Digital Challenger Banks in South-East Europe – The Next Innovation Frontier?

As most Western European digital challenger banks fall short of their initial promise, it’s time to look elsewhere for disruptive opportunities

Emerging in the aftermath of the Global Financial Crisis, digital challenger banks in Western Europe offered an exciting chance to break with traditional banking practices and create new investment opportunities. More than a decade and a half later, achieved performance in most cases falls short of this promise. Often launched with loss-leading niche products to attract customers, many struggled to capture the imagination of jaded consumers and make the move to broader, profitable core banking relationships. The few that have fared well have proved a magnet for investment, and opportunities are limited for late-comers now seeking to invest.

But all is not lost for investors and entrepreneurs willing to look further afield. With increasing political stability and a business-friendly outlook, the emerging economies in Romania, Bulgaria, and Greece are creating the ideal environment for digital challenger banks to grow and prosper. As we discuss in this article, the size of the opportunity is considerable.

Helpful Friction

Our work across the sector has shown us that challenger banks prove most successful in areas where banking friction is significant. With consumers currently paying to open bank accounts – a situation long obsolete in Western Europe – and consumer credit in short supply due to high costs and high-cost, high-friction affordability checks, the appetite for change is significant.

Add in limited competitive choices for consumers, highly under-developed online banking offerings, and limited non-bank lending, as demonstrated for Greece, Bulgaria and Romania, in Figure 1 below, and the region is ripe for change. Lack of meaningful competition, at least until recently, has stifled innovation and the prospect of competitive pricing – a situation set to change as South-East Europe becomes the next frontier for innovation in the banking sector.

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Consumer needs significantly unmet in South-East Europe

South-East European countries are often poorly understood by Western European and U.S. investors. Contrary to popular perception, many countries in the region are politically stable and experiencing strong economic growth with unemployment rates lower than the European average, as shown in Figure 2:

For example, we have highlighted three key countries that present strong opportunities for digital challenger banks and their investors:

• Romania: The Romanian political landscape has undergone significant positive change since 2021, with a three-party coalition ending political polarization and a period of political stalemate. The government is committed to improving stability and business predictability with steadier, more transparent legislation. GDP grew at 4.5% in 2022, and the near-term economic challenges of high inflation and economic slowdown are slowly normalizing. Unemployment rates are among the lowest in Europe and have stayed consistently below other countries, even during the pandemic.
• Bulgaria: Widespread civil protests lasting six months in 2020 succeeded in ousting then prime minister Boyko Borissov on suspicion of corruption. Disruption has since reduced, and the government is working to improve the legislature and to reduce corruption with widespread reforms across the judiciary. Real GDP grew by 3.9% in 2022, supported by wage increases and growth in exports. Unemployment is expected to rise slightly, but will remain among the lowest in Europe.
• Greece: Historical issues with an overly complex regulatory environment seriously limited business’s ability to operate in Greece. 2021’s government approved recovery and resilience plan promises significant improvements both to the regulatory framework and to tax and customs administration. Economic recovery is expected post 2024, and unemployment rates ?– steadily improving since 2013 – are expected to remain at c.12% for the foreseeable future.

Economic growth across Romania, Bulgaria, and Greece is outpacing Western Europe with fuller employment and a population looking for better ways to manage and protect their money. The young, digitally-native consumer population are fundamentally credit-worthy but are struggling to secure credit from conventional banks. The scene is set across South-East Europe for new thinking and investment opportunity in the banking sector.

The rise of non-traditional banks and lenders

As multiple new lenders and start-up banks enter the market, South-East Europe’s banking sector is in bloom. Increased consumer choice is on offer as new entrants broadly fall into three categories.

1. International major players seeking a foothold in the region: The highly localised behaviours, regulations and market structure of the region are unlikely to fit well with their ‘everything everywhere all at once’ model. Brands such as Revolut are spread thinly across multiple markets and are perceived as viewing ?markets such as Bulgaria and Romania?as small.
2. Regional champions with already proven economic models and the ability to scale economies to their advantage: Nimble and adaptable, their business models offer key lessons for challenger banks elsewhere, including in the UK. They are likely to be the winning model in the region.
3. Small local start-ups typically operating in a limited number of markets and product segments: Their lack of scale, credibility, and access to customers and merchants creates significant barriers to growth.

These models are explained further in Figure 3:

Recipe for success

Banks finding success in the region share a wining model. Brands such as tbi bank and Mokka have found new ways of engaging with consumers by tapping into an under-developed point of sale finance (PoS) market. Their business model focuses on attracting customers with PoS finance using a digitally enabled approval process. For customers joining through this process, an added benefit is automatic access to a deposit account with highly attractive interest rates.

?Once onboarded, customers are continually assessed for creditworthiness, and are able to see their borrowing limits and access other financial products. By adopting this revenue-first model, South-East European challenger banks are able to swerve many of the issues facing their counterparts in markets such as the UK, delivering consistent profitability and strong growth as shown in Figure 4 and Figure 5:

Despite the perceived challenges of their country markets, the pragmatic approach of South-East European banks is arguably showing the way for the “more advanced” Western European digital banks. This is very much in line with fintech investors’ recent renewed focus on profitability, cashflow and the “now”, rather than the long-term nebulous promise that “digital banking is the future” sometimes associated with the more prominent Western digital banks. The lessons we are learning from challenger banks in South-East Europe also have great potential when it comes to helping new challengers in other geographies.

We are finding exciting and profitable businesses that are thirsty for supportive investors to take them to the next stage of their potential. The opportunity available to both banks and their investors is considerable.

This article was co-written with my colleague?Bronswe Cheung.

Connect with our thought leaders

Ashish Khanna, Partner;?Peter Ward, Partner;?Eilert Hinrichs, Partner;?Sam Halliday, Partner;?Bronswe Cheung, Partner;?Pretam Singh, Partner;?Gigi Wong, Partner;?Sam Shinner, Partner;?Clayton Souza, Partner;?Felipe Ahouagi, Partner

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The?L.E.K. Consulting?financial services team helps clients develop fact-based, practical, winning strategies for our dynamic sectors. Our work for investors, shareholders and leaders brings insight and a rare breadth of experience and perspective to drive strategic decision making.