House of Commons Treasury Committee
Competition and Choice in Banking
Ninth Report of Session 2010–11
Volume II
Oral and written evidence
Additional written evidence is contained in Volume III, available on the Committee website at www.parliament.uk/treascom
Ordered by the House of Commons to be printed 24 March 2011
HC 612–II Published on 2 April 2011 by authority of the House of Commons London: The Stationery Office Limited £22.50
The Treasury Committee
The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.
Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) John Cryer MP (Labour, Leyton and Wanstead) Michael Fallon MP (Conservative, Sevenoaks) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross) Mr Chuka Umunna MP (Labour, Streatham)
Mr David Rutley MP (Conservative, Macclesfield) was also a member of the Committee during the inquiry.
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Competition and choice in retail banking
Witnesses
Thursday 18 November 2010 Page
Adam Phillips, Chairman of Financial Services Consumer Panel Ev 1
Peter Vicary-Smith, Chief Executive, Dominic Lindley, Principal Policy Advisor, Which?, Philip Cullum, Deputy Chief Executive, Consumer Focus, and Sarah Brooks, Head of Financial Services, Consumer Focus Ev 7
Tuesday 23 November 2010
Lord Turner of Ecchinswell, Chairman, and Hector Sants, Chief Executive, Financial Services Authority Ev 10
Tuesday 30 November 2010
Sir Donald Cruickshank Ev 21
Tuesday 7 December 2010
Eric Daniels, Group Chief Executive, Helen Weir, Group Executive Director Ev 30 and Patrick Foley, Chief Economist, Lloyds Banking Group
Tuesday 7 December 2010
Stephen Hester, Chief Executive, RBS Group and Brian Hartzer, Chief Ev 44 Executive, UK Retail Wealth & Ulster, RBS Group
Tuesday 7 December 2010
Benny Higgins, Chief Executive, Tesco Bank Ev 56
Tuesday 14 December 2010
Vernon W Hill II, Vice Chairman, and Anthony Thomson, Chairman, Metro Ev 62 Bank
Tuesday 11 January 2011
Bob Diamond, Chief Executive, and Antony Jenkins, Chief Executive, Global Ev 74 Retail, Barclays
Tuesday 18 January 2011
Jayne-Anne Gadhia, Chief Executive, Virgin Money Ev 98
Ana Botin, Chief Executive, Santander UK Ev 109
Competition and choice in retail banking
Thursday 20 January 2011
John Fingleton, Chief Executive, and Clive Maxwell, Executive Director, Ev 118 Office of Fair Trading
Tuesday 1 February 2011
Douglas Flint, Group Chairman, and Joe Garner, Deputy Chief Executive UK, Ev 132 HSBC plc
Neville Richardson, Chief Executive, and Rod Bulmer, Managing Director, Ev 142 Retail, The Co-operative Financial Services
Graham Beale, Chief Executive and Chris Rhodes, Executive Director, Group Ev 149 Product and Marketing, Nationwide
Wednesday 2 February 2011
Mark Hoban MP, Financial Secretary, and Alison Cottrell, Director, Financial Ev 158 Services
List of printed written evidence
1 Consumer Focus Ev 173 2 Barclays Ev 177, 261 3 Virgin Money Ev 180 4 Nationwide Building Society Ev 185 5 Which? Ev 191, 231, 267 6 Co-operative Financial Services Ev 207, 255 7 Tesco Bank Ev 212, 274 8 Royal Bank of Scotland Group Ev 214 9 Lloyds Banking Group Ev 218, 258 10 Financial Services Authority Ev 222, 253 11 Financial Services Consumer Panel Ev 230, 243 12 Sir Donald Cruickshank Ev 236 13 Office of Fair Trading Ev 239, 254 14 Metro Bank Ev 248 15 Santander Ev 259 16 HM Treasury Ev 263
Competition and choice in retail banking
List of additional written evidence
(published in Volume III on the Committee’s website www.parliament.uk/treascom)
1 Campaign for Community Banking Services Ev w1, w3 2 Unite the Union Ev w4 3 David Johnston Ev w6 4 Mr and Mrs Ralph Ev w7 5 Ian Kerry Ev w7 6 VocaLink Ev w7 7 Building Societies Association Ev w9 8 Kensington Mortgage Company Ev w13 9 Intellect Ev w15 10 Consumer Financial Education Body Ev w20 11 Payments Council Ev w23, w57 12 Yorkshire Building Society Ev w24 13 Paragon Group of Companies Ev w28 14 Toynbee Hall Ev w30 15 Association of British Credit Unions Limited Ev w32 16 Professor David T Llewellyn, Loughborough University Ev w37 17 nef (new economics foundation) Ev w42 18 Competition Commission Ev w47 19 Cut Loose Ev w52 20 eBay Ev w54 21 Callcredit Ev w54 22 Delta Economics Ev w55
Treasury Committee: Evidence Ev 1
Oral evidence
Taken before the Treasury Committee on Thursday 18 November 2010
Members present: Mr Andrew Tyrie (Chair)
Mark Garnier John Mann Stewart Hosie Mr George Mudie Mr Andrew Love Jesse Norman ______
Examination of Witness
Witness: Mr Adam Phillips, Chairman of Financial Services Consumer Panel, gave evidence.
Q1 Chair: Mr Phillips, I’d like to carry straight on without significant regulatory intervention, and I from our previous session, touching on some of the pointed out the role of a benchmark product in the points that you raised, or began to get into, in response pensions market, for example. I think in retail banking to earlier questions. In your submission you said that, there is a real question mark about whether the new “Structural change”, that is structural change to entrants will, in fact, be able to change the shape of regulation, “could be a stimulus for greater the market without significant intervention by the competition”. Can you tell us what this structural regulator, for example to make it easier to switch change is? accounts. Mr Phillips: Yes. The FSA has had a number of Chair: Let us come on to this in a moment because a objectives: financial capability, consumer protection number of us are going to be asking exactly these and the protection of confidence in the financial questions. system. Its concern with consumer protection, in my view, has not been at the level that it should be. One Q3 John Mann: You state there are barriers to entry of the most interesting things to me was that of the to the retail banking sector, you don’t tell us what they three managing directors of the FSA, until quite are. Would you like to? recently, one was responsible for supervision, one was Mr Phillips: Yes, surely. If you are a major bank one responsible for risk and one was responsible for of the great advantages is that you have a large branch everything else. Consumer protection was a subset of network. People need access to branches of banks at risk. In other words, one of their three major various times. You can do a lot on the internet but objectives did not have a managing director who was essentially it’s quite important to be able to get to see responsible for it. I believe that has led to a situation someone, just occasionally, especially if you’ve ever where they have not thought—until quite recently— tried to get through on the phone. So the big banks do enough about the role of a regulator in providing have an advantage in that they have those networks. effective consumer protection. That is the first problem. It is a problem which, for Since the beginning of last year they have focused example, Tesco doesn’t face because it has the much more on being an outcomes regulator. They’ve branches, but for any other new entrants there might looked at their effectiveness. They have moved into be an issue. this area called “conduct risk supervision”, which is You can see that in the work that the OFT did on about beginning to think about consumer protection, switching a few years ago, where switching of bank and I think they’re making good progress. But for that accounts with banks with less market share, was much progress to be maintained I think it’s important that higher than banks with a higher market share. The the governance body focuses primarily on their reason is that the banks with less than 15% market consumer protection objective. share tend to be on the internet, they tend to be offering good savings products and people will Q2 Chair: At the end of the last parliament, the therefore switch for the best rates. But when it comes Minister responsible for this in the Treasury said, in to where they do their transactional banking, it’s about Committee in the House, that he thought competition the accessibility of the branch. It’s very expensive to should be elevated to an objective of the FSA. Do you move and difficult to move your account if you have think it should? lots of standing orders. The banks make it very Mr Phillips: In our original submission to you, which difficult for you to do that. Those banks with big we put in about six weeks ago, we said we did believe shares tend to hold their customers. I think that is one that. I know we’ve done more work now and our view of the issues about barriers to entry. is it should be a secondary objective, not the primary Another issue about barriers to entry is that holding objective. The primary objective has to be—we phrase the database of how your customers spend their it more broadly than consumer protection—let’s say, money, how much free money they have, is a very for the purposes of this, consumer protection. The useful asset. I happened to have a bit of money in my reason for that is that in some areas of the market it account this year, because I have two children getting is hard to see how competition can be made effective married and I was going to give them wedding Ev 2 Treasury Committee: Evidence
18 November 2010 Mr Adam Phillips presents and pay for the weddings, and my bank Q6 John Mann: Compared to other sectors in the manager, who I have not heard from for about a UK economy, where would you place banking in decade, rang me up and said, “I see you have a lot of terms of competition and competitiveness? money in your account, I wonder if we can help you?” Mr Phillips: Some aspects of banking are very I said, “The reason is because my children are getting competitive. The issue for me is whether the married”, and he said, “Well, in that case, perhaps competition is effective in delivering value to the you’ll need to borrow some money. Perhaps they want customer. They may find it difficult to make a profit, a mortgage”. So owning that database provides an but that’s not quite the same as meeting the customers' opportunity to sell, and that’s also a barrier to a new needs and providing a value that people appreciate. entrant who will not be able to do that. As an example—you will be talking to others about this—the anecdotal evidence is that people don’t Q4 John Mann: I understand that, but what can be switch their account because they don’t think they’re done about those two? going to get better service from another bank. That Mr Phillips: I hope the Banking Commission is going suggests that there is a real problem here about to look at this—they are doing a much more effective competition. systematic piece of work than we are, I have to say— but I think that we need to look at this issue of Q7 John Mann: You talk about poor outcomes in transactional banking, of the utility nature of banking, your submission. Can you evidence which group of and the fact that most people are not aware what their consumers have suffered most from poor outcomes? bank account is costing them. Mr Phillips: I think that in the recent past, the people Again, the work the OFT did demonstrate that who have suffered most have been the people who foregone interest on accounts in 2006 was to the order have been in debt and who have found themselves of about £180 per account. They were unaware that missing a payment. For no reason their pay might go that was the money they could have got in interest. in a little late or they may have a standing order they Equally, they’re unaware of the cost of providing that may have forgotten. It has pushed them over the edge. account. Only if they fail to do something— They immediately have a significant bank charge, then John Mann: But those are separate issues from the they have a letter telling them they have a significant two barriers you raised. You raised data and the bank charge and so they have already spent nearly number of branches. How should those two be £100 before they can put it right. There is a lot of addressed? evidence that people who, once that begins to happen Mr Phillips: I think the data issue is almost to them, find it extremely difficult to get back to a impossible to address. I think you have to make it situation where they’re in credit. The work that the possible for new entrants to get into the market and Financial Inclusion Taskforce undertook demonstrated accept that they will then compete on their own terms. that the majority of people who don’t have bank Although it’s interesting that, if you make the accounts have previously had bank accounts, but don’t transactional service one where people can transfer— choose to have them now because they feel that as we do with mobile phones—to somebody who is they’re a trap. So I think that is the real issue. offering a better service, so it becomes easier to move your account, it may well be that we can change that Q8 John Mann: Finally, ideally, for the best behaviour. An example of that I would give is that, competition, how many more banks and how many talking to one of the new entrants, he said that his more building societies would we have operating in bank opens a new account within 15 minutes. If you the UK economy? What is your best guess on that? want to transfer your account it takes a month because Mr Phillips: In the UK we have six major banks who of all the standing orders and direct debit payments, dominate the market. Most of the building societies and they are very efficient. That transfer is extremely have quite small shares; they’re in this below 15% difficult to make. So for a customer who wants to level. Assuming that we do not forcibly break up move their account it’s quite hard work to do so and, some of the banks, which is a possibility, the only therefore, banks benefit. other route is to make sure that there are no major financial barriers to the new entrants— Q5 John Mann: I understand that, but you raised John Mann: Ideally, how many more would we have branches as one of the issues. What can be done to maximise competition? about that? Mr Phillips: I think we have enough already. The Mr Phillips: I don’t think anything can be done about issue there is that the market is very skewed towards branches. As I say, a new entrant who is offering their a small number of large banks. So there is competition services through an organisation that has existing at that lower end of the market share, but at the top branches, like a major retailer, will have the ability to end it is what I would describe as resembling an be available on the ground. It’s very good that Tesco oligopoly. They work together to have prices that are is coming in. I think they have that possibility. If you very similar, and deliver service that is very similar, look at Metrobank, they’re expecting to take between and therefore the consumer has no choice. now and 2020 to get to 200 branches in the south-east Chair: That’s a very serious observation, and I bring and they think that’s a very aggressive plan. The only in Stewart Hosie at this point. other thing that could be done would be to look at a break-up of some of the major retail banks. As I say, Q9 Stewart Hosie: That is twice now you’ve spoken we’re not in a position to do that work. I hope the about oligarchic banking, and your submission Banking Commission will have a look at that. highlighted specific problems in Scotland and Treasury Committee: Evidence Ev 3
18 November 2010 Mr Adam Phillips
Northern Ireland. Do you believe there are regional take you up to a month, because of things like moving monopolies or regional duopolies there? standing orders across, and this kind of stuff. You also Mr Phillips: I have no evidence of that. The point that have the slightly farcical money laundering rules that we were making was that in the UK you have six we have to comply with, which frankly are pretty major banks. In Scotland and Northern Ireland you tedious. So the regulator is effectively denying have four major banks. However, in Scotland the competition. That’s the first part about it. The second share of the two largest banks is enormous. So for part is that I’m hearing anecdotal evidence that when many people there is no real choice because they may anybody wants to set up a bank it’s taking them a year have to go to one of those two large banks, and when or two years to get regulatory approval. This is also you get a situation like that there is a tendency for the something which is holding up competition. Do you companies involved to be uncompetitive. I think that’s think that’s a fair criticism? the best I could say. Mr Phillips: It’s worthwhile spending some time checking out the people who are going to be running Q10 Stewart Hosie: Is that the only worst outcome a bank. If it takes a year—two years does sound like from Scotland and Northern Ireland being a long time—but if it takes a year that may be a wise uncompetitive, or— investment to make sure that these people know what Mr Phillips: The lack of competition means that it’s they’re doing. expensive for the citizen to get banking services, and the range of products that are made available to them Q13 Mark Garnier: It is quite an expensive lead-in may be restricted. Those are the risks that they run. time for that person who is trying to— Mr Phillips: The real cost is in creating the branch Q11 Stewart Hosie: Let me ask this question in a network; is in putting in the software systems; is in different way. We hear that story a lot in relation to raising the capital. So I agree with that, but I think my SME lending. It’s a huge issue that every MP has. view would be—I don’t know enough about the detail But in Scotland right now Lloyds have the disposal of it—that a reasonable amount of time to inspect the programme; there is a possibility of the recreation of skills’ ability and knowledge of the people who are the TSB; Bank of Scotland is operating as a stand- going to be doing that is a good thing to do. I’m sorry alone bank with high lending decisions taken locally; I forgot your second question. RBS have the disposal programme; HSBC have Mark Garnier: The second point was to do with employed a chief executive in Scotland; Virgin Money things like the money laundering reporting rules— at Tesco Bank is bringing in a lot of jobs; and Mr Phillips: There are two things: you have rules and Clydesdale Bank’s assault on the market is very the application of the rules, and we have consistently aggressive indeed. Is not much of the problem that the argued that the way the rules are being applied is SMEs in particular are too dependent on bank lending unnecessarily onerous. Although they are much lighter and there is no access to other equity outwith the retail than they were companies still—for reasons to do with banks, and it isn’t really a competition issue at all? staff training and risk—tend to failsafe, so they tend Mr Phillips: You’re specifically looking at SMEs? in default to do things that they don’t necessarily have Stewart Hosie: In particular, because that issue we to do, and I think that’s unnecessary. get a lot. Mr Phillips: Yes. I think what I would say about Q14 Mark Garnier: I also wanted to pick up on your company lending—and this is not my special area— example of when your daughters were getting married is that there is a general lack of finance, at that sort of and you had some money coming into your bank. This medium level of risk, available as a whole. At the sort of data isn’t just about banking; it’s also about moment it is in extremely short supply. The situation things like IFAs, insurance companies, and all this is unusual at the moment. We are not normally quite kind of stuff. It gives them a monumental advantage. so short of liquid funds, which can be lent to If you were to talk to the average IFA they are quite companies who want to borrow; and, quite reasonably, unhappy about the fact that a bank will be the banks who are trying to de-risk their balance sheet undermining them because they know exactly what are much more willing to offer it to people, like me— your habits are. as I said—when I’m thinking possibly my children Mr Phillips: There is an issue here—which, again, I might need a mortgage, than to me running my hope the Banking Commission will think about— consultancy business, where there is no chance they’re which is that if you think of the English pub about 25 going to lend it to me because I do not have a solid years ago, you could have any beer as long as it was asset, in the shape of a house, to put up against it. So the beer the brewery made. So if you wanted a pint of it’s a slightly unusual situation at the moment. It’s not bitter and you wanted Bass, you went to a Bass pub. just about lack of competition. It’s also about lack of If you wanted Pils you went to a Watney pub, because risk capital being available. they were the only people who sold it. If you wanted both, you had to walk up and down the street and Q12 Mark Garnier: I just wanted to follow up on decide where you wanted to be. The separation of the John Mann’s line of questioning on barriers to entry, retail outlet from the provider had the effect that and just develop a couple of these themes. The first immediately the retailers brought in the things that one that I wanted to look at was the role of the people wanted into their outlets. regulator, in terms of things like switching and in I think if we look at the bank-assurers as being highly terms of setting up other banks. You talked about the integrated, the focus of the business is not purely on fact that if you want to switch account it’s going to the customer, it’s on the business, which is an Ev 4 Treasury Committee: Evidence
