The Weekly - Are challenger banks the future?

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24/09/2019
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Overall, traditional banks have generally been a bad investment since 2008. Investors thinking about dipping their toes back into the water may well be concerned about the rise of challenger banks and what this means for the traditional banks.

Challenger banks have enjoyed a spectacular rise since the 2008 financial crisis. It is easy to see why, with many of the traditional banks being blamed for bringing the UK close to the brink of economic collapse. In addition to this, traditional retail banking operations have paid out billions in compensation from the mis-selling of payment protection insurance (PPI) and have been subjected to astronomical fines by various regulators around the world.

Prior to the banking crisis it was difficult for companies to acquire a banking licence – a necessity for accepting retail deposits. The process was expensive, arduous and time consuming. However, since the regulations for bank authorisation have been relaxed many more challenger banks have been popping up, but what does this mean for consumers and investors alike?

Competition is good for consumers, especially when we are in a prolonged period of low interest rates. Competition for the highest interest rates for savers and lower interest rates for borrowers is to be welcomed. Additional incentives to encourage switching bank accounts are also a bonus, especially when the ‘current account switch guarantee’ regulations stipulate that switches must take place within 7 working days. You can now move banks for a financial incentive with very little disruption, with all your direct debits moving across to your new bank automatically.

However, most challenger banks do not distinguish themselves from the ‘old guard’ by virtue of better interest rates. Their ‘hook’ for new clients is often better technology or gimmicks such as a brightly coloured debit card. Of course, better technology for banking should be welcomed.

It drives innovation and helps to keep systems robust, which in turn avoids frustrations when customers face IT glitches and are unable to access their online banking.

Nevertheless, while the majority of challenger banks might offer more convenient ways of banking online, many do not have a high-street presence. Online might be more convenient for the younger generation, but by having a pure online presence you are removing yourself from the market for many of the older generation who prefer to do their banking on the high-street.

The other issue that comes from having a more fragmented banking sector is the increased risk of collapse of one or more banks. If you think back to the 2008 financial crisis the banks were too big to fail, resulting in government bailouts for certain banks. Would a challenger bank in financial difficulty get a government backed bailout?

Challenger banks are bringing welcome competition and a new way of banking, but we would not write off the big four just yet. While brightly coloured bank cards and apps that tell you where you are spending money might be nice, they certainly aren’t game changing. We would argue that you should know where you are spending your money regardless of whether an app tells you.

Perhaps the biggest threat to the established banking sector isn’t challenger banks, but companies and platforms that start to offer banking services. It should come as no surprise that Apple recently announced it was launching its own credit card – Apple card. We expect other tech companies such as Amazon to follow suit.

Nevertheless, don’t underestimate traditional banks and their ability to adapt. As they close more and more high-street branches, they are turning their attention to bringing the fight to the challenger banks online. They are also investing more and more into their IT infrastructures as well as offering more of the same services that led to the rise of challenger banks.

Should the collapse of Thomas Cook be a surprise?

Unfortunately, holidaymakers would have woken up on Monday morning to news that Thomas Cook has collapsed. For many people planning a late summer getaway with the group this is of course a disappointment, but it does not come as much of a surprise.

We speculated at the beginning of June this year that Thomas Cook was on the brink of collapse. Due to its highly publicised financial difficulties it was always going to spiral into annus horribilis. We were not the only ones that believed this to be the case; due to the disclosed short positions in Thomas Cook, over 10% of their shares were held ‘short’. This means 10% of shareholders in Thomas Cook benefited from any fall in the share price. At the time of its collapse it was the most shorted share in the FTSE All-Share.

