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Difference between retail, challenger and neobanks on the example of the UK market


13 min read

Why do you need to know the difference between bank types?

To create high-quality fintech digital solutions you need a good understanding of business and regulatory details. We’ll distinguish between the types of banks and the scope of their activities using the example of the UK market.

New types of financial organisations emerge as a natural reaction to market demand. Therefore, challengers and neobanks that are common in the UK are the natural progress of the retail banking system. These two definitions are often confused, mistakenly believing that both types are ordinary online banking systems (which is also provided as a service by retail banks). But it is not so.

The main difference is based on the following parameters:

  • Revenue streams and business model
  • Licence parameters
  • Banking products and services
  • Means of accessing clients

Why do we need a regulator in the banking sector?

Banking activity has a number of risks: financial, reputational, credit, business, systemic. In addition, the amount that is on the client’s account and bank capital are different figures. A retail bank holds cash deposits from its customers and then uses those deposits to make loans to other customers. If this process of money movement is left uncontrolled, there can be negative consequences, which is why the regulator of this whole process is so important.

The UK banking system has a unique clearing system that allows participating banks to process money on behalf of their customers more efficiently and cheaper than in many other parts of the world. Cheques and other paper documents are physically transferred between banks simultaneously with the processing of electronic data. All financial management is handled by the Financial Conduct Authority (FCA), which operates independently from the UK government and is funded by charging fees to participants in the financial services industry. The FCA is responsible for regulating financial institutions that provide services to consumers (including retail banks) and maintains the overall integrity of the financial markets in the United Kingdom.

Regulatory requirements for the financial sector are dictated not only by the FCA, but also by the Prudential Regulatory Authority and the British Financial Policy Committee. In addition to regulating financial activity, these two organisations also have the authority to conduct investigations and even freeze the accounts of individuals and legal entities until the circumstances are clarified.

In 2015, the FCA created a separate payment systems regulator, PSR. Its task is to develop the payment systems sector and ensure the safety and comfort of their use by individuals and legal entities. PSR conducts competitive procurement processes for future contracts in order to prevent corruption and increase the transparency of the process. With the assistance of PSR, an international messaging standard (ISO 20022) for Bacs and Faster Payments was also adopted to reduce barriers and encourage new market entrants.

As an example of PSR work is to effectively ‘police’ the payments sector, highlighting any misdemeanours, bringing culprits to task. An example of “crime and punishment” is National Westminster Bank Plc. Violations were recorded in its activities: larger cash deposits were made to customer accounts, than were allowed. Approximately £365 million was allegedly transferred to customer accounts, of which approximately £264 million was in cash. However, NatWest’s systems and controls were not able to properly monitor and scrutinise these activities. In the fall of 2021, NatWest pleaded guilty to the crimes.

Retail bank

Retail bank is a financial institution that accepts deposits from the public, makes loans and is responsible for maintaining liquid checkable deposits.

Retail banks are classified as “national” or “public” based upon the beneficiary. Previously, the work of retail banks was limited to business hours, although the use of multiple channels helps them to reach more customers: ATMs, branches, websites, call centers.

To verify the identity of the user, banks need to check the photo ID in person at the branch, and to confirm the address a utility bill or tax statement is required. It is also necessary to visit the branch, for example, when reissuing a card.

This is can be considered one of the primary differences between Retail and neobanks, which are digital tools for personalization and process cost reduction. Implementing a chat bot is cheaper than opening 200 branches across the country.

Banking products and services

Retail banking provides financial services to individual consumers rather than large institutions. In this case, retail banks can be local public banks or divisions of large commercial banks.

Standard set of banking services offered by retail banks:

Transactional accounts – a demand deposit account opened with a bank or other financial institution. They are divided into current and savings accounts.

Debit card – a payment card that can be used instead of cash to make purchases. The money for the purchase must be in the cardholder’s bank account, and at the time of the purchase, it is immediately transferred from his account to the seller’s account to pay for the purchase.

Credit card – is a payment card to allow the cardholder to pay the merchant for goods and services based on the cardholder’s accumulated debt.

Traveller’s cheques – are a medium of exchange that can be used instead of physical currency. They may be in the form of cheques with a fixed amount, intended to enable the person signing them to make an unconditional payment.

Mortgage – is a loan used by buyers or existing owners of property to raise funds for any purpose when collateralizing a mortgaged property.

Personal loan – is any type of debt or general obligation not secured by a guarantor or secured by a pledge of specific assets of the borrower in the event of bankruptcy, liquidation or non-compliance with repayment terms.

Certificate of deposit (CD) /Term Deposits – is a term deposit, a financial product usually issued by banks, savings institutions and/or credit unions.

However, whilst these facilities are normally associated with Retail Banks, many fintech companies can now duplicate these services in an increasingly efficient manner.

