At the recent Wolfe Fintech Forum conference, Q2’s Rahm McDaniel and Moven’s Bryan Clagett spoke on the subject of challenger banks and how they’re disrupting the digital financial space.
(You can watch the full video at the bottom of this blog post.)
What is a challenger bank?
A challenger bank is a startup digital bank that competes with traditional financial institutions (FIs). They don’t have the branch network and infrastructure that traditional FIs have, but they are nimble in product development and attractive to segments of the market difficult to serve or ignored by traditional FIs. As a result, we’re now seeing challenger banks displacing relationships held by traditional FIs, particularly large ones.
Why set up a challenger bank?
Banking has become highly commoditized. This has led to complacency among some bankers who don’t think about banking “until something goes wrong,” says Clagett. But to break this commodity trap, bankers are adopting a “challenger mindset” and looking at setting up fully digital challenger banks of their own.
This shift is happening because a large portion of the market is underbanked—16% of U.S. adults, according to the Fed in 2019, although estimates vary. That’s a huge market, and doesn’t even include teenagers, so it’s no surprise that entrants like Chime (12M users in 8 years) and Step (roughly 1M users in their first four months) would grow as fast as they are. According to McDaniel, there are three types of problems that help explain why this is happening:
- Engagement problem – Consumers are turning to other digital financial solutions to fill in the holes of their digital experience with traditional banks. The rest of consumers’ digital lives are relatively frictionless, and banks struggle to meet that bar with their digital offerings.
- Economic problem – Bankers aren’t motivated to work as hard to acquire or keep new groups of retail customers due to cost-of-service issues.
- Systems problem – Most core processing was developed before the internet was publicly available, and they aren’t built for eCommerce best practices.
A challenger like Chime isn’t limited by these three factors and they’ve tilted their services toward users who are unhappy with traditional offerings.
Why don’t we see more traditional FIs standing up challenger bank models?
According to Clagett, traditional FIs aren’t standing up challenger bank models because there’s a lot of fear in the industry, a lot of unknowns. While bankers tend to blame the cores, the reality is banks are stifled by bureaucracy and struggle with customer-centric thinking. Going back to the commoditization of banking, this thinking-related problem has led to a lack of innovation. McDaniel added that introducing new banking products is “time consuming and disruptive,” and banks have systems in place for carefully vetting any new thinking that could introduce risk to their primary modes of business.
Also, McDaniel says, scope creep is a huge problem. Banks will often view these projects as transformational in nature, which makes product restraint difficult for a full-service financial institution. In reality, they should view these initiatives as product launches. The most effective challenger banks have tightly-defined target customers, use cases, and only the most critical products and services needed to support them.
How does a financial institution set up a challenger bank?
To launch a challenger bank, there have been three traditional methods: build it, partner for it, or buy it.
- Build it – This option has a high potential for scope creep, as mentioned earlier. You also have a talent problem. The best developers in the world tend to want to work for development-centric companies like Credit Karma—not FIs, and especially not mid-size FIs. The tricky thing about mid-size FIs is they often have visionary thinkers on board, but they aren’t big enough to build whatever they want.
- Partner for it – This can be a good approach and Q2 is seeing this materialize in its banking as a service sector. The main point here is that FIs need to accept the idea that someone else controls the customer experience and relationship.
- Buy it – This option addresses both problems of building and partnering for it: you get the outstanding user experience that development-centric companies can offer, plus you get to own the customer relationships. In this scenario, banks will need to consider marketing, which will play an outsized role in the program’s success.
On the subject of buying a challenger bank setup, Q2 has engaged in a collaboration with Moven to offer banks the ability to set up a standalone digital bank of their own. Q2 has a core that can work with any front end, and Moven has a front-end system that can work with any core, so together, the result is a turnkey bank-in-a-box product. This isn’t a new concept by any means, but Q2’s research shows that the market has wanted such a product for a while and the right product simply didn’t exist.
Check out the full video here:
If you’d like more information on how FIs can launch a challenger bank, visit our Digital Bank in a Box page.