18 November 2010 Mr Adam Phillips integrated business of producing the product and about the six major banks dominating the core branch selling the product. There is a real issue that an network. You simply cannot replicate that. But, one effective retail bank is a bank that depends on its of the things that major banks have lost is that local customers, sees its customers as a long-term asset. knowledge. In Kidderminster you have the big banks, With the movement from defined benefit to defined but they’re referring back to some bloke in Lombard contribution schemes people are now looking for a Street in order to find out what they should or different kind of product. They’re looking for a long- shouldn’t be doing. Do you not agree that one of the term relationship in the area of advice. So there is a ways forward is that the regulators should encourage real opportunity for a change in the market where the setting up of local banks in districts or towns or people want a retailer. counties, or whatever, which cater to the people and the businesses within that local area? Q15 Mark Garnier: But are banks going to give Mr Phillips: That’s one way to solve the problem. We this? I think this is an important point. A bank is going did some research on fairness, which we published to do two things: first of all, it’s going to sell its own relatively recently, and one of the things that people product first; and secondly, it’s going to sell a product. wanted was someone to talk to. There are situations If your bank manager had been really smart he might where you want to talk to somebody. If you talk to have phoned you up and said, “I see you have”—I people who have been in retail banking they will say don’t know how much money you’re spending on that the demise of the professional bank manager was your daughter’s wedding, but let’s say £5,000— a real problem; that dealing with a call centre, having Mr Phillips: If only. someone who doesn’t know anything about you Mark Garnier: The good advice would have been except for what comes up on the computer creates real possibly, “You have £5,000 on your credit card. You problems. But this is to do with the removal of costs need to pay this off first”. But he’s unlikely to do that. from the system because there isn’t any benefit in He’s more likely to say, “You need to buy my bank’s providing the additional service. That’s a very strange saving product”. Or, “You need to buy my bank’s issue, and I think it comes from this lack of effective overdraft product and not pay down the credit card competition. Somehow it seems very difficult for debt on my bank’s credit card product”. banks to provide a better service and stay in business. Mr Phillips: Because he is looking at the product that the bank is trying to sell. If he’s looking at building Q18 Chair: Can I just take you back to what you the customer relationship, because of the value of the said earlier. Did you say that there was evidence of an customer, he might well tell you to pay down your oligopoly or oligarchic behaviour? credit card debt, because he wants you to be a good Mr Phillips: I will be very careful about what I say, customer. but what I said was— Mark Garnier: But he hasn’t spoken to you in 10 Chair: That is why I’m asking you to have another years. The only reason he has phoned you up in 10 go. years— Mr Phillips:—there appears to be an effective Mr Phillips: Is because he’s come up with a red flag monopoly operating, in the sense that people need on his computer; absolutely. utilities— Mark Garnier: Which sounds to me like incredibly Chair: The operation of a monopoly is illegal. bad banking. Mr Phillips: Yes, and it doesn’t— Mr Phillips: That’s what we have. Q19 Chair: Have you had a word with the OFT Q16 Mark Garnier: So how are we going to stop it? about this? Mr Phillips: It comes back to the objectives of the Mr Phillips: Yes, I know. I am trying to find a way of managers. If you listen to somebody from Tesco or explaining a behaviour that appears to me to provide Asda, they talk about, “Our business depends on our a very consistent and similar level of service across customers. If our customers don’t have a good all banks. All banks provide free banking services— experience they don’t come to our store, they go to Chair: These things can happen by a happy accident the people down the road. We need to stock the from the point of view of the bank, but if there is any products they want. We need them to be able to park operation, if there is any design behind this— in the car park. We need to be open when they want Mr Phillips: I have no evidence that there is any us. We need to solve their problems and, if necessary, design behind it at all other than that, in this industry, we replace the product because we want to keep the people tend to copy each other’s behaviour. relationship”. None of that happens in a major bank. Chair: You have not had a word with the OFT? What they want to do is move the product they want Mr Phillips: I haven’t had a word with the OFT. to do. This is why the SMEs have a problem, because they’re not thinking about building the business in Q20 Mr Love: My question relates to what we’ve their community. They’re thinking about what their been discussing here, but in a sense it’s a matter of lending requirements are and whether they want to principle. Under the Financial Services and Markets suck in money or push it out again. There is a lack of Act, the FSA had to have regard to competition. I engagement with their customers. wonder whether we should consider that, in the future, the regulator should have regard to diversity. By Q17 Mark Garnier: The American model is one “diversity” I mean large and small, regional rather where you have a lot of small banks in towns, and than national. But, in my particular interest, what I’m this kind of stuff. You make a very important point mainly focused on is mutual and co-operative Treasury Committee: Evidence Ev 5
18 November 2010 Mr Adam Phillips structures, as well as the more conventional financial shape of the u-curve? Or are the banks making that services. Is there any merit, from a consumer’s point up when they tell us that? of view, to having that as something that they should Mr Phillips: There are a lot of older people who rely have regard to when they’re overseeing the on their savings and they are finding it very difficult marketplace? to get any decent return on their savings. To the extent Mr Phillips: It’s a very interesting suggestion, which that there is money coming into the system, you we haven’t thought about. I think there could be would have thought that it would be possible to pay a considerable benefits in that, yes, just as you put it to higher interest rate. So the exact mix of what is going me. But as a panel we haven’t thought about that. But on in the market—as I say, this is not my area—but the requirement to maintain or endeavour to maintain Lord Turner would be a good man to ask. diversity in this area could be a very interesting requirement. Q26 Mr Mudie: Mr Phillips, could I say I’m disappointed with your evidence, in that you’ve given Q21 Mr Love: Let me just act as devil’s advocate. What would be the argument against it? Whenever us 2½ pages on this; Which? have given us 26½ and this has been raised before it is always suggested that you have 7½ on the previous subject. Why is it so you don’t want to place too many responsibilities of short when it’s dealing with a key subject for that nature on to a regulator. Do you see that as consumers? something that would cause you to have second Mr Phillips: I think that we would— thoughts about that? Mr Mudie: In terms of competition and choice in Mr Phillips: I don’t think that would be a problem. I banking, do you think this is strong enough for the think the real issue is that where you do have within Committee? Are you treating it less importantly than an Act “have regard to”, it is essentially to draw the it should be treated? attention of the organisation to things it needs to take Mr Phillips: No, I think what we were trying to do account of. We’ve seen the FSA—who has was raise the major issues for you so that you were in considerable powers in the area of competition— a position to understand where we were coming from. failing to use those powers in the past. So, “having You have the opportunity to ask me questions, which regard to” draws their attention to it, but it doesn’t you have done, and to the extent that you want more mean that they have to do it. information we would be quite happy to provide it.
Q22 Mr Love: Can I ask you about the interest rate Q27 Mr Mudie: From your organisation, I think margin? Where are we? Is it at record levels? you’d expect more and I’d welcome you putting in Mr Phillips: It’s a very good spread at the moment; more evidence. We have just started the inquiry, and absolutely. we’re starting the inquiry speaking to consumer Mr Love: Is it at record levels? representatives. It is an opportunity for you to put the Mr Phillips: I don’t know whether it’s at a record problems on the table, so that when we meet the level but it’s certainly higher than I’ve ever seen it. bankers themselves we have spoken to you in depth and you have had the opportunity to put everything Q23 Mr Love: What are you as an organisation you need on the table, and I’m disappointed you doing to highlight that, because I would assume that haven’t. it’s contrary to the benefit of consumers, and what But one of the things you did put on the table—and should we be thinking about? Sorry, does its being so I’d like you to convince me of—was free banking. high reflect a lack of competition in the sector? Why are you so in favour of free banking? It’s almost Mr Phillips: It would have been better to ask my the one thing in your paper that you pull out and it friend Ian Cornish what he thinks about that, because seems to me extraordinary. he is chief executive of a building society. I would Mr Phillips: The problem with free banking is that it hesitate to say that it is a lack of competition in that respect, but it is quite clear that, historically, the is notionally free, so it’s not actually free. The effect spreads are bigger than they have ever been and we of that is to favour certain kinds of people against would expect to see them come down as interest rates others. To give an example, the provision of basic begin to go up again. If they don’t come down, I think bank accounts to people who need a basic bank there has to be a real issue here. account in order to survive, costs banks money. They provide that “for free”. In fact, to the extent that Q24 Mr Love: Let me put it to you another way: are those people— the authorities turning a blind eye to the need of the Mr Mudie: Or they don’t provide it and that’s financial services sector to rebuild capital, at the another problem. expense of benefit to the consumer? Mr Phillips: That’s right. So our view about this is Mr Phillips: I don’t know whether they are. It is the that if we are going to have an effective transactional case that those spreads are very high and I could not market for provision of financial services we are going say any more than that, but it’s certainly a question to have to look very hard at this “free market”—the you could ask Lord Turner when he comes before you. free provision of banking—because there is a real risk that banks will not provide that service. There is no Q25 Chair: Isn’t part of the reason for the wide formal agreement by which people have a right of spreads the cost of borrowing for banks caused by the access to a basic bank account. It is a voluntary Ev 6 Treasury Committee: Evidence
18 November 2010 Mr Adam Phillips agreement. There is a cost associated with it and it is Q30 Chair: That would be extremely helpful. In your important that those costs are understood and are evidence you say, “Lack of transparency about interest shared. That could be a cost that the individual has to foregone on current accounts and the difficulty of pay. It may well be that if you’re on benefits that that establishing the total cost of a current account work would be something that would be taken account of. against customers making a rational decision”. I think It would provide much more clarity when it comes to most people around this table would agree. You are in people looking at the value of bundled bank accounts, a uniquely strong position to have done a bit of where they’re getting a built-in insurance coming number crunching. Do you have any idea how much through or some benefits, other benefits. you are paying for your account? Mr Phillips: No. Q28 Mr Mudie: I hope—and I would like you to Chair: Don’t you think it might be something to take persuade me—that by advocating this you’re not a look at? handing the banks another opportunity to put another Mr Phillips: Yes. When I say that, it’s very hard to charge on, the front door charge. They have put find out. enough non-transparent charges on; everything we do, we are accounts. Why would this be a guarantee that Q31 Jesse Norman: Between free competition and suddenly transparency would take place and outright collusion there is an interesting intermediate competition would take place? It just seems to me it area of price signalling between players, and you’ve would be two things. There would be another charge mentioned some of the behaviour of economic effects. straight up. It might be the only charge you get put Do you think there might be some price signalling transparently to you. It might be, if you’re suggesting going on between the providers, which would explain a competition takes part over that, that it’s a minor why many prices have seemed so high, both in the victory for consumers. But secondly, we are trying to wholesale and the retail markets? persuade people. We are trying to persuade the banks Mr Phillips: Again, I think where you get a market to give them basic bank accounts, and we’re trying to with a small number of players the risk of that exists. persuade people to take them up. Tell me why it helps I look across what the charges appear to be; the both matters? Isn’t it just handing the banker behaviours are very similar. something they don’t need, a blank cheque? Jesse Norman: So your suspicion would be this is Mr Phillips: If that is all we do, then that is exactly happening here? what it will do. The issue here is that the reason we Mr Phillips: What I said before, I stand by, which would be doing it would be to change the banking is in this industry people copy each other. So when sector and the way it works. somebody does something that seems to work, people copy it. If you look at PPI, one of the big problems Q29 Mr Mudie: I accept that. But that’s what I’m about PPI was that once one organisation could see a saying about your evidence. Why didn’t you go into lot of money could be made from it other people things that Which? go into—all the ways the banks copied that. I think in the future one of the jobs of the are fleecing their customers: with charges; there’s no regulator will be to stop that copying happening. transparency; there’s not even knowledge; there’s no Chair: That was extremely helpful evidence you have argument; there’s no discussion. given this morning. We are very grateful, and you can Mr Phillips: We did submit evidence to the Which? sense our interest in this subject in our thirst for more. banking commission, quite extensive evidence, more Indeed, a number of us—I was a bit surprised for a extensive than we’ve submitted to you. Their report is moment—are asking for a lot more written evidence, a very good report. There is no reason for us to but we certainly do need it. duplicate that work. We’ve referred to it in our Mr Phillips: I have made some notes. evidence to you as being a very good report. We’ve Chair: There are a number of things on which it quoted from it. So I think at that level we would say would be helpful if you could come back to us. that we agree with virtually all of their conclusions, Mr Phillips: I have certainly made notes but if and we’ve been quite clear about the ones that we somebody could tell us exactly what you want. think are most important. The provision of free Chair: The clerks of the Committee will be in touch banking services is a very complicated area, and we in due course. Thank you very much indeed. We’re would be willing to come back with more evidence in going to take a three minute break and then carry on this very specific area. with the next session. Thank you very much. Treasury Committee: Evidence Ev 7
18 November 2010 Mr Peter Vicary-Smith, Mr Dominic Lindley, Mr Philip Cullum and Ms Sarah Brooks
Examination of Witnesses
Witnesses: Mr Peter Vicary-Smith, Chief Executive, Which?, Mr Dominic Lindley, Principal Policy Adviser, Which?, Mr Philip Cullum, Deputy Chief Executive, Consumer Focus, and Ms Sarah Brooks, Head of Financial Services, Consumer Focus, gave evidence.
