What does it take to build a bank?
Although creating a bank from the ground up is, arguably, more straightforward than it’s ever been, plenty of challenges still await potential new entrants to this market
The financial services industry is becoming an increasingly welcoming place for challenger banks seeking to shake up the system. Reforms published in 2013 by the Bank of England and the then Financial Services Authority lowered entry barriers to the UK banking sector, encouraging dozens of newcomers to start trading.
Valentina Kristensen is director of growth and communications at OakNorth, a bank established in 2013 to serve small and medium-sized enterprises. “Our experience with the regulators has been very, very positive. They’re forward-thinking and innovation-friendly,” she says, citing open banking and regulatory sandboxes as key developments that have made the banking ecosystem a safer place for innovation.
A more conducive regulatory framework is not the only factor that’s fuelled the upsurge in neobanks. Falling IT costs, owing to the advent of cloud computing, and the ever-increasing number of digital-native consumers have both played their part too. Unlike conventional banks, which have costly physical branches and legacy systems to maintain, challengers have been able to use the most effective technological tools to best serve their customers from the get-go. Putting the right systems in place can give a startup a crucial competitive edge over incumbents that lack cutting-edge IT.
Even with the reforms that have made building a financial services business from scratch easier than ever, this process – from ensuring compliance to establishing the right strategic partnerships – is still far from straightforward, of course. There is also an increased onus on new banks to create a realistic plan for breaking even and demonstrate their longer-term viability.
“This was evident from a Prudential Regulation Authority paper published this April,” Kristensen says. “The regulator stated its expectation that a new bank should have a very clear path to profitability from day one and become profitable within five years at most.”
She adds that the importance of cybersecurity will only increase too. “It’s an area in which many new banks that are seeking a licence must make very strong investments.”
Virraj Jatania is the co-founder and CEO of fintech startup Pockit, a challenger bank that has been working since 2014 to offer financially underserved people a simple digital banking service. He notes that one of the basic, yet crucial, tasks that startups often overlook is to clearly define their target market and the needs it has that they’re aiming to satisfy. These factors “will drive your product development as well as your communication strategy”.
Startups must also get to grips with all the compliance aspects of developing a banking product. Building effective relationships with the regulators is important in achieving this, Jatania notes.
“Several laws have been put in place to ensure that firms act in the best interests of consumers when it comes to treating them fairly and protecting their funds, especially from fraud. Without deep expertise in this area, it would be impossible to build an offering for consumers,” he says, stressing the need to recruit skilled advisers.
Forging partnerships with established firms can lend startups some experience in navigating the complex banking ecosystem too, Jatania adds, while “guidance from expert investors is also fundamental in helping you to bring your idea to life and grow the business”.
But attracting talent is one of the big challenges that new banks will encounter, warns Ali Niknam, CEO of Bunq, a bank that he founded in the Netherlands in 2012. Startups “have to ask themselves how hard it’s going to be to recruit skilled bankers and back-office staff”, he says.
While many of the industry’s big players have been established for hundreds of years, startups cannot rely on a storied history to attract talent, which can prove especially tough at a time when skilled people are in such high demand.
Niknam cites another significant hurdle that any new bank will need to surmount. Even though regulations have been rationalised across the wider European banking sector in recent years, some fundamental problems remain. Proving viability is difficult when the venture has zero revenue, for instance – as is offering sufficient guarantees against risk for a customer base that doesn’t yet exist.
“When we were starting Bunq, we ended up submitting about 1,400 pages of documentation to the regulator,” Niknam recalls. “It literally took years for dozens of people to go through everything.”
Such a lengthy, bureaucratic process can create further complexity, he adds. “By the time we obtain regulatory approval, the world has changed.”
Rather than wondering why so many new banks have entered the market in recent years, people should instead be asking why “there’s such a big gap between the conventional banking offering and what they expect”, Niknam argues. “If a company in any unregulated sector even came close to the levels of process inefficiency and cost dissatisfaction achieved by many current banks, it would not survive.”