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Should you buy Lloyds for retirement as the threat from challenger banks rises?

There’s a galaxy of great blue-chip income shares for UK investors to snap up today. But I’d be content to continue ignoring Lloyds Banking Group (LSE: LLOY), despite its big dividends and low earnings multiple.

Its forward P/E ratio of 8.3 times sits well below the FTSE 100 average of just below 15 times. Meanwhile, a mammoth 6.1% dividend yield for 2020 dwarfs the 4.1% prospective average that the Footsie currently offers up.

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Though the PPI scandal might be drawing to a close, the banking giant has three other colossal problems to overcome that strike me with dread. The threat of a disorderly Brexit at the end of 2020 threatens to keep UK economic conditions under pressure this year (and possibly beyond). This could lead to interest rates being kept at profits-crushing lows. And the likes of Lloyds also face the ongoing attack from so-called challenger banks.

A huge challenge

New data from BDO LLP illustrate the colossal impact these rivals are having on the banking industry’s traditional players. This shows the amount of lending by newly-launched challenger banks has doubled in the last five years to a record £115bn.

The accountancy and business advisers point to three factors that the new kids on the block attribute to their success: their brands not being tarnished by mis-selling scandals that have cost traditional banks billions of pounds worth of penalties; their more flexible approach to lending decisions; and their use of brand new IT systems instead of outdated legacy systems, resulting in lower costs and enabling them to offer loans to customers at more competitive rates.

Whether you’re a customer, a lender or a market commentator, it’s clear that digital banking in particular has become an industry game-changer in recent years. And BDO LLP is quick to point this out in its study, noting that “challenger banks’ use of disruptive technology in digital banking services and improving customer service has helped them quickly acquire new customers.”

It adds that “some of the UK’s traditional banks have been slow to catch up.”

Cheap and nasty?

The likes of Lloyds continue to desperately cut costs to offset the impact of falling revenues and weakening margins on their bottom line. Just this week, the Black Horse Bank announced that it was closing another 56 branches between April and October. This suggests a possible stepping up of expense-saving measures following the 15 closures it announced late last summer.

Broker estimates underline why Lloyds could be desperate to accelerate branch closures. City consensus suggests that earnings will decline 3% in 2020, reflecting expectations that income will fall again.

Despite these measures, I fear that a mix of mounting competition, ultra-loose monetary policy, and Brexit-related threats could keep profits on a downtrend beyond the current year. I think we could see significant downgrades to these 2020 forecasts. Lloyds is cheap, but it’s cheap because of the massive challenges it faces long into the future. And it’s a share I’m avoiding like the plague.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.