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Online banking as a service

Some retail banks allow you to access your accounts online.This greatly simplifies the client verification process. So, online banking means accessing a bank account and performing financial transactions via the Internet on any device convenient for the user. This allows you to quickly (and most often free of charge) perform tasks such as paying bills and transferring money, without the need for an in-person visit or a call to the bank.

Online banking requires a device, internet connection, and a bank or debit card. To access the service, you must register in the online bank. Thus, an online bank is just a representation of a retail bank on the Internet, and, for example, verification of your identity or submitting documents will still require a visit to a branch.

Challenger Banks

Challenger banks are fintech companies that optimise the classical banking system. Their main difference and advantage is that they offer advanced financial technologies to reduce the costs and inconvenience that retail banks have.

The Challenger Bank has a banking licence, meaning it is authorised to accept deposits from individuals from the UK’s financial regulator, the Prudential Regulatory Authority. Essentially, it offers the same list of features as a retail bank, but in a more flexible and user-friendly format.

The appearance of challengers has presented an alternative to the “big four” UK banks.

The “big four”, the concept is frequently used in the UK to refer to the four largest banking groups: HSBC, Barclays, Lloyds Banking Group, NatWest Group. In May 2021, the market capitalization of the United Kingdom was $3,363.797 billion.

After the global financial crisis in 2008, the UK government took serious actions in 2012 by proposing options for strengthening the resilience and development of the banking sector, opening the sector via the Financial Services Act. It was decided to open the way for new banks (in fact, challengers), for which the PRA (part of the Bank of England), created its own division. It received the right to accept applications from potential banks, “authorization with restrictions”, if necessary, until restrictions were lifted and a full banking licence was granted to the firm. When this happened, a UK banking licence was issued for the first time in 100 years!

Other measures taken include interest rate management, monetary easing, and the introduction of fiscal stimulus. Further, It was also proposed to introduce new companies into the industry, with the offer of grants and many types of incentives at the legislative level, thereby the challengers received even greater opportunities for development. All banking transactions at this type of bank are protected by the Financial Services Compensation Scheme (FSCS).

In total, there are about 20 Challengers in the UK, and almost all of them have been created within the last 10 years. Among the most famous challengers are Atom Bank, Yolt, Monese, Monzo and Revolut. Most challenger banks offer a full range of services, while others specialise in a single service such as mortgages or loans.

Challenger features include: debit cards, mobile interface, credit limit overruns, deposits. Competition from challenger banks strengthens the UK banking system. In response to the challengers’ innovative services, retail banks are responding by raising their service levels to match them. Challengers have also made it much easier for the user to switch banks by changing the current account switch process, which was previously a complicated and long procedure.

Disadvantages of Challengers

Most challengers are still doing credit checks on potential clients. This brings them closer to retail banks, and moves them away from neobanks, which are attractive because of a low entry threshold.

Another point is the lack of additional income that large banks receive from customers who pay interest on loans and mortgages. Even the commission that brings profit to such banks also differ depending on additional details (account type, banking provider fees, type of operations).


Neobank is a fintech company that offers banking services but is not as regulated as a retail bank. The UK has two key regulatory authorities. The Prudential Regulation Authority (PRA) is responsible for the financial safety and soundness of banks, while the Financial Conduct Authority (FCA) is responsible for how banks treat their customers and behave in financial markets. All transactions and regulation here take place in the format of electronic money, therefore, according to the requirements of the FCA, they must be called a financial institution. Neobanks provide applications and software that help streamline the banking process.

From customer acquisition to classic banking services such as money transfers, utility bills and personal finance, neobanks offer a wide range of offerings for retail and SME customers. Typically, neobanks apply a design thinking approach to a specific banking industry and tailor their products and services to make banking easier and more convenient for end customers.

From 2018 to 2021, the number of neobanks around the world increased 4 fold already reaching 256 at time of writing. That is, over the past two years, every five days, one neobank has been launched somewhere in the world.

If earlier neobanks were concentrated in Europe, more precisely, in the UK, now they have become a global phenomenon. They have also spread to the Asia-Pacific region and the Americas. Latin America deserves special attention, as it is a region that is practically not developed by fintech companies and it looks to be in desperate need of it! So far, only Nubank from Brazil can boast of achievements there, meaning it has achieved a monopoly in the region! As far as China is concerned, ecosystems like Ant Financial and WeBank have been able to dominate the industry.

The position and type of neobanks are related to the level of entrepreneurial development and market opportunities available to neobanks in a particular country.

Typically, neobanks are more flexible and transparent, and often focus on a specific service area. The popularity of neobanks also influences the improvement of online banks, which, among other things, have the right to provide loans.

