Why Barclays PLC & Royal Bank Of Scotland Group plc Shouldn’t Lose Sleep Over Virgin Money’s Flotation

Piggy bank

Today’s announcement that Virgin Money will float is being viewed as good news for the banking sector. After all, Virgin Money provides additional choice for consumers and its plans to float indicate that the UK banking sector is returning to full health.

One thing it shouldn’t be viewed as, though, is a problem to incumbents such as Barclays (LSE: BARC) (NYSE: BCS.US) or RBS (LSE: RBS) (NYSE: RBS.US). Indeed, they seem to have bright futures whether or not Virgin Money’s flotation is successful. Here’s why.

Challenger Banks

As one of a number of so-called ‘challenger’ banks, Virgin Money is aiming to shake up the banking industry and provide financial products in a slightly different way. Indeed, new entrants to the banking industry are being encouraged by the government, which wants to lessen the UK’s reliance upon a small number of large banks so as to potentially avoid a ‘too big to bail/too big to fail’ scenario in future.

However, challenger banks such as Virgin Money are unlikely to pose a serious threat to the bottom lines of banks such as RBS and Barclays. That’s because they simply do not have the size and scale of their more established peers and, in the long run, are unlikely to be able to compete when it comes to the rates and flexibility offered to customers by banks such as RBS and Barclays. This may hold to a lesser extent in personal banking, but in business banking it could prove to be a major advantage to the larger, more established banks.

Furthermore, it’s tough for challenger banks such as Virgin Money to grow and to develop size and scale. That’s because banks such as RBS and Barclays conduct loss-making activities (such as free current accounts) in order to generate significant cross-selling opportunities. This has the dual effect of boosting their bottom lines and also increasing barriers to entry.

Looking Ahead

Despite the increasing prevalence of challenger banks such as Virgin Money, incumbents such as Barclays and RBS have bright futures. For example, Barclays has remained profitable throughout the credit crunch and is due to increase earnings by 26% in the current year and by 28% next year. Meanwhile, RBS is forecast to return to profitability in the current financial year and recommence paying dividends next year.

With shares in Barclays and RBS trading on price to book ratios of just 0.67 and 0.39 respectively, they seems to not only have bright futures but offer tremendous value for money, too.

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Peter Stephens owns shares of Barclays and Royal Bank of Scotland Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.