Overall, traditional banks have generally been a bad investment since 2008. Investors thinking about dipping their toes back into the water may well be concerned about the rise of challenger banks and what this means for the traditional banks. 
Challenger banks have enjoyed a spectacular rise since the 2008 financial crisis. It is easy to see why, with many of the traditional banks being blamed for bringing the UK close to the brink of economic collapse. In addition to this, traditional retail banking operations have paid out billions in compensation from the mis-selling of payment protection insurance (PPI) and have been subjected to astronomical fines by various regulators around the world.
Prior to the banking crisis it was difficult for companies to acquire a banking licence – a necessity for accepting retail deposits. The process was expensive, arduous and time consuming. However, since the regulations for bank authorisation have been relaxed many more challenger banks have been popping up, but what does this mean for consumers and investors alike?
Competition is good for consumers, especially when we are in a prolonged period of low interest rates. Competition for the highest interest rates for savers and lower interest rates for borrowers is to be welcomed. Additional incentives to encourage switching bank accounts are also a bonus, especially when the ‘current account switch guarantee’ regulations stipulate that switches must take place within seven working days. You can now move banks for a financial incentive with very little disruption, with all your direct debits moving across to your new bank automatically.
However, most challenger banks do not distinguish themselves from the ‘old guard’ by virtue of better interest rates. Their ‘hook’ for new clients is often better technology or gimmicks such as a brightly coloured debit card. Of course, better technology for banking should be welcomed.
It drives innovation and helps to keep systems robust, which in turn avoids frustrations when customers face IT glitches and are unable to access their online banking.
However, while the majority of challenger banks might offer more convenient ways of banking online, many do not have a high-street presence. Online might be more convenient for the younger generation, but by having a pure online presence you are removing yourself from the market for many of the older generation who prefer to do their banking on the high-street.
The other issue that comes from having a more fragmented banking sector is the increased risk of collapse of one or more banks. If you think back to the 2008 financial crisis the banks were too big to fail, resulting in government bailouts for certain banks. Would a challenger bank in financial difficulty get a government backed bailout?
Challenger banks are bringing welcome competition and a new way of banking, but we would not write off the big four just yet. While brightly coloured bank cards and apps that tell you where you are spending money might be nice, they certainly aren’t game changing. We would argue that you should know where you are spending your money regardless of whether an app tells you.
Perhaps the biggest threat to the established banking sector isn’t challenger banks, but companies and platforms that start to offer banking services. It should come as no surprise that Apple recently announced it was launching its own credit card – Apple card. We expect other tech companies such as Amazon to follow suit.
Nevertheless, don’t underestimate traditional banks and their ability to adapt. As they close more and more high-street branches, they are turning their attention to bringing the fight to the challenger banks online. They are also investing more and more into their IT infrastructures as well as offering more of the same services that led to the rise of challenger banks.
Donald Maxwell-Scott is technical investment manager at Rowan Dartington. The views expressed above are his own and should not be taken as investment advice.