Challenger Banks vs. Traditional Banks: Reimagining the Race to the Top

Challenger banks, or neobanks as they’re commonly referred to in the U.S., are banks that operate exclusively online without traditional physical branch locations.  Until recently, U.S. consumers have been reluctant to fully rely on challenger banks, as they still perceived the cost of switching to be high, and coupled with a ‘flight to safety’ amid economic turbulence, many have been hesitant to move all of their financial matters to these new, digital banks.

However, the convenience of a digitally native, seamless customer experience means that challenger banks’ cards are finding their way into more digital wallets. A recent study conducted by Morning Consult on behalf of the American Bankers Association (ABA) reported, nearly three-quarters (72%) of those surveyed turned to mobile devices to conduct banking transactions in the prior month and 48 percent of those surveyed said they had done so frequently. Additionally a recent study by Lightico found that 63 percent of U.S. consumers said they were more inclined to try a new digital app for banking than they were prior to the pandemic.

Card offerings from challenger banks are increasingly being used for day-to-day purchasing, as tech-savvy consumers recognize the advantages that up-and-coming fintechs can offer. And their numbers are growing. According to recent data from Insider Intelligence, neobanks like Chime and Varo are projected to grow by nearly 19 million U.S. account holders between 2021 and 2025, and by the end of 2025, close to 40 million U.S. adults will hold accounts at these types of digital-only banks.

Many new challenger banks have the distinct advantage of not being tied to legacy systems, and as such have the ability to run more agile, mostly cloud-based operations. They also have the advantage of a blank slate when it comes to building reputations for customer service, without the added burden of staffing and maintaining physical branch networks. As such, it’s unsurprising that digital banking has seen more uptake during the pandemic, resulting in increased market share for challenger banks.

It’s understandable that traditional banks are feeling threatened by the emergence of neobanks, and many are trying to understand both the nature of the challenge, as well as how they can best respond to it. With the disruption now faced by the whole industry, banks face a once-in-a-generation opportunity to truly engage with customers and find unique ways to add value and differentiate themselves. The challenge for traditional banks will be to ensure their payment cards hold the top spot in consumer wallets, helping them to fend off competitors while increasing transaction volume. To do this, they will need to rethink customer engagement, with targeted programs responding to consumer demands for simplicity, transparency and value.

Driving Customers to Digital Channels
Even prior to the pandemic, financial service providers had been focused on reducing costs  – as evidenced by the closure of bank branches, reduction in staff numbers and the implementation of new efficiency-focused technology. Increased use of digital channels, from websites to apps and even social media, can help further as they reduce the need for physical branches and call-centers. Yet for traditional banks, this can be difficult to implement, as digital experiences must be rolled out in the context of an existing infrastructure.

Digital-native banks, on the other hand, have never had to deal with physical branches – this means that their digital capabilities are integrated across the board, making for a more consistent and intuitive customer experience. Traditional banks can take cues from what fintechs are doing in terms of which experiences are more popular with consumers, before committing to transformation projects – but in any case, the goal should be to drive customers towards the most frictionless (frequently digital) channels, to future-proof their business.

Using Data and Rewards to Drive Engagement
Digital transformation also allows financial services brands to be more interactive with their customers, facilitating better engagement – however, this requires unique customer data to better understand their behavior and anticipate their needs, a challenge that can often be made more complex by data privacy regulations restricting the level of granular insight that a bank can gain.

As payment transactions are often the most frequent interaction a customer has with their bank, payment-linked rewards are an effective way to obtain this valuable data; it incentivizes the customer to use a particular payment card more often; ideally exclusively. It also presents an opportunity to engage customers with marketing communications and personalized rewards matching their preferences and spending patterns. Not only do these rewards raise perceived switching costs, as the customer would be sacrificing an opportunity by not continuing to use the card to earn further rewards or gain prestige, they also enable credit card issuers to earn more through the increase in transactions.

Financial services brands can then pull this data together to help create highly targeted, relevant and personalized offers and discounts to their customers and can then push these offers out directly through highly-visible digital channels for maximum engagement.
Mark Roper is the Global Market Development Director of Collinson Valuedynamx.

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