The term ‘challenger bank’ is perhaps something of a misnomer, as very few constituents of this universe are indeed challenging the ‘big five’ banks in any meaningful manner.
Instead they are filling a void vacated by the big banks, offering a service that is no longer part of the bigger banks’ business model post the 2008 financial crisis.
Banks such as Virgin Money and TSB have perhaps stolen the headlines, but smaller names such as Secure Trust Bank, Aldermore Group and Shawbrook Group have come to market in recent years without so much fanfare.
Each challenger has so far been able to rely on a core competence to differentiate themselves from the existing banks – whether that be a brand and culture that is more palatable, or a product range that is no longer offered by the big players.
The recognition that their business models are sustainable, coupled with a desire to kick on, has been a primary reason behind this surge in initial public offerings. The additional capital raised will offer a sound platform for further growth.
The challenger bank market is rather fragmented by market cap, product offering and business model, therefore like-for-like analysis is not broad-brush and possibly not fair. However, we can see that the larger challenger banks have return on equity (ROE) ratios broadly in line with the big five (2.1 per cent versus the big five’s 2.8 per cent in 2014) and the smaller players have far greater ROEs (18.2% in 2014).
Likewise, and perhaps interestingly, the cost-to-income ratio is far lower for the smaller players, despite a commonly held belief that scale offers cost advantages.
Loan growth for the larger challenger banks has been relatively modest at 3.2 per cent (2012-14) while smaller challenger banks have grown their loan books by a notable 32.3 per cent over the same period. What is wonderful to see is that much of this loan growth has come from the SME market, which has been horribly underserved by traditional lenders for some time. If this trend continues, then we have a win-win situation unfolding – for the banks, the SME sector and ultimately the economy, to which the SME sector is of paramount importance.
These very crude observations offer a rudimentary conclusion that the smaller challenger banks are a very exciting area of potential growth, which may lend itself to more green economic shoots coming through.
The question is whether the growth that has been witnessed in recent times can in fact be repeated and sustained. At this point, it is worth noting that only 23 per cent of current account users have any relationship with a challenger bank – so the scope for continued growth is certainly there.
This encouraging start to life as a challenger bank has been achieved despite low interest rates. So, with monetary tightening on the agenda (to varying degrees), we could be at the start of something quite disruptive in the banking sector.
As KPMG succinctly asked: “Will too big to fail become too big to compete?”
James Sullivan is investment director at Coram Asset Management
