A ten-year study from global management consultancy A.T. Kearney claims that the profits of European retail banks are at an all-time high. This has been driven by a positive economic environment and lower risks, with risk costs relative to total income at lowest level 5% compared to 12% in 2008.

However great this news sounds, the future is not that spectacular for the heritage banks, as the Kearney report suggests it the topline is stagnating. A.T. Kearney’s ‘Retail Banking Radar 2019’ analyzes data from 92 banks across Europe and found that despite continued strong growth in volumes, income remains weak with a dramatic drop in income per client (-1.1% 2018 vs 2017; -11% 2018 vs 2008). Meanwhile, a quarter (24.6%) of bank branches across Europe has closed since 2008.

Simon Kent, partner and global head of Financial Services at A.T. Kearney comments:

“Our ten-year study shows that whilst the industry is stronger, it is stagnating. Not all banks will survive the tide of change as customers increasingly favor digital banks and innovative products and services. Branch closures is a short-term fix to steady the books but it is not enough — traditional institutions need to consider strategic transformation to improve cost and top line and also offer more innovative products and services if they are not only to survive — but thrive — in the new retail banking landscape beyond 2019.”

The neobanks are coming

The banks are facing the tough challenge coming from neobanks in Europe. These new, ‘digital only’ models,are attracting rising numbers of customers. The Radar showed that neobanks’ customer bases across Europe have grown by over 15 million since 2011, compared to a decrease in 2 million customers for retail banks. Up to 85 million Europeans will be customers of these banking models by 2023 according to the study — which equates to around 20% of the population over 14 years old.

UK-based Revolut bank already has upwards of 4 million customers, while Monzo, another leading neobank based in the UK is eyeing the US market, which has been much slower to grow than the European neobank sector.

The Radar report also showed that up to 50% of European customers are ready to share personal data with their banks. European initiatives like the Second Payment Services Directive (PSD2), Open Banking has meant more information sharing between banks, third parties, and their customers, have helped this enormously.

Daniela Chikova, partner at A.T. Kearney comments:

“The shift towards digital banking, only compounded by the introduction of Open Banking, has caused a transformation in how and where customers want to bank. They’re more open to sharing their data with third parties, have greater trust in banks’ ability to hold their data safely and, particularly amongst younger generations, don’t have a need for in-branch banking any more. Open Banking has been a key driver in banking innovation, and we expect this to continue into September as the new Regulatory Technical Standards come in.”

Payment transactions have certainly been a winner for the neobanks, thanks to their speed and lower fees, as I mentioned in my previous article. One of the other ways in which these challenger banks are stealing a march on the traditional banks is in the area of lending and credit products. For starters, the neobanks are able to provide their credit products with lower charges and interest rates, and in the Medici report “Neobanks: A global deep dive,” the authors use Brazil’s Nubank as an example of this advantage.

Nubank does not charge fees for using its credit card. It allows its customers to lock and unlock the card, ask for an increase in their credit limit, as well as change the due date for repayments, and all this can be done from the Nubank app. That makes the customer’s life a lot easier. You may wonder how Nubank makes money. The report says that it does this in two ways: first through customer transactions, and second, through financing a part of, or the total amount of, consumer invoices. It relies on a public database for all its customer data and groups customers into hundreds of different profiles. This is its way of screening out unqualified customers. Furthermore, unlike many other credit card providers in Brazil, it does not charge any fees as long as the customer makes their payments on time. And now it has added a current account and a rewards programme to its product offering.

What’s happening with neobanks worldwide?

Another of the things that the Medici report highlights is the geographical location of neobank startups. Where would you guess that most of these challenger banks start their journey? Perhaps you think it might be Silicon Valley, or Seoul.

Actually the highest concentration of neobanks is in Europe, and within Europe, the United Kingdom is home to the greatest number of them. Why and how has this happened, especially since neobanks have shown the most rapid growth since 2016, and the UK has been in political turmoil since that year over the vote to leave the European Union, which it is due to leave at the end of October. Medici explains the situation: “the UK has a high concentration of challenger and neobanks owing to two factors, chiefly.

One: compared to the US, which has very high numbers of large banks, the UK has far fewer. Two: when it comes to digital banking, the UK can be considered an early adopter, going back to the dotcom boom between the late ’90s and early ’00s. This provided it a ‘prime-mover’ advantage, through which the UK came to be at the forefront of challenger/neobanks and alternative models. Another factor providing the

UK with an edge in this space is the EU’s common standards being introduced, which has aided neobanks rapidly expand their customer base while remaining in compliance with regulations.”

The last reason will seem ironic to those in the UK who are against leaving the EU, and if the country is to retain its advantages for neobanks, it will need to retain those EU regulations.

The banks that have led the European ‘Charge of the Neobank Brigade’ are Atom Bank, Tandem Bank, Monzo, Starling Bank, Revolut, and N26.

For full details of all the neobanks worldwide and an overview of their services, I recommend you read Medici report for a fuller understanding of how neobanks are changing the banking sector, especially for the retail customer.