In 2013, the UK financial regulator at the time – the Financial Services Authority (FSA) – published a paper seeking to reform the authorisation process for bank applicants; and create a major shift in the approach to the prudential regulation of banking start-ups. These changes were designed to reduce the barriers to entry and expansion and increase competition in the banking sector. A month after the paper was published, the FSA was replaced by new UK financial regulators – the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).
They understood that any successful market economy or sector needs to have the capacity for new entrants to be able to compete with existing incumbents – they bring fresh ideas, new business models, and innovation. They also understood that since Metro Bank had been granted its banking license in 2010, the first in the UK in 150 years, no others had been granted, so they were keen to change this. This started with Paragon in 2014, followed by OakNorth, Atom and Tandem in 2015, and since then, there have been almost three dozen new banking licenses granted in the UK to players such as Monzo, Starling, and Allica.
So, it’s fair to say the regulators have delivered on the first goal – reforming the authorisation process for bank applicants – but what about the second to create a major shift in prudential regulation of banking start-ups? I’m incredibly proud of the impact OakNorth Bank has had on the British economy in terms of job creation, home building, and GDP growth since 2015, but none of us new entrants have yet to scale enough to be considered significant competitors to the incumbents.
One factor that has prevented this has been regulation.
But what’s needed is not less regulation, but better regulation – I.e. regulation that is agile, proportionate, focussed, and risk-based. Regulation that ensures financial stability and consumer protection, whilst allowing growth, innovation, and competition to flourish.
Currently, the burden of regulation falls more heavily on challenger banks than it does on larger, systemic institutions. That is evidenced by higher capital and regulatory requirements per pound of risk exposure. These risk and reporting requirements don’t differ between small, new banks and global multinationals. With an ever-broadening scope of regulatory requests and requirements, it seems counterintuitive to competition to disregard size and status. What’s more is that at present, capital requirements penalise banks that only lend in the UK, which many scaling banks do as obtaining licenses in other markets is a time and resource-intensive process.
One of the recommendations from the Kalifa Review of UK FinTech published 18 months ago was that regulation needs to be “right sized according to the nature of the business in question and the specific risks it presents”. In other words, smaller, newer players in the banking sector like all those I’ve mentioned, shouldn’t have to adhere to the same regulatory reporting and capital requirements as large, systemic institutions.
In a post-Brexit environment, UK regulators must take advantage of the flexibility that comes from our exit from the EU. They need to regulate in a way that removes the barriers to growth and scaling, develops a more proportionate and risk based regulatory framework, and allows innovation and competition to flourish. This will benefit consumers and business with lower costs and better services without sacrificing financial stability or consumer protection. Recognising this, the PRA has proposed a new “Strong and Simple Framework”. This seeks to simplify the prudential framework for non-systemic domestic banks and building societies, while maintaining their resilience.
We’re supportive of the initiative but are waiting for the details of what this new regime will look like. I explained to the Treasury Sub-Committee on Financial Services Regulations when I was recently invited to give oral evidence to them on this subject, there are two key areas which need to be addressed in order for it to have real impact. The first is that we should remodel banking regulation and look at it through a systemic and non-systemic lens. At its core should be ensuring financial stability and consumer protection, but in a way that acknowledges risk and proportionality. Secondly, requirements for smaller non-systemic banks should be reviewed to ensure they are proportionate and risk sensitive. This should include capital, reporting, and compliance requirements, which are largely the same regardless of whether you are a local or global multinational bank.
I also argued that we should never see the banking sector as a zero-failure regime. This is not how a healthy and competitive market economy operates. To support this new approach, I suggested that the funding of the Financial Services Compensation Scheme (FSCS) should be reviewed. At present, our scheme is only funded to deal with very limited bank failures. It is not able to cope with failures from systemic banks which is why when they failed during the financial crisis, they had to be bailed out by the taxpayer through HMT. This model makes government and regulators more risk averse, seeking ever higher requirements to ensure they are not blamed for any kind of failure. Whilst no one is seeking bank failures, it should not be a taboo subject. We should look at a more robust and fuller funding model for the FSCS, funded by the banking sector with those who bear the most risk paying the highest contributions. That would give regulators and government confidence to make the necessary changes to the system for more proportionate and risk-based regulation to enable competition and economic growth.
With the UK on the brink of a recession, consumer finances squeezed, and businesses facing rising energy and rent costs, labour shortages, and ongoing supply chain issues, we need our neobanks more than ever. The changes I’ve outlined above will help neobanks scale and challenge the dominance of the big five, creating better outcomes for consumers and businesses.
Nick Lee, Head of Regulatory and Government Affairs at OakNorth Bank
