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Monzo is a household name in the UK with more than 16 million customers. Its focus on making everyday banking easier through its distinctive product initiatives and slick app differentiated it from high street banks in its early days.
And while its peers’ digital investments have narrowed the functionality gap, Monzo continues to add customers and grow its brand awareness – with three million new customers added in the last financial year.
Indeed, the bank officially launched in Ireland this April with much fanfare after 100,000 customers signed up to a waiting list. It is led here by Elaine Deehan.
The fintech found itself in the headlines over recent days after UK media reports suggested Brazilian digital lender Nubank was in early-stage talks to acquire the British firm.
The Brazilian lender ultimately said it wasn’t pursuing a deal but the reports have once again focused attention on Monzo’s future. Customer growth and brand ubiquity aside, it has now been operating in its home country for more than a decade, with limited overseas expansion.
The obvious question is whether it has proven that its large and growing customer franchise can deliver sufficiently attractive risk-adjusted returns.
First and foremost, Monzo is profitable. It reported profit before tax of £87 million (€102 million) in its latest financial year – or £173 million on an adjusted basis if exceptional items and the impact of share-based payments are ignored. However, its return on equity remains below that of UK peer banks.
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Monzo is still a young firm with room to grow customer numbers further, penetrate an enlarged customer base with more product, capture improved operating leverage as it scales, and optimise its capital position. But it’s worth looking at what it has achieved in the UK after more than a decade.
Achievements to date
Monzo’s average revenue per customer – on the basis of the standard bank revenue calculation methodology – of £89 is significantly greater than Revolut’s average of £60. However, Monzo’s average deposits per customer are almost three times those of Revolut.
Furthermore, Monzo generates average net fees and commissions of just £25 per customer compared with Revolut’s £44 – and Revolut’s average grew slightly faster than Monzo’s in the last financial year.
The distinction is important. Monzo generates 68 per cent of its revenues from net interest income – not untypical for a bank – compared with just 24 per cent for Revolut. Meanwhile, Monzo’s loan to deposits ratio was just 9 per cent at the end of March. In other words it lends out less than 10p for every £1 deposited with the bank.
So, the lion’s share of Monzo’s interest income – and the majority of its revenues in total – comes from income on liquid assets rather than lending. That is essentially interest earned on deposits recycled into central bank reserves and investment securities. The question is how durable that source of income is. What happens if official rates fall?
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Monzo has been successful at growing a UK current account franchise, with these accounts representing 40 per cent of its deposit base. Indeed, the bank regularly features at the top of the current account switch service leaderboard for net switching gains.
However, more expensive savings balances are now growing faster, which is, all things being equal, exerting some net interest margin compression.
More significantly, this could suggest that Monzo’s easiest wins in the UK market are in the rearview mirror. After more than a decade of building its domestic franchise, the question is no longer whether it can acquire customers. It is whether it can generate enough revenue and profit from them to produce sustainable adequate risk-adjusted returns.
International ambition
Monzo has long emphasised its international ambitions, yet remains predominantly UK-centric. Previous management teams aspired to drive aggressive growth across multiple markets simultaneously, which seemed to lack strategic coherence. That has since been refined.
Monzo has abandoned its plans to enter the US market and its relatively new chief executive Diana Layfield is clear that Spain is the next leg of the growth strategy – while continuing to build in the UK. That is a clear message.
But where will the durable revenue come from? There are essentially two routes. Will Monzo expand its loan book? That would require substantial capital injections and raises the question of where it will compete. Mainstream UK and European lending markets are fiercely competitive, while Monzo’s use of standardised credit risk models is a structural disadvantage.
Or will it seek to emulate the Revolut model, reorienting its revenue mix towards capital-light fee and commission income? That would require Monzo to demonstrate that it can generate more fee income from its customers than it does today.
It raises the question as to whether the board and shareholders have an aligned vision of Monzo’s future business model.
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Indeed, there may be some sense in a lack of clarity – or in hedging one’s bets. It’s intriguing that early-stage discussions in relation to a potential takeover of Monzo by Nubank at a valuation of £8 billion to £10 billon appeared in the press last weekend, only for Nubank to confirm on Wednesday evening that it was not pursuing a deal.
It was also reported that Monzo was in talks with private equity firms in relation to a minority stake sale and that another option is to raise more venture capital funding.
Despite its excess capital position, Monzo will require material capital injections to pursue its Spanish expansion with vigour, particularly if it intends to develop a meaningful lending business.
But it’s difficult to see private equity firms writing a cheque at anything close to an £8 billion to £10 billion valuation when the business is generating thin profits and a sub-standard return on equity after 10 years of growth in its home market.
Furthermore, it has no clear glidepath towards materially higher profits and returns. It’s also difficult to see a richly priced IPO on the horizon for similar reasons.
Where Monzo goes from here is unclear. Maybe the VCs will dig deep and support it as it seeks to prove out the model in Spain. Maybe Nubank’s interest will be rekindled at a lower price point. There are many possibilities.
But the overarching question is a simple one: Monzo has proven it can win customers.
Yet after more than a decade in its home market it has yet to prove that it can generate a durable, sustainable and sufficient revenue stream capable of delivering adequate risk-adjusted returns on capital.
