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Future of Banking 2017 Special Report

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22 / 01 / 2017 RACONTEUR raconteur.net 7 FUTURE OF BANKING Challengers feel strong tailwinds in stormy markets Despite their smaller size, challenger banks have survived the buffeting of Brexit and could now gather speed for take-off CHALLENGERS DAN BARNES C hallenger banks – small and of- ten innovative banks that are as- sailing the ivory towers of the big five – have had a tough year. Low interest rates and high levels of regulation are putting all banks under pressure. For challengers, events such as Brexit were harder hitting than for their larger rivals. Following the government's regulatory attack on the buy-to-let property market in 2015 via higher stamp duty, the need to put more capital against buy-to-let loans and a reduction in ta x deductibility for such properties, many retail banks could see lending becoming tougher in 2016. The June 2016 vote for the UK to leave the European Union led to further con - cern about the effect on smaller financial services firms. Shares in listed challenger banks were sold off, according to analysts at Barclays. However, in October the analysts also observed that challenger banks have prospects. Despite the rapid expansion of lending and lack of track record, the challenger banking sector had an aver - age loan-to-value ratio closer to 70 per cent than 60 per cent, meaning their loan books had "considerable protection" against house price corrections. In addition, their efficient cost base and the wide difference between what they pay out to borrowers and get in from lenders make it unlikely the chal - lengers would get into trouble, except in extreme circumstances. They may be small, but they are re- silient. They also have to be more than simply a smaller version of a larger bank. All else being equal, bigger is better, so challengers must have good idea if they want to stand out. " The majority of cha llenger banks star t from a customer base that is underser ved and whose needs are not addressed," says Sophie Guibaud, vice president of Euro - pean expansion at cha llenger Fidor Bank. "In order to stand out from the crowd, cha llenger banks create a ver y close link, usua lly digita lly, with their potentia l customers, ta king on board their feed - back and seeking solutions to integrating this into product offerings and a lso cus- tomer ser vice. In this way, customers are at the hear t of ever y thing that cha llenger banks do." A big part of this is technology. Big banks have been undergoing a behind-the-scenes review of their technology after the Pru - dential Regulatory Authority described it as archaic in 2014. Banks cannot replace their IT every year and the longer they leave it, the older it gets. Since the advent of smartphones and cloud technology, it has begun to look very old indeed. That reliance on legacy systems poten - tia lly means cha llengers have a window for getting ser vices in play that larger banks would str ug gle to suppor t. This is assisted by reg ulator y inter ventions that are forcing banks to a llow third par ties access to their customer data, if the customer wants to use another f irm's ser vice. The first is the European Commission's Payment Services Directive, due to come into force in 2018, which creates a frame - work for firms offering aggregation or transactional services based existing bank data. The second is the Competition and Markets Authority's Open Banking Initiative which is pushing UK banks to develop a standardised open gateway for accessing data – an application program - ming interface (API) – that will facili- tate the reading and use of data between banks and service providers. A firm could make payments for a bank 's customer or aggregate their account data from banks, insurers and pension provid - ers to deliver services that banks might otherwise provide. As the rules will open up incumbent banks and challenger banks they could see a new line of competition within financial services, and tools that have never been developed before. Banks and others may move away from fighting for the account ownership relationship and move toward wanting the aggregator relationship. "If you are going to have that aggre - gator relationship with somebody then it's got to be a trusted brand," says Bevis Watts, managing director at Triodos Bank UK, a challenger focused on ethical fi - nancial products. "You can imagine all sorts of trusted brands, potentially the Apples and John Lewises and Guardi- an newspapers, thinking about entering that relationship." Some cha llenger ba n k s a re a lready prov ing t heir met t le by building out t heir technica l capabilit ies. Mon zo, which wa s g ra nted a rest r icted ba n k ing licence over t he sum mer, is a mobile - on - ly ba n k ba sed on a n app t hat interact s w it h t he pre -pa id Ma sterCa rds it ha s issued. It ha s opened it s A PI to a llow developers to build apps to ser v ice t heir customers. Fidor Ba n k ha s a ra nge of 60 -second ba n k ing loa n a nd sav ings product s which a re desig ned for t he dig - ita l-f irst approach to business. This concept sees a bank develop its systems around the customer first, rather than around a product. It gives the bank a picture of each customer and their in - teraction with products. By gathering a single view of the customer, the banks can analyse the data to offer a more tai- lored service. The traditional approach of building systems around products only allowed the bank to know how a product was performing. Alex Kwiatkowski, senior strategist for banking and digital channels at banking technology provider Misys, says: "We can see a landscape where the right product gets to the right customer at the right time through the right channel." At the least challengers should be able to avoid repeats of the mis-selling scandals, such as payment protection insurance or Customers are at the heart of everything that challenger banks do 01 PACE OF CHANGE While banks are aware of the 2018 deadline for the Open Banking Initiative, which will allow third parties to access bank customers' data to provide new services, challenger banks such as ING have already launched new services like account aggregator Yolt, putting pressure on others to compete. 02 DIFFERENT SERVICES Challengers offer new ideas for services. These can be products that are delivered at high speed or via mobile, or have a specifically ethical bent such as Triodos's offerings, or are targeted at specific customer groups, such as Aldermore's specialist lending to smaller businesses and entrepreneurs. 03 MOBILE BANKING Atom Bank, Monzo, Starling and Tandem are all digital-only banks with apps that offer real service via a mobile phone. Importantly those banks allowing developers to build apps based on their APIs are opening up the full potential of the developer community, keeping customers engaged. 04 COMMUNITY SERVICE Lip service paid by traditional banks to "listening to the customer" is a common frustration. By engaging with social media at the outset, challenger banks are able to monitor customer sentiment to understand their needs. Fidor Bank uses its online community to attract new customers and also assess its offering. 05 DISRUPTION Having a digital-first approach can allow challenger banks to offer the sort of personalisation seen in digital retail businesses, such as Amazon, and apply it to financial services This is something banks built on older legacy technology will struggle to do and turns a challenger into a contender for the banking crown. HOW CHALLENGERS ARE CHANGING BANKING PPI, where the wrong customer got the wrong product at the wrong time, to the cost of billions of pounds in compensa- tion. At best they could deliver a tailored service that puts product-first banks in the shade. Share this article online via raconteur.net Monzo Bank is a mobile-only bank based on an app that interacts with pre-paid MasterCards Monzo Bank FUTURE LANDSCAPE OF BANKING AND FINTECH Source: Economist Intelligence Unit 2015 Survey of senior bankers and fintech executives on the future competitive balance between banking and fintech Deposits (short term) Small business loans Term deposits Credit cards Payments and money transfers Home equity loans Transaction accounts Mortgages Banks will be dominant/ major players Fintech will be dominant/ major players No answer The market will be evenly split Auto loans 67% 67% 66% 59% 68% 72% 60% 79% 68% 11% 17% 20% 28% 21% 20% 32% 19% 20% 1% 1% 2% 3% 22% 16% 14% 12% 11% 8% 7% 9%

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