Part Two: How challenger banks can lead a fair economic recovery from COVID-19

Welcome to our series exploring how challenger banks can lead a fair economic recovery from COVID-19.

In Part One, Josh Gavzey argued that by focusing on support for hard-hit SMEs, challenger banks can support the recovery and deepen their ties with a key segment of the market. This week, Oliver Maskell looks at how challenger banks can earn the trust of new customers, broadening access to their services and boosting their market share.

Increasing trust with a broader demographic

Digital banks continue to acquire both customers and column inches, yet most remain unprofitable. In the UK, it took until 2020 for a digital-only challenger bank, Starling Bank, to become profitable1. One significant barrier digital banks face is trust, an area where legacy organisations, for all their scandals, retain an advantage. Increasing trust with customers can help digital banks to become profitable – its broadens access to their services to a wider demographic and ensures customers are treated fairly through increased competition. ​

The trust issue

Firstly, let’s explore the issue of trust and digital banks. Trust in banking is multifaceted; customers are loyal to existing legacy banks, and trust them with higher-margin activities such as mortgages and commercial lending, and are simultaneously sceptical of digital banks, either believing they will not survive long-term2, or not trusting them for more significant services. Added to this, some customers have not heard of digital banks. These attitudes are visible in customer behaviours. For example, many customers who use a digital bank, also use another, often legacy bank3, for other services. Even more concerning for digital banks, many people simple stick with the bank they have always used, often since childhood, because they do not believe it to be beneficial to switch, despite attempts to make the process easier.​

All of this has a knock-on effect on profitability, access and fairness. Because legacy banks take a larger proportion of high-margin activity, such as mortgages and commercial lending, their revenue per customer is significantly higher4. Whereas digital banks rely mostly on smaller transactions which do not generate much revenue. Furthermore, the fact customers are loyal to their existing banks means they may not be receiving the best service and are not being treated as fairly as they could be, as banks do not have an incentive to improve their offering. 

We can therefore see that unlocking the trust of customers would give digital banks a number of advantages. But how can they do this?​

How challenger banks can earn the trust of customers

We believe there are two key ways digital banks can improve their trust rating. It is clear their future success depends, in part, on attracting customers to higher-margin services. To do this they should focus on an area of the market that is less cornered by the legacy competition, such as small business lending. By proving themselves with customers in an area like this, they can demonstrate that they are a safe, long-term bet and encourage customers to change their behaviours and bring additional higher-margin business their way. ​

Secondly, they should redefine their value proposition in order to attract a broader customer base. To date, digital banks have primarily focused on younger, more urban customers, drawing them in with slick apps and promises of an exceptional digital experience. This offering, however, will only reach so many people. By switching their emphasis from digital experience to universal access, quality products and services, and responsive customer service, they can target other types of customers. Doing so will help demonstrate that digital banks exist, that they have customers’ interests at heart and are here for the long-term, and they can offer customers the service best for them. This helps boost business for the digital bank, and increases access for the customer, boosting fairness by handing them the freedom to select the best right for them.​

Final thought

The two points discussed above are interlinked. By acquiring a broader section of customers for services and products where they have strength, they can then use some of the trust capital built up to provide a greater range of services to these customers, therefore increasing the likelihood of profitability and ensuring customers are treated fairly through choice and competition.

Look out for Part Three next week, where the series will conclude by investigating how challenger banks can offer customers greater access to financial services, particularly to those impacted by branch closures.

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Oliver Maskell Senior Consultant