Q32 Stewart Hosie: On competition in particular, the there is precious little competition. If you look at PPI, retail bank market contains a number of distinct for example, I don’t think there is a great deal of segments, there’s mortgages, there’s a bit of financial variation in either the terms of PPI or the pricing products. Do you view competition as ineffectual charged. It was driven by the levels of commission across the whole sector or are there bits of the and Alliance & Leicester salesman received, I believe, segments within it where competition works well? something like six times as much commission for Ms Brooks: I think there are sections where selling a loan with PPI as selling a loan without PPI. competition works better than in others, but I think Surprise, surprise, they sold an awful lot of PPI. it’s more a question of where competition doesn’t That’s what I mean by rivalry. There are lots of work well that I could look at. If you’re looking at products available and precious little transparency. It low-income consumers, that is a big issue. Banks have is very hard for consumers to compare them one to not traditionally seen low-income consumers as a another and, as a consequence, consumers think, group of people that they need to compete for, and “Everything is the same. What is the point of that’s a big problem because, as we know, banking is switching, because all these banks are the same?” now an essential service. There is very little you can which they’re not, but that’s the perception people do. If you don’t operate a current account, our have, and therefore there is no need to genuinely research on the margin shows that you are excluded compete. It is a much cosier industry than the BBA from being able to set up direct debits; you can’t buy would like to portray, and certainly—if I can just online; you can’t have your wages paid in if you don’t finish—one of the things we often talk about is if have a bank account; you can’t buy insurance products banks are genuinely competing, why do they spend all or pensions. So it is important that people do have their time talking through the mouthpiece of the access to a full range of financial services, but banks BBA? I used to work at Procter & Gamble. Procter & have traditionally shied away from this market, and Gamble would not dream of sitting on an association that has led some other operators to come in. We with Unilever producing a joint formulated response. talked about payday loans earlier, because some of the Tesco and Sainsbury’s and Asda wouldn’t dream of banks are not willing to be flexible with the way they doing the same, yet in this industry, it is all very cosy operate their bank accounts because bank account and everyone sits behind and we have the lowest charges are so non-transparent. That has led people to common denominator of the BBA, which represents go to a market, which has APRs of 2,000%, which the view of the industry. That’s a sign of rivalry, to then leads to calls to clamp down on that. The issue my mind, not cut-throat competition. around competing for the lower-income consumer is that there doesn’t seem to be enough choice. The Government had the opportunity to use the Post Office Q34 Stewart Hosie: You have spoken about a square as a way of increasing competition, by setting up Post dance. You have said “cosy” twice. Is there collusion, Office banking. Now they’ve closed that down. But or is it just pricing? what they have done, quite excitingly, is to open up a Mr Vicary-Smith: I wouldn’t want to get into the possibility that credit unions could come into Post legalities around it. I don’t think you need to have Offices in a greater way than they already do. There’s anything overt in what goes in the market. It’s already access to credit unions at Post Offices, but interesting, isn’t it, that unauthorised overdraft rates there is a possibility that the Post Office could form are at over 18% now, which is the highest they’ve their own credit union and that could have a current been for 15 years, so all of the competition of banks in account there. I think that would be a good way of response to the OFT court case, changing their terms, introducing a new competitor. The Post Office has changing their rates, coming out with new deals, all about 12,000 branches, so if there were moves to the rest of it, hasn’t made a blind bit of difference to encourage competition for the lower end, that would what the consumer actually pays. So I have no certainly open up the market. evidence there is any collusion that went on in those, but the net effect to the consumer at the end of it is Q33 Stewart Hosie: I’m sure that’s something the no difference. Chairman has heard, because there is a huge range of financial products the bigger credit unions operate, Q35 Chair: Consumers know the price of a bottle of compared with the very basic things that the smaller shampoo from Procter & Gamble, and they have a ones do, and there is some real competition there as rough idea of what the rival prices are of most of the well. The Which? independent banking commission products Tescos sell. They haven’t in banking, and concluded that the retail market was characterised by suggestions on how they get closer to that are rivalry between the firms, rather than competition. gratefully received. Can you explain the difference? Mr Vicary-Smith: One thing the supermarkets have Mr Vicary-Smith: It is where you have a number of done is of course when you go to buy your products, people who are doing a different square dance of under the price it will say, “Price per 100 ml”. appearing to compete with each other, but in practice Chair: Yes, but we don’t know what the— Ev 8 Treasury Committee: Evidence
18 November 2010 Mr Peter Vicary-Smith, Mr Dominic Lindley, Mr Philip Cullum and Ms Sarah Brooks
Mr Vicary-Smith: They make it very easy to compare can’t believe that, then that puts you in a very difficult and the banks don’t. position. So what we see, and what we always say, is Chair: Well, what we need are suggestions on how to that loyalty seems to be very much a one-way street enable the banks to do it. The OFT are looking at that, with banks; that they will presume on that, but they lots of other people are looking at that. don’t offer it the other way around, and I do think that Mr Vicary-Smith: We’ll submit an— it should be incumbent on banks that if they want to Chair: I’m sorry to be rushing, because I know a capitalise on that loyalty, then we need to see much number of colleagues have already signalled to me more evidence that they are offering the right products that they need to get away today. and the right advice to their customers. On of my colleagues used to work in a law centre, Q36 Mark Garnier: I just want to follow up on and she had cases where adults with learning another question with a previous witness about the big disabilities would come in and there would be charges banks’ access to huge quantities of data about their that they couldn’t work out on their bank accounts. It customers, and how this relates to competition with was because they’d been sold a bundled account, so independent financial advisors, mortgage brokers, that they’d been sold an account where you had to pay a kind of stuff. You know that if you are a customer of fee on it. Now, that is not only wrong, it should be a bank and you pay in some money into your account illegal that you can take advantage of people in that and you have a lot of money floating around, your way, and these are not isolated occasions. So going bank manager will get in touch with you suddenly out back to regulation, it is about reputation regulation. of the blue. As the last witness said, for the first time We’d like to see the FOS doing more of that, more of in 10 years, you get a telephone call from a bank the putting out cases, but also the FSA taking action manager, who would then like to sell you a product. to make sure that the customers are treated fairly. There are two points about this that I’d like you to Mr Vicary-Smith: Two points: I think first of all you comment on. First, the banks obviously have this are absolutely right on information, which is why it is access to this data, which is not available to a bit rich when banks complain about the cost of everybody else, and they are using that, to my mind, running a personal current account, because, apart unfairly. The second point is that they are selling a from the £8 billion a year that they get and the fact product, and that product is not only going to be their that retail banking was profitable right the way own product and not one from a wider pool, but it through the crisis—so it is not an unprofitable stream will also be something to buy, and in many cases, one anyway—they get an enormous amount of data that of the best ways you can save if you have a pile of they can use, as you say. If I was looking at it as cash coming into your bank is not to buy a savings a businessman, I’d probably be quite happy to have product or a pension product; quite often the best way personal current accounts almost as a loss leader, of saving is to pay off your 25% credit card debt, because of all the other things that it enables me to which of course will be the bank’s product as well, so do. So we don’t have much truck with them they do not want you to do that. Do you have any complaining about the profitability of current account comments about how we can deal with this or whether banking. you see this as a big problem? Sarah, you’re nodding On the other dimension of what you get sold, you’re vigorously. absolutely right, that often paying down debt is the Ms Brooks: I’m nodding, because we’ve recently best form for many people of using windfalls. When done some research into switching rates on personal you’re then sold a product from your bank, as we current accounts and it is relevant to your question, argue strongly—this is one of the disappointing because only 7% have switched in the last two years, and that compares with energy at 32%, and 17%—so aspects of the retail distribution review—the bank 8 million people—had considered switching, but then sales staff should be called “sales staff”, not didn’t do it. So those 8 million who thought, “Oh, yes, “advisors”. “Restricted advisors” doesn’t do it for me this might be a good idea” didn’t do it, and why was either. They’re not giving advice, they’re selling a that? They were concerned about how complicated it product their bank happens to make and I think we might be; they were concerned about things going should be clearer with consumers about who is giving wrong, and also they were concerned about things like advice and who is making a sale. Finally, one of our credit rating, because your time with the bank can recommendations to the Future of Banking affect your credit rating and that seems to me to be a Commission was that we believe that frontline bank very anti-competitive move. staff should not be remunerated on the basis of But the other factor is that there is a huge amount of commission, because we see the enormous distortions brand loyalty, so of the people who hadn’t considered time in, time out that that has caused in the it, it was because they were satisfied with their bank, marketplace. and I think it’s because people have very low expectations of what banks should do. But also I think Q37 Mr Love: Let me ask about unarranged it’s something to do with the fact that your bank is so overdraft facilities and the OFT. The first question— important to you. It’s how you pay your mortgage; it’s and this is one that we hope that you’ll be able to how you put food on the table; it’s your line of credit. respond to—if the case had been won, would that You might have your pension with them, so in a way, have meant the end of what they call free banking? they have you to ransom there. It’s almost a sort of Secondly, the OFT has suggested a way forward that form of Stockholm syndrome, where you want to hasn’t met with universal approval. What’s your view believe that you can trust your bank, because if you on how we can take these matters forward? Treasury Committee: Evidence Ev 9
18 November 2010 Mr Peter Vicary-Smith, Mr Dominic Lindley, Mr Philip Cullum and Ms Sarah Brooks
Mr Vicary-Smith: Well, first of all, you’re absolutely control, and it’s one of the things that comes out again right in the distinction. We always call it free in-credit and again with all of our research of disadvantaged banking to differentiate it. I don’t think it would have consumers. The real market failure here is the failure meant the end of that, no, because what we’ve seen of banks to pay attention to their customers, to listen is that current accounts are already highly profitable to what they want from some of these accounts and ventures—50% of the £8 billion, I mentioned earlier, then provide it, and hopefully make some money out is from interest foregone. It’s not from other types of of it. That’s what they’re in the business to do. We are charges anyway, so there are many ways that banks bewildered at times by their failure to act in their own can make money and make current accounts self-interest and, as we listen to these customers and profitable, as they should be. We have no problem potential customers, the big thing that comes out from with current accounts being charged for in some way, our research is that people want to have control, if and people are paying for it now and they would pay they’re not used to financial products particularly, and for it in the future. The models may change and we’d yet the ones that banks provide just don’t provide like to see a variety of ways that people can pay for them with that control. We then end up with the their banking, but if the case had been won, some bizarre paradox where people who don’t have very banks would have changed, some banks would not. much money pay more for products that they perceive give them more control, and so they’re turning down Q38 Mr Love: Miss Brooks, you mentioned earlier the ones that are cheaper, because they don’t think it’s on about low-income consumers, vulnerable doing the business for them, and that is a really clear consumers. It raised with me the question of where market failure on the part of the banks. we go now with the decisions that have been made in relation to the Post Office. It doesn’t seem to me Q39 Chair: I’d just like to put one question about there’s been entirely a market failure. Basic bank UKFI to Peter Vicary-Smith. You’ve suggested that accounts are out there, there has been quite a lot of UKFI should apply a public interest test to secure take up. I notice from your submissions that you’ve greater competition in the market and the decisions redesigned—if I can call it that—the basic bank they take on divestment. Could you explain how that account. Will that make a difference and do we need would operate in practice? to bring regulation into this to, in a sense, put more Mr Vicary-Smith: UKFI of course has competition as pressure on the financial services sector to respond to one of its objectives, but looking through what it the needs of low-income consumers? How do we deal actually does, I see scant evidence that anything that with this going forward? it’s doing is increasing competition in banking. The Ms Brooks: It relates to a certain extent to the prime example of that of course was the sale of the previous question about unauthorised overdraft fees, RBS branches and payment centre to Santander, because if we could resolve that situation, so that the which could have been used to kick start a new player fees were transparent and people knew and they were in the marketplace. The public interest test I reflective, then people could understand what they mentioned would be to say, in looking at the future were getting into. A low-income consumer doesn’t disposals in particular, and of course, we all have in necessarily just need the most basic banking, they still mind the Lloyds branch disposals that will be coming need access to the full range, but what they need to up, it should not just be a matter of looking for the be able to do is to control money coming in and absolute highest price. It needs to get a good return, money coming out. If there were more regulation but not the £1 more than the nearest bidder. It should around the overdraft facilities, but also if there was a also be saying, “What is this going to do to way that people could control their own direct debits, competition within the banking sector, and is it going so that you could control the date it was going out, to enhance competition?” because we have a once in you could cancel it yourself, so you had a sort of joint a generation opportunity to increase competition mandate on direct debits, that would allow low- through enabling a new entrant to get to scale quickly income consumers to have more control of what they through these disposals, and it would be tragic if we were doing. So I think it does require some regulation. didn’t use that opportunity and instead flogged it off Not everybody who goes in wanting a basic bank to one of the existing incumbents. account comes out with one, and that should be Chair: Well, there is a great deal that has struck a looked at as well, so that people aren’t being sold the chord with many of us that we’ve heard this morning, wrong products for them, as I alluded to in my and I’m very glad that the session ran on a little longer previous answer. so that we could hear some more. If there are further Mr Cullum: Just to add to that, one of the key things points you want to come to us with, please do. Thank that Sarah’s alluded to a couple of times is about you very much for your evidence this morning. Ev 10 Treasury Committee: Evidence
Tuesday 23 November 2010
Members present: Mr Andrew Tyrie (Chair)
Mark Garnier Mr George Mudie Stewart Hosie Jesse Norman Andrea Leadsom David Rutley Mr Andrew Love John Thurso John Mann Mr Chuka Umunna ______
Examination of Witnesses
Witnesses: Lord urner of Ecchinswell, Chairman, and Mr Hector Sants, Chief Executive, Financial Services Authority, gave evidence.
