There has never been a better time to launch a bank in Australia.
After a lengthy government enquiry last year uncovered high-pressure sales tactics and flagrant misconduct by many in the industry, the country’s incumbent commercial banks are scrambling to rebuild their reputations.
Much of the evidence tabled at the Royal Commission related to the four biggest banks – ANZ, Commonwealth Bank of Australia, National Australia Bank and Westpac – who were shown to have used their size and distribution power to stifle competition. Customers complained bitterly about being charged high fees for average service, or in some cases, no service.
For a long time weary account-holders have had few banking alternatives. But two new digital banks are now set to change all that because for the first time in 28 years the Australian Prudential Regulation Authority (APRA) has issued new deposit-taking licenses.
The new players on the scene are Volt Bank and Xinja Bank.
The timing couldn’t be better for Eric Wilson, chief executive officer at Xinja, who said the Royal Commission into the financial services industry had highlighted the disconnect between how the big banks conducted their business and what customers wanted.
Wilson knows what it is like to be on the other side. He worked for National Australia Bank where he ran its trustee business before resigning in 2015. “I no longer felt comfortable being in an industry that was purely focused on profit,” he said in an interview with FinanceAsia. “I liked banking but I could not understand why we had to sell products to customers that weren’t in their best interests.”
Wilson added that didn’t realise how much people hated banks until he stopped working for one.
Volt is also run by former bankers. Steve Weston and Luke Bunbury worked together at St George Bank (part of Westpac) and Challenger Financial Services, where they built a mortgage business in the mid-2000s.
Their careers diverged after the global financial crisis: Bunbury moved into the startup space, while Weston went to London to work for Barclays.
“When I returned to Australia in 2016 I ran into Luke again and we started to talk about our thoughts on the changing banking landscape and the upcoming opportunities for digital banks,” Weston said.
Then in May 2017, APRA announced its plans to establish a new licensing structure. “Luke and I were immediately on the phone to each other,” Weston continued. “We ran a six-week feasibility study before deciding to apply for a banking licence, which we did in October 2017.”
Both Volt and Xinja expect Australia’s mobile-only banking market to evolve along a similar trajectory to the UK, where new entrants like Monzo, Starling and Revolut have been busily winning market share. Since it was founded in 2015, Monzo has built a customer base of 1.2 million people and in December toppled First Direct as Britain’s best-rated lender.
Monzo’s founding director, Jason Bates, is a friend of Wilson’s and also sits on Xinja’s board.
“Jason has been very helpful in guiding our strategy and we have unashamedly borrowed many of Monzo’s ideas such as its prepaid debit card,” Wilson told FinanceAsia. “We already have 10,000 customers on this beta product.”
Both the new banks have to date largely been funded by high-net-worth individuals and family offices. Xinja also ran two crowd-funding campaigns in March 2018 and February this year, netting the bank around A$5 million ($3.6 million).
“The campaigns are less about raising money and more about giving our customers a chance to own shares in the company,” Wilson said. “When we launched the second crowd funding earlier this year we passed our minimum target amount within four hours and reached A$1 million in four days.”
Wilson and Weston said early conversations with venture capital funds have not been fruitful due to a mismatch in investment time horizons and the complexity of the regulatory framework governing the banks.
“The Australian VC market is still finding its feet and isn’t deep enough or sophisticated enough for us,” Weston said, adding that he expects Volt’s next round of funding to include institutional and strategic investors.
In telling their story to investors, the banks have been talking up their digital platforms, which allow them to personalise functions, display data clearly, and streamline application processes.
The idea is to use technology to give customers an overview of their cash situation, arm them with information about the best rates and nudge them into managing their finances more efficiently.
“We want people to be free of debt as soon as possible, which is contrary to how banks have operated in Australia,” Wilson said. “We know this means making less profit on each product but by being focused on doing the right thing by customers, we expect they will come back to us for other products and tell their friends about us.”
Xinja has been running co-design sessions with customers, asking them to play with early prototypes and contribute ideas to how the platform should function. “When we invite people to attend these sessions we say we need a panel of 10 and we sometimes have 200 people applying,” Wilson said.
Xinja’s beta product is an app-based spend-and-pay card that allows users to monitor their spending patterns and can be used overseas without additional fees. The bank’s plan is to launch a full suite of retail banking products by early next year.
Volt tested its technology by piloting an institutional term deposit product offered to companies and other banks. By late April it expects to launch a savings account for retail customers, followed by transaction accounts and retail term deposits, then personal and home loans. Next year it plans to tackle business banking.
