David v Goliath: Challenger Banks raise record levels of investment

Investors have committed $6bn to Challenger Banks since the beginning of 2014, according to research from FinTech Global

Helping customers manage their wealth has become a major target area for FinTech disrupters. For decades, complacency and neglect have been the main elements of the modus operandi for many banking providers. This, along with the antiquated approaches of many wealth and asset managers, has invited innovators to create better versions of wealth/asset management, private banking and digital banking products and services.

It comes as no surprise, then, that the latest figures on investment in the WealthTech sector continue to show sustained growth. In particular, it’s interesting to see the huge growth in investment in the challenger bank category, which FinTech Global includes as a subsector of WealthTech, since all challenger banks are looking ultimately to sell savings and investment products to their customers (what would be the point of acquiring accounts otherwise?).

Challenger banks raised $6bn since 2014, a quarter of which was raised in Q1 this year.

Since the beginning of 2014, $16.9bn was raised by WealthTech companies in over 1,300 transactions. Of this total amount, $6bn was invested in 219 deals in challenger banks, as shown in Figure 1.

Investment growth in challenger banks has been dramatic. The first quarter of this year saw over $1.5bn in aggregate investments, which is equivalent to around 78% of the figure for the whole of 2018 — and ten times the figure for the whole of 2014. As the number of transactions in Q1 2019 is almost the same as in Q1-Q4 2014, the average transactions size has clearly grown ten-fold as well.

The first phase of challenger banks were reported to be focused on acquiring millennial accounts, either in the belief these customers could in future be cross-sold, or with the intention of selling these accounts to laggard major banks that have underserved this segment. Since then, more sophisticated strategies have evolved.

OakNorth, for example, focuses on serving small and medium-sized business and reached profitably less than three years after launch. The bank raised $440m in February 2019, in an investment round led by SoftBank Vision Fund, at a $2.4bn valuation. It’s rapid rise to unicorn status is based on its innovative business strategy and advanced technology capabilities in a market where most other banks offer a big dose of bureaucracy and contempt (ask any small business owner how happy they are with the business banking services they get from their bank!).

The picture is not quite so rosy for every player. RBS is now embarking on its third attempt at retail digital banking: it gave up on using the old Williams & Glyn name (which was originally created in 1970) as the brand for a new challenger bank; it then invested in Loot, a banking app focused on students and young people, which went into administration earlier this year; and now they will try again under the brand name Bo.

Over 300 different investors have backed challenger banks since 2014

The attractiveness of challenger banks has caught the attention of a wide range of investors. Over 300 different investors have participated in the 219 deals since the beginning of Q1 2014. The 10 most active investors have completed 57 transactions between them as shown in Figure 2.

London-based venture firm Passion Capital has been the most active investor in challenger banks over the past five years, having completed 10 deals. Its largest commitment was in the $108m Series E round in Q4 2018 undertaken by Monzo, which propelled the bank to unicorn status.

In the US, Ribbit Capital has been the most active investor in the space, having been involved in six deals since 2014, including Revolut’s $250m Series C round in Q2 2018, which was led by DST Global.

Challenger Banks dominate the top 10 WealthTech deals in Q1 2019

Seven of the top ten investment deals in the WealthTech sector in the first quarter of this year involved challenger banks, as shown in Figure 3.

Almost $1.7bn was invested in the ten largest WealthTech deals globally last quarter, with challenger banks raising over $1.4bn of this total.

N26, head-quartered in Berlin, was the second largest deal of the quarter, raising $300m in January to expand its global operations and achieve its target of acquiring 100 million customers worldwide. This investment, led by Insight Venture Partners, valued the challenger bank at $2.7bn.

A major boost was given to a number of UK-based players as state-owned Royal Bank of Scotland was forced by regulators (as a somewhat belated condition of the government bailout in 2008) to distribute money from its Capability and Innovation Fund to three challenger banks: Metro Bank, ClearBank and Starling Bank. In addition Starling Bank raised $97m in a Series C round from Merian Global Investors and QuanRes in February 2019.

Having engaged with hundreds of FinTech investors in the WealthTech space and hundreds of major financial institutions, the FinTech Global research team expects the growth in investments in third-party challenger banks to continue over the next year with billions more to be allocated to in-house digital banking initiatives. We expect David will continue to outwit Goliath for a while longer.

Originally published at https://www.linkedin.com.