Q40 Chair: We will begin again slightly Q44 Chair: Are you talking about in terms of size? shorthanded, but I am sure we have enough of a team Mr Sa ts: In terms of size as opposed to general here to ask some reasonable questions on this very capital and liquidity and other measures of important subject. investment practice. Could you begin, Hector Sants, by telling us whether you think the retail banking market in the UK is Q45 Chair: In terms of market share and sufficiently competitive? concentration, then? Mr Sa ts: I think it is a difficult question to answer. Mr Sa ts: Yes. I don’t think that their market share The following things are certainly true. It is obviously and concentration is a barrier to the disposal of the one of the more concentrated retail banking markets stakes in them, no. that you find around the world. It is not the most concentrated, like Canada and Australia, but it is Q46 Chair: Have you discussed this personally with clearly one of the more concentrated and it the OFT? undoubtedly has a couple of institutions with some Mr Sa ts: Not in detail. very significant shares of the marketplace. So, it is a concentrated one. The question then is, is it Q47 Chair: Was that a yes or a no? nevertheless a competitive one and are the consumers Mr Sa ts: Not in any formal sense. I have informal deriving all the benefit they could from that meetings, I am sure you appreciate, with the OFT all competitiveness? Of course that then leads us into the the time. On a personal level, you would expect me problem—and Adair can expand on this—whereby to do that, in terms of co-ordination. We, of course, the fact that in financial services it’s not immediately have general discussions, but not in a formal sense, obvious that conventional competition is always no. allowed to work to the advantages of the consumers in a straightforward way, not least because of the Q48 Mr Mudie: I read your evidence, maybe it was asymmetry of information between the consumers and late at night yesterday and I was ready for sleep, but the providers and the complexity of the products I could not, from paragraphs to 8, decide what being offered. you were trying to tell us about free banking. Are you for it or are you against it? Is it a barrier to Q41 Chair: Do you think we need structural reform competition? Have a look, Hector, and remind to reduce concentration? yourself what you have written to us. Mr Sa ts: I think there is a credible argument to be or ur r: I think it probably is the case that free made that some benefits would accrue from reduced if in credit banking does create a bit of a barrier to concentration in certain areas, whether you need— new entrants, because it’s important to realise it is not just free if in credit, the current account in itself is probably for many customers loss making or Q42 Chair: That is a pretty guarded reply. It would marginally profitable. It is essentially a loss leader. It be helpful to have something clearer on that. is just a classic loss leader, or at least low-return Mr Sa ts: I think, on balance, yes. The question is leader, which banks provide in order to get hold of a whether we need structural reform to achieve that, as relationship on which they can then sell other opposed to whether that could be achieved by the products. There are two problems that follow from passage of time, and we are seeing some more that. One is that because of that there is a desire for entrants into the sector. I think you could achieve it in them to sell other products, including sometimes both ways. products that are not appropriate, and that is where we get some of the problems from aggressive selling, Q43 Chair: Do you think we can privatise the because they’re trying to make up for the low holdings of the nationalised or part nationalised banks profitability of the core product. It is also the case that in their current form? a loss leader product, almost by definition, makes it Mr Sa ts: Not in their current form at this very more difficult for new entrants to come in, because precise moment. they can’t make profit just out of the core product. Treasury Committee: Evidence Ev 11
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants
They have to immediately be able to cross-sell other or ur r: No, not at all. I am just saying it’s products as well. The structure is probably something necessary but not sufficient. that tends to make it more difficult for new entrants to come into the market. There are other important Q52 Mr Mudie: You have brought packaged barriers to new entrants, however, which I notice the accounts into these paragraphs. Why are they OFT have also set out in their recent report. relevant? or ur r: They are almost a further step in this Q49 Mr Mudie: Let’s stop it there. Hector has had process of having a product where other things are enough time to read the report. added on. Here there are sometimes explicit charges There is one thing you don’t mention that we got from for it, which then add other products on. These are our first evidence session. An important thing you’re sometimes products that the consumer doesn’t leaving out lies between the person walking through necessarily need, but they are tempted to take on the front door, free, being able to open an account and board because it looks like an attractive combination get on to insurance and mortgages and so on, and the at the time. Wherever we see complex combinations £8. billion the banks charge opaquely to customers of things, the ability of the customer to understand for things like overdrawing on cheques and so on. where they are getting value is sometimes degraded. They broke it down: £ .1 billion was interest forgone, We are clear that packaged accounts can be a valuable with a small amount they pay on their accounts. They part of the system but we know that, for instance, make £ .1 billion out of that and they make £ .3 we’ve had major problems where people package billion out of charges. If you left free banking alone, payment protection insurance with a loan and don’t the free entry, but you got stuck into these hidden make it clear to the purchaser that they have an opaque charges that the banks make so much money absolute right to take one without the other. Package from, wouldn’t that be a very good area of combinations are among the mechanisms that competition? sometimes end up with consumer detriment, but not or ur r: When you say “stuck in”, you mean always—they can sometimes be good product regulate or control? Yes? combinations as well. Mr Mudie: Whichever you choose. Mr Sa ts: It’s all in the same space as you’ve already or ur r: This is an issue that we’ve discussed at alluded to. The packaged product is a perfectly valid great length, because we did discuss at great length product for some, and many consumers who are the issue of the unauthorised overdraft charges where, offered packaged products don’t avail themselves of you are absolutely right, the process was, you have a the package. While it may not be a sufficient solution core product that might not make money out of the to the problem of improving the consumer value person who doesn’t go into overdraft, but the moment proposition, there is absolutely no doubt that having they go into overdraft they get hit by unauthorised greater transparency and the availability of simple, overdraft charges. There was a clear legal decision, unbundled banking products, which the consumers you have to remember, that the banks were justified can hopefully more easily understand, has to be a in doing this. Even before that, this was more an issue helpful step in this direction, and one that we would for the OFT than us, because you have to remember support. It doesn’t mean there can’t be packaged we do not regulate at the moment consumer credit, products as well. and overdrafts count as consumer credit. But the answer is, when and if all that is tidied up, yes, I do Q53 Chair: You’ve said, Lord Turner, that think the appropriate regulatory authority should be transparency is not enough. Have you ever tried, just directly looking at both the transparency and indeed as an exercise, to work out what you reckon you are the level of unauthorised overdraft charges. That paying your bank? should be part of our regulatory machinery. or ur r: No, I haven’t. Funnily enough, as I was reading the evidence again, various bits of it, in Q50 Mr Mudie: You don’t necessarily have to put a preparation for this, I asked exactly that question. charge on and compete on it and see it as a Broadly speaking, like I suspect many people in this competitive issue for opening the bank account. The room or elsewhere, I took out a bank account at the competitiveness would come over this £8. billion age of 18, and the bank has then been bought and sold they are taking. They can give a decent interest rate several times and ended up with a different brand and for positive balances and, secondly, they can make a different name, but that’s where I am. That’s what clear what charges they are levying, and at the many people do. moment they don’t. They just land on you and you just pay them. Q54 Chair: Can we get competition without getting or ur r: I agree that disclosure and transparency to a point where people know what they’re being is a good thing, but what we have found in many charged? other areas of the financial services market is that it’s or ur r: I’m sure it would be good to have certainly not sufficient to make the system work well. greater clarity of what the charges are. To a distressing extent, even when disclosure is clear, consumers don’t necessarily pay attention to it. Q55 Chair: Yes, we know that. That’s the motherhood and apple pie reply. The question is, can Q51 Mr Mudie: I understand that, but I don’t we get to an acceptable level of competition in this suppose for a second you’re arguing against openness market without that level of transparency on current and transparency. accounts? Ev 12 Treasury Committee: Evidence
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants
or ur r: I think I’d be willing to accept that it work through that process. So we are now giving them may well be a necessary and, therefore, we can’t. I a lot more help. think it will be a long way short of sufficient, because I think there are dynamics of this market, which the Q59 Mark Garnier: This is all about the pre- OFT have set out. application briefings and— Mr Sa ts: This is the pre-application process. Q56 Chair: We have understood that point. You’re often answering a slightly different question to the Q60 Mark Garnier: Getting back to the question, one asked. how many in the last 18 months? or ur r: I’m sorry. Mr Sa ts: In the last 18 months, we’ve listed it in Chair: The question is: is it a necessary condition? there, it’s about 12, I think, if I just turn to the right You’re now saying— page. or ur r: My judgment is it probably would be, but it is not something that we do. Q61 Mark Garnier: Twelve new applicants for retail banks? Q57 Mark Garnier: I want to carry on with the Mr Sa ts: No, not for retail. We’ve only had one that barriers to entry. The Office of Fair Trading came to we’ve authorised. Currently in the pipeline, I think we the conclusion that certain aspects of the authorisation may have about two or three, roughly. process may have acted as barriers to entry and that Mark Garnier: Two or three. this may have led to a detrimental impact on price Mr Sa ts: In the pipeline. One we’ve authorised for quality and range of products available to consumers. what you would call a mainstream conventional Just for absolute clarity, what I’m referring to from retail bank. now on is the high street banks and retail banks, as opposed to investment banks. Also I’m going to Q62 Mark Garnier: Which is where you or I would specifically ask questions around new applications as go and open a bank account when we are 18 and opposed to any other type of new banking. What I deposit money in and have cheque account and that want to do is get a bit of flavour about what is going kind of stuff? on with new applications. Can you tell me how many or ur r: I would stress that across the world people have put in new applications for high street there just isn’t a general tendency for new start-up banks, retail banks, in the last 18 months or so? retail banks. They don’t often happen. Mr Sa ts: We can, but if I may point out 1.12 in that report, “The OFT considered firms do not face Q63 Mark Garnier: In America you have lots and significant barriers to entry arising from regulatory lots and lots of banks that are catering to local towns, requirements that must be met in obtaining local communities, that type of stuff. Here you don’t. authorisation to accept deposits or offer mortgages.” One of the ways that you can have competition in What it did observe, which is by the way perfectly banking is ultimately to have more local community- reasonable, was that our authorisation process for focused banks. What I am getting at with this is that mainstream deposit-taking banks is a relatively there are a number of different problems when you infrequently used process. If you look back over the are trying to start a bank. Some of them could be to do statistics, which are in the document, you will see it with the fact that you need capitalisation: you won’t has traditionally only been eight or nine in a year or authorise a bank unless it has capitalisation; the so. We have, in the light of feedback over the last 12 investors won’t capitalise a bank unless it has months, brought in a number of changes to process to authorisation. You have a Catch-22, so that is a make our process easier to use. blockage that has to be got around. There are various other things. But if the problem in opening retail Q58 Mark Garnier: So you do recognise that you banks is lying with you we need to get to the bottom did have a problem? of it. Mr Sa ts: I think what happened at the beginning Mr Sa ts: Yes, but it’s not. It absolutely is not. The concerned the obligation to authorise within six OFT is not suggesting it is, we’re not suggesting it is, months if the application is fully filled out; 12 months and I have talked to those people who are— if it’s incomplete. What we found was that the vast Mark Garnier: A number of people are suggesting it. majority of these applications were, broadly, Mr Sa ts: What precisely are they suggesting is the incomplete, so our average authorisation time for problem? deposit-taking authorisations over the last few years Mark Garnier: They’re suggesting you’re taking a varies between seven and 10 months—so within the hell of a long time to get through this; you’re taking 12 months—but obviously firms are struggling to give 18 months, two years to do this. us the right information upfront. Plus, we have Mr Sa ts: Which is not correct. changed our standards in terms of what we are looking for in terms of business model analysis and capital Q64 Mark Garnier: Can you absolutely and liquidity, which is what you would expect post categorically guarantee that? the crisis. I think we concluded not that we had Mr Sa ts: We would comply with our standards, problems, but that the applicants needed more help, which are set for us. If you give us a completed form and that we needed to be a more positive organisation we would do it within the six months. I have analysis in terms of giving them more guidance and being here, as I say, of the average application time over the prepared to sit down with them more regularly and last few years, and it varies between seven and 10 Treasury Committee: Evidence Ev 13
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants months, which is within the time we are allowed to have in place, which has slightly changed over the take for all deposit-taking institutions who are year or two, I think, to make it more efficient, is applying for deposits. We basically haven’t had a working well, that it’s efficient, it’s opening up the mainstream retail bank apply in the pre-2008 period. barriers to entry, it’s making it easier for people to Since 2008—I have the figures in front of me here— come along insofar as it is affected by the FSA? we authorised 15 deposit-taking institutions, of which or ur r: I’m very confident, in what I think is a eight were in the retail space and only one of which, very important issue here, that our regulatory as we said, we would describe as a mainstream bank. processes are not a significant barrier to entry. I think Basically, people are not applying. It is not a question there are other barriers to entry that are important, of people applying and being— which might suggest that if you want more competition you would have to do it by breaking up Q65 Mark Garnier: Why do you think that is? existing banks, rather than by facilitating new entry. Mr Sa ts: Well, I think that’s to do with the business model and the general discussion that is now on the Q69 Mark Garnier: How much does it cost? table about their expectations of making a reasonable or ur r: I think this is one of the fundamental return as a new entry start-up. questions that you and others and the Vickers or ur r: I think the essence of it is as set out in Commission have to consider, but it may be that there the OFT report. As Hector has already said, the OFT is something structural about this market where you report in 1.12 says fundamentally it’s not an issue will not get significant new entrants, even if we about regulatory requirements, and in 1.10 it says, authorise them immediately. “New entrants face significant challenges in attracting personal and SME customers through a combination Q70 Chair: Let’s have a view. What’s your view? of low levels of switching, high levels of brand loyalty Mr Sa ts: We have sub-models now starting up. As and consumers’ preferences for providers with a I’m sure you understand, we are reluctant to discuss branch network.” This is a market where, across the firm-specific names, but it will be very interesting to world, it’s very difficult to enter except through the see whether that approach is successful. The past acquisition of existing branch networks. People on the clearly demonstrates it has been easier if you leverage whole don’t go to a new bank which has 10 branches your existing brand name and existing infrastructure, across the country. They go to one which has 200. and that entering without an infrastructure, without a branch network is very difficult. It may be possible, Q66 Mark Garnier: If someone like Tesco wanted but I think it would be very difficult in the long term. to set up a bank, they have a branch network, they can do it. So that would take them, what, seven months to Q71 Chair: But do we need to break up these big get it done? banks to get enough competition? It’s the same Mr Sa ts: We would do it within the six months, question I asked earlier. Lord Turner moved away assuming they applied to us with a fully filled-out from the earlier position to something that sounds as authorisation process and, as you say, given they’re if he thinks that’s something we should be looking part of a wider group, the type of business model at carefully. concerns that we have for standalone start-ups, where or ur r: Well, I think it should certainly be we look carefully at their sustainability and their looked at. We now have— capital liquidity position, as you would expect, Chair: But what’s your view? obviously those risks would be significantly less in the or ur r: I don’t think it’s appropriate for me to context of a large group such as Tesco. have a personal view. I think this is something that is appropriately looked at by the Vickers Commission. Q67 Mark Garnier: There are banks that are the If it were the case that we had a somewhat wider set other end of the scale. There are banks where they of retail banks I think that could be a good thing, have two or three branches. but I don’t think it’s for me to say, “I believe the Mr Sa ts: Of course, we have seen huge growth in concentration should be .” But it’s certainly a retail banking products being offered by groups such legitimate issue to be looked at. as Tesco, who are able to leverage off their existing Chair: Actually, I took the floor from Mark and I established infrastructure and a strong brand name, apologise. and that type of business model appears to have been more successful in gaining market share over the last Q72 Mark Garnier: I am pretty much done. The few years than a new entrant with a very limited only thing I’d like to ask—and then I know Chuka is branch network. Obviously we’re now seeing one or going to get stuck in in a minute—is, what is the two people looking at that strategy and we’ll have to actual cost? Obviously there’s the cost of paying your see how they fare. But there is no evidence at all that fees and all the rest of it. the regulatory authorisation process is the problem. I Mr Sa ts: £25,000 or whatever, yes, for the fees. hear odd comments made to the media, but whenever Mark Garnier: Sorry, how much is it? I ask people to tell me, “What is it you would like us Mr Sa ts: The fees are £25,000 or so but, as I say, to change?” I never get back any specific points. I there’s an administrative cost that goes with the think it’s more of a sort of noise in the system. programme.
