Digital Banking vs. Traditional Banks: Who will win?

For over a decade now, a war has been raging in financial services between digital banking vs traditional banking. This all began in the years after the 2008 financial crisis when global economy was shaken to its core. With governments bailing out banks with billions, regulators were tasked with ensuring the same mistakes were never repeated. The traditional banking system was put under tighter restraints than ever before, with lending being heavily constrained and these organisations required to have much larger amounts of capital on their books. The message was clear, that banks could not be allowed to lend in a way that left themselves (and the economy) exposed to such risk again.

This created a crossroads moments in fintech and banking. For so long, these traditional banks had been dominant players in financial services, and they were suddenly sidelined. Fortunately, this opened up the market and led to the emergence of challenger or neo banks. As the name suggests, these new upstarts were being launched to challenge for market share and brought with them new business models.

The key features of challenger banks

The digital challenger banks were able to use their perceptive weaknesses as advantages. They did not have the resources or scale of traditional banks, but with technological innovation these challenger banks have been able to explode in popularity.

Through technology, the challenger banks have provided a growing customer base with accounts, overdrafts and debt – essentially everything traditionally provided by bricks and mortar banks, but now with greater flexibility and efficiency. These challenger banks are also offer cheaper solutions as, unlike traditional banks, they are not having to cover the huge overheads of large workforces and high street branch networks.

Challenger banks have also used technology to re-invent the banking customer experience. Whereas people used to be only able to go down to their local high street branch, or test their patience with a call centre, challenger banks are arguably much more customer-centric. As well as using AI-powered chatbots (which we’ve written about), challenger banks’ entire proposition is designed around the customer and to be something different to what is being offered by incumbents. Challenger banks’ online experiences, that champion mobile connectivity, align with how we expect most of our customer service experiences.

In the same way Uber, AirBnB and Amazon offer cleaner, simpler and more efficient ways of ordering taxis, booking holidays and making retail purchases respectively, these challenger banks are transformed how consumers use digital banks. The proof is now undeniable – every six months the UK’s Competition and Markets Authority surveys banking satisfaction. In the latest survey, Monzo and Starling bank – two notable challenger bank brands – have continued to command the top spots. In contrast This has created a fintech disruption of traditional banks which have had to invest more in their online operations, in a realisation that their own models are increasingly in need of revitalisation.

What’s next for challenger banks

Digital-only banks have taken off, with the advantage of growing from a low base, and not having the legacy issues (such as PPI) that have continued to hold back traditional banks. The success of digital banking adoption is clear in the numbers. According to the British Business Bank, in the UK challenger banks collectively surpassed the big five banks’ market share after 2021. These big five accounted for 63% of total banking lending in 2014, but this has since fallen to 41% in 2023.

Challenger banks are now big business and, ironically, some are becoming more similar in size to the very traditional they launched to compete against in the first place. It is estimated that the challenger bank market was valued at $118bn in 2023, but this is expected to grow to $2.5trn by 2031. That is a staggering CAGR of 47% in less than ten years.

These achievements are considerable but there is still some way to go in the digital banking vs traditional banking war. For one, despite their growth many people still view challenger banks as fringe offerings. In a recent YouGov survey, out of the 20 million UK challenger bank customers only one in five view this account as their primary account. Also, these banks are still subject to the same regulatory scrutiny – and failings – as traditional banks. Earlier this year, the FCA fined Starling Bank £29m for failures in financial sanction checking. This harmed the bank’s reputation and created hesitation around trust in digital banks.

The rise of digital banking has been immense, but it remains to be seen how challenger banks continue to grow and tackle the challenges that come next.

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