By Daniel Hunter
Challenger banks are outperforming the 'Big Five' High Street banks, but the larger ones need to do more to stand out, according to a report by KPMG.
The new annual report, The Game Changers, analyses the full-year results of some of the largest UK challenger banks, grouped in three categories — the ‘Large Challengers’, ‘Small Challengers’ and ‘Retailer-owned’ banks.
The Large Challengers are Post Office, National Australia Bank (NAB), TSB and Virgin Money. The Small Challengers are Aldermore Group, Handelsbanken, Metro Bank, OneSavings Bank, Shawbrook Group and Secure Trust Bank.
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.
In 2014, the Big Five saw a 2.8% return on equity. The challenger banking sector as a whole average 3.8%. However, smaller challenger banks reported much stronger result with an 18.2% return of equity. Larger Challengers saw just a 2.1% return.
KPMG said Small Challengers have benefited in a reduction in their cost to income ratio (CTI), from 65 to 53% between 2012 and 2014. Larger challengers reported a higher CTI of 64% in 2014 as many have inherited a higher cost base, which has yet to be optimised.
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.