Fintech industry challenges banking watchdog

The industry body for UK fintech, Innovate Finance, has issued a critical report targeting the Prudential Regulation Authority (PRA) for its “logic-defying” regulations. The report accuses the PRA of imposing “excessive” requirements that create an “uneven playing field” for UK challenger banks by placing heavy burdens on them. These banks are reportedly struggling with a “suite of existing and incoming rules” that disproportionately affect them.

Janine Hirt, chief executive of Innovate Finance, emphasised the importance of a supportive regulatory framework, stating, “It is vital that the regulatory framework supports – rather than hampers – [challenger’s] success.” She urged regulators to adopt a ‘Think Challenger’ approach to foster innovation.

The report criticises the PRA for undermining the “British banking success story” through overly burdensome regulation. These concerns arise despite Chancellor Rachel Reeves’ commitment to “rewire the financial services industry” as part of her Leeds Reforms package. Reeves has highlighted the success of UK fintech and pledged to bolster the sector in her Financial Services Growth & Competitiveness Strategy.

Innovate Finance argues that the UK’s regulatory structure “unintentionally favours large, established incumbents,” which hinders the competition the system was designed to encourage. Challenger banks have become dominant in the small- and medium-sized enterprises (SME) lending space, accounting for 60% of the market, a significant shift from 2019 when the four largest banks held 90% of lending.

However, the report warns that the implementation of Basel 3.1 reforms, which are part of the UK’s adoption of post-2008 international banking safety rules, will pose significant challenges for challenger banks. Although the Bank of England developed the Small Domestic Deposit Taker (SDDT) regime as a simplified framework for smaller banks, the report claims it remains overly burdensome.

Innovate Finance warns that these regulations could reduce critical lending to SMEs by up to £44 billion, describing this potential reduction as a “growth tax” on the SME economy that could impact the UK’s entrepreneurial sector and future productivity.

Challenger banks are also affected by the minimum requirement for own funds and eligible liabilities (MREL), which the Bank of England increased earlier this year. MREL rules, introduced after the 2008 financial crisis, impose strict requirements on banks with assets between £15-25bn to ensure they can be resolved in a crisis without taxpayer bailouts. The threshold has now been raised to £25-40bn.

Innovate Finance has called for a more “proportionate application of the MREL by the Bank of England to better reflect the realities that fast-growing challenger banks face.” It argues that the regulation forces challenger banks to “hoard capital for regulatory compliance rather than deploy it for essential lending and investment.”

The report concludes that the regulatory burden on challenger banks contradicts the government’s and regulator’s commitment to growth and competitiveness. Rachel Reeves has urged regulators to focus on “regulation for growth,” but she has faced resistance from the Bank of England, with Governor Andrew Bailey countering claims that post-crisis financial regulation is hindering growth.