'New breed of UK start-up banks force licensing rethink' James Eyers, AFR
Starling Bank provides a glimpse of how start-up banks could help reshape the competitive landscape for financial services in Britain.
Founded in 2014 – the same year the UK's Prudential Regulation Authority changed bank licence rules to encourage applications from "challenger" banks – Starling was awarded a restricted banking licence in June last year after raising £48 million ($82 million) in January. Last month, it began beta testing of a new digital-only deposit account with 500 customers. It plans to launch to the public later this year.
It is early days for Starling and similar digital-only new banks in the UK including Atom, Monzo, Tandem, Redwood and ClearBank. Fourteen new banks have been approved in the UK since 2014 and a further 20 have been talking to the PRA about licences, which are now granted in a staged fashion, allowing regulation to step up as the bank develops but ensuring it is not overwhelmed at the outset.
The model is also being closely watched by incumbents as many of the new brands are seeking to build out "marketplaces", which will seek to link millennial customers with various products and services via partnerships with niche fintechs.
If start-up banks can hold deposits, other fintechs can provide an ecosystem of financial services. iStock
Starling's chief platform officer Megan Caywood describes it as a "marketplace platform". "You don't need to build it all yourself, but give your customers transparency and choice," she told a delegation in London last week, arranged by the Australian British Chamber of Commerce.
While Starling will operate a current account (it plans to make money from providing overdrafts), it has also announced partnerships with TransferWise for foreign exchange and Moneybox for wealth management, as it builds an "ecosystem" to link its digital native customers with whatever financial services they require.
"People sometimes get overwhelmed about what is the right financial product for them, but if we can provide a clear, transparent way to value [options] and what is the best product for them, then that is a win for us," Ms Caywood says.
There has been very little in deposit innovation in Australia for the past 20 years and only one new bank has been licensed in the last decade that was not a branch of a foreign bank: Tyro.
But that might change if recommendations from the House of Representatives economics committee are adopted, as policymakers suggest the arrival of start-up banks, like those appearing in the UK, would boost banking competition, a priority for the government.
"It is start‐ups' ability to 'remake the playing field' that makes them so critical to improving the competitiveness of Australia's banking sector," said the second report of the committee chaired by Liberal MP David Coleman.
The committee wants the Council of Financial Regulators to review licensing requirements for banks to determine whether they present "an undue barrier to entry"; and whether "the adoption of two‐phase licensing process would improve competition". It also wants the Australian Prudential Regulation Authority to improve the transparency of its licensing processes while maintaining "high prudential standards and financial stability".
"Given expected growth in the use of fintech services over the next year and the potential for such firms to effectively disrupt traditional banking business such as payments, foreign exchange and remittance services, these are critical steps," said the report, to which the government is yet to respond.
Andrew Corbett-Jones, the head of the Tyro fintech hub who is also working as an adviser to the UK government and was in London last week, told delegates the absence of a start-up bank in Australia is imperilling the fintech ecosystem. This is because the ability of niche fintechs to scale is limited by the power of the existing oligopoly and the lack of an explicit competition mandate from government to regulators.
"Where are Australia's challenger banks? In their absence, what is the next stage for fintechs wanting distribution and scale?" he asked. "Maybe they move to the UK and flourish, or maybe they stay in Australia and hope to capture the attention of a bank. But which of our big four have any record of successfully and repeatedly partnering with fintechs? I am sceptical."
Australia had been reasonably successful developing some early-stage fintechs but this represents only the first stage of three in the development of fintech, Mr Corbett-Jones suggested. The second is the creation of start-up banks that can take deposits – like Starling – while the third phase sees those new banks achieving scale, distribution and sustainability by partnering with fintechs in the first phase.
"Australia has done well in stage one, but stage two – the rise of digital banks – is missing in action," Mr Corbett-Jones said. "But new, digital-only banks that focus on customer service, usability, and affordability in their DNA – and provide a range of products from many providers which are seamlessly delivered through a mobile phone via a beautiful user interface – can appeal to a new generation."
Yet there may be some movement at the regulatory station in Australia. As the Coleman committee report noted last week, applying for a banking licence from APRA can take several years. While minimum capital and other prudential requirements "are prudent and necessary, there is evidence to suggest, however, that simplifications to the initial licensing process can have a significant effect on the number of market entrants and competition," the report said.
APRA's 'authorisation guidelines' for 'authorised deposit taking institutions' have not changed since April 2008. To call themselves a "bank", prospective applicants require at least $50 million in Tier 1 capital, generally common equity.
But APRA chairman Wayne Byres indicated in March that the regulator is commencing a review of the license process and would rejig it to better facilitate non-traditional business models and unconventional applicants, without lowering entry standards.
Imran Gulamhuseinwala, the global had of fintech at advisory firm EY, said the "modularisation" of regulation in the UK has been a "game changer" for increasing competition.
Before the regularity changes in 2014, prospective banks had to comply with the full gamut of regulation to get approved. But now "you only have to confirm with pieces that reflect the work you are trying to undertake and that is a phenomenal game changer for many fintechs". Furthermore, vesting the Financial Conduct Authority with a competition mandate "has made a massive difference".
"The barriers to entry to financial services are finally coming down," Mr Gulamhuseinwala said.
Despite the UK reforms, life for start-up banks will continue to be challenging. Last month Tandem, one of the new UK digital banks, lost its banking licence after failing to secure funding from a Chinese conglomerate, according to a report in the Financial Times. Tandem said it would no longer be launching a savings account in the short term but would still offer credit cards.
Starling's founder and CEO Anne Boden told Business Insider last week that starting a bank in the UK is still "very difficult", "not for the faint-hearted" and requires a lot of capital.
Yet the amount of capital required has been falling. As part of its reforms, the UK PRA reduced capital requirements for new entrants to a minimum of £1 million ($1.7 million), down from £5 million). And the costs of banking technology are also falling.
The cost of a core banking system in the early 2000s would have been around $500 million, which dropped to $50 million five years ago and currently was closer to $5 million or even less, Mr Gulamhuseinwala said.
"All around the world the fintechs wake up and say a little prayer to Amazon Web Services. The upfront costs of technology are de minimis. Because costs are variable, you can create business plans and if they work, you pay for it, and if they don't, you don't. Software as a service has been game changing."