Andy Davis shows how big banks are responding to competition from start-up rivals
by launching their own digital-only offshoots and upgrading their IT systems.
Bó, Mettle, Monzo, Revolut, Starling, Tandem. The list of app-based start-up banks crowding the UK market is growing – and increasingly these perky newcomers are being launched not by venture-capital-backed interlopers but by the aristocracy of British banking.
Why do the industry’s biggest names suddenly feel they have to spawn digital-only offshoots with trendy brands? One important, if prosaic, reason is that the Capability and Innovation Fund – part of the competition remedy following the government bail-out of Royal Bank of Scotland (RBS) – is about to start doling out money to challenger banks, defined in this instance as those with assets of less than £350bn.
Some £280m of the £425m RBS must provide for this fund will pay these challenger banks to develop “more advanced business current account offerings and ancillary product sets”. Another £80m will be handed to others seeking to modernise their existing business current account offers. It is no coincidence that stories emerged last year that HSBC, Santander and others were developing digital-only SME banks. RBS has launched its own app-only SME bank, Mettle, in anticipation of the new wave of competition about to break.
The Capability and Innovation Fund is undoubtedly important – as is the £275m RBS will also provide to incentivise certain of its SME customers to switch to other banks – but there are other, longer term factors behind the big banks’ push to launch stand-alone digital brands.
What they want, when they want
The growing traction of the neo-banks in personal current accounts, particularly Monzo and Revolut, is becoming too obvious to ignore. Both passed 1m UK customers last year – just over three years after launching – and the popularity of their slick, mobile-first alternatives to the industry-standard products is forcing the incumbents to react, if only as a defensive, risk-mitigation exercise. Both Monzo, which has started contributing data to the Current Account Switch Service (Cass), and Starling show net gains from switching alongside their success in winning new account openings. Most of the big players are net losers from switching.
“All the neo-banks are doing is using today’s technology to deliver today’s services,” says David Brear, co-founder of the digital banking consultancy 11:FS, which built Mettle for RBS. It is clear that the neo-banks’ technology will become the industry’s mainstream because it provides a better customer experience and is much cheaper to operate.
Sven Schindele, head of banking products at Tandem, says, like many other services in the digital age, “banking is becoming a more personalised service that has to integrate with people’s daily lives. The key to delivering that service is being digital and having real-time data on each customer so they can do what they want, when they want.”
For incumbent banks, with their customer data spread across multiple legacy systems from the 1970s or earlier and dependent on once-a-day batch processing – itself a reflection of old-world branch opening hours, this is proving a difficult and expensive hurdle to overcome. RBS spends £1bn a year on its IT systems, most of it simply to keep its ancient technology running. The risk statement in its 2017 annual report warns of potential “disruption due to end-of life hardware and software” and admits that the financial fall-out of the banking crisis led to “insufficient investment prior to 2013 to keep the IT applications and infrastructure up to date”.
The big question confronting the incumbents, therefore, is whether they can modernise their technology fast enough to keep up with the shifts in their customers’ expectations, which are being shaped not only by Monzo et al., but by digital giants such as Amazon, Apple and Google.
TSB’s attempt to switch overnight to a new system in April 2018 ended in humiliation and cost chief executive Paul Pester his job. The reaction of customers, politicians and regulators made one thing clear: “big bang” transformations are out. TSB is the biggest net loser from account switching in the latest set of data.
Others are moving more gradually. Lloyds is investing £3bn a year to update its old systems in the hope of matching the personalised, user-friendly experience that the challengers offer, such as real-time balance updates, separate “pots” for different savings targets, and automated nudges to help users stay on budget. But the risk of trying to overhaul and modernise vast, complex systems, whose engineers are now disappearing into retirement, is that your transformation will be too expensive, slow and ultimately too difficult.
Two years ago, RBS had to abandon its previous EU competition remedy – splitting off part of the bank into a new entity, Williams & Glyn – after the project’s IT costs spiralled to £50m a month. It was that failure that led directly to the Capability and Innovation Fund now fuelling digital competition in SME banking.
