Word on the web: A new breed of banking

‘Challenger’ banks are increasingly appearing in the UK market, but stringent regulation has stymied the growth of competition

ClearBank, the first new, purpose-built clearing bank in 250 years, has been unveiled as the latest market entrant in a wave of new ‘challenger banks’ muscling into the UK financial sector. The multi-million pound project – which has spent three years in private development with input from “payment processing networks, the Bank of England, the Payment Systems Regulator, two of the four existing clearing banks [Lloyds, Barclays, HSBC and Royal Bank of Scotland], and Microsoft, who helped develop the technology” – is the brainchild of fintech entrepreneur Nick Ogden, writes Business Insider UK’s Oscar Williams-Grut. 

The new clearing bank – Ogden’s third start-up venture after the highly successful WorldPay and Voice Commerce Group – will offer two key services, says Williams-Grut: processing “payments across all major schemes in the UK, including Swift, MasterCard, Visa, CHAPS, BACS and Faster Payments”, and a core banking platform “meaning credit unions and building societies can offer banking services through an ‘off the shelf’ product”. Huge amounts of money – ClearBank secured an investment of £25m from PPF Group and CFFI Ventures – have been injected into the development of state-of-the-art technology. 

The move represents a “step change in the delivery of financial services in the UK” and “disrupts the status quo”, says Ogden, who is quoted in the article. However, the firm does not intend to compete with the four existing clearing banks, instead envisaging ”healthy collaboration“ and a focus on smaller organisations that are not currently catered for profitably. A six-month period of stress testing is due to commence shortly – which will involve running payments from three unnamed partners through the network – and the bank is on track to open its doors in autumn 2017. 

Other market challengers currently include Monzo, Tandem, Starling and OakNorth, says Williams-Grut, as well as Atom, which has recently expanded its latest funding round to absorb £113m from BBVA, Toscafund and Woodford Investment Management. This takes the total funding raised to just under £250m, one of the largest sums of money to be injected into a UK technology start-up.   

Business Insider UK article
Relaxing the rules And there’s good news for challenger banks on the regulatory front, with the Bank of England recently vowing to change capital guidelines, namely in relation to mortgages. 

“Following consultations with politicians and banks, the Prudential Regulation Authority (PRA) has said that it will rethink its approach to Pillar 2A capital, a rule regarding the add-ons of capital, which individual banks must set aside above sector-wide minimums,” writes FT Adviser’s Kathryn Gaw. The more flexible approach is set to reduce costs for challenger banks and “allow them to compete more equally on higher loan-to-value mortgages”. 

Pillar 2A has received criticism in the past for favouring “incumbent banks”, says Gaw. Challenger banks are required to use the regulators’ standardised models to calculate risk for loans in order to determine Pillar 2A capital requirements; however, these banks possess both limited data and operating experience, resulting in an increase in capital add-ons. Incumbent banks can make use of bespoke models that are formed based on past loan portfolio performances, at a much lower cost than standardised models. 

“Some official estimates have found variations of up to 960% for the same residential mortgage, between lenders using the standardised approach and banks using the bespoke models,” says Gaw. 

It is hoped that a relaxation in capital rules will ease the pressure on challenger banks to accept higher-risk mortgages in order to reduce costs. Head of the PRA Sam Woods, who is quoted in the article, says: “This consultation is a major step forward for the PRA in facilitating effective competition [and] reducing capital requirements for eligible small firms.” 

FT Adviser article
Fair game Challenger banks have responded positively to the move to support more effective competition and improve safety – by reducing the incentive for lenders to concentrate on higher loan-to-value mortgages – says Bridging & Commercial’s Tom Belger. According to managing director of Masthaven Jon Hall, who is quoted in the article, the PRA’s plans mark a start in equalising the position of newer banks competing in the mortgage market. 
The percentage of variation found for the same residential mortgage between lenders using the standardised approach and banks using the bespoke models

“The mechanical application of the standardised approach will continue to deliver a significant disparity in capital requirements,” says Hall. “However, as a bank which firmly believes in the fact that one size does not fit all, Masthaven welcomes the approach proposed by the Bank of England to apply discretion based on a risk-based approach.”

Co-founder and CEO of OakNorth Bank Rishi Khosla, also quoted by Belger, highlights the need for a relaxation of rules beyond the mortgage market. “It is essential that [it] is not limited to mortgage products, but that it [is] applied to business and property development loans too, especially given the ongoing shortage in housing supply.”

At OakNorth, every loan granted requires the company to set aside several times more capital than the major market players, greatly affecting how much it is able to lend, and when it is able to do so. 

“By being able to apply our own model regarding risk weighting – instead of having to use the standardised approach – we would have a larger amount of capital at our disposal, which would ultimately mean more money that we can lend,” says Khosla. “This would be good news for competition and good news for borrowers.”

The PRA’s plans represent a step in the right direction to support smaller players in the UK banking market, but more needs to be done to improve competition on a broader scale. 

Bridging & Commercial article

Seen a blog, news story or discussion online that you think might interest CISI members? Email rosalie.starling@wardour.co.uk.
Published: 03 Mar 2017
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