Digital challenger banks will struggle to scale profitably in the Coronavirus-caused recession, although those able to weather the storm will innovate and thrive.

This is according to a new report from Forrester, which explained that mobile-only players will have to fight harder for deposits and new account signups; will struggle to attract more venture capital funding; may have to reduce operations and see a deterioration of business performance; and will have limited exit strategies as a result of the COVID-19 crisis.

The report also noted that hardly any have achieved profitability to date: Aldermore and OakNorth Bank in the UK stand out as rare exceptions.

However, at the same time, a handful of digital banks will use the crisis as an opportunity to innovate, developing features and services to help customers better manage their finances and reassure them of financial safety.

The report noted Monzo and Starling Bank reaching out to customers to explain that they are fully licensed banks and members of the Financial Services Compensation Scheme and that customers’ deposits are therefore fully protected up to a value of £85,000.

It added that as fraudsters have exploited the outbreak, Starling for instance published a blog post, explaining to customers what to look out for to spot a Coronavirus scam and stay safe.

Senior analyst Aurelie L’Hostis emphasised that challenger banks were already experiencing issues before COVID-19, with a crowded market, a lack of clear product differentiation, and struggles to scale. “The outbreak of the virus has changed the market radically in just a few weeks, further clouding challenger banks’ prospects.”

Some incumbents might want challengers’ technology stacks to upgrade their technology, but this is a risky bet, according to L’Hostis. “Devaluation among digital banks will start a race among incumbents to pick up digital capabilities on the cheap, so founders might only get low offers, if any.”

Moven, a pioneer mobile bank in the US, shut down its business-to-consumer side at the start of 2020, while German digital bank N26 pulled out of the UK market this year as it struggled to acquire new customers in an already saturated market. “We expect many more to follow suit,” noted the report.

A handful of digital banks, including N26 and Starling, were eyeing an Initial Public Offering (IPO) in three to five years’ time - any sooner IPO plans are realistically no longer an option, as valuations are getting hit hard, Forrester suggested.

“Challenger banks will need to fight to survive – a handful of digital banks will manage to weather the pandemic crisis until the third quarter of the year and then make it through a 12–18-month recovery period.”

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