Challenger Banks- Welcome to the ‘Upside Down’!
On March 25, 2020, due in large part to the economic repercussions associated with the COVID-19 pandemic, interest rates on short-term treasury bills in the United States turned negative: Think the ‘Upside-Down’ in Stranger Things- an alternate, parallel universe where things (particularly, interest rates) don’t behave ‘normally’ (the Demogorgons, in this case, are the negative interest rates).
A negative interest rate means the borrower gets paid to borrow money from the lender. Essentially, banks have to pay central banks to keep their excess reserves stored rather than receive interest income. An example of this, although highly unlikely due to the competitive nature of financial institutions and the short-term nature of negative interest rates, would be a consumer, you or I, PAYING the bank to hold our cash deposits. (Those ‘high yield checking or savings accounts’ you’ve likely seen advertisements for would all but vanish. Say goodbye to days of 3% high yield savings accounts! You’d have to get a long-term savings bond to see those rates- and even these are likely to be negatively impacted.)
For banks, a negative or near-zero interest rate has asymmetrical effects- especially banks that have a heavy reliance on retail deposits (the cash you and I put in our bank accounts). In a nutshell- the bank’s cost of borrowing goes up and is not immediately off-set by the price it charges to lenders. This means that the bank’s profit margins get tighter and tighter and bank managers start to constrict credit to only those with above-average credit- a sort of credit rationing/tranching. Luckily, major financial institutions in the United States do not typically rely solely on retail deposits- many have diversified portfolio mixes or ‘asset mixes.’ For example, a bank could gain funds through the issuance of a home mortgage, student education, and car loans.
Enter into the arena: Challenger Banks!
Challenger Banks or so-called “neo-banks” are the digitally-first players entering the financial field at the moment (think the software-as-a-service version of a brick and mortar bank). These banks are customer-obsessed, an application powered (few have physical storefronts), and usually represent a disruptive force to the more traditional financial institutions. Most of your traditional banks have been in business for many, many decades (Citi- 207 years, Wells Fargo, 168- you get the picture). These ‘legacy institutions,’ as the name may imply, are not usually quick to change and, more often than not, have antiquated, siloed data systems that are both costly and cumbersome to run. The current pandemic has created an unprecedented need for e-commerce and mobile payments (Stripe’s recent $36 BILLION dollar valuation)- Afterall, many of the brick and mortar banks across the world are either closed or running on a skeleton staff.
You may already be familiar with some challenger banks: BankMobile, Chime, and SoFi all fit the mold of a challenger or neo-bank. These challenger banks all offer varying features, but some common features include Fee-Free ATM access, online bill pay, P2P mobile payments, little or no account minimums, and, no-fee checking/savings accounts. With these offerings and lower barriers to access, these neo-banks can ‘bank’ (a term that means providing banking services or funding/capital) to the under and non-banked portions of society. These digitally-first banks have even been appealing to high-wealth clients who view the ease of doing business online or through their phone as reason enough to open a new account and transfer funds.
Large financial institutions that have big digital banking footprints and understand their digital-first clients will have a leg up on their competitors in the months and years ahead. Throw into the mix near-zero interest rates and you have a mighty cauldron boiling. Banks and other financial institutions will all be clamoring to diversify their asset mix and many, if not all, will feel the pressure to boost their mobile and digital banking experiences in order to have a leg up on their competitors and attract more clients. We will see banks and other financial institutions ramping up their customer service, application features, and, all-around ease of doing banking. As banks feel the squeeze to attract low-cost capital reserves, consumers will be the victors. Consumers today are just a couple taps on their iPhone away from trading stock, managing their retirement portfolio, and even refinancing their home- why shouldn’t they expect a banking experience that is both inexpensive and user-friendly?
