, there is now the possibility of real change across the sector as a result of a new wave of banks with business models that are based on digital technology and mobile applications (apps).
`Appy days for consumers
Earlier this year Atom Bank became the first app-based bank to receive a banking licence from the Bank of England. It is joined by a host of other FinTech companies such as Fidor Bank, Monzo, Starling and Tandem seeking to shake up the UK banking market with new approaches to personal banking.
These companies are coming to market with a range of different business models and products, but one thing that they have in common is that they are seeking to take advantage of the way people increasingly rely on mobile technology.
Historically the barriers to entry in the retail banking sector have been extremely high. In addition to meeting capital requirements, the need to invest in a branch network, technology and substantial workforce were all factors that limited the number of new competitors in the market. Digital banks operate from a much lower cost base than their traditional high-street counterparts, so the prospect of new entrants mounting a genuine challenge to traditional banks is very real. Digital banks avoid large real estate overheads as well as the costs involved in maintaining legacy systems. In addition, the launch of the PRA and FCA's New Bank Start-up Unit this year as well as the FCA's Project Innovate and Regulatory Sandbox reflect the fact that above all there is now a supportive regulatory environment for new market entrants and digital innovation.
Keeping pace with digitisation
The truly digital banks aim to digitise all aspects of the customer's experience - from account opening to the granting of secured and unsecured loans, including the identification and verification process. However, completely removing the need for customers to present themselves at a branch or send in physical documents with `wet-ink' signatures is challenging when the legal system is itself trying to keep pace with advances in technology. As a result, certain aspects of the customer-bank relationship, such as evidencing a power of attorney, still need documentary evidence. As the Land Registry requires a wet-ink signature on a paper version of any document submitted to it for registration, electronic signatures are still not an option for most mortgage deeds.
Biometrics over passwords
Consumers are understandably cautious when it comes to trusting a bank with their salary and personal savings. This is another factor underpinning the major banks' dominant position in the UK and elsewhere. Winning trust and confidence is particularly challenging for new market entrants that are also trying to convince people to adopt a completely new approach to banking. The digital banks will look to alleviate any security concerns by offering options for using biometric technology (such as the face and voice biometrics already used at airports) as authentication methods, rather than the traditional password and PIN. It will be critical to ensure that digital processes throughout the organisation are secured by the most advanced cryptographic techniques. Breaches of cyber security would severely undermine customer confidence in any bank - but particularly a digital bank.
The end of the Big Five?
Consumers have increasingly taken advantage of digital technologies across other sectors, e.g. when shopping, booking holidays or finding a taxi. An `Uber moment' in financial services seems unlikely; but as credible digital banking propositions take shape, market commentators expect customer adoption to follow fast.
That said, overcoming customer inertia, particularly in current accounts, continues to be an obstacle for all challenger banks. This may mean that the traditional banks still have time to respond to the new challenge. Some are doing so through acquisitions (such as BPCE and BBVA buying stakes in Fidor and Atom respectively) whereas others are adapting and developing their own digital solutions.
One thing is clear: as digital natives and the digitally savvy represent an ever-increasing proportion of the population, the ability to develop an efficient, profitable and agile model that delivers a smooth customer experience will be critical to both the survival of the high street banks and the rise of the digital challengers.