Feb 25, 2021

Will challenger banks lead the post-Covid recovery?

Aman Behzad, Managing Partner ...
5 min
Will challenger banks lead the post-Covid recovery?
2020 was a roller coaster year for challenger banks. They have bounced back strongly. But are they up to the challenge of driving the post-covid recover...

Neo banks were disproportionately impacted by the pandemic and saw usage drop by 90% at the beginning of lockdown - 30% more than traditional banks.

The differential impact was driven by the nature of the typical spend on a card from a challenger bank vs traditional bank. There was also a massive hit to revenues given the dependence on interchange income generated. But by the end of 2020 the tide seemed to have turned. Leading challenger Starling became the first to turn a profit, Revolut broke even and funding was back on the table. But there was a clear shift with European B2B fintechs raising €5bn last year, compared with €3.1bn for B2C firms.

By building trust with customers, focusing on sustainability, and expanding their consumer offerings, challenger banks will be able to acquire customers but what impact will this have on the economy? Could the development of business offerings (and particularly those focused on SMEs) and new sources of funding help kickstart the economy?

Trust issues 

The biggest issue that has always faced challenger banks has been consumer trust. In a market that equates trust with financial security, and financial security with reliability, challengers have struggled. Around a fifth of the UK public perceive challenger banks as less reliable than traditional banks. This trust was exasperated during the pandemic when Monzo customers were locked out of their accounts during lockdown.

For challenger banks to continue to grow and play a major role in the economic recovery, they need to start making inroads on this trust deficit. We have already started to see some challenger banks invest in building trust with consumers. Revolut implemented a donate function to their application at the start of the pandemic, offering a lifeline to local businesses. This move helped enforce the message that these banks are invested in their communities and are here to stay. Starling on the other hand played a key role in providing access to the government sponsored Business Bounce Back Loan Scheme (BBLS) to thousands of SMEs. Providing this support in a time of great need has helped put a different complexion on Starling’s brand for its users.

New product offerings

Consumers still rely on traditional banks for mortgages and loans – the real revenue generating products that banks offer. Challenger banks are still largely used to pay for smaller items of discretionary spending, such as meals out, travel, money transfer, and general consumer spending. Creating new innovative products that are actually tailored to consumer and SME needs will help make challenger banks more attractive to users as we ease out of lockdown and enhance the uptake of financial products to hasten the economic recovery.

New businesses are being forged from the seismic changes that the pandemic has had on the world. These businesses will be agile, and they will need a financial services partner that can match their own innovation and pace. Challenger banks are better placed to facilitate these rapidly changing business needs, kick starting the economy as a whole.

Focus on sustainability

Green finance will be top of the agenda throughout the Covid recovery. The UK government is promising a green recovery initiative to ‘Build Back Better’. UK-based challenger banks have also seized the initiative, showing how ESG banking can be done effectively. Eco friendly challenger Triodos hit their milestone of £1bn in sustainable lending last year, whilst maintaining their steady profitable presence in the UK after 25 years.  

Both political and demographic tailwinds are encouraging challenger banks to go down this route. Millennials and Gen Z are the primary users of challenger banks and this group is especially concerned about sustainability issues. A focus on ESG banking as a USP can further proliferate challenger banks, allowing them to thrive post pandemic.  

New sources of funding

Leading challenger banks around the world have accounted for a large number of the tech unicorns that have been minted in recent years, but these businesses are either barely break even or are still deeply loss-making. This lack of profitability in combination with high valuations is prohibitive to any potential acquisitions by incumbent banks. This had led to increasing unease around the ultimate path to liquidity for shareholders of these businesses. 

However, challenger banks are now increasingly looking to go public through SPAC (Special Purpose Acquisition Company) transactions. This has recently been demonstrated by MoneyLion, a leading US-based challenger bank’s transaction with Fusion Acquisition Corp, valuing the company at over US$2.4bn. Whilst only a limited amount of liquidity was taken by existing shareholders initially, it will provide a public market route to liquidity for existing shareholders. 

