Tag: Digital banking

This blog is the second publication in our blog series. In our previous blog entitled ‘Challenger banks: Disrupting the Swiss market’, we outlined the history of banks, the different categories of Challenger banks and how they can mitigate the risks they are facing. In this blog, we further explore the various obstacles that Challenger banks are facing today, such as economic and political difficulties, and provide recommendations on how to navigate these hurdles and grow in the years to come.

Challenger banks are facing significant threats to their survival due to economic obstacles. Their growth has slowed, and most have not yet achieved profitability or are currently operating at a loss. Overall business development strategy, regulatory & compliance, and data security have developed into important focus areas if they are to become sustainably profitable and compliant. To withstand the current economic and geopolitical uncertainties, Challenger banks should act promptly by revaluating their strategic course.

The financial sector is grappling with challenges posed by major players such as FTX, BlockFi, and Celsius, resulting in a “crypto winter” that wiped out over $2 trillion in market value. This not only impacted the digital asset market but also affected the broader financial industry, including challenger banks . In addition, two California-based financial institutions, SVB and First Republic, experienced a sudden exodus of customer deposits, thereby indirectly threatening the banking sector’s stability. Finally, UBS acquired Credit Suisse amidst the financial turmoil caused by the collapse of the two US banks.

Furthermore, macroeconomic setbacks such as high inflation and increasing interest rates, coupled with microeconomic factors like rising energy costs, have arisen from global geopolitical tensions. This resulted in a slowdown in investments and increased risk aversion, impacting Challenger banks. This stands in stark contrast to the high valuations seen in Fintech firms at the end of 2021. With decreased investor participation and public scepticism, Challenger banks must now address profitability issues, improve customer retention, ensure compliance, and enhance data security.

Challenger Banks and Profitability Issues

In recent years, Challenger banks have been confronted with the reality that once abundant investor funding is now dwindling, down by 45% in 2022 as compared to 2021. In addition, the number of global Challenger banks launched has dropped to an all-time low (a 46% decline between 2020 and 2022), as the market matures and becomes more consolidated and less attractive for new entrants.

The decline in funding can be attributed to decreased investor appetite and major players reaching maturity, hence not needing further investments. Early pioneers, like Revolut, have secured enough backing to focus on profitability rather than raising new funds.

Profits of Challenger banks are linked to scale: generating revenue from an expanding global customer base across diverse products and services while minimizing prospect acquisition costs.

In recent years, there has been a rise in M&A deals, which has led to market consolidation, indicating that some Challenger banks depend on financial acquisitions to achieve the necessary scale and profitability. Prominent examples include Starling Bank’s purchase of buy-to-let mortgage provider Fleet Mortgages Ltd. in 2021. From 2021-2022, the number of annual Challenger banks launches has steadily declined and so have the number of M&A deals completed (a drop of 43%). Regulators have also played a role by implementing regulations (e.g., PSD2) that aim to level the playing field, challenging the dominance of established players.

Uncertain Times and Pressurized Margins

It can be argued that the core issue lies in revenue generation. According to industry experts, the estimated revenue per active customer is around $30 per year. Challenger banks, such as Monzo, Revolut, and N26, offer limited product portfolios with lower fees, including subscription fees, foreign exchange fees, and card fees. They lack more lucrative products like mortgages, business loans, or investment products, which traditional banks typically offer. This limited range may constrain their revenue potential. Recent economic situations have also strained consumer spending, further affecting digital bank revenues.

Despite Challenger banks’ popularity, many retail customers are still hesitant to use them as their primary account. According to industry surveys, 25% of respondents cited data security as their main concern, followed by fraud (22%) and “not being perceived as a bank” (20%).

Players are addressing higher cost base due to…

Increased business development and client attraction expenditures

Revolut’s 25 million client milestone is an exception, as many Challenger banks face difficulties acquiring new clients. Traditional banks now offer similar services and products after significant investment in digital user experience. For example, UBS’s commission-free “key4” credit card appeals to frequent travellers, while Zak by Bank Cler and CSX by Credit Suisse provide more options for clients in Switzerland. Additionally, unified mobile wallet solutions like TWINT, offered by most major Swiss banks and used by 5 million users, cover various financial needs, leaving few unfulfilled niches.

Challenger banks face fierce competition, constantly introducing new features. However, recent scandals involving digital asset firms such as FTX, including some Challenger banks, have eroded public trust. Industry experts don’t consider them “proper banks” and express concerns over fraud, resulting in low penetration rates in certain regions (e.g., US) and some banks exiting markets (e.g., N26 exited UK and US).

Tighter Compliance, New Regulations – and Costs

One major cost driver for Challenger banks is increased spending on regulatory compliance. As these banks attract more users, their responsibilities towards regulators and clients expand. They have made progress in financial crime control measures, but regulators expect further improvements in areas like customer due diligence, transaction monitoring, and Suspicious Activity Reporting (SAR). The Financial Conduct Authority (FCA) states that financial crime control resources, processes, and technology should match a bank’s expansion. To address this, Challenger banks are creating new positions in their Compliance department.

