A new market segmentation for retail banking

1st July 2015
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We all know the context. Despite billions of pounds of investment in new propositions, brand “refreshes” and other marketing, trust in the UK banking sector is still at an all time low. There is very little actual differentiation between the main retail banking players, and almost no perceived distinction when you ask customers.

If people bother to move at all, they are pushed out by bad service, unexpected fees or lack of product competitiveness, and are pulled to an alternative by little more than convenience of alternate branch or until recently joining cash incentive.

But we believe the market is on the tipping point of major change.

There is a new generation of players that have or are about to launch. Many will play in the traditional retail banking space, but differentiate by channel or customer experience. Some are taking one element of the services traditionally delivered by the banks, and either offering a best in class experience or serving previously under-served audiences. This is the sort of market disaggregation that has happened in the US, and we believe is inevitable in the UK as well.

This article attempts to take this moment in time, and capture who’s doing what, in order to help the uninitiated navigate this increasingly complex, brave new world of how the UK population can manage their money.

Segmentation of retail banking services

Big banks and traditional challengers

The players here are well known. Defined, and some would say hampered, by their history and, in most cases, their high street presence.

Legacy systems restrict innovation, and large customer bases restrict the ability to expand quickly to meet evolving customer expectations.

The likes of TSB and Williams & Glyn have been forced into existence by EC mandates to increase competition post financial crisis but are simply “a chip off the old block” encumbered with legacy without the scale of the originating big bank.  I’m not sure this is where you would start if you really wanted to create a new and agile player likely to introduce some true competition.

The exceptions to this are the new players of Metro and Virgin Money. That said, there was much expectation set at the launch of both players, but little delivery beyond making slightly better what was annoying customers – faster account opening, branch hours more reflective of a busy, urban audience, and some small product innovation.

Savings and mortgages – building societies as was plus new entrants

For some time yet, there will still be power in the savings and mortgage space, occupied by those that can offer increased value. This is mostly driven by their ability to price competitively in moments of key market demand.

It will be interesting to see how this sub-category of brands retain relevance as the generations who remember the power of the building society model mature. Currently price is still their biggest draw to younger generations, but the lack of investment in defining their brands beyond this rational hook may result in further disaggregation in this space, as we’ve seen in other lending markets.

The supermarkets and other retailers

This sector saw large levels of investment between 2012 and 2014, but it feels like focus has returned (out of necessity) to their core business of grocery.

Trust remains an issue – many people seem happy to take out insurance or a reward based credit card, but very few are moving their current account relationship.

Why does a banking licence matter?

So one of the key questions we get asked is why we are bothering to apply for a banking licence? And the answer is simple.

For the time being, the word ‘bank’ is still the frame of reference that people look to in terms of where to securely keep and manage their money. Alongside this, there is still an element of trust that comes with the increased regulatory supervision imposed on the banks. Most importantly of course, it provides the maximum available protection for customers’ money, with balances being underwritten by the Financial Services Compensation Scheme to the tune of £85,000 per customer, per bank.

As we come on to some of the disaggregated products hitting the market, there is a common misconception that this means money is protected in the same way. And of course, whilst they are regulated, the same level of protection isn’t offered.

The next generation of banks

The simplest way to think about the core of new market entrants is that they will effectively replicate the full set of products and services a traditional retail bank has, just through all or a subset of digital channels. Necessary branch based services (e.g. paying in cash or cheques) will still be offered, but via a third party arrangement.

That’s not to say this reference to the traditional product set is a bad thing in any way. Customers still frame their decision around the core set of products that have existed for many years. And the advantage all of these players have is in building the majority of their systems for current market requirements, enabling them to both avoid the sins of the past and hopefully deliver genuine innovation in customer experience.

Some are specialising based on audience – OakNorth and Civilised are focusing more on the small business audience; Lintel believe there is untapped potential with foreign nationals, but the majority still see the advantage in servicing a broad base of customers.

How will Starling be different from this?

We believe there is an opportunity to go further than just replicating a full set of retail banking products, and focus on delivering an exceptional, mobile-first experience for the core customer need of money management, by building a single, best in class, current account.