Disasters such as Williams & Glyn and TSB help to explain why some big banks have decided that to have a decent chance of keeping pace with the start-ups they need to be more like them. This means setting up stand-alone digital offshoots with new technology and, critically, a very different corporate culture.
Brear, who previously held senior digital transformation roles at Lloyds and Aviva, says: “Fifty per cent of the transformation job is culture… The most impressive thing in the neo-banks is the agility in their organisations. Big banks will do five deployments to production in a week. Mettle is doing 80 a week. That changes the mentality – if everything you do is big and expensive, you’re cautious and you move slowly.”
Not surprisingly, the incumbents have tended to set up their digital offshoots in separate offices with their own teams, although normally under the leadership of a senior executive from the parent: Bó, for example, is led by Mark Bailie, previously RBS’s chief operating officer. They are distanced from the parent in branding terms but are not separately capitalised. Ultimately, most big banks are hedging their bets. They are investing heavily to update their legacy systems while simultaneously building new, appbased propositions on modern tech platforms – in effect taking out insurance in case their core IT upgrades do not bear fruit quickly enough.
This strategy makes sense, says Schindele. “You build up your alternative system on a small scale; you iterate it; you learn; you test; you make it robust. And you do this bearing in mind you’re going to bring over many of your existing customers.” The ultimate prize could be to escape their outdated technology without having to attempt a “big bang” switch-over.
But whether this happens via a migration of existing customers from the old brand to the new app remains moot. “I wouldn’t read too much into the emergence of challenger banks within banks as the endgame,” says Brear. “It’s not the strategy: it’s part of the strategy. The migration could be of the technology from the new thing to the old thing.”
Meeting customer expectations
The key issue is meeting customers’ evolving expectations. That is partly about the ease of use of new digital banking apps – but it is also about much more basic issues such as saving customers money.
Two factors are crucial. Anyone launching a neo-bank that simply replicates the features of existing online banking is unlikely to succeed: the winners will be those that develop the next generation of banking services. Often this is likely to involve wrapping additional services into the proposition.
Mettle, for example, blends current account functionality with the accounting and bookkeeping technology RBS gained with the acquisition of FreeAgent in March 2018. The aim is to “create a chief financial officer in your pocket”, giving SMEs a forward-looking view of their finances, automatically chasing invoices, predicting future cash-flow shortfalls and offering pre-emptive funding to bridge them.
But just as important is the need to deliver lower-cost banking. It is notable that both Monzo and Revolut broke into the market by undercutting the big banks on foreign exchange. The drive to save customers money is going to remain an important factor in which digital banks succeed, says Chris Ward, principal consultant at Mapa Research. “The question is ‘how can you pull customers onto these platforms with some real benefit?’. Ultimately, it’s not just about digital services. It needs to be built around saving them some money in some way.”
If low-cost banking is the goal, modern technology is a key advantage because it cuts the “cost to serve” hugely. According to industry estimates, Monzo’s losses have shrunk from £50-£60 a customer per year at one point to about £6.50 per year for every customer that pays their salary into a Monzo account. Those customers are still a minority but Monzo’s technology is so cheap to run that if it can become its customers’ primary bank, it will need to generate only a small increase in revenue from each of them to reach profitability. That will give it a lot of flexibility in its pricing.
The game is far from up
Pressure on the incumbents is growing, but the game is far from up. “We’re seeing a fundamental reset of what ‘good’ is in banking and that’s being led by Monzo and Starling,” says Brear. “The foolish banks are looking at what they’ve done; the smart ones are looking at how they’ve done it because if you figure that out, it’s replicable.
“The big banks have all the customers, the money and the capability. If they swerve quickly enough away from the iceberg, they’ll be ok.”
Andy Davis is a writer on investment, finance and business and a former editor of FT Weekend. He is an associate editor and investment columnist for Prospect magazine and writes a weekly blog for the Alternative Funding Network.