* New banks increased lending by 16 percent in 2014
* New banks average return on equity better than 'Big Five'
LONDON, May 22 (Reuters) - Britain's new banks are achievingsuperior returns than larger rivals, picking up customersshunned by bigger lenders since the 2007-9 financial crisis,consultancy KPMG said on Friday.
Britain has seen the emergence of several new banks sincethe financial crisis, looking to pick up customers as biggerrivals slim down in order to bolster their balance sheets andmeet tougher regulatory requirements.
The KPMG report showed new British banks increased lendingby 16 percent last year, compared with a decline of 2.1 percentat Britain's 'Big Five' retail players - Lloyds Banking Group, Royal Bank of Scotland, Barclays,HSBC and Santander UK.
KPMG noted, however, that the combined loans of the fivelargest challenger banks are still equivalent to just 5 percentof lending provided by the 'Big Five' and it is therefore easierfor them to achieve higher levels of growth.
The research found that smaller 'challenger banks', such asMetro Bank, OneSavings Bank and the UK business ofSweden's Handlesbanken were growing at the most rapidrate, with larger challengers such as Virgin Money, TSB and the Post Office showing slower growth.
However, Britain's competition body, which is investigatingthe industry, has warned moves to improve competition have yetto have the desired effect.
"Although the overall 'challenger' banking sector is growingrapidly and securing greater returns, it is the smallchallengers who are driving its growth," said Warren Mead, headof challenger banking and alternative finance at KPMG.
The research showed that smaller challengers achieved anaverage return on equity, a key measure of profitability, of18.2 percent, last year. That compared with 2.1 percent atlarger 'challenger' banks and 2.8 percent at the 'Big Five'.
"If this trend were to continue, as the challengers grow andbenefit from economies of scale, it poses an interestingquestion for the 'Big Five' as to whether too big to failbecomes to big to compete," said Mead.
(Reporting by Matt Scuffham Editing by Jeremy Gaunt)