As customer dissatisfaction with the UK's existing high street banks intensifies, new entrants are sprouting - many of which are extensions of established retail brands, striving to create the winning formula using their innate consumer insight. Will these new operations pose a sustained threat to the existing ones? Writer Michelle Price

Attempting to enter a marketplace characterised by ongoing uncertainty, widespread consumer disgruntlement, declining profitability and hyper-consolidation may strike many onlookers as an act of commercial suicide. But in the UK, a number of intrepid new players are known to be doing just this, in the belief that now, more than ever, is a time of major opportunity. According to reports, they are busily buying technology, appointing consultants and hiring staff: but who are these new players, where have they come from and what do they have to offer?

The most visible of these new players include well-established UK retail brands expanding into the banking business. Examples in this category include Virgin Money, the personal finance subsidiary of the Virgin Group which is awaiting the outcome of its application for a 'banking' or deposit-taking licence, filed in October 2009.

Virgin Money declined to comment, but it is widely publicised that the company will launch an internet bank through which it plans to take deposits and offer mortgages, followed by the build out of its branch network. The company, which is presently raising funds, has said it will consider acquisitions as part of its branch expansion plans and it is tipped to be the most likely buyer of the so-called 'good bank' being spun out of Northern Rock.

In early December, meanwhile, the UK Post Office unveiled plans to capitalise upon its brand and infrastructure by launching what it calls a "people's bank", although the details remain sketchy. But by far the most hotly anticipated new player is Tesco Bank. The UK's largest supermarket already offers 28 popular personal finance products through its Tesco Personal Finance business, which was founded as a joint venture with Royal Bank of Scotland (RBS) in 1997. In summer 2008, however, Tesco moved to buy out RBS's 50% share of the business in what was widely regarded as a precursor to an aggressive expansion of its finance business. Then, in March 2009, Tesco put an end to market-wide speculation when it unveiled its intention to launch a full-service retail bank. It is also expected to purchase Northern Rock assets.

The retailer has launched five in-store branches, in addition to its pilot store launched in 2006. Benny Higgins, CEO of Tesco Bank, was not available for comment, but a spokesperson told The Banker that Tesco Bank is awaiting customer feedback before expanding its branch network further. This strategy is only to be expected from a supermarket that has built a retail empire based on giving customers exactly what they want, or so Tesco claims.

Building on trust

Many commentators believe that highly recognisable brands such as Tesco could be strong competitors for the current account market due to the high levels of customer trust they enjoy and their strong customer insight. Tesco, which is regarded as the poster child for customer segmentation techniques, will establish its own contact centres this year in order to retain control of its customer service, in a strategy that aims to capitalise on the poor, one-size-fits-all service typically associated with traditional high street banks. "We don't run our business by looking at what other businesses are doing and finding niche markets: we listen to what our customers are telling us that they want. That is a big difference," says a Tesco spokesperson.

But Tesco Bank is not the only new banking outfit that believes popular discontent with unresponsive high street banks presents a competitive opportunity. In London's Holborn district, a swathe of advertising banners has emerged with the somewhat unfashionable message: "love your bank". More specifically, the campaign is inviting the onlooker to love Metro Bank Plc, the new UK upstart founded by Anthony Thomson, chair of London's Financial Services Forum, and Vernon Hill, the US entrepreneur credited with pioneering a new style of service-driven retail banking.

Mr Hill, who founded the successful US-based Commerce Bancorp using this model, is named, along with Mr Thomson, as a director of the new bank in documents filed at the UK's Companies House. The filings show that Mr Hill is the primary backer and controlling chairman of Metro Bank, owning some 75% of the new entity, with Mr Thomson taking the remaining 25%. According to its September 2009 accounts, Metro Bank has just less than £5.5m ($8.9m) in liabilities and equity.

The new bank, which was incorporated in November 2007, has a licence application pending. The Banker understands that in the meantime, Metro Bank, which will offer savings products, current accounts and mortgages, plans to replicate the same convenience-focused customer-service techniques that Mr Hill deployed in the US: this means a branch-focused strategy with some 200 'retail outlets', as they will be marketed, being the initial goal. In tune with other retailers, but very much in conflict with historical retail banking trends, Metro Bank will strive to attract customers via fun, cosmopolitan family-friendly branches that open early in the morning, on weekends and late at night, seven days a week.

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Eye on SMEs: Phillip Monks, CEO of Aldermore

Knowing the customer

In this regard, Metro Bank, which aims to launch in 2010, is following a similar consumer-led philosophy to that of Tesco: customer convenience is key. But not everyone regards the UK consumer base as the primary target market. Elsewhere in London's City district, other new outfits have identified the small and medium-sized enterprise (SME) sector as profitable, if neglected. One such outfit has been founded by Sandy Chen, a respected bank analyst at City investment bank Panmure Gordon. Mr Chen, who was unavailable for comment, is in the process of raising £100m via private backers and a London public offering for the start-up Albion Bank, which will focus on lending to cash-strapped SME companies. Panmure Gordon is acting as an adviser to the new entity but will likely take a 5% stake in the new venture instead of a fee.

Albion Bank, which is reportedly seeking backing from Sir Brian Pitman, the former chairman of Lloyds Bank, will fund the lending business by raising chunky deposits from affluent individuals seeking specialist high-interest products. There is also speculation that the new venture may seek to purchase assets from those UK banks being forced to slim down by the European Commission. But it remains to be seen whether Mr Chen, who hopes to launch the bank later this year, will be able to raise the funds and procure a licence.

