It was with the joviality of a winking emoji that Monzo CEO Tom Blomfield tweeted Halifax UK earlier this month, to point out the remarkable similarities between the design of Halifax’s brand-new app and his own company’s well-established and popular version. It was all meant in good spirit, of course, but the scenario perhaps tells a bigger story.
‘Disruption’ is a de rigueur hot topic, with Monzo and its ilk of ‘challenger banks’ representing just one disruptive faction of the financial sector. While the idea of disrupting banking has been brewing steadily since even the dot com boom, finnCap’s latest research suggests we’re just now beginning to see the disruptive become the mainstream.
We’re just now beginning to see the disruptive become the mainstream
The release this week of finnCap Financial Sector quarterly research (read the research summary here) suggests that fresh investment of risk capital in recent years has seen smaller financial players now overtake their entrenched, big bank rivals. The strong growth in especially private market equity raisings over the period, suggest that the new money is predominantly going to new players.
Indeed, the paradigm may have permanently shifted in the favour of David-sized, more agile banks over their multinational Goliath competitors.
We looked at equity raisings for financial companies in public and private markets since January 2016 – a few months before the UK referendum on leaving the EU – to April 2019. Looking at the size of average equity raisings and the list of names that have raised capital, fundraisings for the smaller, specialised, more agile, highly digitised banks have been bucking the Brexit trend, with volumes raised continuing to grow over the period, despite the political uncertainty.
The markets are resilient
We’re seeing that financial disruptors can raise money in uncertain times; their markets for new capital are resilient. The period we studied was notably characterised not just by significant political turmoil, but also a deteriorating macroeconomic outlook. These two factors contributed to the wider financial sector underperforming the total market by around 15% over those three years.
On the other hand, smaller, AIM-listed financial companies outperformed the market by 5% and outperformed the wider UK financials index by close to 20%.
Investment of risk capital in recent years has seen smaller financial players now overtake their entrenched rivals
Recent years’ issuer data seems to be another indication of the increasing disconnect between the market view of the incumbent, full-scale banking sector and the smaller, more specialised financial companies. The smaller financials’ shares not only outperformed the wider index, they also continued to attract increasing amounts of new equity capital to fund growth over the period.
Between 2016 and the first quarter of this year, new public money raised across both primary and secondary markets amounted to £4.71bn across 154 raises in the public market, compared to £6.84bn in the private markets across 1,592 raises.
The opportunity is much broader for smaller institutions with more disparate or specialised services
What has changed?
Investment in smaller financials is seen as more attractive in today’s environment, in a way we have hitherto not experienced.
What has fundamentally changed is that risk – and, importantly, opportunity – is spread. The opportunity is much broader for smaller institutions with more disparate or specialised services, rather than a large one-stop-shop player like, say, a Halifax. Where once these services were all in one place, investment now prefers to differentiate and spread risk between, say, a fintech company, an asset manager, a specialised lender, and so on.
Meanwhile the nature of private equity investment suggests an increasing number of funds are actively searching the private market for the next big product or technology to disrupt the incumbent banks.
Indeed, these newer, more specialised players are able to pitch their case to investors from an understandable, altogether more entrepreneurial context. Big, full scale banks often have tens of thousands of employees worldwide, they run on entrenched, legacy IT systems, and fundamentally lack that entrepreneurial culture that a hungry new player often brings to the table.
A fresh-faced fintech disruptor, for example, can be understood from the ground up. Its technology will be precise and specialised in its function. It can be appreciated from an investment perspective on its own merits rather than in the context of being a cog in a far bigger machine.
Furthermore, new platforms demonstrate agility in new ideas generation. Monzo says that approximately 35,000 people a week open a new account with the bank, thought to be driven at least in part by the transparency, speed and ease of use of their design-led, app-based systems.
That entrepreneurial culture that a hungry new player often brings to the table
Finally, the people potential cannot be ignored. While bigger banks may be able to replicate the design features of a user-friendly app, changing internal culture to one that replicates or reflects, say, a small fintech, might seem harder, especially when recruitment processes in the smaller players will almost certainly be geared towards attracting a younger, dynamic workforce with very defined skillsets or technological expertise.
Why are we seeing this trend now?
As mentioned, the dot com era laid the groundwork for disruption in the financial sector. The UK banking industry indeed experienced a small boom in more agile, more specified banking players at the time. The infrastructure was there. What was not there was the trust.
Put simply, there were scant people willing to transfer their money over the internet back then, or certainly not in the way we do nowadays.
The digitalisation of banking products has now reached levels where a large physical footprint – for example, extensive branch networks – that used to protect the large incumbent banks from new entrants, is losing its value. Indeed, the number of branch visits has fallen sharply over the recent decade.
The catalysing impact of the smartphone cannot be understated here. Apps aside, the mere presence of a WiFi-connected, secure super-computer in everybody’s pockets, more or less regardless of one’s income or location, equalises the playing field. Having a smartphone for instance effectively replicates a huge branch network.
A new banking era?
The healthy appetite for new risk capital in mainly smaller, specialised UK financial companies contrasts somewhat with the generally more subdued view of the larger full-scale banks, where the continued low interest rates, litigation risk, legacy IT systems and concerns about the value of the large branch networks has added to the increasing macroeconomic concerns and raised questions about the longer-term profitability of the larger full-scale banks.
The infrastructure was there. What was not there was the trust.
It should be made clear that these findings by no means suggest that the big banking players cannot come back and respond positively to the disruptive challenge. Far from it, in fact. It is true that the big banks of today were once the small disruptors themselves, some properly establishing their names in the mid-to-late 1800s or early-to-mid 20th century. One might look for example to the unveiling of the world’s first cash dispenser in June 1967 by a Barclays branch in North London as one of the last major disruptive events that inherently altered the way we bank.
Nevertheless, the insights from our research quarterly suggest that this cycle has come back round.
The smaller, more specialised, digital-centric financial players are the ones now predominantly receiving new risk capital. The smart money has, it seems, permanently shifted and these Davids may yet prove the Goliaths of a new banking era.