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To be, or not to be, a bank?

Written by Graham Andersen,  Chief Executive, Australian Mortgage Marketplace.

Australia has gone through a long period where no new mortgage funders of any significance, either banks or non-banks, were created but we are now seeing a new era of neo-lenders and challenger banks appearing on the scene.

Since 2007 the financial system has heavily favoured finance incumbents, especially the major banks, excluding new entrants from being able to compete. Consequently, new entrants have been almost non-existent. Over the last few years the financial system has evolved so that new disrupters are not only poised to enter the market but to take significant market share from the incumbents.

A short summation of the reasons that new entrants can now compete are:

  • Regulatory and capital requirement changes,
  • Loss of trust of banks by the public and intermediaries,
  • Inefficiencies of incumbents, and
  • Technological solutions that add to the efficiency of banking and borrower solutions.

AMM and Athena are launching as neo-lenders, regulated by ASIC and focusing on mortgages while Xinja, Volt, 86400 and Judo are launching as challenger or neo-banks regulated by APRA (and ASIC) and focusing on retail deposits, multiple loan classes and other products.

There is a raft of existing non-banks (as per our montage above) that fund mortgages and other loans and have long histories for the larger institutions.

Whilst these existing non-banks have been receiving much attention in the last year with three being purchased by private equity funds, none appear to be evolving into the new digital world or changing their funding structures through major bank warehouses and traditional securitisation. The non-banks were the disrupters of the 90s and 00s and have performed very useful roles during that period, while even gaining market share currently.

The new neo-lenders are not focused on the old existing model but are re-inventing both the origination methodology and the way mortgages are funded in the capital markets. The challenger banks, as demonstrated overseas, are reinventing banking in the digital form without branches.

The neo-lenders and the challenger banks would not consider the old disrupter non-banks to be competitors; rather their competitors are traditional banks dominated by 4 major banks. The new disrupters should consider the network effect that being part of this new disruptive group gives; great credibility with success breeding success.

So, what’s it better to be, a neo-lender subject only to ASIC regulation, or a challenger bank primarily regulated by APRA?

The answer does depend on the organisation’s business plan and the product focus, as there are many different positives and negatives of APRA regulation that given a different focus will produce a different paradigm.

It may be useful though to list those positive and negatives to perhaps better understand why organisations make the choice: to be, or not to be, a bank?

The positives of being a bank (APRA):

  • The name ‘bank’ gives a badge of quality to an organisation
  • Access to ‘cheap’ funding through deposits
  • Average cost of wholesale funds cheaper than non-regulated organisation
  • Access to RBA system liquidity (funding)
  • Deposit base also becomes the asset base through loans
  • Banks create money through lending and are a vital system cog
  • Technology allows new banks to compete successfully with incumbents
  • Access to the federal government’s support of deposit losses

The positives are quite significant and would seem compelling for a budding finance business, but as always there’s a cost.

The negatives of a bank and APRA regulation:

  • Cost of obtaining a licence and minimum capital requirement to launch
  • Cost of APRA reporting and regulated compliance
  • Complying with APRA capital requirements to protect the balance sheet
  • Capital dilution of early shareholders due to Tier 1 equity requirements as assets grow
  • Restrictions on securing assets and securitisation of assets
  • The cost of deposit customer acquisition from competitors

The negatives are not insurmountable, but do come at a large cumulative cost that is manageable for existing banks but can be considerable for a new lender.

The positives of being a neo-lender without APRA regulation:

  • Lower cost base
  • Mono-product focus
  • Ability to use and rely on internal risk models
  • Proper pricing for risk without focus on regulatory capital
  • Free to be fully transparent on asset base and offer assets as security for funding
  • Free to use all the modern fintech that technology can offer
  • Free to use any funding or security structure available
  • Ability to structure capital requirements so that early investors are not diluted

The positives of being a neo-lender need to be weighed with the positives and negatives of an APRA regulated bank. It’s no simple equation.

Clearly the new challenger banks have done their sums and come out in favour of regulation. Or to put that another way, the challenger bank’s business models stand up under the costs and benefits of regulation.

On the other hand, for a neo-lender that sources funds in the capital markets and is mono-focused on mortgage lending through broker networks, as is AMM, the equation is different and so is the answer.

Just like the mortgage non-banks that started in the 90s and before, the business model of the new neo-lenders just does not warrant or support the costs and benefits of APRA regulation.

There is no single correct answer to our question of: to be, or not to be, a bank? There is room for both neo-lenders and challenger banks and that is what’s required to give the market real choice in what customers want and need.