What are challenger banks?

They regularly top the savings charts and tend to have a reputation for offering great service too – but what is a challenger bank, and can they be trusted as an alternative to the established banking giants?

What defines a challenger bank?

Challenger banks can be defined as smaller retail banks set up with the intention of competing for business with the “big four” banking giants – specifically Barclays, NatWest Group (which includes NatWest, RBS and Ulster Bank), HSBC and Lloyds Banking Group (including Lloyds, Halifax and Bank of Scotland).

Most have been formed since the 2008 financial crisis, and the majority far more recently than that. Yet challenger banks are still authorised by the Prudential Regulation Authority, and this means they are also covered by the Financial Services Compensation Scheme (FSCS).

They’re commonly thought of as being the new wave of branchless, digital-only banks, but there are other types of challengers too, some of whom have been around for a while and others that are more recent additions to the market. These include:

• Challenger banks with a high street presence, such as TSB and Metro Bank.
• Shari'ah banks, including Bank of London and The Middle East (BLME), Al Rayan and Gatehouse Bank.
• Challenger banks focused on commercial lending, such as Shawbrook Bank, Aldermore and One Savings Bank.
• And the digital challenger banks, such as Atom Bank, Monzo and Starling Bank.

What types of challenger bank are there?

Mature challenger banks

While the term ‘challenger bank’ typically denotes a provider that’s new to the market, there are a number that have been established for several years.

New challenger banks

These are the newer entrants to the sector. They offer a fresh, new approach to providing banking services and often utilise the latest technological innovations – and they can be a force to be reckoned with. As is often the case with challenger banks in general, these are typically the places offering the most attractive deals and best savings rates.

Banks in this category include names such as Monzo Bank, Tandem Bank and Starling Bank.

Digital challenger banks

Digital challenger banks definitely fall under the “new” category. They embrace new financial technologies as a way of improving service to their customers and have no physical high street presence at all, instead relying on phone, app and online banking. This allows them to avoid the high costs of maintaining a branch network and makes them ideal for customers who prefer to bank in this manner.

However, some still offer ways for people to pay in money at a counter (through partnerships with other banks or the Post Office, for example).

High street challenger banks

Although digital banks tend to grab the headlines, there are a lot of challenger banks that compete on the high street as well. Some, such a Metro Bank, are more recent additions to the UK market, while others – like TSB – are offshoots of larger banks.

Shari’ah challenger banks

Of the core categories, it’s fair to say that encounter the most confusion and lack of understanding from consumers in general. Very basically, Shari’ah banks are run in accordance with Islamic finance principles. This covers two elements: ethical banking and the offering of an expected profit rate rather than interest. 

What is the difference between a challenger bank and traditional bank?

The main differences are in terms of service and functionality. Because many modern challengers operate solely in the digital space, they typically offer more features than their mainstream counterparts, such as budgeting tools and real-time spending notifications.

This also means that customers can bank at any time, rather than needing to go into branches, offering another level of convenience and flexibility. They’re known for offering better customer service and regularly top the savings charts too, and there’s often a big difference in terms of branding as well.

Yet not all of them offer the same financial products as more traditional banks. Some specialise in only one or two areas – current accounts and savings, for example – meaning those who want a full-service bank may need to look elsewhere.

Why did challenger banks come about?

The UK financial regulators encouraged more competition in the UK banking sector following the financial crash in 2008. Their aim was to reduce the hold the biggest UK banks had on the market, estimated to be as high as 87% of all current accounts in 2017.

Metro Bank was one of the first challenger banks and had its banking licence approved in 2010. Since then, numerous other new banks have been awarded licences, including Aldermore and Paragon Bank.

Will I get a better interest rate with a challenger bank?

While interest rates are rarely static for long, it is often the case that challenger banks can offer better savings rates than their high street counterparts. This is because their lack of physical presence on the high street, combined with more streamlined operations and reduced legacy issues, means they have lower running costs, and they can pass those savings on to the consumer.

Not only that, but challenger banks need customer deposits to build their balance sheets, which is another reason why they are usually willing to offer better rates than the more established brands.

How safe are challenger banks?

Challenger banks are required to be fully regulated and authorised by the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA), and are covered by the Financial Services Compensation Scheme (FSCS). As such, they offer the same financial protections as any other bank, making them as safe for your money as anywhere else.