Why lack of consolidation among challenger banks is a problem for all

What’s remarkable about UK retail banking is that a market with so much in the way of innovation and activity can result in so little genuine upheaval.

A decade after post-crisis angst about competition in banking, mid-market challenger banks have proliferated, with overseas entrants also braving the UK market. The regulator has authorised almost 30 new banks since 2013, from digital upstarts such as Monzo and Starling to this year’s wannabe northern champions GB Bank and Bank North.

What all this dynamism boils down to at a market level is underwhelming. This is also an area sadly lacking in decent data, something a regulator somewhere should surely rectify.

But a recent report by the Social Market Foundation (caveat: “supported by” Metro Bank) found that concentration in the market for personal current accounts and mortgages had barely changed since 2015. The personal current account market was more concentrated than before the financial crisis, the SMF said.

Other figures also point to customer inertia. Annual switching rates have been stuck at 2 per cent. A crop of challengers such as TSB, Metro Bank and Virgin Money haven’t reached the kind of market share that presents a meaningful competitive threat (which post-crisis was talked about as 5 per cent). The Big Six incumbents’ market share in gross mortgage lending basically hasn’t budged since TSB was spun off from Lloyds in 2013, according to numbers from trade association UK Finance.

These numbers don’t tell the whole story, of course. The fact that ringfencing forced the biggest lenders such as Barclays and HSBC to refocus on their UK businesses, and trapped funding in their UK banks, has meant keen pricing in areas such as mortgages. Incumbents have proved adept at aping digital innovation and features produced by upstarts, a win of sorts for consumers.

Not that it necessarily matters, because as the competition regulator noted in 2016 this is a market where disparities in quality — where digital and challenger banks consistently tend to fare better — and price don’t translate into customers shifting their business.

The effects of the pandemic aren’t yet clear. Lockdowns accelerated the adoption of digital banking and boosted challengers’ and fintechs’ share of lending, according to some research. But the funnelling of government support to companies via big banks reversed challengers’ gains in small business lending. Current account switching fell lower still. The need to invest in digital arguably adds to the benefits of scale, in a sector where everything from data to compliance costs already favour being big.

Everyone broadly agrees that the challenger bank market needs to consolidate. But Co-operative Bank’s tilt at TSB went nowhere and private equity group Carlyle on Thursday said it had ended talks about buying Metro Bank, the customer service-focused challenger with a surprisingly large number of shiny branches and surprisingly small sliver of retail deposits.

Agreeing deals just now may be tough: Metro Bank was trading at only 20 per cent of tangible book value before Carlyle’s interest became public this month. Value investors (and really, who else would own them?) are wary of selling out just as rising interest rates might help profitability.

Metro Bank’s shares fell almost a fifth on Thursday, despite the board’s warm words about its standalone prospects. Deal failures are a problem for the newer banks, many of which face an uncertain path to profitability let alone showing they can produce decent growth and returns.

They are also a problem for the regulators, who might have some reservations about the private equity ownership model but are faced with a market where it isn’t clear who has the appetite, expertise or credibility to lead consolidation, and where they are under increasing pressure to water down regulation for smaller lenders as part of their remit to help competition.

And they’re a problem for the rest of us, who by most accounts are still paying over the odds for subpar banking services.

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