How are challenger banks disrupting the retail banking industry?
- More challenger banks are coming to market, aimed at disrupting retail banking.
- They have been attracting significant private funding in recent years.
- Ongoing growth could provide opportunities on the public market in the near-term.
What long-term trend are we observing?
Since the start of the digital revolution more than a decade ago, challenger banks (source) have emerged with the aim of disrupting the retail banking industry. The past 2-3 years have seen challenger banks gain traction, with some attracting significant venture capital funding.
Investment activity has been especially strong in Europe, with a supportive regulatory environment for alternative banking models. Notably, the largest two Europe-based fintech transactions that took place during the first half of 2018 involved challenger banks (source). Revolut raised $250 million in April 2018, bringing its valuation to $1.7 billion (source). Germany-based N26 successfully raised $160 million in March 2018 (source), and has had two further successful financing rounds of $300 million in January 2019 (source) and $170 million in July, pushing its valuation to $3.5 billion (source). Other European challenger banks to have secured sizeable commitments from investors include Monzo (source) and Atom Bank (source) – both UK-based.
Since the US Office for the Comptroller of the Currency opened up national bank charters to fintech firms in 2018, challenger banks in the region, some of whom don’t have their own banking license, have been actively raising funds to build out their operations. In March 2019, Chime, which is covered through its partnership with The Bancorp Bank (source), raised $200 million to push its valuation to $1.5 billion. Meanwhile, Varo Bank, which secured $100 million in July 2019 (source), has applied for a banking license and edges closer to becoming the first standalone digital bank in the US (source).
Furthermore, we are continuing to see new online-only banks come to market through established banks, as part of their efforts to maintain their overall share of the market. This includes Marcus by Goldman Sachs (source), Openbank (source) and Superdigital by Banco Santander (source), and Pepper by Bank Leumi Le Israel (source).
What does this mean for investors?
The amount of private capital raised by challenger banks is on track for a record year in 2019, having already collectively secured $1.5 billion in investor commitments in the first quarter alone, just below the $2.0 billion for the whole of 2018 (source).
This figure is expected to accelerate as challenger banks look towards building international partnerships and making their own acquisitions to drive global expansion opportunities. Digital banks have historically focused on their domestic market, but some have recently announced their intention to broaden their horizons. Brazilian-based Nubank plans to launch in Mexico with 20 staff, with plans to quadruple its operations there by year-end (source). Monzo (source) and N26 (source) have both launched in the US, while Revolut has ventured into Australia (source).
Challenger banks have typically focused on providing niche products, for instance opening current personal and business accounts, with many customers having to go elsewhere for services such as credit cards and mortgages. However, as these firms begin to broaden their offerings and grow their brand presence, we anticipate them raising more capital. Investment not just by European venture capitalists, but global investors including Chinese tech giant Tencent in N26 (source) illustrates the potential investors see in the market.
As new technology emerges, there becomes an increasing need for banks to keep up with their customers’ ever-increasing demands and tap into a growing millennial customer base. This is something that challenger banks have been doing well, free from legacy infrastructure issues, although monitoring customer trends will be pivotal when looking to launch new products and further disrupt the retail banking market.
Challenger banks are currently unproven business models on the public market, with very few digital banks listed to-date – an example includes Norway-based S*banken. However, with the financial world shifting towards more tech-focused, customer-centric products, and recent times seeing such banks attract lots of investor capital, we expect to see more listings in the near term. Within Framlington Equities, we base our decisions on fundamental, bottom-up stock selection; so, key financial characteristics such as a healthy balance sheet, return on invested capital and a good track record post-IPO will be taken into account before deciding whether to invest in a company.
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