Another private equity-backed bank has already got off the ground, however. Phillip Monks worked at Barclays for 26 years and went on to play the leading role in setting up Arab Bank Europe, where he was CEO until 2007. He regards the UK SME segment as a wasted opportunity. "The competitive landscape will never be the same again: the banks have huge black holes in their balance sheets so a lot of the competition is looking inwards, while the SME market is desperately crying out for bank lines," he says. In summer 2008, Mr Monks approached specialist private equity house AnaCap Financial Partners to secure backing for a new SME-focused UK-based bank. AnaCap went on to buy Ruffler Bank, a niche asset-financing outfit, the control of which was transferred to AnaCap in April 2009. The firm immediately merged Ruffler with specialist commercial mortgage lender Base Commercial Mortgages to create Aldermore, the first 100% private equity-owned UK bank.

AnaCap has not wasted any time in beefing up the new entity with further acquisitions. The private equity firm intends to inject up to £80m into the new bank during the next few years to support the expansion of its SME lending portfolio. Aldermore is also taking on deposits via a range of high-interest savings products. "Our strategy is to secure asset financing to UK SMEs, focusing on hire purchase, leasing and invoice financing," says Mr Monks. "We're building a bank based on traditional values: that's what the public and the UK business sector is looking for."

In the UK's south-eastern county of Essex meanwhile, another initiative has taken a more direct approach to SME funding. 'Banking on Essex', which was launched in April 2009, was conceived by Essex County Council (ECC) in response to the recession. According to Ian Hatton, a manager at ECC, council leaders have long-admired the local municipal banking model prevalent in the US. When the recession hit and SME lending in the UK all but evaporated, ECC began exploring ways that it could facilitate lending to local Essex-based businesses. "We looked at setting up a bank and we realised it would take far too long," says Mr Hatton. ECC determined that a joint venture would be the quickest means of supplying badly needed funding to local businesses.

Under a deal that ECC subsequently signed with Santander, both partners have provided £50m of funding, with each entity funding 50% of every loan and taking 50% of the interest earned. By January 2010, the joint venture expects to have issued £1m-worth of loans. But it is not stopping there. ECC recently developed a framework for the provision of overdrafts while, in the long-term, it may consider setting up a fully fledged bank or establishing a longer-term joint venture, says Mr Hatton. The joint venture is also assessing the scalability of the model and whether it could be extended to include other local governments.

But so what?

This raft of ambitious upstarts is just the first wave. Neil Tomlinson, head of retail banking at consultancy Deloitte, who is working with a number of the new players, believes there will be a "plethora" of new entrants attempting to gain a foothold in the UK market. "They will come in various guises," he adds. For the UK government, whose stated ambition is to boost competition in the UK market, this is all good news. But is there a genuine appetite for new players?

According to Simon Bailey, payments director at bank infrastructure provider Logica, which has been in discussions with several up-starts, the fact that other new entrants have already died an invisible death suggests that the challenges are easily underestimated. Do the new ventures reflect a change in attitude among consumers of banking services in the UK? And even if they do, will these banks be able to survive in the long term?

Recent research undertaken by YouGov and sponsored by Deloitte suggests that, at least among the consumer base, there is an appetite for fresh and trustworthy banks: more than 50% of respondents said they would consider buying a product from a non-traditional organisation and a further 20% said they had moved a banking relationship due to dissatisfaction - a remarkable figure given the inertia that has traditionally characterised UK banking relationships. "That, to me, says that there is a movement towards being more attracted to new entrants than in the past," says Mr Tomlinson. The survey also suggests that Tesco and Metro Bank are taking the right approach: customers still want face-to-face interaction and excellent branch-based service.

Untainted by the crisis, new banks have a strong brand advantage, say some people. Both Aldermore and Banking on Essex evoke the so-called traditional values of banking: low-risk, small-scale and localised. Aldermore has crafted a marketing message out of eschewing the big, over-bloated banking model under which the needs of local businesses and consumers have been neglected. Meanwhile, Aldermore, an old English tree and Albion, an ancient poetic byword for the British Isles, are not-so-subtle plays on the national protectionism that has grown out of the crisis.

However, Julian Skan, a senior executive in the retail banking practice at Accenture, questions the sustainability of the local ideal: "Customers will not make consistent choices based on that," he says. Products, he adds, are the real issue. Mr Hatton says, however, that traditional high street banks struggle to meet the needs of local businesses. To this extent, localism is not just a marketing ploy, at least for the SME business: both Mr Monks and Mr Hatton argue that being locally focused allows them to tailor products and services specifically to their clients.

It is also frequently argued that the new players will benefit through ultra-modern technology that will be operationally superior and cheaper to run. Both Tesco Bank and Metro Bank will be starting afresh with new, flexible core banking systems, provided by Fiserv and Temenos, respectively. Tony Catalfano, division president of bank solutions at Fiserv, says the company has devoted a great deal of effort to providing Tesco with the seamless customer experience the retailer demands. Mr Monks certainly believes that technology will be a key advantage. "We can change every single banking system and make it world class - name another bank in the UK that can change its entire technology system," he says.

Nonetheless, new players will not be able to achieve the economies of scale necessary to compete in a market that is now dominated by mega banks such as Lloyds Banking Group and HSBC, says Mr Skan. To say nothing of declining profitability, the UK cost base is simply too high. "Everybody is trying to go the next mile around economies of scale. The new players might have the new technology, but will find themselves more expensive on a per-unit basis," he says. Banks such as Tesco already benefit from their existing infrastructure, which the retailer intends to optimise to its fullest extent. But Metro Bank will start from zero. "I don't think those types of players will go to the scale point and be part of the long-term environment," says Mr Skan. It seems almost inevitable that Metro Bank will be built up to be sold on, say many onlookers. Searching out growth from a fragmented base, meanwhile, is not typical of the private-equity model.

To this extent, it remains unclear whether many of the known new entrants will be able to develop a sustainable, cost-efficient model. But if they are simply the first wave of new entrants, as is widely believed, the established players may yet have reason to worry.

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