Q68 Mark Garnier: But you’re very clear on this. Q73 Mark Garnier: So the cheque that goes with You are absolutely happy that the system that you the application form to you is £25,000. That’s not Ev 14 Treasury Committee: Evidence
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants entirely unreasonable, and you have a job to do. What or ur r: Let me draw a distinction. I think there about the legal fees that are going with these is an issue of the size of banks and whether they’re organisations that are going to have to set it up? I too big to fail and whether they have a financial speak as somebody who has gone through the stability risk. There is a separate issue about regulatory process of two regulated firms, one under competitive intensity. It was the issue about the the FSA and the other under the SFA, and these are intensity of competition, where I was saying that the small firms, but I can tell you it’s mighty time Government has chosen to set up the Vickers consuming. It’s very expensive in terms of legal fees, Commission, which will look specifically at this, and and then obviously you have your regular fees. which I welcome, and where I have expressed the They’re acceptable—I’m not arguing against those— point of view that I would be perfectly sympathetic to but by the time you look at all of this process and the the idea that perhaps a bit more competition might be time involved and the effort by a lot of people and the a good idea, but it’s not our core issue because we are cost that you have to go into the process right at the not a competition authority. very beginning, with the investors having to sit on If we go back to financial stability, the issue of how non-productive business while this process is going we make banks not too big to fail is not only part of through, what is the cost of actually getting a bank our agenda, it’s probably the single most important bit set up? on which I have concentrated my own efforts over the Mr Sa ts: I don’t know the cost to a firm of its own last year. commitment. Mark Garnier: It’s an incredibly important question Q76 Andrea Leadsom: uite. So should banks be and I’m disappointed you don’t know the answer. broken up for the reasons of— Mr Sa ts: It’s perfectly reasonable. I know, it’s a or ur r: No, I don’t think we need to break them perfectly reasonable question. I’m not in any way up for dealing with the too big to fail problem, saying it’s an unreasonable question, I’m just saying I because I think we can deal with that through other can’t tell you exactly what the cost was to the very small number of applicants that have applied for pure mechanisms, through the mechanisms of having them retail banking authorisations over the last couple of have enough capital, through having resolution years. I have had conversations with the one procedures which enable them to fail in a structured successful authorised firm, which is listed in fashion and, if necessary—and this is going to be the paragraph 17 of our submission. In order to make sure big debate over the next year—through capital I listened to them carefully to see if there’s any surcharges for larger systemically important banks, so improvements we can make in our process, and this that for those we are being even more cautious than was not a factor that they brought up with me. we are for smaller banks. That is a proposal for which More generally, could I just reiterate on this point of we, the UK, have very strongly argued in the authorisation? When I say I’m confident we are not Financial Stability Board and which is now an agreed an issue in terms of deterring entrants, I’m sure that statement of the Financial Stability Board and the is the case, but equally, we’re always here to improve Basel Committee, that large systemically important our processes, and if anybody brings me a specific banks have to have levels of loss absorbency higher suggestion as to how our process could be improved than the Basel III standards. So I don’t think that the I will take it on board. But at the moment, I’m not too big to fail agenda necessarily says we have to take aware of any specific suggestions outstanding that any the big banks in the world and break them up. I think of the people I’ve spoken to have made to me. we have other mechanisms to achieve that. I draw a distinction between that and the debate which we’re Q74 Mark Garnier: Just very quickly, how would having about consumers and competitive— they do that? Would they get in touch with you? Mr Sa ts: Yes, absolutely. I have talked to those firms Q77 Andrea Leadsom: I completely disagree with who have been through the process successfully you, because I think that you simply cannot divorce directly myself, and I have been in contact with one the issue of too big to fail from a regulatory point of or two of the firms who are currently going through view and issues of competition in the banking sector. the process who have raised issues, to make sure that You said yourself that the big failing, which is we’re dealing with those firms efficiently and fairly, attributed to Greenspan but was generally held, was and we will always respond to them. But the OFT the sense that investment banking and banking would has looked at it as an independent process, and the look after itself, that the mechanisms were all fine and conclusion it reached is very clearly set out in the would all continue to work, so long as we left them report. alone. That was the big regulatory failure. Now, isn’t it the case that all the way through, going right back Q75 Andrea Leadsom: Lord Turner, I’m amazed to Adam Smith, a key requirement of capitalism is that you think it’s none of your business to say free entry and free exit of market players, and isn’t it whether large investment banks, banking groups, the case that over the last 10, 15, 20 years, regulation should be broken up. Surely, as the Chairman of the always trumps competition? It’s all tied up with Financial Services Authority, it is very much your barriers to entry. You said, Hector Sants, that nobody business and very important that we know your view is applying and you don’t really know why nobody of whether our banking groups are too big to fail and is applying. whether they should be broken up. Mr Sa ts: I didn’t say I didn’t know why. Treasury Committee: Evidence Ev 15
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants
Q78 Andrea Leadsom: Well, very few new players corporate, needs the same category of price protection are applying. Isn’t it the case that competition, this as a retail customer. whole issue of the all powerful regulator and the regulatory powers are stopping new entrants from Q80 Andrea Leadsom: So you think it’s acceptable coming into the marketplace and allowing existing to have oligopolistic pricing in the wholesale markets market players to dominate markets and to create but not in the retail markets? barriers to entry precisely that are creating these or ur r: I don’t think there is oligopolistic systemic problems? pricing in the sense of any collusion. I think there are or ur r: I don’t agree with that. I don’t agree naturally arising processes to do with brands and the that regulation has created barriers to entry. I think incentives of the purchasers of these products, which there are naturally arising barriers to entry that may do tend to produce dominant players and high degrees push these markets naturally towards greater degrees of profitability. I think, however, these are so of concentration than we want, but I don’t think it’s inherently arising that if you went in and took the our regulation that has done that. A problem that we investment banks and broke them up, five years later have to fix is that where there is a perception that they would have congregated again. Well, why is this? some banks are too big to fail, they might clearly— It’s because the CFO who is purchasing and and this is more to do with corporate customers and underwriting a product from a major investment bank, institutional investors—have a slight funding in terms of their personal incentives, their personal advantage, because people will deposit money with self-interest, the benefit to them of negotiating down them at a lower price than they would with smaller the underwriting fee is very little, and the disbenefit banks. That’s not the case, of course, at the retail to them of anything ever going wrong or them being customer level, because deposit insurance tends to criticised for having gone away from the golden circle even out the playing field for them. of the best brand names is very high. So you have There is a potential competitive advantage of very big incentive structures that tend to produce dominant banks, and that’s why we have to put a stop to too big players, but in a sense that’s no different from the old adage that nobody got criticised in the 1 80s for to fail through the mechanisms of things like buying IBM. contractually bail in-able debt, resolvability and higher capital surcharges, which are absolutely, as I Q81 Andrea Leadsom: But you do accept then that say, not just part of the agenda but probably the single there isn’t transparency and that there isn’t fair value biggest thing for which I’ve been arguing on an pricing in the wholesale market, but yet you don’t international basis over the last year. There is lots accept— more work to be done over the next year on that. The or ur r: I think there’s transparency. I think work on improving resolvability of major banks, these people know exactly what price they’re paying, which Paul Tucker has led within the Financial it’s just they choose to go to dominant— Stability Board, is a very important way forward. I just don’t think we have to take the 100 biggest banks Q82 Andrea Leadsom: But there isn’t fair market in the world and split them up in order to get round the value, and don’t you accept that that is one of the too big to fail problem. I don’t think that’s necessary. I reasons why there are barriers to new entry? If you think we have other tools to get there. have a market that is artificial, that isn’t properly priced and isn’t properly valued, isn’t that one of the Q79 Andrea Leadsom: So, do you then disagree that reasons why you don’t have new entrants to that there is, at the very least, oligopoly-type pricing going marketplace, because it’s an artificial market? on in certain parts of investment banking and or ur r: The wholesale market of investment wholesale markets—for example corporate bank advice is actually full of boutiques continually underwriting, corporate advisory? Are you concerned emerging, splitting off from existing banks, and in the about that? Do you not believe that it is part of a advisory side of it is a very open competition market. regulator’s role to ensure that there is fair pricing in It’s just that there are certain functions within it, in markets? particular underwriting, where, because of the or ur r: That is a very good issue, and let me naturally arising risk averseness of the purchase of tell you exactly what I believe. First of all, in relation these customers, they tend to go to the dominant to wholesale markets, our philosophy, which has been players with dominant distribution market share, broadly supported, is that you have sophisticated because those are the ones with whom they believe customers and investors who may need protection the thing will go well. So I don’t think this is an issue against market abuse and insider dealing but who do about either collusion or transparency or, in a sense, not need protection in relation to the price at which an artificial market. I think there are some markets— they buy a particular product. And although we have and we have them elsewhere, we can have them in signalled quite a significant shift to a more soap powder and so on—where dominant brands tend interventionist approach in the retail customer side, to arrive at a dominant position. That’s how premium our approach and that of regulators—and so far, I brands work. think, of Governments and Committees like Andrea Leadsom: Just one last question. yourself—has been to accept that rather free market Chair: A quick question and a quick answer, please. approach in wholesale markets. I would be wary of moving away from the idea that a buyer of Q83 Andrea Leadsom: One last question. Is it not underwriting services, which is the CFO of a major the case then that in order to achieve at least fair Ev 16 Treasury Committee: Evidence
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants pricing of risk within the banking sector that you need pure betting, is highly imperfect. I have not been to reach a position where you can allow a bank to fail? convinced that there is any easy way to draw that legal or ur r: We need to be able to have all banks distinction, and I think they will find it difficult. fail in a controlled fashion, imposing losses on people What I think is a very good idea, which I know the above and beyond the equity owners, but in a way Vickers Commission is looking at, is to consider that preserves the fundamental functions of the bank, whether within large universal banks we should more in particular of lending to the real economy, and that clearly put trading operations and retail or commercial is the trick in the too big to fail debate, and that’s— banking operations into different subsidiary units so that we could, if necessary, in resolution processes, Q84 Andrea Leadsom: Are you there yet? Are you draw a distinction between what we do with the able to— trading operations and what we do with the or ur r: No, we are not there yet, and that is commercial banking operations. It’s also vitally why that is identified as our most important agenda important that we get the capital requirements right. I item at an international level over the next year. That would not be opposed at all to us having the Dodd- is absolutely the most important agenda item, which Frank wording to, as it were, give reinforcement to we still have to get right. what we want to do in regulatory terms in any case.
