Cambridge history student Theo Innes explains the challenges facing digital banks in the UK and why a transatlantic move might seem appealing
In recent years, Britain has been an international leader in fintech innovation, second only in total investment to the US. The sector has grown remarkably thanks to a combination of startup-friendly regulation and a wealth of talent. However, this development seems to be slowing down. Companies are increasingly responding by looking to America as a destination for possible expansion and public listings.
Fintech stands for financial technology. This covers everything from digital banking to crypto, but in this article I use the term as synonymous with companies that offer specifically digital banking and digital tools. For example, entities such as Revolut, who offer fully comprehensive digital banking and crypto services.
In what follows, I explain the liberal regulatory framework that facilitated such fintech growth, why it is now standing in the way of greater growth, and the complex rules companies will need to navigate if they are to set their hopes on the US market.
How Britain succeeded in fintech
The 2008 financial crisis brought the banking industry to the brink of collapse. Risky lending practices forced a series of large public bailouts of failing entities, sparking a significant anti-banking wave in public sentiment. Politicians sought to separate themselves from the industry and introduced a series of stringent regulations to attempt to prevent future crises.
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Faith was put in the idea of competition. Breaking up the ‘quadropoly’ of HSBC, Lloyds, NatWest, and Barclays was seen as a key method of introducing good industry practices. If banks were no longer ‘too big to fail’ they would be less inclined to engage in risky behaviour, or so the theory went.
The Bank of England, through its Prudential Regulation Authority (PRA) sought to introduce greater competition by fast-tracking development of ‘challenger banks’. As evidence of this, 40 new banking licences have been issued to startup banks since 2013. Companies like Monzo and Revolut were supported to disrupt the traditional industry with their fashion-forward cards, fee-free foreign exchange, and slick software.
Alongside easier access to banking licences, the Financial Conduct Authority (FCA) supported these upstarts through their ‘sandbox’ system. This allowed banks to test their products on a limited number of customers to check for regulatory or safety issues. Innovation was therefore encouraged, and much easier to test than in other regions.
Supporting the development of new banks and the proliferation of new technologies has been remarkably successful. British fintech firms dominate lists of European startups. 7 of the top 20 fastest growing finance companies in Europe are based in the UK.
Why growth is now faltering
A fairytale story of British banking is unrealistic. The end to ultra-low interest rates, a dearth of IPOs in the UK, and regulatory hurdles have undermined the sector’s prospects of growth continuing at the same rate.
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Though the UK has regulations that are very useful to fledgling entities, mid-size banks have a much tougher time. As an example, the Bank of England maintains strict ‘external minimum requirements for own funds and eligible liabilities’ (MRELs) rules. These are rules dictating that banks hold a certain level of liquidity or specific types of debt that can be used to bail themselves out in the event of crises. Initially focused on members of that quadropoly, they also apply to medium-sized banks. This represents a not insignificant hurdle for banks seeking to grow from small challengers to established mid-sized institutions. A number of other regulations apply to banks seeking to grow, such as rules around ringfencing assets.
Though Chancellor Rachel Reeves has pushed for a reduction in regulation and has specifically supported fintech firms — such as pushing for Revolut to be given a lending license in the UK — this campaign has thus far been unsuccessful.
Regulatory speedbumps make an already challenging development harder. It is difficult to become an established bank — people often hold accounts with alternative providers like Monzo, but few use it as their main bank. They are often used instead for the fun features like fee-free holidays, budgeting tools, or one-time-use cards.
This is not to say there are no prospects for fintech organisations. Allica Bank, for example, is a challenger bank that focuses on lending specifically to Small to Medium Enterprises (SMEs). This market has been largely ignored by traditional players due to restrictions from post-2008 regulations. This method has proved successful, with them being named the fastest-growing startup in Europe.
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The upshot of all of this is that it is easy to become a bank in the UK, but difficult to grow into an established player. For firms with valuations often based on large projected growth, pressure to continue their meteoric rise is clearly significant.
The attraction of the US
For those seeking greater growth, expansion into the US makes sense. Not only are there more potential customers than in the UK but the industry is also ripe with opportunity. It is not oversaturated by challenger banks and there is scope to improve current offerings which are often full of fees.
More significant, though, is that US banking is more lucrative. JPMorgan’s personal banking arm Chase returned 36% on equity. This is a remarkably high. For reference Monzo in the UK made only £60.5 million in profit off a revenue of £1.2 billion, or roughly 5%. It is difficult to estimate the returns Monzo made from just personal banking, but it is clear the margins are lower.
The opportunity US markets present is not just short term. As several companies debate going public, US listings are attractive. Higher liquidity in US markets generally leads to larger valuations.
Legal problems facing American hopes
As Akila Quinio in the Financial Times notes, the clear problem with expansion into the US is getting licensed. Monzo abandoned an initial attempt to get regulated in the US in 2021 after prospects to get licenses looked bleak. It is quite easy to see why. The US operates a complex system of state and federal laws, with licenses often taking several years to be approved. No fewer than six separate regulators exist on just a federal level for ‘Depository Institutions’ alone.
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To become licensed, prospective banks have to receive either a federal or state charter. These are given either directly by the Office of the Comptroller of the Currency, or any state regulator. They then must be approved by the Federal Deposit Insurance Corporation, the national insurer in the case of bank failings, similar to the British FSCS scheme.
Instead of going through this process, British banks seem to be gearing up to just buy their way in. By partnering or purchasing an existing bank, firms can leverage existing licenses to expand into the market easier. OakNorth, another British fintech, has taken this route, purchasing Michigan-based Community Unity Bank in March this year. Revolut is seemingly following suit, raising funds earlier this year for the purposes of US expansion.
Though the Fed has previously looked none-too-kindly on risky fintech banks trying to skirt regulations through partnerships with established banks, the current climate in the US seems conducive to expansion. Donald Trump has continually signalled he shares Reeves’ appetite for regulation elimination. His pick for Vice-Chair for Supervision at the Fed, Michelle Bowman mentioned at a conference earlier this year ‘we must encourage ongoing innovation in the banking and financial systems’. Innovative foreign neobanks may fit with this goal.
Takeaways
Regulatory frameworks enabled the creation of British fintech but are now pushing them into other markets. Expansion to the US offers companies more customers and greater margins. Regulatory hurdles are significant and have proved difficult to clear in the past. However, the deregulatory pressure in the US, combined with larger and better-financed British firms could make this the opportune time for entities like Monzo and Revolut to make the jump.
Irrespective of the outcome, attempted cross-border expansion will create significant work commercial lawyers. Firms with large footprints in both jurisdictions will be essential to meeting regulatory and compliance standards.
Theo Innes is in his second year reading history at the University of Cambridge. He is interested in urban design, cross country, and runs a substack (@theoinnes).