Over the last few years we have seen a number of so-called “UK challenger banks” entering the UK mortgage market. These include the likes of Tesco Bank, Virgin, TSB and Metro all of whom wanted to shake up the UK banking sector and offer something different to consumers. The idea was that traditional banks had been tarred in light of the 2007/8 economic downturn and a new brand of lender was required. However, it seems that competition, increased consumer debt and a requirement for further capital reserves is hitting the sector.
A crowded sector
UK challenger banks have all reported an increase in competition in the mortgage market, reduced profit margins and difficulty in attracting customer deposit accounts. There are obviously two sides to the banking industry, the use of customer deposits to raise lending finance and direct mortgage finance raising exercises in the money markets. The fact that it is currently relatively inexpensive to borrow money on the money markets has seen a number of UK challenger banks slashing their headline mortgage rates in a race to the bottom.
This reduction in headline mortgage rates may look competitive on the surface but it is leading many lenders to take undue risks. We could have been writing this comment just prior to the 2007/8 sub-prime mortgage collapse in the US which led to the eventual demise of the worldwide economy. In this sector it became obvious that lenders were taking far too greater risks for minimal returns and eventually the tide did turn.
UK housing market
In times of buoyancy and increased demand for UK property there is generally more than enough business to go round. However, in the current environment an acute lack of affordable property has seen some house prices squeezed to levels which are “overvalued” but forcing buyers to bid because of a lack of alternatives. This means that on many occasions agreed mortgages have a greater level of risk for both lenders and borrowers.
Capital reserves for UK challenger banks
There has also been an issue with capital reserves for some of the so-called UK challenger banks with an unexpected requirement for increased capital reserves. This has seen the likes of Metro Bank recently tap the markets for £278 million in additional capital reserves with more fundraisings likely to follow. This particular issue was as a direct result of the £600 million purchase of a mortgage book which grows the business and levels of capital reserve required. So, on one hand we have excess competition reducing margins, while on the other, as businesses try to grow they require more capital reserves.
While there has been no talk so far, it does seem likely that some of the UK challenger banks will either withdraw from certain areas of the market or perhaps merge with their counterparts. The idea that smaller more nimble banking institutions would attract “the new financially savvy customers of today” appears to be fading. In the world of banking size does appear to be everything and the traditional lenders still have a stranglehold on the UK mortgage industry as well as general consumer credit.