The DNA of digital challenger banks

A global phenomenon

Customer preferences are evolving to a digital-first mindset, and customer expectations are anchored on seamless, real-time, integrated, and personalized experiences. The financial services industry is not immune to these headwinds, and a new wave of competitors is emerging. Digitally native “challenger banks” are unpacking the banking value chain and redefining the boundaries of the industry. These new competitors are growing rapidly and are stealing market share from incumbent banks.

The "challenger banks” are branchless, digital-native banks that intend to compete head-on with incumbents. While they start with a simple product offering, their long-term ambition is often centered on a more complete suite of financial products and services. The need for significant R&D spend means that these challenger banks often emphasize growth over profitability in their early years and rely heavily on external funding to support their growth ambitions.

Deloitte has analyzed more than 100 challenger banks globally and while each value proposition is not quite the same, we have identified a set of fundamental characteristics that make up their DNA, enabling them to successfully disrupt the banking status quo around the globe.

The disruptive DNA

To understand the long-term disruption these digital challengers are likely to drive in the United States, we must understand what has made them so successfully disruptive.

Customers: Challenger banks’ value propositions place the customer at their core and tend to target a specific customer segment—digitally native, unsatisfied, underbanked, or unbanked, and often with simple banking needs.

Product and channel: Challengers have developed a product offering and channel experience that targets the points of the value chain where incumbents’ weaknesses are most exposed and often not easy to fix.

Growth cycles: Challengers tend to follow a recurring growth cycle. Starting with an initial value proposition, challengers gradually expand their customer portfolio as they reach new segments and gain a stronger reputation.

Brand and marketing: Challengers implement high-virality marketing strategies to build customer relationships and brand equity through a wide mix of non-traditional marketing channels.

Platforms and partnerships: Enabled by a new generation of APIs, new entrants no longer need the time and capital to build banking services and products in-house.

Culture and talent: As the banking marketplace shifts toward a more technology-centric environment, the race for top talent becomes increasingly competitive. Incumbent banks now must compete against the startup growth culture of challenger banks.

Why the United States, and why now?

US retail customer expectations are evolving at an unprecedented pace. Through this evolution of needs, customer preferences in banking are now more diverse than ever before. Overall, consumer preferences are shifting toward digital, with a declining importance of access to bank branches. And this trend has further accelerated with the emergence of COVID-19:

• Use of mobile banking apps reached 72% of customers at the four largest US banks in April 2020, up nearly 10 percentage points from 2019.
• Mobile check deposits have soared. In March, the dollar volume for mobile check deposit was up 50% over the month before. The number of checks deposited through a smartphone rose 40%.
• Six percent of new banking customers indicated they were using mobile banking for the first time; 4% said the same of online banking.
• Thirty-five percent of customers have increased their online banking usage during COVID-19, with a significant share of growth coming from digital immigrants such as Boomers.

It remains to be seen how profitable challenger banks will become and which challengers will last in the long run. The oversaturation and rapid growth of challengers could cause sustainability issues and drive a variety of exit and accelerated profitability strategies. However, what is already proven is that challenger banks are causing major disruption across the banking value chain. Thus, at a minimum, incumbent US banks must look at ways of evolving their own DNA in the context of this new potential threat to future-proof their business.

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