Judo, which received its banking license in April, is one of a number of neobanks shaking up Australian banking with the potential to ultimately challenge the long-standing dominance of Australia's "big four" incumbents, Commonwealth Bank of Australia (CommBank), Westpac Banking Corp, Australia and New Zealand Banking Group (ANZ) and National Australia Bank (NAB).
Criticism of the big four has intensified following a government-led misconduct probe into the Australian finance industry that revealed widespread wrongdoing, including the use of bribery to win mortgage business and fees charged to deceased account holders. Following the Royal Commission's investigation, the big four banks have paid out more than $5 billion in customer remediation and are on the hook for billions more.
"Huge profit-fuelled complacency, supercharged by weak enforcement – even of admitted misconduct – fed an atmosphere of bulletproof risk-taking and wilful blindness to the interests of customers, “said journalist Daniel Ziffer in A Wunch of Bankers, his forthcoming book about the Royal Commission's investigation. "The system wasn’t broken. For the banks, it was working perfectly," he added.
While customers aren't likely to abandon the big four in droves, the incumbents have certainly lost some of the public's trust - something that cannot be swiftly recovered. Members of the public submitted more than 10,000 complaints to the Royal Commission online, the Commission noted in its final report published in February.
The findings of the Royal Commission undoubtedly have given additional momentum to digital banking upstarts already riding high on strong investor interest and market demand.
At the same time, Australia's introduction of open banking later this year will give consumers greater banking flexibility, a boon for new market entrants keen to attract business from incumbents. Open banking will allow consumers to have control over the data about them that is sent to banks and other financial institutions. Consumers will decide who holds their data and how it is used. As a result, it will eventually become easier for them to switch financial service providers smoothly.
Finding a niche
Australia's main neobanks are targeting different market niches. Judo is focused on small businesses, an underserved market segment oft overlooked by the big four. Since launching in March 2018, Judo has lent more than $150 million to more than 100 SMEs. Judo customer deposits are subject to the same $250,000 government guarantee that protects deposits at the larger banks.
Judo's founders say that its value proposition is compelling to small businesses, particularly those whom traditional banks have turned away. They set out to establish a bank that wouldn't focus only on collateral to understand a business, but would also evaluate "cash flow, capital and the character of management," co-founder and chief executive office David Hornery told Startup Smart in July.
Hornery and co-founder Joseph Healey emphasize the bank's focus on SME customers rather than advanced technology. Tech serves "as an enabler of our service, not a definer of our service," Healy told The Sydney Morning Herald in May.
Meanwhile, Volt, which in January became the first Australian challenger bank to be granted a full banking license, doesn't yet have any products on the market. However, the company reportedly plans to launch a suite of products and services this year, among them personal loans, home loans, term deposits as well as savings and transactions accounts.
Volt has been explicit about its intentions to offer consumers an alternative to the big four. “Against the backdrop of systematic failures and breaches of trust by incumbent banks, our mission is simple; to empower people and make financial services easier," co-founder and chief executive Steve Weston told The Sydney Morning Herald in January.
Xinja, the only other challenger bank not backed by an incumbent, is operating under a restricted license for now. Like Volt, it is targeting the retail market. Xinja has launched a pre-paid credit card product and plans to roll out other products after getting its banking license.
Xinja's brand positioning emphasizes its independence - which could be construed as a jab at competitors partnering with incumbents - and focus on the mobile internet generation of consumers.
"Xinja will make it quick, easy and fun to track your spending, save for what you want and get a lot more out of your money. All on your mobile," the company says on its website.
Some of Australia's neobanks are choosing to partner with incumbents. While Up, which launched in October 2018, counts Bendigo Bank as its primary backer, and thus didn't have to apply for a banking license. Payments provider Cuscal backs 86 400, although the latter has secured its own full ADI license.
Payments service bank Tyro, which like Judo focuses only on SME business, has posted strong financials and is mulling an IPO in the next year and a half. In the first half of the fiscal year 2019, Tyro transacted $8.5 billion, up 31% annually according to Kalkine Media. In 2018, Tyro Payments was awarded Best Payment Services Bank at the Australian Business Banking Awards.
Big institutional investors are bullish on Tyro's prospects. Analysts say that many of the world's premier investment banks are interested in the expected IPO, including Goldman Sachs, J.P. Morgan Chase & Co. Morgan Stanley, UBS Group and Australia's own Macquarie Capital.
The power of incumbency
Despite the potential augured by Australia's challenger banks, it won't be easy for them to unseat powerful incumbents. As noted by The Sydney Morning Herald in July, Australia’s banks are the most profitable globally as a share of gross domestic product at 2.9%. Only Chinese and Swedish banks are close to as profitable in terms of that metric, 2.8% and 2.6%, respectively.
Given their longstanding profitability, Australia's incumbent banks have been able to invest considerable resources in the development of strong digital platforms. In many respects, their digital offerings are among the best of any traditional banks in the world's advanced economies, Forbes notes in an August commentary. That means the upstarts can't easily depict them as digitally maladroit and behind the times.
Another challenge for Australia's neobanks is that the Australian market just isn't that big. Although Australia is the world's sixth largest country by area, it has a population of just 25 million. Neobanks will have to work harder to gain market share than in the UK (whose challenger banks are among the world's most successful), which has a population of 66 million, Forbes says.
Still, the neobanks have some core strengths that incumbents cannot easily dismiss. In particular, even if a traditional bank has a solid suite of digital services, it still has to grapple with a clunky legacy IT system. There is no way around that. In contrast, a digitally native bank begins with state-of-the-art technology built for the mobile internet era. It also doesn't have to operate a costly network of physical branches. That means it can offer its services to customers for lower fees than incumbents.
In the retail market, Australia's neobanks will almost certainly attract younger customers whose priority is a seamless, low cost digital-first banking experience.
But will that be enough for them to be successful? Perhaps. It won't be easy to go head to head with the big four in retail banking, a market they have penetrated so thoroughly.
But in an underserved market segment like SME lending, there is considerable room for neobanks to grow. That may be why Judo's executives have sounded so confident of late.
"The fact we can start with today's best technology and no legacy core banking system means we can beat them [incumbents] on cost-to-income ratio, return on equity, net interest margin ... we are not a small play," Judo chief financial officer Chris Bayliss said at a venture capitalist panel discussion in June.