The summer marked a 10-year anniversary for Metro Bank plc. But being the first new high street bank to have opened in over 100 years, it also marks a significant anniversary for the Challenger and Specialist bank sector. Over these last ten years, this sector has delivered increased competition, greater choice and better service for its customers. But what does the backdrop look like for continued growth and innovation over the next ten years?
We see three important challenges to be addressed if competition is to continue flourishing:
- Structure of the small and medium-sized enterprises (SME) banking market
- Proportionate regulation
- Funding for non-banks
1. Structure of the SME banking market
At the onset of the COVID-19 pandemic, Her Majesty’s Treasury understandably sought to rapidly transmit stimulus into the economy. To provide liquidity to the SME sector, they went to the large banks, who they knew best and those with the greatest resources.
Whilst Specialist banks and non-bank lenders accounted for meaningful proportion of SME lending pre-COVID-19, the large banks have accounted for an estimated 80% of Coronavirus Business Interruption Loan Schemes (CBILS) and 90% of Bounce Back Loan Scheme (BBILS) lending1. In March alone banks lent (net of repayments) non-financial companies around 100 times the average of net lending over the 12 months to February, the majority coming from the larger banks.
It is arguable that an unintended consequence of ring fencing was that Challenger banks were squeezed out of the mainstream mortgage market. Is the unexpected result of the transmission of these stimulus measures to drive multiple years of SME borrowing demand onto the balance sheets of larger banks?
Of course, it is for the Challenger and Specialist banks to provide compelling propositions and services to win market share in SME banking. The larger banks, having serviced the needs of SMEs at a time of crisis have every right to fight to retain these clients. But do we need more initiatives, along the lines of the Alternative Remedies Scheme, to help rebalance the competitive landscape for SME lending?
2. Proportionate regulation
The New Banks Start-up Unit at the Prudential Regulation Authority (PRA) has been a great success with 22 new licences being issued since its formation in 20132. But increasing the number of entrants is one step in creating greater competition, facilitating growth and an ability to innovate is another. As banks continue to grow, so too will the expectations of standards in their risk management capabilities. Consultation Paper 9/20 (CP 9/20)3 helpfully seeks to clarify the PRA’s approach to new and growing non-systemic UK banks. However, CP 9/20 sets out a guide for a regulatory journey towards being a ring-fenced bank. But most Challenger and Specialist banks have no intention of reaching that scale. One could argue that many of them need a separate regime that, whilst preserving the soundness of our banking system, also acknowledges the more limited risk such banks pose to the overall system. As well as the fact that this is where the under-served are banked and where a lot of innovation takes place. The PRA acknowledges that it is challenging to accommodate this within the existing ‘one size fits all’ regulatory framework, and it is encouraging to hear that there is a willingness to examine whether there might be scope to introduce a new regime for smaller banks following the UK’s departure from the European Union.
3. Funding for non-banks
Non-bank lenders suffered significant challenges in the last financial crisis. With significantly reduced access to the wholesale funding markets that they rely on to finance their lending activities. Most either shrank dramatically or exited the market entirely. As wholesale markets re-opened, existing and new non-bank lenders re-emerged and started addressing underserved needs (e.g. for asset finance) and innovating (e.g. unsecured lending for SMEs). But as the COVID-19 pandemic hit, the wholesale funding markets these lenders rely upon faltered. The Bank of England took rapid action to ensure the continued provision of liquidity to the banking sector, activating its Contingent Term Repo Facility and launching a new Term Funding Scheme (TFSME). Even earlier in the crisis, the so-called shadow banking sector received significant support through expansion of central bank dollar swap lines and unprecedented levels of quantitative easing. The non-bank lending sector lobbied powerfully for equivalent support, but to date nothing significant has been forthcoming. This is not a sustainable situation for the longer-term health of our specialist banking markets. We need non-bank lenders because banks may not be the place for the types of lending non-bank lenders provide, or the place to experiment with their level of innovation.
Six ways to seek a competitive edge in the ‘new normal’
Simply sitting and waiting for favourable policy responses is not an option. So how do you get a competitive edge in our ‘new normal’?
- There have been some seismic shifts in the needs and preferences of consumers and SMEs. Increase your investment in trying to understand the changing human behaviours and the potential impact on your product, services and business models.4
- Embrace the accelerated move to digital that the COVID-19 pandemic has driven. Invest in technology, in particular to cut down on internal friction in your processes, and ensure you are easier to deal with and more responsive from a customer perspective. It will soon be a hygiene factor but we’re not there yet.
- Use the success of the mass working from home change to transform your talent strategy - how you recruit, retain, engage and develop a diverse and inclusive workforce.5
- There is going to be less revenue for a while so look hard at costs. This can in part be an output of re-examining customer needs and experience. But that requires the vision to invest rather than simply cut; as well as how to deploy smart technology to accelerate, improve and simplify ways of working to create a leaner and more slick operation.6
- There is still room for innovation. The last crisis arguably sparked more of it than we’d seen in the preceding decades. For example, there is significant ongoing investment in accessing and analysing data to understand how the COVID-19 pandemic is impacting customers - can banks recycle this to understand how climate change impacts them.7
- Be proactive at addressing the growing demands and expectations of your risk management and compliance functions - modifying frameworks, policies and capabilities to sufficiently manage growth and to enhance your speed and ability to make decisions.
The next couple of years will be challenging for all of us. But there is much that can be done now, both by the industry itself and at a policy level, so that when demand returns, Challenger and Specialist banks can have the same impact on competition and innovation as they have had over the last 10 years.