Challenging Challenger Banks

Thursday 12 November 2015   Category: Banking By Laura Fallon

‘Challenger banks’ has been a name ascribed to a group of newer and smaller banks which now operate in the UK alongside the likes of Barclays, HSBC, Lloyds, RBS and other large well established intuitions. They have been commended by politicians for their lending to small business’ and introduction of much needed competition in the market, but do they offer a suitable secure home for your cash?

The UK challenger banks are Aldermore, OneSavings Bank, Metro Bank, Sainsbury’s Bank, Shawbrook Bank, Tesco Bank and TSB Bank. Whilst most of these have launched in the last six years some may have been around longer than you think: Sainsbury’s and Tesco bank first launched in 1997. There has been a big move to becoming publically listed recently with four of these banks having undergone initial public offerings in the last 18 months.

One very obvious advantage of these institutions is that they have largely avoided the legacy problems of bad assets, government bail-outs, PPI mis-selling and antiquated IT systems that have plagued many of their grown up cousins. They have also all expressed a commitment to good old fashioned banking and do not have large investment banking divisions that could be liable to speculate recklessly, or rig LIBOR rates.

However their newness is also their weakness in that they have less of a track record in demonstrating secure financial performance. Many have only recently become profitable and some continue to make losses as part of their business plan as they grow. Indicators of performance, such as a share price or a credit rating, are generally less available for these banks. These uncertainties become even more apparent when it is considered that many of these organisations are expanding rapidly and changing fast.

The challenger banks are also more heavily weighted towards retail funding. In some respects this is a good thing as retail clients are less inclined or able to withdraw large amounts from the bank quickly in the event of a crisis or ‘run’ on the bank. However it leaves large wholesale depositors including local authorities more vulnerable if the banks were to get into serious financial difficulty and be ‘bailed-in’ (where losses are forced on creditors by regulators in order to save a failing bank and prevent taxpayer funds needing to be used). Retail depositors receive protection from bail-in: large wholesale institutions do not, meaning that for challenger banks there are fewer people available to share any losses and the impact for a single investor would be greater.

Arlingclose’s credit analysis team have conducted in-depth research into the challenger banks. We have scrutinised their published financial statements over the last four years looking at key ratios, trends and how the challenger banks stack up in comparison to more established banks in the market. We have examined how their balance sheets are structured and thus how big losses might be if an investor did experience being bailed-in. For most of the challenger banks we have also been able to meet with their management in person.

This analysis has lead Arlingclose to advise our clients not to place unsecured investments with any of the challenger banks at the present time. We feel that the risks currently outweigh the benefits. However we believe there is certainly scope to be optimistic about the future of these institutions as they grow and establish themselves. How challenger banks might shape the future of UK banking, and their suitability as secure investment counterparties, is something that Arlingclose will continue to watch closely.

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