Challenger banks are raking in cash. Should traditional banks be worried?

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Challenger banks continue to be favorites for private investors, attracting millions in venture capital in their quest to displace traditional financial institutions.

Monzo, the U.K. challenger bank, last month became the latest fintech to attain unicorn status when it raised $110.6 million in Series E funding.

Yet traditional banks still find themselves in a good overall position despite recent buzz from headline-grabbing fintech deals.

“The executive ranks of the biggest financial institutions are not overly concerned about challenger banks as a whole,” said Eric Byunn, partner at Centana Growth Partners.

Instead, traditional banks are increasingly taking their cues from neobanks, Byunn said.

“What banks are doing today is dramatically different than how banks did things 10 years ago,” he said. “In many cases, that’s actually driven, in conjunction or reaction to, many of the fintech startups.”

Still, they may not be evolving fast enough.

Lindsay Davis, a tech industry analyst for CB Insights, said challenger banks are capturing funding because they follow a common theme of targeting ways to address common consumer pain points — points that exist because they’ve largely gone unaddressed by traditional banks.

Chime and Varo Money in the U.S. each completed significant funding rounds earlier this year. In May, Chime raised $70 million in a Series C funding to raise its value to some $500 million. In January, Varo Money completed a funding round worth $45 million.

“We’ve seen a number of deals going to companies building checking account” alternatives, said Davis. “Companies are also building alternatives for customers that have a difficult time accessing credit, like students and consumers with thin credit files.”

Whether Monzo’s successful funding in the U.K. will translate to similar benefits for companies such as Chime and Varo Money in the U.S. remains to be seen.

Byunn said it’s difficult to make direct comparisons between U.S. challenger banks and their U.K. counterparts because the latter is a more mature market.

Companies such as Monzo, Revolut and Starling also benefit from opening banking regulation in both the U.K., and Europe as a whole.

But Byunn said U.S. challenger banks should keep tabs on the market overseas.

“Certainly, if you went to talk to any one of those challenger banks” in the U.S., “they are all watching what goes on in the U.K. and they want to see what is successful and what isn’t successful and see if there are things they can learn,” he said.

And traditional banks shouldn’t be so quick to dismiss challenger banks as a threat, Davis said.

Digital banking alternatives worldwide have more than 15 million users, according to CB Insights’ analysis. Brazil’s Nubank has some 5 million active users. Chime leads in the U.S with more than 1.6 million accounts.

“This matters to incumbents because these companies are growing quickly,” said Davis. “They’re raising private funding to further fuel growth.”

To be sure, Byunn cautioned challenger banks have “eye-popping growth rates because their numbers are so small,” so much so that traditional banks view such accounts as unprofitable.

“When you hear someone like Jamie Dimon talk about fintech, I think they’re more worried about how focused fintechs” are on new features, “disaggregating different services” such as investing, loans and savings accounts, and how fintechs are helping a bank’s main competitors, Byunn said, referring to the JPMorgan Chase CEO.

Still, the dealmaking is expected to accelerate.

Overall, global fintech venture capital-backed funding in the third quarter reached $5.6 billion across 375 deals, according to CB Insights. The U.S. saw 130 funding rounds worth $2.5 billion during that time.

CB Insights expects 2018 deals to reach a record $32.6 billion, which would be up 82% from last year’s figure of $17.9 billion.

“Regulators globally are looking for ways to enable startups for growth and some are lowering the barrier of entry, so we can anticipate seeing more growth of this category globally,” said Davis.

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