Retail banking and the paradox of convenience

Metro Bank’s continued slide has brought into focus the current trials and travails of UK retail banking. Technology continues to disrupt established industries and over the last decade, the emergence of challenger banks has remoulded the traditional retail banking landscape beyond recognition.

The explosive growth enjoyed by the likes of Monzo and Starling has heaped a huge amount of pressure on banks who previously used retail revenues as the foundation stone upon which they built a broader business. This section of the market was heavily moated for many years, with consumers reticent to change providers. Thus, competition remained low, which meant fees and charges could remain high.

But that’s all changed. Brand and tech-led challenger banks, who focus on high-quality service at low cost, coupled with progressive regulatory upgrades (e.g. Open Banking) have flattened the retail banking landscape, making it more competitive than ever. Many small and mid-sized banks, who used to thrive on retail, have either been marginalised and acquired, or forced to focus on niche products and services for a narrower range of customers.

Metro Bank was at the heart of this revolution and, despite recent struggles, it is arguably the best-known of the post-financial crisis challengers. When it cut the ribbon on its first branch in 2010, it was the first UK high street bank to have opened in over 100 years, a testament to how non-competitive and sedentary the market had become. Metro Bank was different and cool. It gave your dog biscuits and opened on Sundays. Whilst it focused on branches rather than tech, its brand and service cut through the stuffy retail market and growth boomed.

Its success is largely down to the foresight of its American founder, Vernon Hill, who spent his career shaking up retail banking in the US, famously wanting to bring fast food convenience to banking. With this ethos in mind, Hill founded Commerce Bank in 1973, and built it into a bank with over 470 branches, delivering on the promise to be, “America’s most convenient bank”. He sold his share in 2007 for $8.5 billion.

Hill wanted to replicate the success he’d had on the US east coast in the southeast of England. And it worked. Metro Bank boomed, opening 60 branches and attracting 1.7 million customers. His 2012 business book, titled “Fans Not Customers”, neatly sums up how Hill believed retail banking should be done. It should be personal. It should be fun. It should be convenient.

A simplistic comparison to draw is between Hill’s strategy of opening costly high street branches against the (seemingly) “leaner” digital-only strategy (Monzo, Starling etc). But it’s somewhat of a false comparison. Physical branches are another avenue for marketing and brand awareness. Indeed, the establishment of physical Amazon stores is a testament to the value of a high street presence for reinforcing one’s brand. Viewed through this lens, both Metro and the digital upstarts face similar challenges.

Monzo illustrates this point. Sure, they don’t have branches, but after growing initially via word-of-mouth, they are now spending a lot on customer acquisition via many channels. Monzo is growing great but they’re yet to prove that they can offer a sustainable route to profit in the same way that more traditional high street offerings did for many decades.

Ultimately, this difference tells a tale about the fundamental economics of banking. Scale – and the ability to lend – are all that matters. Metro’s stumble (classifying commercial property loans as lower risk buy-to-let loans) looks like it was trying to juice up revenues and capital ratios. For a decade-old bank, perhaps the pressure to generate shareholder returns got too much?

Technology-led challengers aren’t under that level of pressure to generate profit… yet. Most of them are three to five years old, not ten, and they continue to leap from funding round to funding round, wolfing down capital, whether generating profit or not. But, if there is a downturn in the tech cycle and the funding environment tightens, these companies will have to generate profit, rather than paying for growth out of raised funds. 

Despite the dinosaur jokes made at the expense of high street grandees like Barclays and HSBC, their huge deposit base and loan books remain cash generative. And that slow burn, positive carry will help them in the battle against negative carry upstarts. The fight for the high street retail banking sector isn’t going to be a walk over for the new guys. Dinosaurs still have plenty of teeth.

Of course, a likely outcome is that an incumbent will dip into their war chest and remove a challenger by acquiring them. In doing so, they’ll fuse the best of the ‘cool’ upstart with the best of the old school, cash-generative retail banking. Of course, that’s what many of these challengers actually want. In a turbulent market and given their continued failure to generate profit, perhaps it could be their best bet?