British challenger, digital and specialist banks continued to grow in 2025, but economic headwinds led to slower expansion of loans and deposits, according to new analysis by professional services company EY.

Loan growth in the sector fell to 4.5 per cent from 8.9 in 2024 as customers prioritised debt repayments over new loans, while deposit growth dropped from 12.3 per cent to 6.7. Property development lending also fell, though it experienced a cautious recovery in the second half of last year.

The report said there is evidence to suggest that this slowing of growth represented an opportunity for challenger banks to improve efficiency, rather than simply reduce profits. Net interest margins rose by 20 basis points to 2.9 per cent, and the average cost-to-income ratio is now 58.2 per cent, nearly seven per cent lower than 2024.

Last year also marked a turning point for profitability in the sector. The average challenger bank’s pre-tax profit is now 0.5 per cent, up from the 1.5 per cent loss in 2024, which EY attributes to robust income from new business, effective cost control and stable credit losses.

Challenger banks are also showing strong balance sheet discipline, increasing their loss loan provisions by an average of 18.6 per cent year-on-year in 2025. They have an average Common Equity Tier 1 capital ratio of 15.5 per cent, more than four per cent above the Bank of England’s latest benchmark and in line with industry averages.

“The UK’s challenger and specialist cohort of banks are at an inflection point,” said Dan Cooper, EY UK and Ireland’s head of banking and capital markets. “Whilst this segment benefitted from rapid scaling and balance sheet growth in prior years, heightened competition and economic headwinds mean that these banks are operating in a very different landscape.

“Looking ahead, as wider economic growth continues to moderate, the mid-sized banks that continue a disciplined strategy of prioritising sustainability and resilience over volume should be well placed to continue growing in the medium-term.”

The challenger bank landscape has evolved rapidly in the UK in recent years, as previously non-bank FinTechs look to grow their margins by leveraging customer goodwill into deposit incomes.

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