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Can Shawbrook Group PLC And Aldermore Group PLC Really Compete With Banco Santander SA?

March was a busy month for the banking sector, with challenger banks such as Aldermore (LSE: ALD) and Shawbrook (LSE: SHAW) listing on the UK stock market in the last few weeks. And, the reception from investors has been very positive, with both companies seeing their share prices surge on their opening day of trading.

Positive Outlook

Of course, the present time is a good time to be involved in banking. Certainly, the sector has been hit hard by the financial crisis and the ongoing troubles in the Eurozone. However, with interest rates being low and set to stay low over the medium term, default rates should remain relatively low and demand for new loans is likely to remain high and, together, this means that profitability for banks could improve. As such, both Aldermore and Shawbrook could deliver improving profitability in 2015 and beyond, which would clearly be good news for their investors.

Challenger Banks

Furthermore, Aldermore and Shawbrook are increasing their customer numbers due to a desire from consumers, regulators and the government for more choice and more competition within the banking sector. This is perhaps understandable following a major banking crisis, when the ‘old guard’ were accused of causing one of the most severe recessions in living memory. As such, it has created an opportunity for a new style of banking that focuses on customer service, ease of use and, perhaps most importantly, a more transparent charging and interest rate structure. Therefore, both Aldermore and Shawbrook could continue to gain ground moving forward.

Incumbent Banks

However, the rate at which they increase their market share may slow somewhat over the next few years. That’s at least partly because incumbent banks such as Santander (LSE: BNC) (NYSE: SAN.US) are improving their financial standing (in Santander’s case through a placing) and are becoming more profitable, which means they can invest greater amounts in marketing, advertising and in winning new customers.

Furthermore, banks such as Santander have huge size and scale which, in the long run, is likely to be a major advantage. Not only will it allow them to more easily absorb a potentially higher default rate as interest rates increase and the performance of the wider economy falters, they can also maximise cross-selling opportunities to a far greater extent than the likes of Aldermore and Shawbrook.

For example, Santander offers a highly lucrative current account which pays customers 1/2/3% for various spending options, which inevitably attracts more customers. In turn, this provides Santander with an opportunity to sell those same customers loans and investments where Santander makes relatively high margins. In other words, it can afford to make a large loss in one part of its business in order to make an even larger profit in another. Challenger banks such as Aldermore and Shawbrook are unable to do this to the same extent at the present time and so may find growth opportunities somewhat limited.

Looking Ahead

While Aldermore and Shawbrook have made positive starts to being listed companies, their long term futures may not be quite as bright as is currently expected. As such, larger peers such as Santander remains more attractive as an investment at the present time.

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Peter Stephens has no position in any shares mentioned. 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.