Challenger banks: More than just a fancy app?

It was hard to go a week last year without hearing another story about a start-up threatening the existence of the banks.

Challenger banks in particular popped up left, right and center, looking to take a swipe at the established players. Many of them are mobile-only banks, allowing customers to carry out traditional banking tasks via an app. But a snazzy app may not be enough for them to shake up the market.

Akos Stiller | Bloomberg | Getty Images

There's no doubt about the excitement for these new banks. In March, U.K. mobile-only bank Mondo managed to raise £1 million ($1.4 million) via equity crowdfunding site Crowdcube in just 96 seconds. And German upstart Number26 has managed to rack up 160,000 customers since its launch in December.

Waiting in the wings are a whole bunch of challenger banks such as Atom and Tandem. There are some cool features, like the real-time tracking of payments or the fee-free payments while abroad.

It's all very quick and sleek, unlike many of the apps for traditional banks today.

But is this really a defendable business model and one that can allow these challengers to scale? There are a number of headwinds these upstarts face.

Firstly, and perhaps the most difficult, is how to convince someone who may have stuck with the same bank account for over a decade, to switch. Last year, there were just over 1 million people who switched bank accounts, an 11 percent drop to the year before. Even if the new players were trying to capture those people, that is not a big pool of users to grab, if split between over 10 banks.

And will the value proposition of the challenger banks be enough to get people to switch? I don't believe that a slick app will be enough to make the majority of people go through the hassle of switching accounts.

While the functionality of apps might be appealing, there's nothing stopping major banks fixing up their digital offering to compete. And if they do that, they already have the scale and products to retain customers.

And some of the upstarts aren't offering anything different. Mondo's CEO Tom Blomfield recently told CNBC that it would offer users zero percent on deposits with interest on overdrafts expected to be between 18 and 20 percent, a figure comparable to the major banks.

Many upstarts have realized they can't go it alone and this is a trend we're likely to see more of. Atom for example recently received $68 million in funding from Spain's BBVA and collaboration is now the name of the game.

Still, some start-ups will want to stay independent but if they really want to be challengers, they are going to need to offer things consumers care about – great interest rates, quick customer service, and attractive products from loans to mortgages. What has made banks so successful is their ability to offer all these products as well as ensuring customers stick with them. No matter how young and cool they are, this is a model the challenger banks will need to replicate.

But if they don't step up, then they might not be more than just another app on a smartphone.

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