KPMG - Are banks too big to fail or too big to compete?

The UK's established high street banks may have to set up greenfield operations free of legacy tech to take on the better-performing small challenger banks nipping at their heels, according to a report from KPMG.

KPMG's study, 'The Game Changers', analyses the full-year results of newer entrants to the UK's banking sector and finds that while challenger banks are outperforming the country's 'Big Five' banks, it is the smaller, more focussed entrants who are enjoying stellar returns.For larger challengers, such as Metro and Virgin Money, key financial indicators, such as return on equity, are becoming very similar to the establishment.Warren Mead, head of challenger banking and alternative finance at KPMG, says: “Financially, the large challengers are looking very similar to those of the traditional banks. To ensure they remain differentiated, they must review their brand, distribution, products, culture and customer service."

The greater threat appears to lie with smaller new entrants, which have much lower cost bases than their bigger compatriots.

“Small Challengers are securing high returns and have better cost optimisation," says Mead. "If this trend were to continue, as the challengers grow and benefit from economies of scale, it poses an interesting question for the Big Five as to whether too big to fail, becomes too big to compete?"

While they appear unable to match the technological prowess and big budgets of the UK's largest banks, KPMG's figures paint a picture of the challenger banks picking-up the whitespace left behind following the financial crisis. This includes areas such as small business lending, second charge mortgages, invoice financing and unsecured lending.

Mead says that the main point of difference between the new market entrants and old-line banks lies in their culture.

"Being largely free of the legacy problems of the past contributes to a sense of social purpose that puts fire in the bellies of their executives and frontline staff alike," he says. "Only time will tell whether the big banks will combat that fire with fire of their own. Creating a ‘bank within a bank’ - a new challenger brand free from legacy conduct, technology and culture - might be the best start.”