Why Challenger Banks failed to “Challenge” the Financial industry? Is it time the Challengers to be “Challenged” in the very core of their business model?
Today we can see a significant raise of FinTech Banks or so called Challenger Banks, “redefining” the banking industry by connecting with a new generation of mobile-first consumers. The brightest examples of Challenger banks in the UK are Revolut, Monzo, Starling Bank; in Europe — Curve and N26: in USA — Chime, BankMobile and GoBank.
A number of them (e.g. Revolut, N26) are considered by industry experts as overvalued, using technologies that in the present age of exponential innovation, might as well considered as actually outdated to some extent, or at least not enough innovative.
“Most Challenger / Neo Banks are not banks at all. They are tech companies acting as introducing brokers to existing banks. To be considered a Bank in very broad terms… the entity needs to be able to “Take Deposits” “issue cards” or “lend from balance sheet” and most Challengers don’t do any of those. So the real value they add is creative marketing. If the user base acquisition was achieved organically then it would be value, but when the trick is to use VC money to subsidise real costs then it’s unsustainable.” — Mushegh Tovmasyan, Chairman at Zenus Bank.
The UK is home to the most Challenger banks unicorns of any country: OakNorth (valued at US$2.8 billion), Monzo (US$2.5 billion) and Revolut (US$1.7 billion). Further, if analysts’ estimates are correct, Atom Bank (US$644 million) is closing in on the magic number of US$1 billion.
What about Profit?
If profitability is a key metric by which to measure what these startups are actually worth, then we can argue that their valuation is inflated. In recent years, as FinTech has steadily disrupted and even occasionally menaced traditional financial services, venture capital has been pouring into the segment. So goes the FinTech Bubble.
Monzo, for instance, faces mounting losses. In fiscal year 2018, it lost £47.2 million, 54% more than the previous year. Monzo’s leadership says that the losses are necessary to grow quickly.
London-based Revolut — which has already raised almost $340m over 12 rounds — hopes to raise another $500M, which will give the company a valuation of more than $5bn. That’s for a company that not only isn’t making any profits, but also has been through a series of embarrassments and controversies in 2019, including having to admit that it had “mistakenly” switched off a system for flagging potential money-laundering for several months last year, and being investigated for false advertising. At the same time CEO Nikolay Storonsky wants the firm to reach a valuation of between $20bn and $40bn before floating on the stock market.
German N26’s valuation is at US$3.5 billion. N26 operates across the European continent and boasts 3.5 million customers, but it is not profitable, nor is it apparently concerned about reaching the black anytime soon.
“How can new firms that have yet to gain customers’ main bank accounts — most of these new players are being used as secondary or even tertiary accounts by many people — be worth half of a Deutsche Bank, when you combine their current valuations?” — Chris Skinner, FinTech Expert.
In the Tech community, a startup’s value is often linked to the size of its user base and the potential to scale rather than a proven business model. There’s good reason for that: If investors insisted on profitability before investing, firms like Facebook, Twitter and Instagram could never have survived. In fact, Twitter had its first profitable quarter in Q4 2017, more than 11 years after its founding. But what was relevant and normal for Social Media growth, and in many other network-related ecosystems (due in part to the synergetic effect of sharing economy business models) may not be implemented as easily for the FinTech Industry.
Hype VS Reality
Many modern Challenger banks only look progressive in contrast to the overwhelming conservatism of traditional financial corporations and banks. The real FinTech industry (built on AI and Data Science, willing and capable to on-board innovations as soon as they are created, constantly staying ahead of the technological curve) has been blurred and delayed by HypeTech, and by overvalued companies who care more about integrating the latest advances in superficial marketing to be on the first wave of Hype, rather than the actual latest tech advances in the Data Science technologies and their applications for FinTech and WealthTech.
80% of Start-up banks will fail to raise still-larger rounds, and inevitably consolidation will begin to happen. Consolidation is definitely coming, not because the companies are overvalued, but because to deliver on their valuations they will have to become broader digital financial services companies (it will be hard to be an FX player worth $US10 billion, for example).
Entrepreneurs are raising bigger rounds, and more of them, because they can. Everything is fine. But raising larger and larger rounds is a lockstep. They have to exit some time. The problem with start-ups raising more and more money in this way, and reaching such stratospheric valuations, is that they are setting themselves up with a Herculean task when it comes to actually trying to sell. They might be buying time, but they are effectively mortgaging themselves.
