How Healthy is the UK Digital Challenger Bank Sector in 2024?

In the first week of 2024, news broke regarding the contrasting fortunes of two prominent UK digital challenger banks. Monese warned that it needed to raise external funding after posting widening losses for 2022. On the other hand, however, despite heavy expected losses for Chase UK for 2023, the JPMorgan-owned digital challenger bank struck a more optimistic tone, forecasting profitability as soon as next year.

So, what does this tell us about the health of the digital challenger bank sector?

• This time last year we wrote about how digital challenger banks were at an inflection point as funding nosedived in 2022 & 2023.
• Scarcer available funding heaped pressure on the sector to pivot away from their “customer growth at all costs” mentality towards profitability.
• Efforts to shift towards more sustainable growth strategies over the last few years are already paying off in the form of healthier financials.

UK Digital Challenger Banks Demonstrate Resilience

Leading UK digital challenger banks, including Atom Bank, Monzo, Starling, and Zopa, have showcased their durability over the last two years in the face of adversity. Each have reported improved financials over the course of the year:

• Starling Bank grew its annual profits six times over for the FY23 while also achieving the milestone of two consecutive years of annual profitability.
• Atom Bank announced its first ever annual operating profit of £4 million for FY23.
• Monzo narrowed its hefty losses and reported it had hit monthly profitability for the first three months of 2023.
• Zopa hit pre-tax profitability for FY22 and forecast full-year post-tax profitability for FY23.

How Have Digital Challenger Banks Managed To Shift The Profitability Needle?

Digital challenger banks have started to better monetise their large customer bases by making inroads into higher margins products while also diversifying their product suite and revenue streams.

Leading digital challenger banks have made great strides towards addressing low revenues per customer by significantly growing their lending portfolios, albeit from low bases. For example, Starling Bank grew its total lending by £1.6 billion to £4.9 billion for FY23. In the context of higher interest rates, lenders have been rewarded through surging net interest income (NII): Starling’s NII grew 187% to £348.8 million for FY23, per its 2023 annual report.

Digital challenger banks have also made great strides into diversifying their product mix to supplement their core incomes. Several leading players have struck partnerships with other financial institutions to offer additional products. Fintech Revolut (that has its eye on a UK banking licence) offers insurance, investments, and trading through its network of partners. Innovative “freemium” models that lure in customers with in-demand features to paid tiers of subscription bring in recurring revenues are starting to also pay off. Monzo grew its income from net subscription fees by 77% for FY23, per its 2023 annual report.

What Can We Expect In 2024?

Against the backdrop of scepticism regarding digital challenger banks’ ability to turn a profit, the sector has demonstrated it has matured. We expect that in 2024, UK digital challenger banks will double-down on sustainable growth as macroeconomic uncertainty lingers.

In addition to growing their lending portfolios, innovative digital challenger banks will lean into Open Finance-enabled products and services to diversify their revenues. Revolut is leading the way with its platform-based “super-app” ambitions. Its Stays & Experiences platform allows customers to book accommodation, exchange money, and get emergency medical care via its premium offering. While Starling Bank’s Banking as a Service (BaaS) offering provides non-banking business customers with the technology and licensed infrastructure to offer banking products and services.

Digital challenger banks must assure investors and their customers about their durability by putting in place robust governance and risk management. Related failings will harm their reputations at a time when they are trying to establish themselves as credible alternatives to incumbents - governance failures were largely to blame for FTX’s and Silicon Valley Bank (SVB)’s dramatic collapse. Fintechs need to double down on regtech and other governance controls to alleviate fears that they lack the resilience of more established firms.

As investors prioritise profitability and resilience over aggressive customer growth, digital banks/fintechs must lean into sustainable strategies to survive. Check out our top fintech strategies to emerge stronger from this difficult period and shape the financial services of tomorrow!