It is anticipated that this is only the first of a number of SPAC transactions involving challenger banks that are likely to take place over the next two years. SPAC deal activity ramped up in 2020 with 248 transactions raising £83bn in gross proceeds – all of this capital looking for a transaction to be deployed in. SPACs offer a time-efficient and regulatory-light way to go public and raise further funding as needed. Various FinTechs have recently chosen a SPAC as their way to go public, including MoneyLion, PaySafe and Sofi.

Looking forward 

Time and time again we’ve seen challenger banks adapt and innovate quicker than their traditional counterparts and surge into new markets. With increased consumer spending on the horizon, a sustainable agenda, and a long-term plan to build highly tailored customer propositions, they can thrive in a post-pandemic world. There will however be one major change in approach from years past; that they will need to have a focus on profitability and become sustainable businesses in their own right. 

But they cannot do it alone. They will also need to convince consumers and businesses to join them on that drive – taking up their offerings and paying for the products offered.

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Jun 17, 2021

Zafin: Banking is now in the era of the tech ecosystem

3 min
FinTech Magazine holds a Q&A session with John Smith, EVP Ecosystem at Zafin, on the evolution of banking and its future as an aspect of tech ecosystems

The development of tech ecosystems is placing the future of post-COVID banking in jeopardy. At a time when Big Tech can replicate the functions of traditional financial institutions, what can banks do to retain a grip on the market?

John Smith, EVP Ecosystem at Zafin, has a few ideas. A SaaS cloud-native product and pricing platform for financial institutions, Zafin is preparing the next generation of banks to cope with this precise challenge.

Smith is responsible for the strategic and tactical management of the company’s ecosystem, including the creation of new business models to support growth and differentiation. We asked him four questions:  

Q. Have the events of the pandemic caused an irreversible shift in the digitalisation of banks? If so, is COVID the sole cause or are there other factors?

It’s a great question and one that I am asked a lot. Without a doubt, the COVID-19 pandemic has driven a significant shift in the acceleration of digital. In fact, I’ve seen some estimates show there to have been as much as four to six years of digital adoption growth since the initial lockdown started. 

While the pandemic may be the primary reason for this growth, two other drivers include fintech disruption and the high costs of operating a traditional retail bank. Both of these factors have caught the attention of banking executives as they set their minds on accelerating digital transformation with a focus on high return, low risk. 

Q. Some commentators believe banks must learn from Big Tech in order to survive. Do you agree? Please expand. 

I agree completely; we’re living in the era of the ‘ecosystem’. All the seismic shifts we’re seeing in technology, be it aggregation, embedded finance, DeFi or hyper-personalisation are all enabled by the foundation of an ecosystem.  

When financial institutions work with a strategic partner like Zafin, which has made the strategic investments in a best-in-class ecosystem, they’re able to capitalise on opportunities more quickly and safely, and will be better positioned for growth now and at the other side of the pandemic. 

Q. What are currently the obstacles to adopting Open Banking? Is it more likely to 'take off' in some regions rather than others?

I would argue that Open Banking has been in the US for some time and will only continue to grow there. By definition, Open Banking is about the secure sharing of financial information that customers are aware of and have authorised. Under that definition, we’re seeing aspects of this well underway even though its full potential remains to be seen.

Third-Party Providers are a natural outcome of Open Banking, whereby they can create propositions beyond what a bank normally does to enable banking functions such as payments, borrowing, saving and so on. Once again, some of these are already present through industry-led initiatives, whereas regions such as the EU have taken the pathway of regulation such as PSD2.  

The industry-led initiatives we’ve seen in the US have also had the added advantage of guard-rails that regulatory bodies like FFIEC and CFPB provide. There are also other technology-led initiatives such as API definitions that are set out through the FS-ISAC. 

I would argue the future of Open Banking in North America will be through the natural evolution of the guidelines and API definitions that have been published, as well as the natural progression of industry initiatives. 

Q. Are there any other bank tech trends you'd like to discuss? 

Coreless banking. Zafin has been pioneering some of the work around externalising functions out of the legacy core to drive a more ‘fintech nimble’ bank, while not having to deliver a ‘heart and lungs’ core bank replacement.  



Real life examples of this include moving some of the core functions of a banking system, such as product and pricing to a platform like Zafin. Origination, onboarding, KYC, risk, and compliance are all other examples of externalising banking functions for added agility.

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