It is important to clarify that upon obtaining a banking licence, a neobank goes into the category of challengers. For example, Revolut changed its status over the years on the market after obtaining a full banking licence.

What are Neobanks revenue streams? Often, a neobank’s income is built on commissions paid by merchants when customers make purchases with their debit card. Because the neobank is always a small entity, they can negotiate higher interchange fee , up to seven times higher than that available to banks with more than $10 billion in assets.

Neobanks often interact with venture capitalists who invest in them in order to generate income. For example, one of the most known neobanks, Chime, received $485 million in Series F in 2020, sending its valuation skyrocketing to $14.5 billion. Thanks to this strategy, neobanks have lower fees, higher interest rates (due to low overhead costs), and increased user experience. But this mobility has a downside, in the form of limited services, and exclusively partnerships with a bank without an actual banking licence.

Disadvantages of neobanks

First of all, neobanks are about technology, this is their advantage, but it also limits users of certain age and social categories. The lack of a physical presence and dependence upon a partner bank, can make it a little more difficult for some clients (for example, to deposit cash). This can impact upon the size of the user base that results in smaller coverage or limited niche.

Another drawback are the higher risks of fraud, if models and security aren’t built correctly. That can result in more money losses than retail banks have.

And of course, the level of customer data security. Potential problems in cyber security can result in hacked accounts and data vulnerability.

Differences between Challenger Bank and Neobank

Confusion between neobank and challenger is a common mistake, and as seen above, there are many reasons for this. Understanding the difference is important for both individuals and businesses.

The key differences between challengers and neobanks:

NeobankChallenger bank
Banking licenceDo not have a banking licence because they use a licence from a partner bank or AMI licence.Have a full banking licence to carry out a full range of banking operations.
Physical PresenceUsually do not have physical branches. (Except for those that receive a full retail licence and move into the category of challengers)Always have small representations.
Areas of activityFocus on a specific client segment, usually SME businesses.Unlimited in their capabilities.
Business ModelTech startups that are focused on user experience, they are also focused on making money fast, with a large customer base.Main way is by lending and increasing their balance.
FormatGenerally they are considered to be a more versatile financial platform, giving clients the ability to transact stocks and cryptocurrencies alongside their day-to-day banking activities. Continue to evolve technologically offering more opportunities for SMBs and API tools for business owners.Actively developing into financial institutions operating on the principle of “all inclusive”, with all the features of retail banks, while maintaining their status as a modern alternative. They still have limited scope.
SecurityDependent on a partner bank and do not have specific legal protections.Considered more reliable and secure, due to the financial license and more stable position.
Client BaseOffer personal accounts, but their main focus is SME businesses.Usually offer personal and business accounts.

Thus, challengers and neobanks are two completely different types of companies with different goals and capabilities. If neobanks are technology companies with an intensive growth of the client base, then challengers are modern banks that seek to increase their balance sheet profitably, focusing the attention of customers exclusively on themselves, and covering all their needs.

One could even say that neobanks are the “embryo” of challengers, since neobanks essentially start out as unregulated fintech companies, and after regulators approve their licence requests, become challengers.

Another important difference between the two is that challengers mostly operate online while neobanks operate exclusively online.

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The differences between retail, neo- and challenger banks are not always obvious due to the large number of evaluation parameters, and also the possible migration from neobank to challenger due to a licence upgrade.

Retail banks are considered more stable and can propose more guarantees to minimise risks for customers. Challengers are closer to traditional banks due to the similar client checks they perform, but they are still more flexible and cost effective. Their downside is a lack of traditional income. Neobanks are much more flexible, cost effective and tailored to the specific needs of customers who want to use banking services online, without the extra bureaucracy 24/7. Of course they have downsides, such as the possible lack of cybersecurity, higher risks due to fraud level and limits in the user base due to the absence of an offline presence.

As relatively new players in the banking sector, neobanks and challengers have already managed to win a significant market share for themselves, in just this past decade. The compound annual growth rate (CAGR) of challengers and neobanks is 46%, projected to reach over $356 million by 2025. The variety of new banks makes it possible to fully satisfy all the needs of businesses and individuals, and fintech startups to find and implement new technical solutions, further developing the sphere.

Obviously, neobanks and challengers are gaining momentum and are seriously competing with retail banks, although they are still dependent upon them. Also they already form a significant part of the business banking industry, regulators need to pay attention to their activities, increasing the level of security and convenience. The UK shows a good example of how the state supports the activities of alternative financial institutions. Adopting such an experience can safely be referred to as key to the growth of a safe and profitable fintech for everyone.

In conclusion, it can be said now that no matter which banks win the race, customers will benefit the most from the transformation of the banking sector and the emergence of new models of banking services. Retail banks are likely to survive, but in a limited way, whilst the new generation banks will take the lead, dictating the rules.

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