Challenger banks and financial apps like Monzo, Starling and Revolut might seem like a natural step in the digital revolution, to today’s consumers. Similarly, Netflix and Spotify have disrupted the film and music industries and set digital delivery and a totally in-app experience as the norm. So it hardly seems surprising that banking and financial services have followed the suite – and new apps with fluorescent bank cards seem to launch every week.
But these new banking services have to process complex transactions and handle large amounts of cash. They operate in a heavily-regulated environment and need cutting-edge security and reliable infrastructure. Launching a startup to disrupt the banking sector seems a tough mission.
How can a challenger bank compete against traditional banks?
Challenger banks might look out of their depth compared to the scale and market value of established, multi-national and multi-billion dollar banking institutions.
But challenger banks enjoy a few big advantages:
- Challenger banks can choose infrastructure and shape banking services that form a scalable in-app banking experience for the end-user.
- Traditional banks have evolved their infrastructure over decades – so it might not be optimum for supporting in-app user experiences. Additionally, they’re likely to offer in-store banking services that don’t scale easily.
Monzo – a challenger bank that’s built to scale
Monzo is one of Britain’s leading challenger banks. Founded in 2015 by Tom Blomfield – the former chief technology officer of Starling (another challenger bank) – they initially offered a prepaid card and only became a bank in April 2017.
‘We’re inspired by companies like WhatsApp, who I’ve heard have something like 300 million users and 55 engineers – which is this incredible scale… Our goal is… What would a bank look like if it had one billion customers and is able to scale like WhatsApp?’
Monzo’s products and processes are designed for scale so that large numbers of new customers might require a larger AWS account and more nodes running on their platform – but they won’t need thousands of new employees or new branches.
‘If you want to have a bank with one billion customers, with fewer employees, then you need to develop processes and products that require no manual input or entry.
‘A lot of traditional banks offer a mobile product, online banking and phone banking.
‘And you can do certain operations through your web browser. But there’s another class of operations that you can only do over the phone – and maybe an even higher class of operations that you can only do in person. And that doesn’t scale.
‘So we need to ensure that you can do everything through the mobile app. In many cases, customers are able to solve their own problems directly.’
Richard Dingwall, Monzo
Why have challenger banks suddenly emerged?
A scalable infrastructure might be important for challenger banks – but it’s only part of the picture. Richard explained two major changes that have helped challenger banks launch:
Startup-friendly banking legislation in the UK
New legislation and banking regulations have made it much easier for startups to gain a banking license in the United Kingdom.
In 2014 the Prudential Regulation Authority (PRA) – one of the UK’s banking regulation bodies – introduced a streamlined banking license application process (called the ‘mobilization’ route), which allows banks to soft-launch in a private, staff-only ‘test mode’ before fully ramping-up to accept new customers. This new process was designed to encourage competition in the UK’s banking sector – which hadn’t seen any new banks emerge in a long time.
Judging by the long list of challenger banks compiled by BankingTech.com, the process seems to be a success. Many of the challenger banks listed now have a banking license – or are waiting for one.
Improvements in cloud computing
Monzo takes advantage of cloud computing to offer reliable and scalable banking services to their customers. But what are the most important benefits?
Cloud providers like Amazon Web Services were not essential for starting a challenger bank, in Richard’s opinion.
However, he thinks that cloud providers offer two significant benefits, nonetheless:
1. Cloud-based infrastructure enables iterative development
Cloud providers like AWS offer scalable IT infrastructure that supports iterative development.
‘We don’t know what the product will look like when we start. It’s a journey and we will change it and try many things until we arrive at an optimal solution.’
On-premise infrastructure would have required physical hardware changes in Monzo’s data center each time their infrastructure changed – which would drive costs up and slow down development.
2. Cloud computing platforms foster engineering talent
Platforms like AWS and Google Cloud are so accessible that a large talent pool of engineers has built-up – which banks like Monzo can leverage.
‘Anyone with a laptop can sign-up for an AWS account and start building quite sophisticated things – so we have much broader access to really smart engineers that are really familiar with the internals of our platform.’
‘Children of the Cloud’ are young engineers who have only worked on AWS or Google Cloud – and have never worked in businesses that have physical, on-premise servers.
What do consumers expect from a modern banking app?
Consumers tend to like apps that make them feel in-control – and challenger banks are keen to give them what they want.
‘We wanted to give power to [banking] customers… like Gmail [does] for managing email.’
For a bank that offers no cash incentive to join and only offers interest for deposits above £1,000 (1%), Monzo has generated impressive momentum:
- In March 2016, Monzo raised £1m in 96 seconds – the fastest crowdfunding campaign ever.
- 66,000 people were on Monzo’s waiting list December 2017.
- Half of Monzo’s users are under 30 and a quarter are under 40.
So why are consumers flocking to sign up to Monzo?
Monzo gives their customers a sense of control over their finances.
‘For something like 90% of our customers, the free foreign exchange is nice, but they might go on holiday once or twice a year. They are living on an average salary and it’s about visibility and control. It’s the feeling that: “With my old bank I never knew how much money I had at any point and I’d spend over a weekend and on Monday morning all the charges would hit my account and I’d realize I’d overspent and it caused me anxiety and stress.”’
Tom Blomfield, Monzo
Challenger banks certainly offer features that traditional banking apps don’t. But the deepest disruption might lie in their relationship with consumers.
Monzo claims to align their incentives with their customers. Utility spending data can be automatically matched with utility providers to check for better deals. Monzo can then recommend alternatives that save their customer’s cash – and earn them a commission. Monzo also makes money from the interchange (fees paid by the merchant to accept card payments) and interest earned at the Bank of England on their deposit. While they charge some interest on overdraft charges, they deliberately keep these low and say they’re keen not to profit from someone in financial trouble (around 25% of bank accounts are in persistent overdraft).
Open Banking paves the way for further disruption
Challenger banks like Monzo have a huge opportunity in the new open banking standard that launched in January 2018 – which forces the UK’s nine largest banks to share their data with licensed startups (if approved by the account holder).
Account holders should be able to view their transactions from all banks in the app of their choice and potentially track services and utilities in the same place.
Blomfield thinks open banking will have a big impact – but over time.
‘With open banking, people are expecting a tidal wave of something. I think it won’t happen in January next year, but the concept behind it has the potential to revolutionize retail finance totally. There is just so much valuable data sitting in these bank accounts. I don’t think banks are doing it malevolently, they are not using it for nefarious purposes, they are just incompetent. They just can’t get it out. And if consumers are able to unlock that data and use it for their own benefit it will create entirely new industries.’
Tom Blomfield, Monzo
Which challenger bank apps do you use?
How can startups leverage the new open banking standard?
Should traditional banks really fear challenge banks?