As highlighted in previous blogs, why do customers have multiple products that do slightly different shades of the same thing? The mental accounting piece aside (because that can be solved in other ways), it’s because banks have spent years telling customers they need them. And why? Because selling (and it was selling) complex products, with opaque charging models made really good commercial sense!

Of course, like all new players, we will be looking to right the many wrongs proliferated by the category. But in focusing on a single product build, all of our investment in the customer experience will be concentrated on the things customers need and use the most.

Neo-banks

If you look at the US and some of the European markets, you can see another area of growth that is likely to hit the UK market soon, in the form of so-called neo-banks. These brands claim to deliver the best in class digital experience, with none of the risk of a balance sheet – so they effectively put a layer of information management over another banks’ product set.

The challenge with this is that customers’ funds and effectively the bulk of the relationship is held with the partner bank, and so in creating those hand-offs, such as in the on-boarding process, this can still be onerous.

Simple and Moven are probably the most well known names in this space, with Number 26 starting to grow their reputation across Europe.

Monese will be the first player to launch in the UK, currently schedule for summer 2015. Whilst full details on their proposition are yet to be revealed, current messaging features the ease and speed of account opening, as well as the lack of hidden fees – but transparency is easier when you don’t allow customers to borrow any money at all.

Pre-paid debit cards

The grouping of brands that have the greatest potential to cause customer confusion have to be the pre-paid debit cards.

Many are calling themselves a “bank”, without needing or possessing a banking licence, and/or promoting their “current accounts”, without offering the full spectrum of benefits customers have come to associate with this nomenclature. Or at least certainly not offering the same level of free banking as is currently offered by the retail banks.

Now this may lead to a greater level of transparency for the sector overall. As one of the brands quite rightly claims, no banking is truly free in the UK, as all businesses need to make money somewhere. The danger though is that currently, many of the players in this space are a viable offer for those that can’t pass the credit scoring required for a full current account with the banks, and would rather have the additional benefits offered (although at a cost) beyond historical “basic” bank accounts. Whilst transparent in terms of charging, I would argue that customers will pay a premium to go via this route. For some it is worth the monthly cost – for those without credit history or credentials, the security of an FSCS scheme and the absence of overdraft facilities is irrelevant. It is better to have a card than no card at all. However, it is sad that the people who least afford services sometimes pay the most and social inclusion in the financial system remains a challenge.

Payments and digital wallets

As payments and mobile technology evolves, some would argue whether you need a card at all. As NFC technology advances, secure mobile or wearables payments should become the norm.

The two biggest barriers in the UK currently are the roll-out of technology at the merchant end, with many terminals still not taking contactless, let alone mobile, and there are still large populations of customers for whom security is a concern.

Of course services such PayPal, and others like ApplePay, Google Wallet, and Amazon offering a digital wallet still ultimately need to be “funded” from somewhere or only currently house existing, traditional card details. But what are the barriers in the future to them to create their own cards and / or fully-fledged current accounts?

When this happens, markets such as the pre-paid cards will cease to exist, forcing those brands to evolve or die.

FX / international payments

Whilst a much smaller market, international payments has not remained static either, with Transferwise leading the charge to take business away from what it says are the cost prohibitive bank services.

I wouldn’t rule out the old school Western Union and Money Gram however, who still benefit from large volumes of usage by foreign nationals, and are looking at their own innovation to stay relevant in a digital age.

The lending market will continue to evolve

Finally, it will be interesting to see what happens in the lending space after the flurry of new entrants, and market disaggregation in recent years. With much regulatory focus on the payday lenders, we may see some contraction here.

What will be interesting is to see who in the peer-to-peer space is really set to weather any sort of storm (touch lots of wood that we won’t see a financial crisis like the last anytime soon). The attractive rates are bringing in the savers, in an environment of rock bottom rates everywhere else. But as rates start to rise, how much of a return will customers be willing to trade off for their FSCS protection?

So what?

Ultimately, what’s the desired outcome of all of this increased competition? Well of course, it should be to ensure customers will have more choice. And that is the agenda that should be driving what ever proposition the brands of the future create.