In recent years, personal financial management apps have evolved into money management services offered by neobanks like Simple, Moven and others that depend on traditional bank partnerships. Now, the logical Darwinian evolution from PFM to neobanks is becoming fully licensed startup banks — something that's already happening in the U.K, and eventually, will happen in the U.S.
Regulators in the U.K. — namely the Financial Conduct Authority and the Prudential Regulation Authority — signaled their willingness to review startup bank applications and triggered a bank license rush. In the past two years, up to 20 startups are said to have approached the FCA and the PRA to explore banking licenses.
To be sure, not all of them will be granted regulatory approval and a license to operate as banks. One needs the right mix of skills — technology, balance sheet management, credit, governance and banking operations — coupled with the right gravitas such as depth and breadth of experience at the board level to cajole regulators into approval.
Despite these challenges, I fully expect a bunch of startup banks to emerge, first in the U.K. due to regulatory sophistication, then elsewhere in Europe, and eventually in the U.S. where regulatory bodies will have to be massaged into creating the right framework. I can even foresee challenger bank models popping up in emerging markets to accelerate banking innovation as well as financial inclusion and wellness.
Already, Atom Bank received full regulatory approval and earned the bragging rights of the first challenger bank to do so in the U.K. The next challenger bank that received regulatory approval is Tandem, whose co-founder, Matt Cooper, was also a managing director at Capital One. (Full disclosure: in my previous position, I led Tandem's Series A round together with my business partner Michael Meyer).
As these banks ready their launches in the U.K, more startups getting regulatory approval in other countries should follow. There are, after all, a number of advantages a technology-focused startup bank has over more traditional banks as well as institutions that must rely on bank partners.
First, a challenger bank is in a unique position. As a startup without dependency on a traditional bank, it can focus on customers' needs from the start, using data tools. A challenger bank is in a position to advise its customers as to which products and services are the most appropriate. Focusing on customers' needs first and foremost ensures the gap between those needs and product offerings is either miniscule or nonexistent. It also ensures strong engagement — something incumbents struggle with either at a branch or online.
Second, a challenger bank enjoys the benefit of creating its technology from scratch. From a high level point of view, we are dealing with newish core systems, usually a refresh or newer version of software. Challenger banks also benefit from specialized data hubs that allow them to acquire, analyze, monitor and act on data in a holistic way. Unlike a traditional bank, data does not sit passively in a silo after having been acquired.
These challenger banks have the ability to develop a dynamic pricing so granular and precise in time that the customer targeted is always serviced in the right way at any point in time during his or her relationship with the financial services provider. This is something traditional banks struggle with because their IT is designed in silos, putting their data in silos, which makes it difficult to get a holistic view.
That is an invaluable competitive advantage, especially at a time of high regulatory pressure when bank liquidity ratios and capital reserves as well as other directives are forcing c-suite executives to become more efficient with their cost structures and revenue and pricing models.