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Could New Banks Really Challenge Barclays PLC, Lloyds Banking Group PLC And Royal Bank Of Scotland Group plc?

Piggy bankDespite the government desiring otherwise, there have been next to no new entrants in the banking world since the start of the credit crunch. That has allowed the likes of Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds (LSE: LLOY) (NYSE: LYG.US) and RBS (LSE: RBS) to recapitalise, strengthen their balance sheets and, in the case of Lloyds and RBS, return to profitability this year (Barclays has been profitable throughout recent years).

However, there are reports that literally dozens of new, challenger banks are set to enter the industry. That’s because various entry barriers are being relaxed so as to make it far easier for new entrants to gain a foothold in what has historically been a tough industry to enter. Indeed, roughly five times as many companies are applying for banking licenses as this time last year. Could more competition mean less profit for the old guard?

Loss Leaders

Clearly, more competition is rarely good news for any industry. However, in the case of the banks, their sheer size and scale means that it will be hugely challenging for new entrants to compete with them. For example, current accounts are generally free, but amount to a cost for the banks that they are happy to encounter due to the cross-selling opportunities that current accounts offer. Indeed, some banks (for example, Halifax) even pay customers to open a current account with them and then keep paying every month so long as it is being used.

This highlights the huge attraction and opportunity that current accounts present to banks. They would not be free if they did not offer the potential to make profits on other products such as mortgages and credit cards. While the likes of Lloyds, Barclays and RBS can afford to take a loss on current accounts, it is unlikely that new entrants will be able to, and so could miss out on highly lucrative cross-selling opportunities.

Niche Players

New entrants will also be unable to compete with the old guard in terms of a branch network. They can’t, for example, suddenly open hundreds of branches and employ thousands of staff to run them. However, what they could do is become niche players who embrace new technology. For example, they may offer online-only accounts, focus on savings products and mortgages, or try to differentiate themselves based on customer service.

In doing so, they could pose a threat to the major banks in the long run. Of course, the extent of this threat will depend upon how onerous regulation will be in future, as well as how RBS, Lloyds and Barclays react to new technology and the change in customer tastes. Thus far, they appear to be embracing it and are improving their online offerings, closing branches and keeping up with new technology.

For now, then, the established banks still look strong and, with profitability and payout ratios set to soar over the next couple of years, now could be a great time for investors to buy in to Barclays, Lloyds and RBS.

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Peter owns shares in Lloyds, RBS and Barclays.