The UK banking industry is opening itself up to new entrants in the hope that this will stimulate greater competition in the market. The early signs are that innovative new players could be doing exactly that.

Life has got easier for anyone wanting to set up a new bank in the UK. Simpler regulation, cheaper technology and political pressure on the industry to encourage more competition in the banking sector are just some of the reasons why the UK is now more likely to see new entrants to the market.

According to one news report from April 2014, 29 companies are in the process of applying for a banking licence in the country. This includes names such as Atom Bank, Starling and Lintel Bank, all of which are currently being considered by the UK’s regulators.

Of the new licencing process, Anthony Thomson, founder and chairman of Atom Bank, says: “It is a lot easier, but it is not easy.” He should know, this is the second time he has been through the process of setting up a bank in the UK.

Easing up

When Mr Thomson set up Metro Bank in 2008, it was the first time in more than 100 years that someone had created a new standalone bank in the UK. Although the regulator at the time – the Financial Services Authority (FSA) – had received applications for new banking brands, these were all set up as subsidiaries of existing companies, which already had a banking licence. For example, Egg, an online bank launched in 1998, was created by the banking arm of UK financial services provider Prudential; First Direct was a branchless brand from UK bank HSBC; and ING Direct was a subsidiary of Dutch banking group ING.

In setting up Metro Bank, there were a number of challenges owing to the length and the opaque nature of the authorisation process, says Mr Thomson.

Another challenge, he says, related to the amount of regulatory capital the FSA required a new bank to hold. A minimum figure was not fixed and “it kept asking for more and more, which is not efficient from the shareholders’ perspective”, he says. Access to the payments systems also proved difficult for a small, new player.

Now, Mr Thomson notes, there is a payment systems regulator in the UK, which ensures fair access to payments systems for players of all sizes.

Since his experience with Metro, Mr Thomson says there has been a “real sea change” in the attitude of the UK's regulators. Since March 2013, he says the process has been simpler and clearer.

More options

There are now two regulators in the UK – the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), which replaced the FSA in April 2013. But new bank hopefuls need only apply once to the PRA, which is the lead regulator for banks. There are also now two options for banks to apply for authorisation: 'option a' and 'option b'. Option a is suitable for companies that already have investors, capital and technology in place to set a new bank up quickly. 

With ‘option b’, banks are able to able to overcome the old problem of having to make plans without a licence. Previously, it was difficult to attract investors and raise capital without a banking licence and it was equally difficult to get a banking licence without investors and plans in place.

Option b is a staged 'mobilisation' route, and is the option that Atom Bank, Starling and Lintel Bank have all opted for. Firms can be authorised based on their business plan but are restricted from operating as a bank until they have raised the necessary regulatory capital. By gaining regulatory approval first, it makes it much easier for banks to then mobilise the funds from investors.

Atom, for example, has already been authorised with restriction and is now in the process of raising more capital. In December 2014, it announced another investor – Jim O’Neill, the former chairman of Goldman Sachs Asset Management – who invested £25m ($49.1m) in the bank, which plans to launch in 2015.

Emerging competition

Another new entrant to the UK market is Starling, which also plans to launch in 2015. Anne Boden, the bank’s CEO, says “option b makes things a lot easier – before that you could not hire people or make contracts”, without a banking licence.

Ms Boden explains that there are now numerous opportunities to discuss an application with regulators. A number of meetings are offered, such as a coffee meeting to discuss the proposition, then the applicant can send in a business plan and discuss it with the regulators, then there is a challenge session. After an applicant has gone through all these stages, it can then hand in its formal application, explains Ms Boden.

UK regulators are now far more welcoming to those hoping to set up a new bank, an attitude borne out of a wider political drive to encourage more competition in the country's banking sector. Politicians from all parties have been calling for the dominance of the big four high street banks – Barclays, HSBC, Lloyds and RBS – to be reduced, especially since two of these players, Lloyds and RBS, needed taxpayer bailouts at the peak of the financial crisis.

Making the switch

One initiative, the current account switching service, was launched in the UK in September 2013, and is aimed at motivating more consumers to consider switching their current account to another bank. It was thought that one of the factors stifling competition in the UK was the reluctance of many consumers to switch to a new bank, because of the perceived difficulties in changing payments to a new bank account. The scheme simplifies the process of changing current accounts and also guarantees the payments, with a promise to reimburse customers for any charges that occur for erroneous transactions.

The current account switching service was a technology project implemented across the banking industry in the UK. However, it is not the only new technology making life easier for new entrants; other advances are also helping to make it easier for new challengers to enter the market.

Now, explains Mr Thomson, it is possible for start-up banks to rent the technology infrastructure necessary to run a bank rather than having to buy it or build it themselves. Atom Bank has opted to use Fiserv’s software for its operations. Fiserv is one of the first providers of a simple off-the-shelf technology package for start-up banks, but Mr Thomson anticipates that more technology providers will start offering similar solutions in the future.

