How is a challenger bank set up from scratch? The founders of the brand new OakNorth Bank were previously risk data analysts for investment banks. Selling their business to Moody’s provided them with enough capital to start up their own little bank.
“They had not much of an idea about all this regulatory stuff, so their banking licence application was a great business plan, but not much thought was given to capital and funding,” alleged someone familiar with the situation. “So the PRA responded with a long list of questions. They basically started tackling the questions and bit-by-bit got to a bank.”
Then they hired a Barclays veteran with the experience of dealing with regulators, and included Lord Turner – the former chief of the FSA – on their board. The next step was organising the celebration this October at their Manchester office for getting the licence.
The Mancunian RBS staff was eyeing the celebration dinner with envy. The RBS office, where Williams & Glyn Bank is being reborn, is just around the corner. They have just submitted the 16,000-page banking licence application and have hired investment bankers to prepare the stock market flotation of the spin-off bank.
Since RBS was bailed out from the crisis with the state aid of the UK government in 2008, the European Union ordered the group to separate a challenger bank, to create more competition in the UK banking market. All 300 RBS branches in England and Wales, and the NatWest branches in Scotland, are about to be sold under the dormant Williams & Glyn brand. The new bank is headquartered in Manchester, from where the Williams Deacon’s Bank originates.
Divesting the branches means two million personal banking and SME customers of RBS becoming W&G customers. Everyone else in England and Wales will no longer see RBS branches, as the logo and brand will vanish from the high streets. What stays with the RBS Group are the NatWest branches in England and the RBS branches in Scotland.
The same fate casts a shadow over the name of the HSBC branches. Britain’s strict ring-fencing regulation requires the big banks to put their UK retail bank into a separate entity from their riskier investment banking business. As soon as HSBC finishes ring-fencing, that brand too will disappear from the high streets. It will either become the rejuvenated Midland Bank or it will use the name of the online bank First Direct. The Hongkong and Shanghai Banking Corporation (HSBC) was established in Hong Kong, and came to the UK through buying Midland Bank in 1992. The ring-fenced retail head office moves to Birmingham, in the heart of the Midlands. Recently, HSBC has announced that it is considering selling the ring-fenced bank, which would mean creating a new bank with 1,000 branches. The giant international business will continue under the HSBC name.
In many cases, a new challenger bank will use the licence of an already existing financial establishment. Aldermore, for example, is the reincarnation of Ruffler bank, based in Surrey, whose business was financing coin-operated vending machines and fairground games. One-armed bandits, essentially.
Aldermore is the venture of former Barclays executive Philip Monks. In 2008, having lost his job in the financial crisis, he was watching media coverage of the economic collapse. The interviews with entrepreneurs explaining how difficult it had become to get financing from the high street banks with their stiffened risk-taking rules inspired him to establish an SME bank. In the aftermath of the crisis, the dried-up lending environment brought in a crowdfunding investment craze. Peer-to-peer lending started to become mainstream, leading to the rise of the ‘challenger banks’.
Aldermore has been set up with the funding from a private equity company, which means huge pressure from the owners to grow fast. Its loan book has grown to £4.8bn. A big part of the challenger banks’ rapid growth has been fuelled by disillusioned entrepreneurs who have failed to get loans elsewhere, which raises concerns about functioning as the dumping ground for presumed risky customers shunned by the big banks. Also, Aldermore, for example, had not planned to end up with such a big portfolio of buy-to-let residential mortgages, which is a retail category, rather than corporate.
Mr Monks’ business is helping small firms, but he admits his aim is to create value for the shareholders. As chief executive, he holds shares in the bank – as part of his private equity-style employment contract – so Aldermore’s IPO in March 2015 gained him a piece of good fortune. He is not just doing this out of altruism.
When Lloyds managed to float the TSB branches as a separate challenger bank in 2014, investors paid 260p a share. Those shareholders received a 30 per cent premium when a couple of months later the Spanish bank Sabadell bought the shares up. In the offering of Virgin Money in November last year, the shares were priced at 283p, and have been trading around 400p ever since. Many of the challengers have managed to float since then, and the market soon got trading their stocks at around 30 per cent above the offering.
What critics are sceptical about is the long-term viability of these small banks, and their capability to gain enough scale. The Big Four – Barclays, Lloyds, RBS and HSBC – still dominate both the SME business banking and the personal current account markets.
Even a recruiter is concerned, saying: “They are great at attracting talent, but cannot keep any of them, as they get bored at a Tesco Bank.”
The challengers typically operate with no branches, conducting most of their business online. They do asset finance and invoice finance on one side of their balance sheets, and fund the loan growth by taking in deposits from those looking for a better interest rate on their savings. The low interest rate environment brought in those retail monies sitting in high street banks without much return, and many small businesses moved their high street accounts into online deposits with the new banks.
The start-up banks are proud to be doing the old-fashioned banking model – lending money against deposits already taken in – but can they really make it? Virgin Money maintains a branch network, and a good part of its current account customers come from its acquisition of the ‘good bank’ part of Northern Rock, rather than from from Virgin’s own accounts. Their retail mortgages are driving the profits, but Virgin had to make up the gap between loans and deposits with securitisation, whereby it bundled up a portfolio of mortgages and sold them – just like the big banks did pre-crisis.
The branch-based Williams & Glyn is going to differ from the lending and saving specialists, as it offers full retail services. Still, its survival is in acquisitions: targeting, for example, its local rival Co-op – which was founded in Manchester in 1844 – and other local building societies. It might also be bought out by another player after floating. Banco Sabadell, for example, wants to grow its challenger bank through acquisitions into business banking, as TSB is serving only individuals and is missing the small business customers that Williams & Glyn has.
The niche of challenger banking is an increasingly crowded market. Consolidation is anticipated in the sector in the coming years.
Maria Sovago is a freelance journalist
Key points:
Many new challenger banks have been set up since the financial crisis.
Some established banks are having to spin off some of their branches into smaller banks.
Questions remain over whether the challenger banks can build scale.
