12 hours ago
Is it game over for Britain's challenger banks?
Ever since Gordon Brown unleashed Sir Donald Cruickshank to review the competitiveness of the banking sector in 1998, the dominance of the 'big four' banks has been on the minds of Britain's politicians.
Brown's successor, Alistair Darling, even used the aftermath from the 2008 bailouts to proclaim the creation of new high street banks, which would take on the dominant players — Lloyds, NatWest, HSBC and Barclays — and boost competition for consumers.
This sparked the rise of the 'challengers' — a mixed cohort of high-street banks, which at various times have tried to unseat the giants. Back in the 2000s, one of them, Halifax, famously insisted it would 'eat the big four's lunch'.
But, after more than 25 years of effort, it seems it could be game over for challenger banks.
Last week, Sabadell, the Spanish owner of TSB, stunned the City by confirming it had received potential bids for the British bank it bought ten years ago. That came just hours after reports that Metro Bank had received a takeover approach from a private equity house.
• What a TSB bank sale could mean for customers
It led the ratings agency Moody's to warn that consolidation in the sector would 'ease the competitive pressure on the big UK banks'.
That also included the Nationwide Building Society which has bolstered its status by its £2.9 billion swoop on the challenger bank Virgin Money last year. That deal came in a year when the sector was also rocked by Coventry Building Society buying the Co-operative Bank for £780 million.
Benjamin Toms, banks analyst at RBC Capital Markets, said: 'While there has been a lot of noise about trying to level the playing field with the challenger banks taking more of the market, that hasn't really happened.'
So why have the challengers lost their way? And is anything coming to replace them?
Statistics produced by Cruickshank in 1998 are often used to explain the uphill battle they face. He found the big four banks had a 68 per cent share of the current account market. But by 2010, their dominance had risen to 73 per cent because the early challengers themselves had to be rescued by the bigger players, particularly Halifax, which was gobbled up by Lloyds.
It goes to the heart of the problem, according to Barbara Casu, professor of banking at Bayes Business School. 'It's very difficult for the challenger banks and to a certain extent the smaller building societies to compete because of the market share of the big banks,' she said.
Some of the challengers did get a boost from the banking crisis, as Darling had promised. Virgin Money took on parts of the nationalised Northern Rock while the Spanish bank Santander bought bits of the troubled building societies-turned-banks Alliance & Leicester and Bradford & Bingley.
The crisis also gave TSB, which was set up as the Trustee Savings Bank in 1810, a new lease on life when the European Union demanded that Lloyds spin out a new branch network in return for its taxpayer bailout. TSB was floated on the stock market in 2014 before being bought by Sabadell a year later.
But some reckon they squandered the opportunity to compete. Edward Firth, banks analyst at KBW, reckoned that some of the challengers 'weren't particularly well run and made a number of strategic errors'.
Metro Bank, for example, launched in 2010 as the first new bank on the high street for 100 years. But it has never recovered from an accounting crisis in 2019, which ultimately led to its rescue in 2023 by the Colombian billionaire Jaime Gilinski Bacal.
Even after rallying last week on reports of a potential bid from Pollen Street Capital, its £850 million market value is still a fraction of the £3.5 billion it was worth at its peak.
Firth also blamed regulations requiring smaller banks to hold more capital as a ratio than larger ones for holding back challengers. 'That makes it very difficult for anybody to ever challenge because you're not playing on a level field.'
He said the big four's dominance in current accounts also mattered, because these accounts pay very low rates of interest — if any — and so provide these banks with a cheap way to finance their lending.
One of the many reviews into the sector recommended the creation of a current account switching service to make it easier for customers to move between banks.
But while the big four's share of current accounts had fallen to 64 per cent by 2022, according to the latest analysis by the Financial Conduct Authority, it was not the challengers who benefited.
Instead, it was the digital banks such as Monzo and Starling that gained market share, from about 1 per cent in 2018 to 8 per cent by 2022. This seems to be the result of customers opening additional current accounts, as the FCA found that the number of accounts had increased by 15 per cent over four years. On average, each adult in the UK now has 1.9 current accounts.
Casu at Bayes said this also reflected the dominance of the big four: 'People have not shifted entirely to challenger banks. They use them as e-wallets, to travel on the Tube or buy online, but they don't put their whole salary in there.'
The big four have also staged a fightback by spending billions on their own apps. At the same time, they have cut costs, particularly by closing branches. Barclays, for instance, has reduced its network by a remarkable 77 per cent over six years.
The digital banks still outcompete the big four when it comes to customer service.
The Chase app — the retail banking arm of JP Morgan, America's biggest bank — is the highest rated of any of the banks for customer service.
Karim Haji, head of financial services at KPMG, said it was important not to see competition in the narrow terms of the traditional challengers. There are also competitors targeting specific sectors, such as buy-to-let mortgages, payments services, and business banking.
Still, the potential takeover of TSB would be a key moment in the story of the challenger banks.
This week the pressure is on to find a suitor as TSB's fate is tied up in a hostile takeover of its parent Sabadell by Spanish rival BBVA.
The Spanish government is scheduled to announce on Tuesday whether it will sanction the takeover of Sabadell. But if Sabadell agrees a deal for TSB it would need to be put to a shareholder vote under Spanish rules — delaying any deal. It could also scupper the BBVA takeover by altering the financial terms.
Hence, the speculation in the City that news of the potential sale was fortuitous and that if any formal bid was going to be made it needed to happen quickly, with expectations that Friday is an informal deadline for any approaches.
It is rumoured that the Spanish owner is seeking £2 billion for the bank but it is not clear how easy that will be to achieve. Despite speculation about bidding wars for Co-op Bank and Virgin Money last year, no rival offers emerged for those banks and TSB has been subjected to repeated takeover speculation.
Analysts said that all of the big four would take a look at TSB, but Lloyds seems an unlikely bidder given it was forced to sell off TSB in the first place. NatWest has ruled itself out.
Barclays, however, is known to be seeking expansion in the UK. TSB would provide a 2 per cent market share of deposit taking and mortgage lending.
While any deal might trigger the need for the Competition and Markets Authority to look at the transaction, few think it would stand in the way, particularly in light of the government's pro-growth agenda. Neil Baylis, partner at the law firm CMS, said: 'If you have a story that you're basically doing something that is good for the UK economy, then you're in a better position [to do deals] that you've been in for quite some years.'
Other potential bidders could come from the reinvigorated building society sector, with Yorkshire's name in the rumour mill. As it stands, Nationwide has already bolstered its position as competitor to the big four and this wave of consolidation could result in a new 'big five' or even a 'big six'.
Nationwide looked at TSB and other challengers before bidding for Virgin Money last year, and that deal is still being integrated. On the day of Nationwide's results this month, when asked about further deals, chief executive Debbie Crosbie, who was made a dame this month, said she was 'super focused' on Virgin Money. 'You never say never in the future, but right now we're focused on making the most of this acquisition,' Crosbie said.
Nationwide claims to have a relationship with one in three Britons after the Virgin deal and is promising a major expansion into the business banking arena, where the big four also dominate.
Intriguingly, Santander is said to have expressed an interest in TSB. This has surprised some in the City given speculation that chief executive Ana Botin was looking to exit the UK market, something she was forced to deny this year.
While Santander has already claimed a slot as the fifth-biggest bank in Britain since arriving on the scene with the takeover of Abbey National in 2004, it has struggled to achieve the dominance it craved. Buying TSB might edge it closer to that goal.
A sign, perhaps, that the game to challenge the big four is not over yet.