Challenger banks must also manage requirements related to their banking license, such as renewing a license from FINMA (the Swiss regulator). This can be challenging due to capital requirements, which depend on the bank’s category and risk profile. A minimum of 8% of total Risk-Weighted Assets (RWA) and suitable financing sources are required. Management must find a balance between the significant regulatory costs of maintaining their banking license and managing costs for scalability purposes.

Intensified Data Security and Fraud Risks

Challenger banks have long operated with a “scale first” approach, often overlooking other critical aspects of their business, such as fraud prevention and cybersecurity. Traditional banks allocate around 20% of their annual budgets to IT-related expenses, including data protection, according to a J.P. Morgan study. In contrast, some rapidly growing Challenger banks struggle to maintain a strong technological and security infrastructure for customer data protection.

These banks also face a shortage of skilled back-office employees, like fraud and cybersecurity specialists. Consequently, many rely on third-party vendors, increasing their vulnerability and dependency due to insufficient internal cybersecurity capabilities. As a result, numerous Challenger banks have encountered security challenges, including fraud attempts, scams, phishing, and client data breaches. For example, in September 2022, Revolut suffered a cyber-attack that affected around 50,000 clients, representing 0.2% of its 25 million customers. Although the percentage is small, such attacks have significant privacy and reputational consequences.

Challenger Banks and Future Outlook

Challenger banks, particularly in the Swiss market, must implement a strategic approach to sustain growth and maintain competitiveness.

Firstly, they can boost revenues by revising pricing models, such as Spain’s Bnext, which created a marketplace offering for not only financial products but also travel and energy services. They can also target more premium clients, akin to Revolut’s “Ultra” subscription plan aimed at higher income client segments.

Secondly, cost control is critical, encompassing measures such as reviewing cost structures, automating processes, and exiting non-strategic markets, as seen with N26’s decision to leave the US and UK markets.

Thirdly, Challenger banks need to differentiate themselves to attract customers. This can be done through strategies such as offering competitive and profitable products, exceptional support, and implementing client retention initiatives. The introduction of Apple’s high-yield savings account, which offers an impressive 4.15% annual return, is a notable advancement in the financial industry that can significantly disrupt the landscape. This innovative product, initially launched for US customers in April 2023 and accessible via the Apple Card in the Apple Wallet mobile app, not only signifies a transformative step in the financial industry, but also holds the potential for expansion into other global markets, bringing its potential for disruption to a worldwide scale.

Lastly, enhancing data security is paramount to reduce data breach risks, as highlighted by Deloitte’s Global Future of Cyber Survey 2023. A combination of these strategies, including the introduction of new products, cost control, customer attraction, and enhanced data security, will be key to surviving and thriving in the ever-evolving Swiss banking landscape.

Conclusion

As Challenger banks face key operational hurdles on their road to success, they should carefully evaluate the root cause of their profitability challenges and fraud and cyber risks to reframe their company strategy. By adopting strategic options such as revising pricing models, reviewing cost structures, offering new products and services and partnering with other companies, Challenger banks can navigate the challenges they face. In a highly competitive and rapidly evolving challenger banks landscape, they must keep agile and innovative to stay ahead of the curve.

Sergio Cruz, Partner, Consulting

Sergio is the lead Partner of Deloitte’s Business Operations practice in Zurich and has more than 25 year of experience in Consulting. He focuses on large scale front-to-back digitalisation programs in financial services and has worked on several large assignments both in Switzerland and abroad, covering the implementation of regulatory requirements and the definition as well as implementation of target operating models and process optimisations.

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David Klidjian, Partner, Consulting

David is a Partner in Consulting and leads Deloitte’s Business Operations Banking Industry for Switzerland. He has significant experience of Investment Banking and Wealth Management working in the UK, US, Asia and Switzerland. His focus area is on large Front-to-back operations transformations and setup and expansion of new banking operating models.

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Soheil Modheji, Digital Assets and Cryptocurrencies Lead 

Soheil is a Director within Deloitte Consulting Switzerland. He is engaged in formulating strategies for banks and developing target operating models as well as leading business, regulatory and IT/Ops strategy-driven banking projects. In the DLT space, he has been involved in projects and initiatives for implementing crypto asset trading and custody solutions at banks.

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Katerina Kochova, Senior Consultant, Consulting

Katerina is a Senior Consultant at Deloitte Switzerland in the Business Operations team. She is specialized in banking and FinTechs working in France, Luxembourg and Switzerland. Katerina has experience on large digital transformation, process excellence setups and Target Operating Models definition projects in Retail Banking, Private Banking and Wealth Management.

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Hongming Li, Consultant, Consulting

Hongming is a Consultant at Deloitte Switzerland in the Business Operations team with focus on the banking industry. Mainly engaged in business testing activities, client risk scoring and client onboardings, Hongming has supported major Swiss Banks in its client life cycle management efforts.

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