Challenger banks are having challenges on their path to profitability

There has been no shortage of challenger banks competing for the customer’s attention in the past decade. However, it is far between the ones that manage to turn a profit. As capital becomes more scarce, and valuations are declining, challenger banks with no clear business models other than nifty features and a niche target audience, are facing a bumpy road ahead.

Since the rise of challenger banks began a decade ago, the number of challenger banks has grown rapidly, and also their ability to attract users, with more than 1 billion user accounts around the world. After a peak year of funding in 2021, the total valuation for the challenger bank segment is estimated to be more than $300 billion.

Challenger banks have played a crucial role in setting the agenda for banking innovations in the past decade. Spearheading mobile-first user experiences experience, open banking, personalization, and increased customer centricity, challenger banks acted as a catalyst for change in the industry. However, the perceived success of challenger banks is only on the surface.

I have previously covered the disconnect between challenger bank valuations and their profit potential (or lack thereof).

According to research by analysts, Simon-Kucher, only 5 percent of challenger banks are able to turn a profit, while the majority of challenger banks earn less than $30 USD in annual revenues per customer. Out of the 25 biggest challenger banks, only two of them were able to reach profitability.

The research also discovered that in the US, less than “a handful” of the country’s leading 85 neo-banks have reached a breakeven point, and several are losing as much as $140 per customer annually.

Alongside the growth of the sector, competition has also increased, making it harder to stand out as new entrants in the market. Not only have incumbents invested in their digital offerings, but as many as one in three challenger banks are digital subsidiaries launched by incumbents in the financial services industry. Thus are able to combine deep industry knowledge, lower cost of capital for lending, as well as piggybacking on established brands in the market.

As growth has been the primary metric for success, many challenger banks have rapidly expanded in new geographies and have been obsessed with opening as many accounts as possible without thinking about how to make them profitable, while at the same time been operating with affiliate programs and customer onboarding benefits that might not be financially sustainable in the long run.

At this point, the research points to challenger banks shifting their focus from get reach towards get rich, a mindset shift that can be difficult to orchestrate for companies that have built their entire culture around user attraction and growth.

Without turning a profit, many challenger banks will struggle to survive, no matter how many clients they serve. Some may be consolidated by competitors or incumbents, but as the market for challenger banks is maturing, challenger banks need to realize that they are in fact banks, and without profit, they will not have the right to live and will ultimately dissolve.