CHALLENGER banks have been freed to create more competition in the industry and boost SME lending, the new regulators have claimed.

The Prudential Regulation Authority and Financial Conduct Authority said last year's reforms to lower barriers to entry for new financial institutions had led to five new banks being authorised, and a "substantial increase in the number of firms discussing the possibility of becoming a bank with the regulators".

In the year to March 31 the regulators held pre-application meetings with over 25 potential applicants. "These firms have a range of different business models, from retail and wholesale banking to FCA-regulated payment services firms who are looking to enter the banking market and offer deposits and lending to their current client base (including small SMEs), and others who are proposing to offer a mixture of SME or mortgage lending funded by retail and SME deposits."

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The review found that the new 'mobilisation' option (where authorisation is granted to a firm meeting primary requirements) had been helpful for firms that may previously have faced "challenges in raising ­capital or investing in ­expensive IT systems without the certainty of being authorised". Three of the five newly-authorised banks had used the mobilisation option.

In February Edinburgh-based Scoban became the first start-up bank to gain a licence, and will open its doors as Hampden private bank later this year. Founder and chairman Ray Entwistle said: "We worked very closely with people in these organisations and as a result we have a new Scottish bank."

Capital and liquidity requirements for new entrants are lower, and are set out clearly at every stage. Mr Entwistle said that had been "very helpful" in attempting to raise £40million for the launch of Hampden, adding: "We are getting very close."