Q85 Mr munna: I just want to follow up on some Q86 Mr munna: Just to clarify, are you saying that of the questions that the Chair asked and also Andrea you would like to see banking legal entities asked too, because I’m still not totally sure what the constructed in such a way that you have clear position is on this, and do forgive me. Can I ask you separation of the retail function from the commercial what your view is on separating out retail banking proprietary trading function? from proprietary trading—investment banking? The or ur r: It’s certainly an option that should be Governor of the Bank of England, I think, has been considered and I know the Vickers Commission is quite clear that he thinks there’s a strong argument for going to look at. It is an internal separation rather the two to be separated. The Obama administration in than— some senses agrees. Where are you on this? What is your view? Q87 Mr munna: You are saying it should be or ur r: My view, which I clearly set out last considered. A lot of people would say it’s an absolute year, was that it is not acceptable that retail bank necessity. Do you think it is an absolute necessity to funding, and profitability—to the extent that it was the basically ring-fence my constituents and all the case, but it’s primarily funding—is used to support constituents that we— risky proprietary trading. However, I have not been or ur r: I don’t think it’s an absolute necessity. convinced that it is at all easy or possible to draw a I think we have other mechanisms to achieve the same clear legal distinction between that which is effect. Look, for instance, at what the Swiss have commercial banking—and the key thing here is that done. The Swiss faced this problem on a bigger scale you leave aside retail banking—and proprietary than anybody else with the explosion of the role of trading. Indeed, the difficulty of so doing is illustrated UBS before the crisis. They have gone down the route by the Dodd-Frank Bill and the clauses in that which fundamentally of higher capital requirements for their translate Paul Volcker’s rule into actual action. It two largest systemically important banks. I don’t think basically says in that bit of the legislation, it’s the only route to go, and I’m sure we will use “Commercial banks, things that have banking many policy levers, but it is certainly part of the suite licences, must not do proprietary trading” and then of policy levers that we could use to address the issue immediately it says, “Proprietary trading does not of the dangers that arise from proprietary trading. include trading for the purposes of market making and customer facilitation or hedging” and then it says, Q88 Mr munna: Can I just ask one other question, “Over to you, the Fed and the OCC, to work out how which I think has been mentioned already? There is you’re going to decide when trading is market quite a lot of debate at the moment about what should making, customer facilitation and hedging, and when be done with Bradford & Bingley and Northern Rock. it’s pure proprietary trading.” My own view is that we should very much consider I can tell you, they are scratching their heads at the remutualising both of them, because it will increase moment about how they are going to do it, because the diversity of providers in the sector. Historically, here’s the challenge. If we take a product which is mutuals have a good reputation for having strong undoubtedly socially useful, forward foreign bonds and investing in their communities, and in some exchange—the ability of an exporter to buy some senses they are considered to be more stable. What is foreign exchange six months in advance—for that to your view on the remutualisation of Northern Rock exist you have to have a large commercial bank, and Bradford & Bingley? which has a trading room, which is making a market or ur r: Mutual credit institutions have one in forward foreign exchange. In the course of making advantage and one disadvantage. The advantage is a market, it will take some positions and it will make that they’re not paying out dividends and they some proprietary gains and losses. Our ability to accumulate money out of retained earnings. They can distinguish that element of their market making and use all of their retained earnings to make depositors the related proprietary trading that was there in order safe and build the business. The disadvantage is that to provide the useful service of forward foreign if they get into trouble it’s very difficult to bring in exchange to an end consumer, and that which was new equity, new capital, in order to recapitalise them, Treasury Committee: Evidence Ev 17
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants which is sometimes the perfectly normal pre-market circumstances in which it is incredibly difficult in response to a bank that is in some trouble but not advance to know what is lending activity. You will extreme trouble. I think the resolution is that there is doubtless be interested in the background of what a role for a mutual sector, but it is a sector which happened on the Dunfermline Building Society, since should be focused on a restricted range of activities. I it comes from Scotland. The fact is that two years think the biggest mistake we made—this is something before that got into trouble, our supervisors were to which Parliament could well return—was to allow asking some questions about its commercial real estate our mutual sector, our building societies, in some lending. They asked questions of the auditors about cases to extend beyond the core business of prime real the adequacy of the provisions and were told that the estate lending into commercial real estate lending and auditors did have some concerns because they thought buy to let and other activities. that the provisions were too high, because according Mr munna: I completely agree. to the accounting rules of the time the Dunfermline or ur r: I think there is an unfinished part of our Building Society was, if anything, trying to put too regulatory agenda as to whether we should reverse many provisions for things that shouldn’t have been some of the liberalisations of the building society provisioned, because there was no evidence that the rules that occurred in the 1 80s and 1 0s, which loans were then turning bad. gave us precisely the problems that we had in the What that illustrates is that in an area like commercial Dunfermline Building Society. real estate it’s very difficult to see the problems except at the macro level. At the individual level, you have a Q89 Mr munna: Before we move to you, Hector, loan that is still paying back, and the auditors say, can I just ask what the answer to my question is: do “You should not be provisioning against that.” So in you think the Government should give due that case, we did ask some questions, but the inquiry consideration to remutualising Northern Rock and did not suggest that they were a problem. So, I think Bradford & Bingley? I hear all the useful background the answer is we will be much more aggressive in you’ve given, but what is the answer to that question? future, but I still think that in relation to the building or ur r: The answer is, since I haven’t thought societies, which are organisations, particularly small about it, I don’t have an immediate answer to that. and medium ones, which can only have a skill set Chair: Drop us a line. across a limited range of activities, they should stick or ur r: I will come back on that. It’s not a to their knitting. regulatory issue for the FSA. It’s not something that Mr Sa ts: Can we be quite clear, looking forward I’d thought about, so I’d rather not give an again, that neither the FSA was, nor will the PRA in immediate response. the future be, resourced—the FSA is now much more Mr Sa ts: I didn’t want to reopen the previous point resourced than it was—to a level to be an inspector of on monetary reform. small to medium-sized institutions, and if you want to Chair: Briefly, please. pick up poor credit decisions at the point of that Mr Sa ts: We would welcome reform of the Building decision you effectively have to be in the role of an Society Act being on the Government’s agenda. There inspector and go through book by book. That’s a role is a need to change the framework and consider the which auditors are meant to do, and we’re not overall package of how supervisors, and the PRA, equipped to do that. So the way to manage those which would be overseeing mutuals, would be acting institutions is, first, to have a credible resolution in the future, for the reasons that Adair has just laid regime, so if they do fail, they can fail without cost, out. other than on those who put the capital in; and Chair: The Government no doubt will welcome that, secondly, to have the right set of rules. We recognise too. the global rules for the banks were flawed—Basel II and so forth. We are asking, and I am asking on behalf Q90 Stewart Hosie: Just on that final point, Lord of the PRA in future, that the rules for the building Turner, about reversing some of the liberalisation to societies set by Government through the Building stop the mortgage banks and building societies doing Societies Act should be revisited to get these models many of the things that they did, I understand the back into a safer space. But the supervisors do not do logic. Would it not have been better if the regulators and will not detailed on the ground inspection of every hadn’t allowed them to make such loan to asset single institution in this country, all 25,000. valuations, be it on commercial lending, residential or ur r: It is easier to ask quantitative questions lending or buy to let lending? Rolling back the clock, about what is the average loan to value ratio in should the regulators and supervisors not have simply relation to a residential mortgage loan book—you can done their job and stopped the 125% loan to asset get information from that—than to do the same for valuations on silly things? commercial real estate. The moment you go into the or ur r: Well, obviously this goes to the whole corporate space you really can’t assess credit quality debate about our internal audit report on Northern unless you are individually inspecting individual Rock. Right at the beginning of this session it was loans. noted that the FSA had been more open than I think any other institution around the world in saying that Q91 Stewart Hosie: I am worried about these we had made a set of mistakes and we would learn answers and the answers earlier. We were told before lessons, and I think we would be much more the crash—I remember the Bank of England annual aggressive in future in challenging risky lending stability report—that risk was being managed, it was activities. Having said that, there are some being mitigated, it was caveated with the words that, Ev 18 Treasury Committee: Evidence
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants
“It was being spread so widely we weren’t quite sure Mr Sa ts: Which paragraph are you referring to, if I where it was,” and all that led to. All the answers may ask? today, instead of giving me comfort that we’ll be Stewart Hosie: I don’t have the reference to the watching the risk, managing the risk, mitigating the quote. risk, other than at the macro level and systemic risk Mr Sa ts: I have the report in front of me. Would you level, appear to be saying, “Well, if the capital ratios like to refer me to the paragraph or section? I have fail, so long as we can unwind them we’ll let them read it. fail.” Now, I would have thought there would have Stewart Hosie: I don’t have a reference to that quote been a far more assertive approach, that we want to in front of me. I only have the quote itself. manage these risks away at least as best we can, and Mr Sa ts: I will happily quote you the summary I’m not hearing that. paragraph again, which I think made my point clear or ur r: But the single biggest thing we’re going earlier: “The FSA has recently revised its to do on that is to transform the capital ratios. Let’s be authorisation procedures to increase transparency in a clear that the capital ratios under the Basel II regime more modular approach.” So there is no doubt that allowed a bank to run with equity equal to 2% of risk- changes were merited to make the process easier to weighted assets, so if those assets were mortgages, access, but the OFT’s headline conclusion out of its they could well be 1% or less of the total assets, and summary in paragraph 1.12 is as I set out. we have fundamentally taken that 2% up to effectively 7%. That is a non-trivial change. Q94 Stewart Hosie: So you don’t recognise the Mr Sa ts: If you can resolve a deposit-taking quote I gave you? I can find the reference to it. institution without any cost to the taxpayer or any systemic implications, and without the consumer or ur r: Well, we can’t find the quote. being disadvantaged, why are you worried about that Mr Sa ts: I am happy to respond to it if you would happening? That is a perfectly fundamental question. like to refer me to the relevant paragraph. Why do you think that is a problem? If people have Stewart Hosie: I think we might have to come back put up capital for risk, that’s the nature of the system; to this with the reference. if that capital doesn’t give them a return they have to bear the cost of failure. If that failure is orderly, Q95 Chair: Thank you very much for your answers without any implications for other than the capital on that point. I was astonished by a number of providers, why is that a problem for you? answers that we’ve had today, I have to say, Lord Turner, not least—and I am quoting what you said, I Q92 Stewart Hosie: Well, the answer to the question wrote it as you said it—“A bit more competition is it’s a complete collapse of confidence, which is a might be a good idea.” You are under a statutory duty trigger for all sorts of other things. to have regard to competition. Don’t you accept that Mr Sa ts: Why? the kind of remark you make there is exactly why Stewart Hosie: Because we had a run on the Rock people have come to us saying that competition and people were queuing. should be elevated to the level of objectives of the Mr Sa ts: You misunderstand my fundamental point regulator? then. I think it really is very important. We are trying or ur r: Yes, I think that is an open issue as to move away to a position where consumers have to whether competition should be an objective of the confidence in the system to deliver what consumers regulator. The situation so far is that within the want from the system, and I’m pointing out that in operation of the powers that we have, which are not an environment where failure can be orderly, without structural break up banks type powers, we have to disruption of the provision of services to the have regard to competition. So, for instance, in our consumers, that should not be seen as a regulatory authorisation process, one of the things that we are failure. concerned about is the speed at which people can get Stewart Hosie: Mr Sants, trust me, real world through it, precisely in order to have ease of entry into confidence will not be enhanced by allowing a bank the system. So we do have regard to it, but we have to fail. However, I want to ask— not been set up as a competition authority where it Mr Sa ts: Small banks fail in America all the time has been asked or has the remit or the powers to say without any evidence of diminishing confidence. that there should be an increase in the number of players within a particular market. I think all I would Q93 Stewart Hosie: I want to ask a completely say is that the degree of concentration of UK retail different question as a final question. It relates to banking has now got to the stage where it raises the something Mark said. It was about the time it takes issue as to whether there might be a need for a and the hurdles to entry for new entrants to get their structural response, and that is precisely why the banking licences, their authorisations. You quoted the Vickers Commission has been given that issue. So I OFT earlier a couple of times, but they stated that a think it is an open issue, and if I was on the Vickers number of respondents to their market study had said Commission I would find it very interesting to go all that uncertainty, length of time and cost of the the way through that and end up with a conclusion on application process had proved insurmountable and it. It’s not for us to conclude, because that’s not part they decided not to apply for licences. So, although of our legal remit, but I guess we now have a you quote 20 applications and a number approved, it significantly more concentrated market than we had would appear, at least from the OFT, a number of 15 years ago, so the issue is clearly before us, with others have found the process insurmountable. the caveat to remember that— Treasury Committee: Evidence Ev 19
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants
Q96 Chair: Lord Turner, we had been hoping to get we’re a mature economy with a developed financial some sort of indication from you about where you system. So, yes, that must be right. think policy should go and, to be frank, we’ve had Chair: Thank you for that. Stewart has one very last virtually nothing from you at all. After all, is it not quick question. reasonable to you to offer a view that the Vickers Commission can take account of? Q101 Stewart Hosie: A final reference to the OFT, or ur r: I am not sure that it is for me to offer a page 80, paragraph 5.33, “A small number of view, which would probably be seen as a personal respondents indicated that the uncertainty and length view rather than the view for which the FSA, of which of time of and cost of the application process had I’m Chair, has a legal responsibility. I think we’re very proved insurmountable and that they had decided not happy to answer questions about what we think should to apply for a licence. Others proceeded with an be the approach of the CPMA to competition and, application, but had experienced delays in the process indeed, the many other issues about competitive or revised their business plans. Overall, therefore, it effectiveness, which our FSMA powers relate to. But appears that certain aspects of the process may have the specific issue of should we have a break up to have more retail banks in the UK than we have at the acted as barriers to entry and that this may have led moment, I think it’s reasonable for me to say, given to a detrimental impact on price, quality and range of the degree of concentration, that’s certainly an issue products” and so on. That’s quite clear, I think. that’s on the table, but I don’t think it’s something Mr Sa ts: Can I just respond to that? where I need to have a personal view to share with Stewart Hosie: Yes, of course. the Committee. Mr Sa ts: I think they’re making a comment about process, and we agreed with the OFT, and I had some Q97 Chair: You also said, and I quote, “Regulation discussions with the OFT personally afterwards, that is not a barrier to entry.” A lot of people will be very there were process improvements we could make to surprised by that remark as well. Do you want to make the authorisation process easier, and we have qualify that, now or later, either now very briefly, or made those. Those comments referred to the period later, as long as you like, in writing? before we made the process changes. But specifically, or ur r: Well, I don’t want to qualify it because in 200 there was only one withdrawal and my not us but the OFT has concluded— understanding of that withdrawal, I think it was a perfectly reasonable withdrawal to be made. No doubt Q98 Chair: You have already quoted the OFT. You firms often comment as to reasons why they withdraw don’t think regulation acts as a barrier to entry in applications, but there was only one in 200 and there markets? were seven in 2008. So it is not that there is a whole or ur r: Well, in general it could be the case. It raft of firms withdrawing. clearly can be the case that regulation will act to a Stewart Hosie: I appreciate that. degree as a barrier to entry. Mr Sa ts: uite often they withdraw because it is a polite way of exiting out of the application because Q99 Chair: But in a specific case not; that’s your we’re not comfortable with it. point? or ur r: The fact that there is health and safety Q102 Stewart Hosie: I appreciate that, but you spoke legislation makes it somewhat more difficult for previously about the applications submitted and somebody to set up a new restaurant. As a generic approved, and you’re now talking about one that was fact it must be true. withdrawn in application. The point is that a number Chair: Yes. We’re not going to go into lengthy of respondents decided not to apply for licences. This theoretical examples. may only be perception, but the OFT were clear from or ur r: But, Mr Chairman, with respect, the this small number that uncertainty, length of time and OFT, which is a neutral body, not a set of anecdotes, cost was an insurmountable barrier to their even nor the FSA, has reached a conclusion, which we have applying. clearly quoted. Mr Sa ts: Yes. I have responded to that point. Q100 Chair: You have referred to it now five times, and I think we have that piece of evidence firmly on Q103 Stewart Hosie: Is there not an issue there at the record. Can I end by asking you or by pointing all? out to you that the Nationwide Building Society Mr Sa ts: No, because I responded to that point by described the UK market as, “Effectively a mature saying I discussed that issue personally with the OFT low-growth market”. Do you agree with that and I have satisfied myself that the points that led to assessment? those comments being made are the ones that we have or ur r: It is bound to be the case that, compared now addressed. I’m answering the question, “Going with some of the markets in which some of our banks forward, do you think your process is a barrier to operate, in China or Brazil, this will be a low-growth proper firms, which we would like to see offering market. We would not expect, and indeed we would retail banking services in this country, being not want, the degree of credit in the UK over the next authorised?” and the answer is no. That reflects the 10 years to grow faster than, say, nominal GDP, current process we have in place. I’ve said if you have which, if we are successful, will grow at 5%. That’s any specific comments from any firms to improve the not a fast-growth market. So I think, broadly speaking, current process, as opposed to the process that was Ev 20 Treasury Committee: Evidence
23 November 2010 Lord Turner of Ecchinswell and Mr Hector Sants operating 12 months ago, then come back to me and Chair: I am going to bring things to a close there. I’ll make those changes. But I’m not aware, having We’ve had a very long evidence session and I’m very had detailed follow-up discussions with the OFT, that grateful to you both. I think that a great deal has come there are any other process changes we should be out of it and I’m sure this won’t be the end of our making which we have not made. exchanges on this very large subject. Thank you very Stewart Hosie: That’s helpful. much for your evidence this morning. Treasury Committee: Evidence Ev 21
Tuesday 30 November 2010
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon John Mann Mark Garnier Mr George Mudie Stewart Hosie Mr David Ruffley Andrea Leadsom John Thurso Mr Andrew Love Mr Chuka Umunna ______
Examination of Witness
Witness: Sir Donald Cruickshank, gave evidence.
