UK’s Challenger Banks Face Fresh Headwinds

Chief executives of some of the UK’s challenger banks have issued a fresh warning of headwinds facing the nascent sector. In the past few weeks, the bosses of several lenders have sounded the alarm about the rapid growth of consumer credit, a slowdown in the housing sector and capital issues weighing on fledgling banks.

From supermarket lenders such as Tesco Bank to high street names including Virgin Money, TSB and Metro, these companies are vying for a slice of the retail banking market, but admit they are coming under pressure in several areas, news outlets reported.

The market is becoming crowded, and some lenders are taking higher risks for lower returns. Jayne-Anne Gadhia, chief executive of Virgin Money, recently warned in the bank’s interim results of “areas of weakness to be navigated” in the UK housing market in the near-term. Shares in the bank dropped 8% on the day, as a result of the housing forecast and the bank’s weaker than expected capital reserves, analysts said.

The share price has since rebounded to near 300 points. Over the longer term, Gadhia expected “a strong mortgage market”. But profit margins are being squeezed for challenger banks in this space.

Mortgage rates have come down, partly as a result of new lenders entering the sector and because of the Bank of England’s term funding scheme, which has provided cheap funding to stimulate lending.

On the flipside, smaller lenders that do not have current accounts or the same brand traction as larger high street rivals are having to pay more to attract customer deposits. These two factors are weighing heavily on newer lenders in particular, FT reported.

Capital is another issue for these competitors. “One issue for some challenger banks is that as they grow, the consumption of capital seems to be bigger than people were expecting,” says Andrew Lowe, an analyst at Berenberg.

Metro Bank announced a share placement two weeks ago to raise an extra £278 million ($362.7 million) in capital. It came as the lender revealed a 7.5 percentage point drop in its capital reserves—or common equity tier one—from a year ago, as a result of its purchase of a £600 million book of mortgages in the spring.

In addition to capital and funding pressures, lenders are coming under scrutiny from the Bank of England’s recent focus on the rapid rise of consumer credit.