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Is 2021 the year of mass adoption of challenger banks in Europe?

While challenger banks have captured the imaginations of increasingly digital-savvy consumers, we're still a long way away from mass adoption.

In the UK, where one in four under 37s have at least one account with a challenger bank, the big four high street banks still have 87% of the market share. Similarly, in the EU, traditional banks dominate, despite having lost two million customers over the past two years.

But could the growing number of branch closures — and the more frequent digital interactions brought about by the COVID-19 pandemic — tip the scales in 2021? Or do challenger banks have more work to do before the average customer is comfortable using one as their primary bank?

A long-standing trend

Bank branch closures aren't a new trend. While there was a large uptick during the 2010s — there were 1,345 closures just between 2016 and 2017 — branches have been closing across the UK at an average of 300 a year since 1989.

Similarly, customers had been visiting their local branch less and less well before they had to worry about social distancing and whether a trip was essential. Rather, it's because digital technology has made it possible to do most day-to-day banking any time, anywhere.

In 2017, most customers were already prioritising the quality of the digital offering over branch proximity when choosing who to bank with. And industry analysts CACI predicted the average customer would visit a branch four times a year at most by 2022.

Digital doldrums

With customers already using digital channels and cutting back on trips to the branch, you'd have expected challenger banks to gain more traction sooner.

The likes of Monzo, Monese, bunq, and N26 have accustomed users to blazing fast service and slick user experiences. Meanwhile, research suggests that traditional banks have been failing to meet digital expectations.

In a 2019 survey, 82% of customers said they expect every digital experience to be at least as good as what Google, Amazon, and other tech giants offer. But only 28% are happy with how their bank is doing it.

So why hasn't the mass exodus from traditional banks materialized?

Research suggests it's because, while we might not be visiting the branch or using cash as often as we used to in the past, we like having the option. And under the right circumstances, we'd rather visit the branch than log on to an app. 

The human element

If challenger banks' biggest selling points are speed and convenience, they come with a trade-off. The customer has to take on more responsibility for their financial well-being. And that's where high street banks have traditionally had the edge.

Atom Bank, the UK's first digital-only bank, have openly said that "the customers who are most satisfied are those who dont come into branches …  [and] are also the most financially confident and competent."

This might work well for most day-to-day banking. But research suggests that even the most financially and digitally-savvy consumers seek out human contact in high stress situations.

When we're faced with a big decision — getting a mortgage, or starting a business, for instance — or in a spot of trouble, for example because there's been fraudulent activity on our account, our natural instinct is to speak to someone. And challenger banks, with their lack of physical presence and customer service largely left to chatbots, are falling short.

Is traditional banks' loss the challengers' gain?

Needless to say, COVID-19 has closed the gap between traditional banks and challengers when it comes to face-to-face interactions. If customers had been visiting bank branches infrequently before March 2020, lockdown restrictions have caused visits to plummet further. Meanwhile, online interactions are on the rise.

Case in point, HSBC has said 90% of its customer interactions now happen online. As a result, it plans to whittle down its UK footprint by 14% to 511 branches.

But is the fact that COVID-19 has stripped big banks of one of their key benefits — human interaction and expert guidance — translating into more customers for challengers?

Research suggests the opposite.

During March and April 2020, 6 million people downloaded their high street bank's app for the first time. But challenger bank app downloads dropped by over 23% when compared to the same period in 2019.

So what could have made this happen? And what's in store for challenger banks in 2021?

Will challenger banks ever gain the upper hand?

According to a report by analytics firm Jefferies, traditional banks have maintained the upper hand when the pandemic should've logically favored challengers because they have more pricing power. Indeed, challengers have even complained that COVID-19 support has been skewed to favor incumbents.

But that's only part of the reason. The pandemic has also exposed that challenger banks have a trust problem.

Curve, an app that lets users combine all their different payment cards in one, found that users pick a card from a traditional bank over a challenger bank card 83% of the time.

More tellingly, when users do use their challenger bank card, the transaction is smaller. The average challenger bank card transaction is £20 GBP (ca. 23,30 EUR), where on a traditional bank card it's 30 GBP (ca. 35 EUR). This suggests customers see challengers primarily as a way to ring-fence their entertainment budget, rather than an all-purpose account.

So will challengers ever gain the upper hand?

Only if they become more human.

To date, challenger banks have mainly appealed to younger consumers with high digital and financial literacy. But to make true inroads into the mainstream, they must also appeal to those whose lives are more unpredictable, still rely on cash, and may not have high disposable income or the same level of comfort with digital.

The pandemic has exposed traditional banks' weaknesses, sped up digitalization, and made clear the need for better financial tools that truly empower customers.

The question is, can challenger banks seize the opportunity, or will they fail to adapt like traditional banks did before them?