While banking has typically been dominated by the older names in the industry thanks to their sheer size, shifts in technology, legislation and customer expectations over the years have created a gap in the market that challenger banks have been quick to fill. True to their name, challenger banks are starting to offer some very real competition to those old, big names in the financial services industry.

According to a report published by FT Partners, the rise of challenger banks is by no means a localised phenomenon, unique only to western countries like the UK or US. Instead, the report illustrates the global shift by providing 12 examples of challenger banks that have each raised over $100 million in equity financing, half of them surpassing $1 billion in value.

Best in Brazil

The most successful of the challenger banks described by the report is a Sao Paulo-based company called Nubank. The world’s largest challenger bank now has at least 20 million users and has raised more than $906 million in funding - a full $100 million more than their nearest competitor, which is US-based Chime that has only 6.5 million customers.

Founded by Colombian entrepreneur David Vélez, Nubank was as much a solution to the discomfort of being subjected to weapons searches when entering Brazilian banks as it was a means of combating one of the world’s most bureaucratic and restricted banking sectors. In a country where the financial industry is dominated by just five traditional institutions, whose effective monopoly gives them the option of charging up to 450 percent annual interest rates, Nubank offers a user-friendly alternative for credit cards, personal loans and saving accounts, all directly accessible by smartphone. While no one expects Nubank to topple the big five banks, they have forced the latter to up their tech game and close hundreds of bricks-and-mortar branches as customer expectations shift.

Europe leads by example

While the fertile conditions of Brazil’s banking sector have created the most successful challenger bank in the world, FT Partners’ report still recognises Europe’s role in leading the way in the rise of such institutions. In particular, the introduction of open banking and especially the famous Payment Services Directive regulations (PSD2)  have created an environment in which challenger banks can more easily spring up and rapidly grow.

Of course, legislation does not emerge from nowhere, and the report emphasises the shift in banking activity and customer expectations that began in 2017. More than half of Europeans, it says, shifted their habits towards digital forms of banking, leading to necessary changes in the sector to adapt to this shift. The UK, France and Germany are named among the economies spearheading the change, with challenger banks like Revolut leading the way. It continues to grow at a tremendous rate, expanding its suite of services and markets to become the third largest bank of its kind in the world.

US lagging behind

By contrast to the runaway success of European challenger banks, the US has been slow to catch on to this trend. The necessary regulatory changes were much slower in coming than they were in Europe. However, they are starting to catch up.

A CB Insights report explains that the 2011 law known as the Durbin amendment has enabled challenger banks to grow considerably, though this law is nothing like PSD2. Instead, it allows smaller banks (those with less than $10 billion in assets) to charge merchants up to 1.5 per cent on debit card swipes - over seven times the amount that big banks can charge.

The report goes on to explains that challenger banks are certainly popular among venture and private equity firms, with the likes of Chime now valued at $14.5 billion. However, it also states that customers have a wealth of choice available to them. Not only are there many domestic challenger banks to choose from, but options developed by the big banks are taking a considerable amount of market share, as are the better developed European challenger banks like Revolut. The result is that no single American challenger has been able to grow to a substantial size.

Expectations in APAC

While the Asia Pacific region has not had the legislative boons that Europe has, it is arguably a more fertile ground for the development of challenger banks. Large rural populations, previously unserved by the big banks of their countries, are desperate for the access to financial services that challengers offer, giving them the potential for very rapid growth. In cities, they are able to expand quickly without the need for physical branches, which are hugely expensive in places where land is at a premium. In Southeast Asia, digital banking is a helpful solution to the fact that populations are spread across countless little islands in countries like Indonesia and the Philippines.

India has proved to be a shining example of the opportunities for rapid growth in APAC. Assisted by the fact that the challenger banks here make use of the latest technology, provide an excellent level of security and provide an excellent suite of services, companies like 811, Airtel Payments bank and InstantPay have come a long way over a relatively small number of years.

Even major banking hubs like Hong Kong and Singapore have been quick to embrace challenger banks, with both granting increasing numbers of digital bank licenses. Meanwhile, places like the Philippines and Indonesia have been much slower off the starting line, with the former just launching its first digital bank while the latter is still at the level of a general intentions to go digital.

Australia, itself an ideal place for challenger banks to develop thanks to its widely spread population, has provided some obstacles to their progress. The banking sector here is dominated by just four traditional banks and open banking legislation has been significantly slower in coming here than it was in the UK and the rest of Europe. Indeed, the release of the Consumer Data Right (CDR) was delayed by several months by the outbreak of COVID-19, hampering the development of challenger banks at a time when they had the greatest potential for growth.

Opportunities elsewhere

Sub-Saharan Africa has so far proved to be impressively innovative in coming up with digital banking solutions to problems of widespread populations with limited access to traditional banks. The payment services sector here is especially lively. However, shortages in seed capital and access to technology have been limiting factors and, as such, the region’s first fully-fledged challenger bank is only just starting to emerge as 2020 comes to a close.

The Middle East certainly has the capital, but it has its own challenges. The cost of starting a new business in countries like Saudi Arabia and the UAE is so prohibitively high that the landscape is inevitably dominated by the big, well-established players - the traditional banks, in other words. As a result, bank-backed neobanks have been able to develop well but there are relatively few true challenger banks, with Dubai-based Xpence being the first and foremost.

More to follow

The demand for challenger banks is undoubtedly present right around the world. The technology required to make them possible and practical is already here and is getting better all the time. The limitations and obstacles are often found in the form of legislative bodies being slow in keeping up with consumer demands and trends. While Europe was quick to respond, most other parts of the world are only just warming up to the idea of open banking.

Sadly, many of the places where challenger banks could make the greatest impact are limited by a lack of the funding required to get off the ground. This has proved to be a major advantage to some of the well-established European challenger banks, which are able to enter such markets with little or no competition. However, with investors very interested in putting their money into an industry with such growth potential, the likelihood is that the number of competitors will soon be increasing.