What is a Challenger Bank
The financial crisis of 2007/08 led to many changes in the corporate funding landscape, and this period was essentially the genesis of the alternative lending market and Challenger Banks. In our last article we took a look at how business owners are currently funding their businesses – here we dig a little deeper in to one of the options – The Challenger Bank.
In the UK corporate debt markets were dominated by the four biggest high-street banking Groups – global names with broad product offerings. As they withdrew from lending markets during the crisis many SMEs found themselves unable to access capital, meaning they couldn’t grow (and in many cases couldn’t survive) causing huge ripples throughout the economy.
To help prevent these issues from re-occurring, the Government opened up the banking market by making banking licenses more widely available. Before this, there hadn’t been a new bank in the UK since the early 1900’s. Whilst not all new banks have been successful, there are now well over 100 licensed banks incorporated in the UK, with many more based overseas but operating in the UK.
Often these banks are backed by equity investors as they grow and acquire customers, aiming to become self-sufficient and funded by customer deposits and money markets (similar to the high-street banks) as quickly as possible.
Whilst names like Monzo, Starling and Revolut may be familiar because they offer online personal banking, there are many more who lead with specialist corporate lending products and support to SMEs.
Banks such as Aldermore, Allica, Arbuthnot Latham, Cambridge & Counties, Close Brothers, Cynergy, Leumi, Investec, Oaknorth, Secure Trust, Shawbrook, Triodos and Unity are all regular features of the corporate funding market.
As regulated entities with a range of corporate products, these institutions compete head-to-head with high street banks, but usually on a point of differentiation that can be hugely beneficial to the borrower.
Why choose a Challenger?
There are two key reasons why a Challenger bank would be attractive – expertise and appetite.
In what is becoming a competitive market, Challenger banks know that to take market share they need to have a point of differentiation – put simply they must be better than the high street banks. They can’t compete with the overall product offering but recognise that most customers rely on certain key services – and this is where they focus.
Working capital products that offer greater flexibility or better pricing, funding MBO and MBI transactions, supporting businesses that put ESG at the top of their agenda, providing fast and clear decisions, dedicated relationship managers, pre-profit businesses that are investing in growth, those that have been refused simple bank accounts elsewhere and a whole host of other specialisms that the lender focuses on and uses to win customers.
The appetite point naturally follows this – these banks are growing, and many estimates suggest their market presence will grow by 40%-50% CAGR over the next 4-6 years. Much of this growth will be in the SME market, given how underserved this market is by the traditional banks it’s an obvious hunting ground.
For many borrowers, a Challenger bank is an opportunity to work with a dedicated specialist lender who can provide solutions to their part of the market – while high street banks focus on ever larger clients the void they are leaving is being filled by Challengers.
What are the risks?
There have been a number of issues with lenders in the challenger bank market – Bank North, SVB and more recently Metro Bank have all been examples of what happens when things don’t go so well.
There are a number of different reasons for these issues, and it would be unusual for an industry going through such high growth levels not to see some troubled waters..
The interesting point to note is that HSBC quickly acquired SVB. In the tech market, SVB stood out as a key supporter of new and growing businesses, using their expertise to support businesses that mainstream banks just couldn’t provide services to.
Often the high-street banks don’t serve certain sectors or businesses because they simply don’t have the ability to understand these in-house, and the fact that HSBC chose to acquire a bank that supported clients it couldn’t support itself helps validate the strategy of SVB, and the Challengers more generally.
The banking market isn’t without its issues, and the financial crisis showed that even the high-street banks aren’t immune to these issues. As with any material stakeholder in the business doing your diligence remains critical, understanding who your lender is, how they approach the market and where their funding comes from is essential.
Approaching a funding process in good time opens up a wider market and allows a greater number of options to be properly investigated.
Conclusion
Whilst the Challenger banks are less well known the Bank of England regulatory framework ensures they are held to account and provides a level of comfort for those who don’t just take no for an answer.
The alternative debt market, and Challenger banks in particular, ensure banks operate in a competitive market. To make the most of this and remove any uncertainty, borrowers need to be aware of the options open to them and look beyond the high street.
In todays market, Challenger banks aren’t just a back-up option when the high street bank says no, they are a credible alternative that can often provide a better overall solution, particularly in the SME market.
