Entrepreneurs are backing a second wave of start-up banks attempting to break into the UK, just as private equity groups retreat from the market.
OakNorth is one of the latest lenders to have obtained a licence from regulators, while Atom and Open Bank are among four undergoing the application process.
Regulators have eased requirements to encourage more start-up banks and boost choice for consumers. As a result six new banks have been approved in the past year.
Many of the new outfits are backed by entrepreneurs, keen to enter the fast-growing sector. But doubts are surfacing over the long-term viability of these competitors as a number of private equity groups are selling down their positions in so-called challenger banks.
JC Flowers and Wilbur Ross have offloaded parts of their stake in OneSavings Bank and Virgin Money respectively in the past month.
Some critics question whether start-up banks can gain enough scale to challenge the UK’s “big four” — and cover the significant fixed costs involved in banking operations — especially if private equity backers are retreating.
Andrew Lowe, an analyst at Berenberg, says 80 per cent of current accounts are opened in branches, meaning a vast network is important to banks.
“You need to have scale in banking — but how much scale do you need? That’s the real question mark over these smaller players. Can they make it work?” he says.
Dubbed an entrepreneur and start-up investor, Rishi Khosla, founder of OakNorth, cut his teeth in the banking industry.
After a year at ABN Amro, he joined GE Capital to focus on mergers and acquisitions. Still in his early twenties, Mr Khosla moved to run steel tycoon Lakshmi Mittal’s private office. There he built a private equity venture portfolio before joining forces with an old university friend in 2002 to start-up Copal, an outsource research business for investment banks.
The business was sold to Moody’s last year, allowing Mr Khosla to focus on the launch of OakNorth, a bank designed to address the lending gap for small and medium-sized businesses.
Ricky Knox, co-founder of Open Bank, says some new lenders are “not really trying to change the way banking works” in terms of serving customers.
Open Bank will launch a full-service retail operation, providing current accounts, savings and loans among other products.
In a number of cases, new banks are already established lending businesses. The licence allows them to bring in cheap retail deposits in the low interest-rate environment to help fund loan growth.
Charter Court Financial Services, which is backed by US hedge fund Elliott Management, launched a retail bank brand called Charter Savings in January.
The group already has established lending arms under the Precise and Exact mortgage brands, which are known among brokers. With Charter Savings Bank, it can offer deposit accounts to help fund lending.
Ian Lonergan, chief executive of the group, dismisses the notion that its new banking arm is designed merely to grow and diversify funding.
“From a retail savings perspective, we’re a fresh proposition entirely,” he says, stating that the bank’s savings bonds and notice accounts have been top of the interest rate tables over the past month.
“Clearly we’re an established lender, providing us with solidity and a strong base. We will use retail funds to increase the mortgage lending we can do year on year and consider new lending areas when the opportunity arises.”
Charlotte Nelson, of consumer site Moneyfacts, says challenger banks are seen as an “attractive alternative” to the mainstream banks, with many products appearing in best-buy tables.
But many challengers have restrictive access, only operating online, which makes it tough for customers who rely on a branch network, she says.
With a background in economics and a number of languages under his belt, Ricky Knox’s first foray into the corporate world was as an associate at LEK Consulting, a global management consultancy.
After a brief stint, he joined a venture capital fund investing in high-growth early stage British companies. Three years later, Mr Knox founded his first business, Small World Financial Services, a global money transfer business.
He has also launched GSM Systems, a company that supports mobile networks and Azimo, a social digital payments platform. His latest venture, Open Bank, will provide retail banking products and services to consumers.
“It can be difficult for people to trust unknown brand names particularly, if they are unfamiliar with what their ethos is and can dismiss them in favour of their local bank,” she adds.
Other new entrants are expected to grow faster by targeting underserved markets.
OakNorth, which is set to launch this summer, will focus on lending to fast-growing smaller businesses.
The bank, which was founded by entrepreneur Rishi Khosla and recently appointed Lord Adair Turner, the former head of the UK’s financial watchdog, to its board, will lend against a wide range of collateral. In contrast, high street banks typically only accept property as collateral, making it tough for smaller businesses launching in the digital age to obtain loans.
Mr Khosla says he is targeting this sector as he believes it has always been “structurally underserved” by banks.
But the start-up, which had planned to lend £1bn within a few years, has already seemingly scaled back its ambitions by pushing this out to five years. The bank has lost two chief executives within a year, and is now run by Mr Khosla.
Nigel Terrington, chief executive of the Paragon Group, which gained a banking licence last year, says specialist lenders “have a role that is less about challenging the high street banks and more about complementing them”.
“I also think there’s a danger of specialist lenders getting too big — a danger they move away from being specialist,” he warns.
Branch-based banks that offer full retail services, such as TSB, differ markedly from lending specialists such as Paragon, Shawbrook, Aldermore and OneSavings, even though all are covered by the term “challenger bank”, Mr Terrington says.
The latest wave of entrepreneur-backed start-ups will provide another alternative. But while they will bring new names to the market, there is scepticism among analysts over how much they will boost competition.