They failed to secure an additional £200 million of funding, and while senior management liked to blame Brexit for their eventual collapse, the truth is a lot simpler. A failure to adapt to the changing market conditions led to their eventual demise. Blaming Brexit is of course, the simplest solution for mismanagement. This is not to say Brexit doesn’t have an impact, but Brexit is the easy target now. In fact, according to ABTA, more people took an overseas holiday in 2018 than any of the preceding years:

Britons taking a holiday 2014-2018

Source: ABTA

The truth is a lot simpler, the demand for package holidays has diminished. Most Britons now want ‘experiences’ or city breaks. This is the main failure of Thomas Cook; package holidays did not exist when they were formed 178 years ago, yet they were able to adapt over the course of their existence, through perhaps bigger challenges than Brexit.

However, given the number of holidaymakers stranded abroad because of the collapse of Thomas Cook, it suggests that they were not necessarily struggling with the number of bookings. Their biggest struggle was with their excessive debit pile, undoubtedly hindered by their redundant physical high street stores that have now been replaced by internet bookings. Their debt pile stems back to 2007 following their merger with MyTravel which led to a £1 billion write down in the business.

Unsurprisingly, on Monday morning both TUI and EasyJet were up over 5% as the market seemed to think they would be the biggest beneficiaries of the Thomas Cook collapse.

 

Oil spikes on Saudi facilities attack

Oil was the big mover last week following a missile attack on several major production facilities in Saudi Arabia. The attacks, which occurred on the 14th of September, knocked out an estimated 5.0% of global production and resulted in a considerable spike in prices; the West Texas Intermediate Crude benchmark jumped by more than +13.0% on Monday alone although prices did moderate as the week progressed with the weekly gain around the +7.0% mark.

Despite the heightened tensions in the Middle East, equity markets were largely benign last week. Domestically, the FTSE100 and FTSE250 fell by -0.3% and -0.1% respectively whilst in the US, the S&P500 dropped by -0.5% with stocks in the transportation sector weighing on the index. There were mixed fortunes on the Continent, the German DAX30 was flat with the French CAC40 rising by +0.6%. Meanwhile in Japan, the Nikkei 225 rose by +0.4%, a fifth consecutive weekly gain in what was a holiday shortened trading week.

Unsurprisingly, sovereign bond yields pulled back as investors priced in greater uncertainty. 10-year gilt yields dropped by 13 basis points (bps) to 0.63% whilst the US treasury equivalent yield dropped by 15bps to 1.75%. As expected, the Federal Reserve voted to lower its base interest rate by a further 25bps at last week’s policy meeting, a move criticised by President Trump as not being aggressive enough. Both the Bank of England and Bank of Japan elected to keep interest rates unchanged at their own policy meetings last week.

Sterling enjoyed a positive week as traders priced in higher hopes for a Brexit deal. The domestic currency rose by +0.4% against the US Dollar and +1.0% versus the Euro to close out the week at $1.250 and €1.135 respectively. The Dollar was little changed against the Yen (¥107.89) although the Greenback did rise modestly against its European counterpart.

 

The week ahead

Whilst there is little UK economic data of note scheduled for release this week, there is plenty of activity to consider from overseas.  In the US, a final reading of second quarter GDP is due on Wednesday with the consensus forecast amongst economists indicating no change to the existing estimate of a 2% annualised rate.  On Friday, the Commerce Department is scheduled to publish figures on August’s order levels for durable goods – manufactured products with a life of three years’ plus.  US factory activity has been under pressure amid fears of a global slowdown.  Elsewhere, Japanese inflation figures are due on Friday in the shape of updated Consumer Price Index (CPI) data,  

In addition, a number of central bankers are poised to speak this week at separate events including Mark Carney (Bank of England), Mario Draghi (European Central Bank), and Haruhiko Kuroda (Bank of Japan).  ECB President Draghi will draw particular attention having recently confirmed an interest rate cut and the return to quantitative easing policies.

 

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Source: FE Analytics (information is correct as at 23rd September 2019) 

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Rowan Dartington is part of the St. James’s Place Wealth Management Group. Rowan Dartington & Co Ltd is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. St. James’s Place House, 1 Tetbury Road, Cirencester, Gloucestershire, GL7 1FP, United Kingdom.