European banks are a big buyer group of European FinTech’s but cannot afford to buy heavily loss making fin-tech’s — many fin-tech’s regularly lose €5–10m+ a year, and no bank can afford to pay €100m+ and take on such losses.
However, not all modern FinTech companies are just introducing brokers. There are a number of players that are slicing off a service normally run by a bank and doing it much better. TransferWise is using a smart approach to allow people to send and receive money safely from abroad without the high fees, Funding Circle is doing it in SME lending, Square in card payments, Zopa in peer-to-peer lending, to name just a few examples.
That’s the reason why in May 2019 BlackRock and other large investment funds have acquired a $292 million stake in TransferWise. Audited financials for fiscal year ending March 2018 revealed 77% revenue growth to £117 million and a net profit of £6.2 million after tax.
Challenger Banks were aiming to compete with traditional banks, but in reality they are now competing with each other for a comparatively small slice of the entire user-base due to a lack of accelerated development, which lags behind the current pace of technological progress.
Longevity Bank: It’s all about real Tech and Profitability
“ The One Billion Retired People Globally are a Multi-Trillion Dollar Opportunity for Business” ~ Dmitry Kaminskiy interview in the Financial Times
Challenger banks are chasing income from the middle-age and younger generation, while missing 1 Billion Consumer or 15 Trillion Dollar Market opportunity, developing technology only for a limited age category.
“The global spending power of those who aged 60 and over will reach $15 Trillion Annually by 2020” ~ Bank of America Merrill Lynch
As the share of the population above 60 is increasing in every member state of the European Union, European banks are lagging behind in finding solutions for this age group, especially taking into account the fact that seniors are holding the lion’s share of the savings. Traditional banks like UBS, HSBC, Credit Suisse, Barclays and Citi, as opposed to challenger banks, are making their first steps in AgeTech, adapting their infrastructure for the Elderly. For example, HSBC has partnered with the Alzheimer’s Society to create dementia-friendly products, while Barclays is actively developing software for seniors to make their customer experience more comfortable. UBS went so far as to create The Century Club among their clients, expecting to live up to 100 years.
If traditional banks, with hundreds of years of history and nearly-unbreakable, guaranteed trust behind their brands and their long-standing reputations were willing to on-board data science, AI and advanced IT-solutions and technologies to meet the needs of the untapped Silver Ocean (clients 60+ age), they stand in an almost unconquerable position to challenge and gain the multi-trillion market opportunity that their younger, less experienced competitors failed to capture. If they were able to do so, then the combination of their guaranteed brand stability and consumer/client trust and technology-driven AgeTech, WealthTech, InsurTech, HealthTech solutions would put them in an unstoppable position for growth, and enable them to transform a source of loss (ageing population) into an unprecedented source of growth, prosperity and stability.
As the year 2020 approaches, real FinTech companies should be fully capable of onboarding AgeTech and HealthTech (Health Longevity) into fully integrated financial products, services and solutions for the Silver Generation in order to seize the untapped and overwhelmingly neglected 15 trillion dollar market opportunity of 1 billion people in retirement. Challenger Banks are now making more to a low-margin wholesale marketplace, trying to scalp tiny slices of profit, rather than real financial products that are capable of making a profit for both banks and for their clients, in simultaneity and synergy. This is similar to several years ago when high frequency scalping, mechanic, and robotic systems were taken over by progressive hedge funds, implementing sophisticated systems with strong AI.
As increasing number of HWNIs and regular middle-class individuals age, and begin to recognize Health as the New Wealth, the time has come for banks to offer fully-integrated, AI-empowered, data science-driven AgeTech, WealthTech and HealthTech solutions to create an ecosystem and infrastructure to secure the Stability, Sustainability and Future of the Silver Generation, and to empower, enhance and extend their clients’ Healthspans and Wealthspans in equal measure.
About the Author
This article was written by Sergey Balasanyan. Sergey is Co-founder of Longevity Bank. He is Partner and Head of FinTech Division at Deep Knowledge Ventures and Head of Strategic Development at Longevity.Capital, specialized investment fund specifically focused on the Longevity industry.