Why challenger banks face an uphill struggle

Metro Bank is looking at a £1bn IPO in a sign that the challengers are rising, but the Big Four remain stubbornly dominant.

by Adam Gale
Last Updated: 11 Jan 2016

Metro Bank is reportedly in talks with the London Stock Exchange about a potential £1bn IPO. The bank, which first hit the high street in 2010, would join challenger banks Aldermore and Virgin Money as listed companies, after they floated for £650m and £1.25bn respectively towards the end of last year. Clydesdale and Shawbrook, meanwhile, are both already in the process.

With all that equity coming their way, surely the challenger banks are now set to make inroads into the market for so long dominated by the Big Four (Lloyds, HSBC, Barclays and RBS)? Perhaps not. The big players and the second tier of Santander, Nationwide and TSB stubbornly retain their hold on market share.

The Competition and Markets Authority (CMA) launched a full investigation into the barriers to entering the retail banking sector in November. It concluded that the big four had remained largely untroubled by the new entrants.

‘Very limited market share gains have been made in recent years by those banks with the highest reported levels of customer satisfaction,’ it said, ‘not what would normally be expected in well-functioning competitive markets.’

The reasons are fairly apparent. States may or may not have the view these days that a bank can be too big to fail, but size and history are reassuring to most consumers. The safe sense of familiarity that comes from seeing a Lloyds or Barclay’s branch on even the sleepiest high streets across the country is hard to replicate for a newcomer, even if branch numbers are in fact declining.

Just as importantly, banks benefit from scale. A £10,000 loan will be a far riskier proposition for a bank with £1m in deposits than one with £1bn. The smaller bank has to be more selective. It's also much harder for businesses to switch bank accounts than it is for individuals due to the sums and complex terms involved, creating another barrier to entry.

On the other hand, there is a market for newcomers. The big banks are retreating somewhat in the face of persistent international fines, and their reputation among the general public has been low since the collapse of Lehman brothers in 2008. Some personal customers (and to a lesser extent business customers – the big four have 90% of that market) are clearly willing to make the switch.

Metro Bank has 34 branches now across London, and aims to have 150 by 2020. Compared to Lloyds with over 2000, that might seem small, but if all the challengers grow like that then between them they would be a force on the high street.

That may only happen, though, if the CMA (or indeed the EU or a victorious Labour Party, which has long called for increased competition in the sector) takes measures to break up the Big Four. It may seem far-fetched, but TSB has already been spun off from Lloyds, and Williams and Glyn is being separated from RBS. Admittedly these weren't the result of a decision from on high, but it shows things can change in a big way.

If the challengers were then involved in mergers, or were themselves bought by powerful foreign banks seeking entry into the UK market, the landscape could change quite dramatically. But that’s a lot of ‘if’s – bosses at the Big Four probably won’t be too troubled by the young pretenders just yet.  

Read about the challenge facing the new banks in our archive here.

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