Q104 Chair: Welcome to the Committee this and all citizens to have a systemically sound banking morning. Thank you very much for coming through system. the weather to give us a chance to hear what you have So the answer to your question is: there are a number to say on this very important subject. I’d like to begin of things we can do but, for the markets we are talking by asking you a simple question: do you think that about here, we are never going to get anything that an in the retail market we can get genuine competition, economist would say was effective competition. adequate competition, without much higher levels of price transparency? Q105 Chair: So we are going to be defeated? Sir o al Cruicksha k: Mmm. Oh dear— Sir o al Cruicksha k: We must battle on, and Chair: That was a bigger pause than we had from transparency— the Chief Executive of the FSA when we saw him Chair: But you have told us—like the First World last week. War general—that we must keep on going up that hill Sir o al Cruicksha k: Can I take one point or but it is not take-able. assumption you have made in your question, which is Sir o al Cruicksha k: We can improve our what we mean by effective competition. I think for a position. The 2000 report said, essentially, “Look, as market to work well we need four or five things to be Chairman of this Commission, there is no point in me in place. One is that most of the participants need to digging into the precise terms of credit card penalties be able to trust most of the people most of the time, and suggesting changes there, because if I do that the and frankly we don’t have that in banking. Whether banks will say, Oh okay’, and they’ll change the we should have is another matter, but we don’t have credit card penalties and then do something else which it as we speak. We need to be, as customers, secure will generate the same level of profitability and that our property is not going to be expropriated—that arguably no better service”. So I said, “Let’s look at is, lost—and there are definitely issues surrounding the fundamentals. What is going on here? There is a that point with some of the longer term products, annuities and insurances. That is not what we’re regulatory contract between the banking system, those talking about today, but nevertheless it is what banks who manage banks, and the state. The underlying do as well as provide current accounts. It has to be mechanics of banking are part of the state. We allow easy—and this comes to your question—to get the agents, called banks’, and their managers to do the information about what is available at what quality. job for us but the deal is—or should be—you deliver That has to flow freely and openly. For various systemic soundness and you, the banks, are allowed reasons we don’t have that in most of the markets that to make super-normal profits and pay yourselves lots we are talking about here. Arguably, the only market of money”. That’s it essentially. in which we have that is deposits, by individuals So what we should focus on is how to get that balance depositing money where the information about the right. We didn’t have it in 2000. We made return and the terms are easily available. recommendations as to what we might do about it, So there is something about banking products, and which by and large were ignored. We have the banking markets, which make it difficult for us ever problem again today, which is why, in my paper, I say to conclude that we will have effective competition, nothing much changes. as I have just defined. So the question is: what do we do about these inherent market failures? We regulate, Q106 Chair: Just in parentheses—I say “in is what we do, and the question is whether we can get parentheses”, but it’s a very important thing to that regulation to operate in favour of the customer— clarify—you say that the banks’ collective objections, that is, pile regulation on top of competition law. But that we’re still looking at this after a great deal of then we come to the second problem with the banking work has been done, they say, are unfounded. Broadly sector which is prudential regulation. Up to this point speaking, you’re saying that we are in roughly the in my answer I could be talking about telecoms, same place on the hill. If we have moved up, we’ve electricity, healthcare or whatever, but with banking moved up only a fraction of the way required to secure we have to build in the difficulties that we have in competition. Is that right? making the trade-offs between effective competition, Sir o al Cruicksha k: I think that’s right. I note service or consumers and the need of the economy in my submission that, since I did this, there have Ev 22 Treasury Committee: Evidence
30 November 2010 Sir Donald Cruickshank been 15 competition investigations into various the last decade—I have been doing other things—but aspects of it and— I would aver that things are slightly better. It is easier to switch. Information surrounding choices on making Q107 Chair: These are abnormal times for short- deposits and on credit card terms, and so on, is better. term interest rates, but in normal times do you think But, as far as I can judge from limited statistics, what supplying customers with the difference between base we find is that people are still not switching. Sixty per rates and the interest rate that they’re charged on their cent. of them are still taking the first service that is account, with the sum worked out as the difference on offered to them instead of shopping around. So it is a an annual statement, would give them some indication little better but not as much as we could achieve. of whether their current account is competitive? Sir o al Cruicksha k: Yes. Q110 Mr Mudie: Can I slip in a question that the Chairman doesn’t have on his agenda. From your look Q108 Chair: Do you think we should encourage at the retail banks, why are the investment banks so banks to go down that road? keen to keep their link up with the retail banks when Sir o al Cruicksha k: I have never found they have so little in common, in terms of attitude encouraging banks to do anything was very effective, and objectives? but yes. Sir o al Cruicksha k: Historically, and I am now Chair: Coerce? talking about the last 10 years since B le II—or is it Sir o al Cruicksha k: Why don’t consumers Basel II around this table?—we effectively sold the pursue banks for that information themselves, because pass internationally then, by allowing the banks to they have a right to? Frankly, if you were able to read determine their own capital requirements using their the 23-page document you get about the terms of your own risk models. That’s a bit of a caricature but that current account—and they send you a letter every six is essentially what we did. We are now retrieving that months saying how it’s changed—and if you were but that’s essentially what we did. That enabled the prepared to make that effort you could find out. investment arms of the multiple business banks to However, why do people not make the effort? multiply enormously the capital that was generated by Chair: Actually, you can’t find out. I’ve asked my the retail arm of that bank and to deploy it in all sorts bank that exact question and they tell me, “We don’t of funny ways, trying to make gold out of lead supply it”. essentially. I think that is why they’ve been so keen Sir o al Cruicksha k: Did you accept just one to keep multi-business banks in place. rejection? I’m sure you didn’t. Chair: I wrote them another letter saying I was Q111 Mr Mudie: But you say that in the past tense. shocked and disappointed, to which I was told I can Is it still relevant? Is Mr Diamond aching to get his enter a complaints procedure. hands on the retail side of the bank rather than the Sir o al Cruicksha k: Let’s not exchange stories investment side? about banks because perhaps it tells too much about Sir o al Cruicksha k: I think even after B le III ourselves, but the last time that happened to me I said, has finally come to determination that will still be “Right, I’m leaving”, and I had two of them around true, even though the quantum and the multiples of the table in my study within three weeks. capital that the head of the investment bank will have Chair: You and I are unusual activists. to deploy will be significantly less than they have had Sir o al Cruicksha k: Yes, but it tells a tale. What over the last decade. I put in my paper—and John they’re frightened of is losing customers, particularly Vickers has spelt out—how over that decade the gross current account customers. So the key to getting more assets and liabilities of the banks multiplied four-fold, transparency is to make it easier for you and me and 00%-ish, at a time that the economy grew 35% in everyone else— nominal terms. That was B le II feeding through right Chair: Yes. Dealing with switching and dealing with down to bank managers and mortgage dealers, and so the inertia. on. That has been retrieved to an extent, but in my Sir o al Cruicksha k: Exactly. If we deal with view there will still be a determination among the switching and inertia then the banks’ information boards of the major banks not to be precluded from systems will have to improve to maintain customers, any line of business that they choose. and we will find it easier to get information about the various products they sell. Q112 John hurso: Sir Don, I want to ask you about market concentration. Can I first ask you a slightly Q109 Mr Mudie: You may have answered this, Sir wider question: we’re looking at competition and the Don, but you speak so softly I lose you at points in basic assumption is that competition is a good thing, the conversation. From the consumer’s point of view, but what actual outcomes are we looking for as a has anything changed for the better since your report result of competition? came out? Sir o al Cruicksha k: We’re looking for a Sir o al Cruicksha k: I’m sorry, it’s a little time banking system that operates at a lower cost to the since I’ve been in front of a Select Committee, so I economy as a whole, but enables the rest of the apologise, George. economy to be more efficient. Remember that banks Mr Mudie: We’ll see you in 10 years then, the next are intermediaries—that’s all they are. They have time. access to various flows of money—some from the Sir o al Cruicksha k: No, no, this is my last state, some from depositors—and they deploy it in submission. I haven’t stayed on top of the detail over different ways. So what we are after is the total costs Treasury Committee: Evidence Ev 23
30 November 2010 Sir Donald Cruickshank of the banking system being lower for the greater you please take my current account from the bank benefit to the overall economy. Classically, the down there”, and they would do the money laundering competitive pressures, if they are there, will force the stuff and they would say, “Yes, done”. At the moment players in the market to be more efficient, to be more you can’t do that. innovative, to do things at lower cost and at a higher John hurso: Would you see that as the single service level and to get things right first time instead biggest— of second or third time. So that’s what we’re looking Sir o al Cruicksha k: I think that is the single for in the banking sector. biggest thing you could do, and that takes us to the rather arcane subject of money transmission systems: Q113 John hurso: How might that manifest itself who runs them and their incentives in running them for the individual consumer? the way they do. Sir o al Cruicksha k: It would manifest itself in Chair: We are going straight on to that now, I hope. the lower cost of borrowing. It would manifest itself in higher rates of interest on deposits. It would Q116 Michael allon: In your paper you say control manifest itself in the bank getting more things right of the money transmission system is a major source first time, with fewer direct debits going astray. If you of the banks’ capacity to earn super-normal profits. want to switch it would actually happen without any Four paragraphs later you say it’s the subsidy of cheap anxiety on your part. If you are a small business it money that helps them make super- normal profits. would manifest itself in being able to use any branch Which is it? of any bank to deposit your takings overnight, so that Sir o al Cruicksha k: Both. you were free to bank with any bank you chose. That’s Michael allon: It’s both? how it would manifest itself. Sir o al Cruicksha k: Yes. The subsidy that goes into the banking system enables the system as a whole Q114 John hurso: Coming on to market to make super-normal profits, and in most markets that concentration, there has been a considerable surplus return at rent would be competed away. Why concentration in the market through the crisis. Is there isn’t it competed away in banking, uniquely? Because a correlation between those increased levels of it’s so difficult for us, as customers, to get the concentration and the lack of effective competition? information and, on that information, exercise choice Sir o al Cruicksha k: In my view, a lot less than at no cost to us. is commonly thought. I don’t know what the precise numbers are today, but I would aver that there is less Q117 Michael allon: How do you measure a super- concentration in the provision of services to retail normal profit? customers than there is in supermarkets, sports rights Sir o al Cruicksha k: That’s a very good question and a few other things I can think of. in banking. Superior returns on equity, which are Concentration, number of players, market shares, are earned persistently over long periods and are often not the issue here: it’s the dynamic of the market and associated with pricing that is not cost-reflective, with the ease with which customers can move from one information problems, and so on. It is all the supplier to another which are key,. That is not to say characteristics of an uncompetitive marketplace. that new entry isn’t to be welcomed. It’s not to say When you come down to individual banking markets, that the competition authorities need to be constantly it is very difficult to calculate that number because of scrutinising those who occupy a dominant position— the way the banks manage themselves and because I guess that would be Lloyds and RBS, probably, and they are in so many lines of business. maybe Barclays as well in different markets. So, yes, let’s have new entry and competition scrutiny but, Q118 Chair: Are you talking about provisioning? crucially, let us—either directly via Parliament, or Sir o al Cruicksha k: No. In order to make the indirectly via regulators—have measures which will statement, “You are making a super-normal profit”, improve what I call “the dynamic”, that is, the ease you need two numbers: you need the profit and you with which customers can make choices. need the capital deployed to earn that profit. Calculating the profit is not easy but it’s easy-ish. Q115 John hurso: You are making an interesting Making a statement about the capital that needs to be point that was made to me very recently by one of the deployed to run that business is not easy in banking. banks you’ve just mentioned, which was that, if you The bankers find it difficult, so you and I are going to walk up the high street, you will not have difficulty in find it almost impossible. finding 10 providers of current accounts. That was not Michael allon: You are sure that the profits are the issue; it was more about the way that the whole super-normal? sector worked rather than the number of providers. I Sir o al Cruicksha k: They certainly were then think that is essentially what you are saying as well. and as far as I can judge without redoing the Sir o al Cruicksha k: My ambition, and it was calculation—notwithstanding the crisis of the last few in 2000 that Gordon Brown let me down—or, rather, years, and according to my definition, which is Treasury officials got in his way. Can I rephrase that? persistently over long periods of time, although Treasury officials stopped it. Ministers are not always they’ve had one or two mortgages for instance that in control. I would like to be able to say that you were difficult—I would say, “Yes”. walk down that high street and, because you know something about the bank you see across the road, you Q119 Michael allon: Nationwide in their should be able to walk into that bank and say, “Would submission described the UK banking market as Ev 24 Treasury Committee: Evidence