The new banks are targeting millennials – people, broadly, born between 1981 and 1997 – who grew up with technology and are fanatical about speed.
“Older generations may often complain about the service they receive from the big banks but they don’t do anything about it,” said Weston, who believes millennials are more open to shopping around.
“We are going to take the pain out of switching banks by using technology to transfer payee details and direct debits instantly,” he said. “We expect news about our better rates will go viral and customers will find us. We won’t be spending money on expensive marketing or advertising campaigns.”
As their product sets expand, these so-called neobanks will encounter some competition from mobile-only players in particular products, such as home loans.
In March this year, a new specialist digital mortgage provider called Athena will make its official launch. The company has been in pilot mode for the past 18 months and operates under the Australian Securities and Investments Commission’s framework for non-bank lenders.
Like the neobanks, Athena is working on the premise of improving transparency and offering flexible loans that can be paid off quickly.
“Home loans in Australia need a shakeup,” said Athena co-founder and chief executive Nathan Walsh in an interview with FinanceAsia. “Australian households are taking 10 years longer to pay off their home loans than they did a generation ago. Nearly all Australians want to pay off their home loans faster but only about 20% think their lender wants them to succeed.”
Walsh is equally dismayed and delighted by the fact that the big banks still control 95% of the home loan market. “The Royal Commission shone a bright light on a broken financial system and our research tells us over 40% of big bank customers are now considering switching home loan providers,” he said, adding Athena will aim to offer lower rates than the incumbents.
Athena’s plan is to start by refinancing existing loans for customers and move to writing new purchase loans from the mid-2019.
To be successful as a financial services startup requires a special combination of banking expertise and technological know-how. Paul Bassat, co-founder of venture fund Square Peg Capital – an Athena investor and board member – said finding entrepreneurs that have both these skillsets and can run a startup is rare.
“We see a lot of startup founders who are fiercely creative and very good at executing a business plan but don’t always have experience in the area that they operate in. Banking is different; it is a hard industry to disrupt and requires an intimate knowledge of how the sector works. You also need a mindset for innovation and a willingness to embrace risk,” Bassat told FinanceAsia.
Square Peg has other Australian fintech investments including small business loans provider Prospa, payments firm Airwallex and commodity management platform AgriDigital, highlighting its multi-pronged approach. It also thinks the mortgage market in Australia is ripe for disruption by startups that can acquire customers using digital channels rather than middlemen.
He said one of the factors that drew Square Peg to Athena was the company’s decision not to rely on mortgage brokers to generate business. “The mortgage broking system is expensive and replete with conflicts.”
And while there are other non-bank lenders in the market, none operate as a digital only business, according to Bassat, who is banking on Athena’s ability to make “the process of applying for a loan much simpler and faster.”
Another factor that makes financial services unique as a sector – and a challenge for startups – is the need for leverage and access to capital.
Traditional commercial banks build scale and grow large by taking advantage of a cheap and robust funding mix. In Australia, in particular, the big four banks have used their enormous loan portfolios and AAA credit ratings to borrow extensively via offshore bond markets. This allows them to lend more.
Traditional banks also keep their cost of funding low by amassing large numbers of depositors. For the neobanks to attract deposit holders away from the incumbents, they will have to offer higher interest rates, and this will eat into profitability.
Weston agrees Volt’s cost of funding won’t be as low as the big banks. “Our advantage is on the operating side of the ledger where we can keep costs down because we don’t employ thousands of people in branches all over the country and we don’t have expensive legacy systems to maintain."
As yet, Volt and Xinja are unrated, though Weston says he has been in discussions with the rating agencies. And both have plans to use securitisation of loans as a funding mechanism.
Walsh at Athena has another funding idea up his sleeve. “It is too early for us to reveal full details of the model but it broadly involves bypassing the banks and connecting borrowers directly to the superannuation system,” he said, referring to Australia’s A$2.8 trillion in retirement savings.
“The super funds already invest about A$500 billion a year in bank securities, which predominantly flows to mortgages,” Walsh said. “Direct investment models in markets like the Netherlands have achieved significant scale, and we believe Australia can do the same.”
He is confident Athena can make money by being efficient. “Our profitability will come from cutting the costs of running a mortgage business by 70%. Our digital platform simplifies the mortgage value chain and removes the complexity of traditional paper-based operations,” Walsh said.
The challenge for the neo-banks will be to build sufficient scale and to continue to find new customers as others pay off their loans quickly. And whether they can keep their cost of funding sufficiently low to justify the capital requirements of operating as a fully licensed bank.