The UK challenger banking sector is outperforming the ‘Big Five’ UK high street banks, however, the Large Challenger banks need to accelerate how they stand out in the market, according to a new KPMG report.
The new annual report, The Game Changers, analyses the full-year results of some of the largest UK challenger banks, grouped in three categories1 – the ‘Large Challengers’, ‘Small Challengers’ and ‘Retailer-owned’ banks.
The report reveals that while Small Challenger banks are securing stellar returns, key financial indicators of the Large Challengers such as the return on equity, are becoming very similar to the ‘Big Five’ – Barclays, HSBC, Lloyds, RBS and Santander.
|‘Big Five’ UK banks||Challenger Banking sector average
||Large Challenger group average
||Small Challenger group average
|Return on equity in 2014||2.8%||3.8%||2.1%||18.2%||15%||11%|
Challenger banks overall, are also becoming more cost efficient as they grow. In particular, as Small Challengers have grown, they have benefitted in a reduction in their cost to income ratio (CTI), from 65 to 53 per cent between 2012 and 2014. Larger challengers reported a higher CTI of 64 per cent in 2014 as many have inherited a higher cost base, which has yet to be optimised.
These figures are remarkably similar to the ‘Big Five’, who reported an increase in their CTI from 60 to 63 per cent in the same period.
Warren Mead, head of challenger banking and alternative finance at KPMG, said “Although the overall challenger banking sector is growing rapidly and securing greater returns, it is the Small Challengers who are driving its growth.
“Small Challengers are securing high returns and have better cost optimisation. If this trend were to continue, as the challengers grow and benefit from economies of scale, it poses an interesting question for the Big Five as to whether too big to fail, becomes too big to compete? “Financially, the Large Challengers are looking very similar to those of the traditional banks. To ensure they remain differentiated, they must review their brand, distribution, products, culture and customer service.
“Digital banking is a great example. Our report found that the mobile functionality of the challengers is at best equal to, but often worse than, the ‘Big Five’. For those challengers focusing on customer service or cost as a differentiator, this could be a major hurdle for the future.”
The report also revealed that the challenger banks are strengthening their balance sheets and embarking on a lending spree, while traditional banks reduce the size of their operations as a result of regulation. In 2014, lending assets grew 16%, compared with a decline of 2.1 per cent for the ‘Big Five’.
This translated into an average annual 8.2 per cent growth in loans and advances to customers between 2012 and 2014, compared with a decline of 2.9 per cent from the ‘Big Five’. For Large Challengers, this was 3.2 per cent growth, while Small Challengers significantly grew their loan books by 32.3 per cent. However it should be noted that the combined loans of the five largest challengers are still just five per cent of the Big Five’s loan books, and therefore it is easier achieving higher levels of growth.
These figures paint a picture of the challenger banks picking-up the whitespace left behind following the financial crisis. This includes areas such as small business lending, second charge mortgages, invoice financing and unsecured lending.
However challenger banks face key challenges. Although regulatory rules apply equally to all banks, in practice however, they do not. Challengers have to hold more capital in comparison to established banks.
Depending on the results of the Competition and Markets Authority’s current review into the banking sector, there may also be a significant impact on the fortunes of the challenger banks and their willingness to push further into the small business banking and current account markets.
Mead continued, “For the next few years at least, we expect the challengers to continue to outperform the market in terms of pure financial results.
“However Small Challengers may have to start making trade-offs as maintaining high rates of growth will be difficult to maintain. For Large Challengers and the Retail-owned banks, there is plenty to go for if they accelerate their differentiation journey.
“But for all challenger banks, the main point of difference is their culture. Being largely free of the legacy problems of the past contributes to a sense of social purpose that puts fire in the bellies of their executives and frontline staff alike. Only time will tell whether the big banks will combat that fire with fire of their own. Creating a ‘bank within a bank’ – a new challenger brand free from legacy conduct, technology and culture – might be the best start.”
Other key findings include:
The full report can be downloaded here.
- ENDS -
Notes to Editor:
1. Basis of preparation
The report makes reference to the 2014 results of the UK headquartered banks grouped as follows:
Information has been obtained from published 2014 year end reports (including results presentations and accompanying analyst packs) and company websites. Where total numbers are presented, it is the total of the sub-division of banks as described above, excluding Metro Bank who had not released their full 2014 results at the date of drafting this report.
2. Key financial indicators
We have taken the following approach to calculate each of the measures used in this report:
HSBC presents its results in US dollars ($). This has been translated into sterling using the relevant period end or period average rate. Where percentage changes are presented for HSBC, the percentages are based on the dollar amounts disclosed by the banks, rather than on the sterling translation of those amounts.
Simon Chan, KPMG Corporate Communications
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KPMG LLP, a UK limited liability partnership, operates from 22 offices across the UK with approximately 12,000 partners and staff. The UK firm recorded a turnover of £1.9 billion in the year ended September 2014. KPMG is a global network of professional firms providing Audit, Tax, and Advisory services. It operates in 155 countries and has 162,000 professionals working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.