The UK’s major banks are muscling into new areas of the fintech space as they look to keep up with a pack of young challengers and grab a slice of the lucrative market.
In the early 2010s, a wave of financial technology start-ups burst onto the scene offering new products and slick alternatives to traditional banking.
They have since attracted millions of customers, eye-catching valuations and are becoming increasingly profitable, forcing incumbent firms to reconsider their models.
Fintech is growing across banking, payments, insurance, wealth management, digital assets and more – offering traditional retail banks the chance to diversify their revenue streams away from interest rate-sensitive products.
Big banks want in, and are adopting several different entrance strategies – each with their own risks and rewards.
Software licencing
Bankers are paying close attention to Starling’s software-as-a-service (SaaS) unit, Engine, the first major push into the space by a UK lender and its route to international expansion.
Engine, which formally became a subsidiary of Starling in February 2022, white-labels its software platform to banks in other countries, for which it earns monthly subscription fees.
Although still in its infancy, signing its first two clients last year, Engine has already shown enough potential for Starling’s second-biggest investor to say it could drive the bank to a £10bn valuation in the next few years by signing up 40 to 50 more customers.
Starling’s top brass is also bullish on Engine’s prospects. The unit’s chief executive, Sam Everington, told City A.M. that Engine had seen “very strong interest”, especially since its first client – Salt Bank in Romania – went live in April.
“Last month was by far the busiest for visitors to our London office,” he said, highlighting Europe, the Middle East and south-east Asia as particularly attractive markets.
“Can it be more valuable as a business than the UK regulated bank? Yes, potentially.”
Sam Everington, CEO of Engine by Starling
Everington added that Engine’s revenues could eventually outstrip those of Starling’s UK bank, although “not for a long time” given the complexity of each project.
“It can deliver significant value. The valuation multipliers on technology businesses compared to banks are quite different,” he said. “So can it be more valuable as a business than the UK regulated bank? Yes, potentially.”
Still, not everyone is so optimistic. “You can certainly understand why Starling needs another story, but I’m not sure how credible it is really,” one fintech executive said, noting the difficulty and risks of propping up small banks in so many different markets.
In any case, Engine faces a competitive scene. Cloud banking fintech Thought Machine, valued at $2.7bn (£2.1bn) in 2022, has landed deals with big players like Lloyds, Standard Chartered, JPMorgan and Morgan Stanley.
Other rivals include Mambu and 10x Banking. The latter’s head, Antony Jenkins, who was CEO of Barclays from 2012 to 2015, said the next decade of banking was “all about how you can harness technology to meet your customers’ needs, particularly in areas like artificial intelligence”.
“I was always frustrated by the technology I had to work with,” he added. “I often describe banks as being museums of technology – they have every generation of hardware and software in there.”
Payments and FX
Europe’s biggest lender HSBC also offers embedded banking products and announced a partnership with California-based payments fintech Tradeshift last August to develop financial services apps.
It now competes directly with Wise and Revolut through Zing, an international payments app it launched in January.
These businesses tend to operate as ring-fenced entities. A senior banker at HSBC said this was standard practice when dealing with “risky” entrances into new markets.
HSBC is holding out hope that the “Wise killer”, as some staff have called it, will put up more of a challenge than Monese. HSBC took a stake in the lossmaking neobank for $35m (£30.7m) in 2022, with Monese warning in January that its future was in question amid struggles to secure further funding.
“Incumbent players have not stood still over the past decade,” said Tom Graham, a managing director at Accenture, which consults with banks.
“They are getting quicker at evolving their systems to create similar features for their customers – some banks now even go beyond neobank offerings. Despite this, their core technology remains complex, and their cost base remains high. Whereas, now more stable, the neobanks have rapidly iterated their propositions.”
Recent fintech failures include Barclays’ payments app PingIt, Santander’s SME-focused Asto and RBS’ digital bank Bó, which it launched in 2019 to challenge Revolut and Monzo but axed after just five months.
RBS launched Bó in November 2019 and informed customers the following May that the app would close in July.
Embedded finance
In 2022, Natwest took a minority stake in Polish fintech Vodeno to launch Boxed, allowing large corporate clients to offer financial services under its banking licence – a model known as banking-as-a-service (BaaS).
With a focus on shopping, including buy-now pay-later, its rivals include Swedish giant Klarna and Frasers Plus, launched by Mike Ashley’s retail group last year.
The UK’s BaaS market offers an estimated revenue opportunity of around £5.5bn, according to Boxed. It also found embedded finance could unlock four to seven per cent incremental revenue growth for retailers.
Boxed’s CEO, Andrew Ellis, said it would become a “material part” of Natwest’s financial services revenue pool, with products like BaaS a method of “future-proofing” a bank’s business.
He added that Natwest had an advantage with “the strongest licencing credentials, a trusted brand and a modern technology platform”, as well as “risk management and compliance expertise that perhaps other players in the market cannot offer”.
“We are starting to see more players moving into this space,” Ellis said. “The way banking is distributed is changing… Banks need to embed their products and services into various customer journeys with large corporate brands to ensure they stay relevant.”
Natwest isn’t the only big bank venturing into BaaS. Emerging markets-focused Standard Chartered launched nexus in 2021, catering to the likes of social media firms and ride-hailing companies.
What next?
Graham said that despite “some very successful examples”, so far SaaS and BaaS propositions have “proved hard to scale”.
“The market to sell to other fintechs has slowed, the cost and timelines to sell to big banks has proven painful, and the embedded finance market has consolidated,” he added. “Despite this, there is still a huge opportunity to embed financial services.”
Another route to gaining market share is for banks to acquire fintechs. Lloyds has become a closely-watched player in this regard, buying wealthtech Embark for £390m in 2021 and protection advice firm Cavendish Online in 2022.
Fintechs battered by a dearth of funding could make easy targets for banks with deep pockets. Investment in the sector across Europe, Asia and the Middle East halved in 2023 to its lowest level in seven years, according to KPMG.
A person familiar with the matter said fintech investment and reviewing acquisitions remained part of Lloyds’ strategy. The group plans to launch a buy-now pay-later offering for partnered retailers this year that would compete with the likes of Klarna, it is understood.
Still, Jenkins pointed out “execution risks” around volatility in fintech valuations and integration challenges that made investments and strategic partnerships more likely than acquisitions.
“Banks will increasingly have to partner with firms like ours,” he added. “We have capabilities that they could build themselves, but we spent eight years and half a billion pounds doing this. So why would you try doing that yourself when you can buy it in from us?”