Ms Boden says that Starling has decided to build its own technology and is aiming to bring techniques found in Silicon Valley – and used by the likes of Facebook, Google and Netflix – to the UK banking sector.

Splinter groups

While the UK has seen a number of challenger brands entering the UK banking space – such as Virgin, TSB and Williams & Glyn – Ms Boden argues that these all use traditional banking models. And, although they are new brands, they have been borne out of older entities. Virgin, for example, expanded into a retail bank by acquiring Northern Rock. And TSB and Williams & Glyn are brands that have been spun off from Lloyds Banking Group and RBS Group, respectively, in line with an agreement with European competition regulators.

In return for state aid during the global financial crisis, Lloyds and RBS agreed that they would sell off some of their businesses. They both opted to separate out these businesses by reviving old brands, which will be sold off at a later date.

Ms Boden also points to another trend in the banking sector: “There is a huge amount of disaggregation in financial services – lots of people are providing parts of the value chain. What we are going to do is one thing: we will do current accounts.” 

Banks typically offered a range of banking products to their customers, but now consumers can get their financial products from other sources. This could mean a credit card from personal credit card provider MBNA, a peer-to-peer loan from peer-to-peer lending service Zopa, or a current account from another niche provider.

An e-solution

Alex Letts, CEO and founder of UK-based Ffrees Family Finance, talks of a "componentisation" of the industry, where different financial products can be provided by different players and not a single bank. Ffrees offers a current account, which is targeted at the underbanked segment in the UK. Although it functions in the same way as a bank account, the Ffrees solution does not need a banking licence behind it.

European regulations – through the E-Money Directive – allow the creation of electronic money institutions that can issue ‘e-money’. Prepaid card programmes have proliferated under this regulation and the Ffrees account is an evolution of such a product.

In 2009, the second E-Money Directive, which was implemented in the UK in 2011, made it easier to become an e-money issuer. There are now no initial capital requirements for small institutions that have less than €500,000 of e-money outstanding, on average. Institutions with more than this must hold initial capital equal to 2% of their average outstanding e-money total.

The Ffrees account is provided and licenced by Contis Financial Services, which is an e-money institution that has an e-money licence from the UK’s FCA.

Peter Cox, executive chairman of Contis Group, explains how the company fits into the payments ecosystem. The company is a shareholder and principal member of Visa Europe and is also a Visa-certified processor, he says, which means that Contis processes all the transactions for the cards it issues under its e-money licence for its client brands. Contis is also connected to the regular banking payment rails, which allows funds to be paid into and out of the Ffrees account via the regular banking network.

“We brand ourselves as the home of alternative banking,” says Mr Cox, who explains that the company's solutions are also used by more than 100 credit unions, as well as by other brands in the UK and the EU.

Ffrees makes its money from transaction and monthly account fees. Although such an idea would be unusual to most UK consumers – whose 'free' bank accounts have been cross-subsidised by exceptions charges – the Ffrees proposition is attractive to low-income people who have been stung by bank charges for being overdrawn. Not being able to go overdrawn is marketed as a key benefit of the Ffrees account. 

The account is not a deposit account – such as those offered by banks with banking licences – and so it does not pay interest on the balances. Another difference is that prepaid programmes are not covered by the UK's Financial Services Compensation Scheme. However, customers' funds are held in a segregated account, so if the issuer of the prepaid programme were to run into trouble, it would be protected from the company's creditors.

When asked if Ffrees would ever consider applying for a banking licence, Mr Letts says: “This is not in our thinking. The whole point of running on the e-money rails is to be able to create a business model that out-competes the banks and the new challenger banks with their streamlined services in the core current account business. It means we don't carry the regulatory and capital burdens that the deposit takers face. We do not intend to make a land-grab for the other services offered in the banking ecosystem. We intend to own the heart, not the limbs!”

Homing in

Ms Boden says that Starling has a streamlined strategy, with the current account at the heart of the bank's operations. The mobile banking proposition will help people with their personal finances. For example, when a cheque comes into the account, the bank will notify the customer and will also alert them if it is more or less than they were expecting.

“We will predict for them how much they will have left until the end of the month,” says Ms Boden. The target group is 18- to 35-year-olds, who Ms Boden says usually manage their money well for the first two weeks of the month but, after that, things may get problematic. “We are helping people so they do not go overdrawn,” she says.

When asked what the key to building a new sustainable bank is, Ms Boden says: “Delivering something the customer wants is the most important thing. Banks have been far too focused on solving their own problems [rather] than solving customer problems.” 

For Mr Thomson at Atom, success and sustainability rest on two things. The first, he says, is the strength of the proposition and having a good business plan. The other is the strength and experience of the management team, as well as the oversight and governance through a high-calibre board of non-executive directors.

Putting together a team and building a strong proposition in this way is not easy, but at least now with simpler regulation in the UK it does become a lot easier.


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