Wealth Management: Challenging the challengers – Responding to the Covid-19 downturn

William Haggard, Head of Investment Insights, and Willis Palermo, Financial Analyst, Rothschild & Co Bank AG

Any analysis in 2020 would not be complete without addressing the sector's response to the Covid-19 crisis. What are your views?

Both newcomers and incumbents to the retail banking sector are seeing their margins compressed - it's no secret that low or negative interest rates are hitting banks hard. Big banks still have an advantage when it comes to their cost of funding, which remains lower than for challenger banks. But the current crisis poses three risks for banks (see box 'Covid-19 challenges for banks').

Covid-19 challenges for banks

  1. The low-interest rate regime: lower for longer means banks that have the lowest cost-to-income ratio will be in the best position to succeed. These trends are not new but have been accentuated by the downturn from the Covid-19 pandemic, as seen in the cutting of interest rates in the UK and the US.
  2. A decrease in volumes: with people travelling less, there will be fewer foreign exchange fees; people will be consuming less and generating fewer transaction fees.
  3. Avoiding defaults: for more established banks that offer loans and consumer finance, avoiding default on their debt will be a challenge in the current downturn. Many challenger banks that just offer deposit services, such as Revolut, will be less affected.

We saw Monzo face a valuation drop of nearly 40% in May 2020 based on its latest fundraising round. How are challenger banks likely to respond to a new and more hostile business environment?

There is no single way to respond. As with most businesses during this crisis, they need to find ways to transform themselves, offering something customers can use or that is new. Importantly for challenger banks that lend, the quality of their loans will be key to determining who stays in business.

Monzo still needs to grow its user base, but will also need to focus on securing capital as it remains unprofitable. Meanwhile, as with other challenger banks, it should keep focused on capturing new consumer trends such as the shift from cash to cards and online shopping - the winner will be the one that can monetise these long-term trends.

So an ability to monetise services and products beyond deposit holding will be an important ingredient to the success of challenger banks going forward?

Yes, in banking there is very little differentiation. Customers generally select their mortgage or loan provider based on pricing. This is why challenger banks have introduced cheaper rates on services such as foreign exchange and lending. Overall, the strength of challenger banks resides in their sophisticated digital platforms and lower operating costs, thanks to modern and lean IT systems. Growing and monetising these platforms will be a key challenge going forward. A route to providing these services could be through developing partnerships between challenger and traditional banks. The two have different strengths and could benefit from a degree of collaboration.

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