Finovate talks with Ronit Ghose, global head of banks research and co-head of the fintech theme group at Citi about the future of challenger banks and why some shouldn’t be calling themselves a “fintech” at all.

Finovate: How would you define the different types of challenger bank that exist today, and what are the key differentiating factors between them?

Ronit Ghose: Challenger banks are designed around the digital revolution and are able to leverage data insights via advanced technology stacks. I’d say there are three types of challenger banks that have emerged:

• The first are standalone challenger banks, which are primarily Fintech companies leveraging technology and data to streamline retail banking by offering better convenience and pricing.
• The second are incumbent-led challenger banks, started within legacy banks through investment in technology and by creating new digital-only banks.
• Finally, we’re seeing BigTech-led challenger banks who can use their vast networks to acquire customers quickly as they branch out into financial services.

Finovate: Interesting! So, we’ve seen many incumbent banks attempt to set up their own challenger banks – how successful has this been, what lessons should others learn, and how can banks make their back end look more like a digitally-native company’s?

Ghose: Over the past five years or so, especially since 2016 through 2017, incumbent banks have moved from ignoring or mocking the new entrants to engaging with them and giving them the best testimonial possible: They have begun copying them by setting up their own new businesses. While the results have been mixed, the success or failure of incumbents in this field could be characterized using three factors: markets, technology and operating model or culture.

So in most cases, incumbent banks launch a challenger bank in a market where they are already active; albeit they use their new proposition to better target a specific segment, such as millennials or digitally-savvy customers. With regards to technology, in the past 12 to 18 months incumbent banks appear to be moving to consider more disruptive technology and business model approaches, and to attempt to actually build new brands or businesses “like a startup”. If you aren’t doing new tech, then stop calling yourself challenger or fintech. ‎

Finally, we have to consider bank employee incentives, training, and formation are the human capital equivalent of a fixed income instrument. By contrast, fintech founders work and their employees are growth equity to the bank employees’ fixed coupon bond. In the language of financial instruments, can banks become convertibles not just bonds? ‎

Finovate: Moving away from challenger banks to other new market entrants, to what extent do incumbent banks fear big technology companies over fintechs?

Ghose: The emergence of BigTech has led to heightened competition in the financial services sector. I think the challenge BigTech poses for incumbent and standalone challenger banks is daunting, given the absence of any cost drag from legacy information technology (IT) systems and underused branch networks (common problems for banks) and their natural advantage in customer acquisition owing to their high user engagement models.

One of the most prominent of these is in Korea, where popular social messaging app Kakao Talk launched a digital-only bank in 2017, acquiring two million customers in a short span of just two weeks from launch date. Similarly in China, challenger banks such as WeBank, backed by Tencent, respectively, have seen strong user growth following their launch in 2015.

The experiences of Korea and China are successful examples of internet companies venturing into banking. There are many lessons to be learned from this. Firstly, incumbent banks should not be overly complacent with their existing customer base – the speed of customer acquisition could be much faster through digital channels than the traditional distribution channels. Secondly, internet giants have a clear edge in certain areas of banking, especially around payments and mobile money. Finally, there are opportunities to cross-sell and scale to other products.

Finovate: So there’s potential for a lot of change and upheaval then. What will the bank of the future be characterized by?

Ghose: Legacy banks often have data that is stuck in multiple silos supported by core banking technology that was literally built in the era of black and white television. Manual intervention is high, which slows down operating speed, reduces flexibility, increases costs, and ultimately degrades efficiency and experience. Creating an incumbent challenger sounds like an oxymoron, but as legacy banks recognize the threat that new entrants into banking are posing to revenue and customers, they need to reinvent themselves and reimagine banking. This involves legacy banks partnering with technology companies to create effective joint ventures as well as moving into more disruptive technology and business models to transform themselves into digital competitors. By creating their own Bank X, we believe some legacy banks can transform themselves from slow moving caterpillars to agile butterflies.