What does it take to build a bank?

The finan­cial ser­vices indus­try is becom­ing an increas­ing­ly wel­com­ing place for chal­lenger banks seek­ing to shake up the sys­tem. Reforms pub­lished in 2013 by the Bank of Eng­land and the then Finan­cial Ser­vices Author­i­ty low­ered entry bar­ri­ers to the UK bank­ing sec­tor, encour­ag­ing dozens of new­com­ers to start trad­ing.

Valenti­na Kris­tensen is direc­tor of growth and com­mu­ni­ca­tions at OakNorth, a bank estab­lished in 2013 to serve small and medi­um-sized enter­pris­es. “Our expe­ri­ence with the reg­u­la­tors has been very, very pos­i­tive. They’re for­ward-think­ing and inno­va­tion-friend­ly,” she says, cit­ing open bank­ing and reg­u­la­to­ry sand­box­es as key devel­op­ments that have made the bank­ing ecosys­tem a safer place for inno­va­tion.

A more con­ducive reg­u­la­to­ry frame­work is not the only fac­tor that’s fuelled the upsurge in neobanks. Falling IT costs, owing to the advent of cloud com­put­ing, and the ever-increas­ing num­ber of dig­i­tal-native con­sumers have both played their part too. Unlike con­ven­tion­al banks, which have cost­ly phys­i­cal branch­es and lega­cy sys­tems to main­tain, chal­lengers have been able to use the most effec­tive tech­no­log­i­cal tools to best serve their cus­tomers from the get-go. Putting the right sys­tems in place can give a start­up a cru­cial com­pet­i­tive edge over incum­bents that lack cut­ting-edge IT.

Even with the reforms that have made build­ing a finan­cial ser­vices busi­ness from scratch eas­i­er than ever, this process – from ensur­ing com­pli­ance to estab­lish­ing the right strate­gic part­ner­ships – is still far from straight­for­ward, of course. There is also an increased onus on new banks to cre­ate a real­is­tic plan for break­ing even and demon­strate their longer-term via­bil­i­ty. 

“This was evi­dent from a Pru­den­tial Reg­u­la­tion Author­i­ty paper pub­lished this April,” Kris­tensen says. “The reg­u­la­tor stat­ed its expec­ta­tion that a new bank should have a very clear path to prof­itabil­i­ty from day one and become prof­itable with­in five years at most.”

She adds that the impor­tance of cyber­se­cu­ri­ty will only increase too. “It’s an area in which many new banks that are seek­ing a licence must make very strong invest­ments.”

Vir­raj Jata­nia is the co-founder and CEO of fin­tech start­up Pock­it, a chal­lenger bank that has been work­ing since 2014 to offer finan­cial­ly under­served peo­ple a sim­ple dig­i­tal bank­ing ser­vice. He notes that one of the basic, yet cru­cial, tasks that star­tups often over­look is to clear­ly define their tar­get mar­ket and the needs it has that they’re aim­ing to sat­is­fy. These fac­tors “will dri­ve your prod­uct devel­op­ment as well as your com­mu­ni­ca­tion strat­e­gy”.

Star­tups must also get to grips with all the com­pli­ance aspects of devel­op­ing a bank­ing prod­uct. Build­ing effec­tive rela­tion­ships with the reg­u­la­tors is impor­tant in achiev­ing this, Jata­nia notes. 

“Sev­er­al laws have been put in place to ensure that firms act in the best inter­ests of con­sumers when it comes to treat­ing them fair­ly and pro­tect­ing their funds, espe­cial­ly from fraud. With­out deep exper­tise in this area, it would be impos­si­ble to build an offer­ing for con­sumers,” he says, stress­ing the need to recruit skilled advis­ers.

Forg­ing part­ner­ships with estab­lished firms can lend star­tups some expe­ri­ence in nav­i­gat­ing the com­plex bank­ing ecosys­tem too, Jata­nia adds, while “guid­ance from expert investors is also fun­da­men­tal in help­ing you to bring your idea to life and grow the busi­ness”. 

But attract­ing tal­ent is one of the big chal­lenges that new banks will encounter, warns Ali Niknam, CEO of Bunq, a bank that he found­ed in the Nether­lands in 2012. Star­tups “have to ask them­selves how hard it’s going to be to recruit skilled bankers and back-office staff”, he says.

While many of the industry’s big play­ers have been estab­lished for hun­dreds of years, star­tups can­not rely on a sto­ried his­to­ry to attract tal­ent, which can prove espe­cial­ly tough at a time when skilled peo­ple are in such high demand.

Niknam cites anoth­er sig­nif­i­cant hur­dle that any new bank will need to sur­mount. Even though reg­u­la­tions have been ratio­nalised across the wider Euro­pean bank­ing sec­tor in recent years, some fun­da­men­tal prob­lems remain. Prov­ing via­bil­i­ty is dif­fi­cult when the ven­ture has zero rev­enue, for instance – as is offer­ing suf­fi­cient guar­an­tees against risk for a cus­tomer base that doesn’t yet exist.

“When we were start­ing Bunq, we end­ed up sub­mit­ting about 1,400 pages of doc­u­men­ta­tion to the reg­u­la­tor,” Niknam recalls. “It lit­er­al­ly took years for dozens of peo­ple to go through every­thing.” 

Such a lengthy, bureau­crat­ic process can cre­ate fur­ther com­plex­i­ty, he adds. “By the time we obtain reg­u­la­to­ry approval, the world has changed.”

Rather than won­der­ing why so many new banks have entered the mar­ket in recent years, peo­ple should instead be ask­ing why “there’s such a big gap between the con­ven­tion­al bank­ing offer­ing and what they expect”, Niknam argues. “If a com­pa­ny in any unreg­u­lat­ed sec­tor even came close to the lev­els of process inef­fi­cien­cy and cost dis­sat­is­fac­tion achieved by many cur­rent banks, it would not sur­vive.”