The banking industry has undergone huge change in recent years, and so too have its players. As such, the time-honoured classifications of ‘incumbent’, ‘challenger’ and ‘neobank’ no longer sufficiently describe a bank’s offering, role or position in the industry; arguably some incumbents are proving to take more ‘challenging’ strategies than some of their comparatively younger challenger or neobanks. So how will banks be defined in the future?
by Rivo Uibo, Co-Founder and Chief Business Officer at Tuum
The evolution of banking is partly in response to an underlying shift in the way that people live and work and the demand across diverse demographics for more tailored banking services. Freelance workers have different banking needs to employees; the needs of Gen Z customers, such as saving money and managing subscriptions (including Spotify, Netflix etc.) are far removed from those of older generations. In essence, to prosper in today’s banking industry, banks must now find a means of being relevant to diverse customer demands and desires and provide these banking services in the most convenient way.
In tandem with this trend, the advent of embedded finance, open banking and APIs together with the rise of new entrants to the market including tech giants and superapps and demand aggregators (brands that provide financial services on top of their core offerings such as Alipay, Uber payments or Gusto wallet), are adding further complexity to the banking landscape and the number and diversity of players.
Banks are therefore under pressure to maintain market share and are looking at different approaches to achieve this. Let’s look at the different business strategies that banks are pursuing today and where these business models are likely to lead to.
High street banks
Even before the pandemic, high street banks were ramping up their digital offerings and reducing their number of branches. But in the wake of the pandemic and soaring demand for digital banking, high street banks face strong competition from online-only banks. As a result, they have radically reduced their number of branches; according to a report by Which? published in December 2021, almost 5000 UK bank branches had closed since 2015 or were set to close in 2022.
That being said, In the UK, high street banks offering personal and business banking (including RBS, Barclays, Lloyds and HSBC) are still regarded as the market leaders and mainstays of the industry. Only time will tell if their (albeit reduced) in-person banking services and industry standing will be enough to survive heightened competition from their more nimble digital counterparts. In the meantime, these mainstream banks will be closely analysing the options open to them to maintain customer share (greater focus on digital/focus on other market segments).
These forward-thinking, online-only banks provide banking services that fully reap the efficiency benefits of modern technological capabilities. Leading digital banks currently include the likes of Monzo, Nubank and N26. These large players, which started out as ambitious neobanks, have succeeded in gaining a sizeable customer base through innovative, digital service offerings. N26 is today one of the most valued banks in Germany and is aiming to be one of the biggest retail banks in Europe (without having a single branch) while Nubank boasts 40 million customers in Brazil.
Aside from these larger successful players, many digital banks tend to be niche players, laser-focused on the banking needs of one specific customer group. These financial service providers are made up of both those who have their own licence and those that depend on other banks or banking platforms for their licence – but both are perceived equally by end-users as ‘digital banks’. Their strategy is to gain maximum traction within their target customer segment and then expand and enhance their service offerings. A great example of a niche digital bank is Jefa, a LATAM bank set up by women for women, offering free accounts, a debit card, and a mobile app to assist money management. With the defaults of banking in LATAM broadly hostile to women customers, Jefa is making headway in a giant untapped market that has been ignored by other banks. Another good example is New York-based Daylight, a digital bank that offers services specifically tailored to meet the needs and assist with the financial challenges of LGBTQ+ people and their families.
Notably, as long as a financial institution is fully regulated and users’ money is protected, customers are beginning to show less loyalty for long-standing banks and are increasingly motivated by innovative services and excellent customer experience from digital banks. The rise of platform players – in the form of next-generation core banking and BaaS platforms are playing a key role in enabling digital banks to quickly roll out new tailored banking services and driving innovation in everyday banking.
These banks succeed in functioning in multiple modes; they successfully provide banking services directly to their own diverse customer base while also opening up their infrastructure to provide the technology and licence to third parties.
Goldman Sachs is a key example of such a bank today. It launched a consumer banking brand, Marcus, in 2016, together with a new transaction banking unit, which amassed $97 billion and $28 billion in deposits by 2020 respectively. Goldman Sachs opens up the underlying infrastructure that powers Marcus and its transaction banking unit to external third parties as well, such as Stripe or Apple. By leveraging both its balance sheet and regulatory expertise as well as a modern platform, it is an attractive embedded banking partner for large sticky brands.
Starling Bank is another (online) bank that together with providing award-winning digital banking services to its own customers (it has been voted Best British Bank in the British Bank Awards for the last four years), it also offers its own infrastructure to other banks and fintechs in order for them to roll out financial services.
As embedded finance and the rollout of financial services by non-banks takes off, banks that can offer their infrastructure and banking licences will become increasingly in demand.
Only time will tell exactly what the banking landscape will look like in the future but what is very clear is that the age-old classifications of banks need reconsidering. And in order to survive and thrive banks themselves need to decide what path to take. We are entering a stage in the evolution of the sector where there is no clear roadmap for a given incumbent or a given challenger bank. Each individual bank needs to assess its strengths and ambitions and re-evaluate its strategy to carve out its own place in the industry.
The growing demand for personalised and relevant services will mean that only a minority of banks will be able to operate on multiple levels because it is hard for a bank to be everything to everybody. In the meantime, advances in banking technology and the growth of platform players supporting digital banks will enable this segment to further expand and diversify while the banks that serve both their own customers and support other third party banks and fintechs will help to drive competition and bring about more choice and more options for customers in the future.