30 November 2010 Sir Donald Cruickshank effectively a mature, low growth market. That’s not response to my report, which again didn’t happen. But what you’re saying. these are the two big ones: they got the FSA wrong Sir o al Cruicksha k: I am, and the paradox is and they got money transmission systems regulation that in a mature, low growth market they can make wrong. super-normal profits. This is the question that those Chair: Very helpful evidence. who want to do something about this have to crack. Q123 Mr uf ey: I was struck, Sir Don, on re- Q120 Michael allon: Why do you think nothing reading it, by how insightful your 2000 review was. happened when you recommended this 10 years ago? You’ve updated us and, whether or not profits are Sir o al Cruicksha k: I don’t know how many of super- normal, I think we can all agree that the money you have even read bits of my report, but the most transmission system is something that needs to be important bit of it is the interim report that spelled out addressed. You put it rather well: “Would we allow how the FSA should be set up. That fell to Google to manage the internet? No, never. So why do parliamentary timetables and the unwillingness of we allow banks acting in concert almost absolute Treasury officials to even attempt to implement it, or control over the money transmission systems, over even properly to inform Ministers what it was I was which all financial transactions take place?” I think about. I know that’s a severe accusation to make of that’s the nub of it, and for clarity I just want to return officials but that is the fact of the matter. to some of the answers you gave a few moments ago. If you were to be advising the current Chancellor of Q121 Chair: Do you have documentary evidence to the Exchequer now, what would you advise him to do support that, Sir Don? regarding the transmission system? Sir o al Cruicksha k: I have my own diaries of Sir o al Cruicksha k: I would advise him to give events. I have a copy of the job description of an the CPMA both the competition objective up front, official who was tasked with making sure that the and also give it powers to license money transmission interim report was not effected. I have a record of systems—a licensing regime, in other words. It would meetings with senior officials. be a class licence. It wouldn’t need to be specific to Chair: It would be very helpful if you could set out the different systems, and in the legislation I would in writing what you can recall of these events, not as give the CPMA objectives on using their powers some sort of elaborate post-mortem but designed to under that licence, and they would have sanctions, a enable us to assist in making sure that as the City is bit like Ofcom has. It varies over the utilities, but re-regulated now, as the FSA is reformed, we get it wherever there is a network there is an authority that right this time. licenses activity and has sanctions: in the internet it’s Sir o al Cruicksha k: On page 317—there is no an informal one, in telecoms it’s very formal, but it is need to put it in the record here, but it is interesting— the same thing. it says: “FSA should be responsible for making the In the legislation they would have obligations to trade-off between regulatory and competition pursue—and I have just listed a few things here— outcomes. Financial services should not have price transparency; governance; fair, reasonable and unnecessary exclusions from UK competition law”. non-discriminatory access to these systems; efficient wholesale pricing; barriers to switching and fair Q122 Chair: Should competition be one of the trading generally. These are the headings of what objectives of the regulator? would be line items in the legislation. So it would be Sir o al Cruicksha k: Yes, if there were one a specific capacity of the CPMA to license, scrutinise regulator. It’s not enough to give the CPMA a and sanction the money transmission system competition objective. We also need clarity in the operators. system about who makes the trade-offs when prudential regulation clashes with the outcome that a Q124 Mr uf ey: Could you just give an estimate— competition regulator would like to see. Are we and you probably need advance notice of this coming back to that? question—of the costs of putting that new regime in Chair: We are hoping so. place? What should be the objective in terms of cost? Sir o al Cruicksha k: Those who are asking Sir o al Cruicksha k: I ran Oftel—albeit in simply for a competition objective for the CPMA have simpler times—with maybe 30 or 0 people in this only gone halfway, and I hope John Vickers can go area. We are only talking about 10 or 12 licensees the whole way on this one. When I was doing it— ever, because it is one of these situations where if because, to quote you, the FSA was “the leviathan”— there is a network everybody has to be a member of we could have integrated this trade-off within the FSA it, so that simplifies things no end. but the Treasury refused to do it. The second thing they did was that, in the March Q125 Mr uf ey: Final question, if I may, budget Gordon Brown stood up in the House and said, Chairman. You’ve undertaken to give to the “We will legislate on money transmission systems”. Committee some of the documents you mentioned in It didn’t happen because Treasury officials persuaded connection with Treasury opposition some years Ministers that some—I don’t know what it’s called— ago— Payments Council, meeting under the auspices of the Sir o al Cruicksha k: Well, not many documents. OFT, could do the job. Total nonsense. So that didn’t I’m prepared to set out not just my recollection but happen. Then there were some other second and third the facts of the matter, plus recollection of meetings order statements, which are in the Government’s and notes of meetings, yes. Treasury Committee: Evidence Ev 25
30 November 2010 Sir Donald Cruickshank
Mr uf ey: Sure. I think we will read them with hold, or rather making it absolutely clear that they had interest, but could you give us a sense of what the to serve you well, clearly and faithfully, would make Treasury objection is institutionally? Whatever it was a huge difference. a few years ago, it is probably likely to be the same today. What do think their big problem was with Q128 Andrea Leadsom: Would you agree that it your recommendation? would also reduce barriers to entry, because, at the Sir o al Cruicksha k: Because by the time I moment one of the biggest reasons for not going into reported on money transmission systems the FSMA, the UK retail banking marketplace is simply because the Act, had become a fact. Then I had to say there of the inertia of customers? Your possibility of should be another body that should be legislated for, building a new brand is extremely long term and and the Treasury—like today, this getting rid of costly, whereas if customers could instantly change quangos never ends, does it?—just fell away from the bank then, presumably, that would persuade new thought of generating the energy and the political time entrants into the market? in the House to create another regulator. Sir o al Cruicksha k: The cost of acquisition—to However, this time, because the CPMA is not yet in use a marketing phrase—of a new customer would place and the legislation is not yet before you, I drop dramatically and it would make effective suspect it is simple to put no more than two or three marketing more viable. It is astonishing, if you think clauses into the legislation to give effect to something about it, that brands as strong as Tesco, Virgin and that the Treasury just couldn’t face up to in Marks and Spencer haven’t been able— 1 2000. Andrea Leadsom: Aren’t there. Sir o al Cruicksha k: They are there, but over the Q126 Mr uf ey: Do you think this is the number course of 12 or 1 years they haven’t been able to one, most important, change that is within the power make any real inroads here. I may say it took the FSA of the Government at the moment to improve 17 years to give Terry Leahy a banking licence, but banking competition? hopefully that will change. Sir o al Cruicksha k: For retail banking, and by “retail” I mean current accounts, deposits, secured Q129 Andrea Leadsom: Do you think that it would lending, unsecured lending and money transmission also increase customer confidence in the banking systems—these are the five markets I’m talking about, system if they felt that they could literally move with although there are a lot of other things in the their feet—that they could march out the door and go legislation they have to get right— somewhere else the very next day? Mr uf ey: But this would be the big one? Sir o al Cruicksha k: Yes. The Chairman gave Sir o al Cruicksha k: For the purposes of what the example of him personally trying to get we’re talking about today, yes. information from the bank. It would make it far more difficult for the banks to hold and hide information, Q127 Andrea Leadsom: Sir Don, I’m delighted that and they would just have to be far more forthcoming. you are talking about this. I just want to go back to On the high street anyway—let’s not talk investment the money transmissions systems again. It seems to banking—it would improve trust. me that this is a complete revolution in retail banking. For years it has been a puzzle to me why, as a retail Q130 Andrea Leadsom: In terms of the cost, in your customer of a bank, if you want to change your bank earlier review did you look at the costs to banks of account you have to unset up all your standing orders trying to create a system that would allow the and direct debits, go somewhere else and sort it all consumer to take their bank account with them? out again, running the risk that you won’t pay your Sir o al Cruicksha k: No. Number portability, mortgage or your credit cards on time, and so on. It which you all enjoy now in telecoms, was something has always seemed bizarre to me. It would make a lot that I drove through in the 1 0s, first on the fixed more sense if your bank account stays with you and line and then mobile. In each case the estimates of the you just change your sort code if you wish to switch cost were huge. You could get an engineer sitting in provider, and likewise your mortgage account. Why front of a body like this demonstrating how expensive does that have to be started again from scratch? So I it was going to be. However, if you drive it through, do think what we’re talking about here is an absolute that same engineer is delighted to have the challenge revolution in retail banking, and I think that in one and the costs are trivial. The engineers get at it, they fell swoop it would literally change the competition are legitimised to get at the issue and in today’s world situation in retail banking. Can you comment on that? they should be able to deliver it very easily. I would Do you think that it can be as radical as that? go further: they should be able to deliver it in ways Sir o al Cruicksha k: My judgment is that it that are cost saving for the bank, as well as service would change how well bank managers slept at night, improving for us. and I think that’s radical. It would focus on current Andrea Leadsom: Thank you. accounts. I think straying on to mortgages, in particular, is difficult. Because the current account is Q131 Mark Garnier: Sir Don, I want to turn to new so important to the bank, because of our inertia, and entrants to the banking system. You state in your their opportunities to sell on other products—some of written submission that it is telling that we seem to which we’re not talking about today but insurances have had only one new high street bank in the last and the like—and it is so important to the bank to 100 years, and that was this year. Why do you think have you as a current account customer, breaking that that is? 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Sir o al Cruicksha k: It used to be because there crisis? Personally I don’t think new entries is a big was a catch-22 in the FSA’s rule book, which was that part of the solution, and I would be recommending in order to become a bank you had to be a bank. Now, that the FSA should still be careful, but hopefully not I caricature not much—I can’t find the page but the as blindingly obstructive as they were. Effectively, the actual rule is quoted in the report somewhere—and rule book said: “It is difficult to be satisfied that an I’m not sure whether that rule has gone or not. So applicant, which is not supported by an established although Virgin, Tesco and all the others were branded deposit-taking institution, i.e. a bank, should be as being in the banking industry, the actual licence licensed to take deposits”. I suspect that may have was held by an organisation that had a bank—RBS changed but that is the sort of problem, or versions of typically—either as a majority shareholder or as a it, that I think banks still face. significant shareholder with a shareholders’ Mark Garnier: Thank you very much. agreement. So that was an obstacle. The capital requirements for a new bank were more onerous than Q134 Mr munna: Sir Don, can I just ask you about for an established bank, and that drives the cost of the the mutual sector and, first of all, whether you believe new bank up because of the way it works through that the consolidation between some of the mutuals deposit taking and lending. Access to money has led to increased competition in the retail sector? transmission systems was a problem, although I think that is less so now. Then there is the point that Andrea Sir o al Cruicksha k: I think the demutualisation made about the costs of acquisition of a new customer process was helpful. The problem was that the looking cripplingly high. competition authorities and the Government allowed so many of the effective ones—like Halifax and Q132 Mark Garnier: One of the areas that I would Woolwich—to be taken over by the established banks. like to concentrate on is this regulatory process So it was a lack of proper competition scrutiny of the because I think there are a lot of business cases as to takeover of the Woolwich that was the problem, not why it is difficult—for example, you don’t arrive with demutualisation. So the concentration has resulted a readymade branch network. I think we all accept from failures of competition law, or application of that that is one of them. But where the FSA can make competition law. a difference is important. We had the FSA in last week and they were saying, rather breezily, that it was Q135 Mr munna: Do you not believe there is a relatively easy for people to get new banking licences, benefit in having that model available to the customer and there are three ways you can do it: you can to go to for its service provision, in the sense that a acquire another bank, and do with it what you want; mutual is quite different from a bank? Historically you can set up a new division of a bank; or you can they’re well rooted in the communities they serve; do it from scratch. Certainly, anecdotal evidence that there is a form of democracy, if you like, in the sense I’ve come across is that it is very difficult to get a that it is member—as opposed to shareholder— new bank registered from scratch and although the driven, and there are certain benefits in that. It seems FSA say it’s possible, it takes seven to eight months. to me that, as a model, it has fallen behind somewhat. But you do have these endless catch-22 situations, Sir o al Cruicksha k: Mutuals are banks; they are such as you need to capitalise it before it becomes a licensed banks so the difference is in the governance. bank, which means you then have an expensive non- I think mutuals are absolutely fine as long as they are operating business. What I want to get to the bottom mutuals. What did “mutual” mean in the 1 th century? of is this: do you think that the FSA in its actions It meant that one group of people were depositing and is hindering new banking companies coming into the being lent to, and they were being treated equally. market, or do you think they’re doing a fair job of Today a mutual means that there is a deposit-taking trying to regulate them in a fair way, and in a way that process, which is open to anyone, and then there are encourages new banks to come into the marketplace? different classes of people to whom you lend money, Sir o al Cruicksha k: I find it very difficult to including commercial lending by and large. That answer that question, because I haven’t been drags you away from proper mutuality in the sense I associated with any new bank and I haven’t read the think you’re talking about it; it puts the board and the updated rule book in detail. It is an aggregation of governance of an organisation into a different mindset small adverse detail that makes effective entry difficult. There is a big welcome sign above the door, and set of legal obligations to its depositors from the but there are gates and hurdles and costs before you original mutualisation idea. But I think that can be get there. So I couldn’t give you an authoritative accommodated and, as far as I can see, Nationwide answer to that. and the others do it rather well.
Q133 Mark Garnier: But your sense is that it is Q136 Mr munna: What do you think are the main difficult? consumer benefits of the diversity that I’m talking Sir o al Cruicksha k: My sense is that the about? Do you think I’m going down the wrong welcome sign has gone up but some of the gates and avenue here and do you not think there is a benefit barriers are still there. But to take you back to a point in having this increased diversity in the market for I made earlier, new entry would be healthy but I don’t the consumer? think we should be taking risks with a series of Sir o al Cruicksha k: Diversity is good as long introductions into the banking sector. Do those of you as conditions of mutuality are real and not just a who are old enough remember the secondary banking brand. Then, yes, I welcome it. Treasury Committee: Evidence Ev 27
30 November 2010 Sir Donald Cruickshank
Q137 Mr munna: Presumably you’d agree that service to be provided to that 1 million-plus people those mutuals that didn’t diversify into more complex would be one of them. financial products weathered the global financial crisis reasonably well? Q140 Mr Love: Can I come back to the question Mr Sir o al Cruicksha k: They did but then so did Umunna asked earlier, about consumer benefit of some of the mutuals who were in commercial lending diversity. I wasn’t quite clear, but I thought you and buy-to-let lending, and so on. There were a few— indicated that you felt there was a consumer benefit Dunfermline springs to mind—but not very many who for real mutuals. Is that your view—while accepting became insolvent. Do I have that the right way that some of the mutual movement got into severe around? Dunfermline had a liquidity problem because difficulties, including Dunfermline, and a number of it was wholesale borrowing rather than the actual them, as a consequence, have had to merge or be taken business being insolvent. That’s right. over by other, usually mutual organisations? What can we do to protect the essence of mutuality that delivers Q138 Mr munna: There is somewhat of a that consumer benefit? discussion that is brewing as to what to do with Sir o al Cruicksha k: I have to put my hands up Northern Rock and Bradford and Bingley going and say I’m not at all sure. I would need to think forward—and it may be that the Banking Commission about that. I just can’t think about the process of the expresses a view on this—but it’s my own strong view regulatory action that would be needed for new that we should give serious consideration to mutuals to be created, or if we were in some way to remutualising them. Do you have a view on that? hamper the members of a mutual from becoming a Sir o al Cruicksha k: No. I’m not sure how you non-mutual, which is what happened. So I’m afraid I would do it. The mechanics of it escape me as we can’t be at all helpful on that. speak. I would personally be indifferent as to whether the business of Northern Rock was floated as a Q141 Mr Love: Let me ask you a slightly different separate entity on the markets, was created as a new question. Do you think that regulators understand mutual or, indeed, was sold to a new entrant. mutuals, because often the complaint is they’re very experienced when it comes to ordinary share capital Q139 Mr munna: Can I just ask one last question, companies but they don’t understand the rationale for Chair. I have been reflecting on how things have mutuals? changed since you carried out your investigation. We Sir o al Cruicksha k: Again, I couldn’t comment. find ourselves at the moment in a situation where I would challenge your assumption that regulators many people in my constituency, and I think there are understand banks. Frankly, that is part of the problem, about 1.75 million people in the country, who fall into so if it is exacerbated by this extra layer of complexity a lower income demographic and, as such, do not have surrounding a mutual I can understand why it’s an access to basic banking services. For example, one of issue. I’m sorry, but I cannot be helpful on that. the things I find in my constituency is that this has driven people into the hands of loan sharks and Q142 Mr Love: I understand, and I’ll just ask you dreadful doorstep lenders. Going forward, what one one final question. Much of the mutual movement— thing do you think we can do to ensure that those and indeed right across the financial services sector— 1.75 million people do have access to basic banking is suggesting that when it comes to changing the services and aren’t driven into the hands of these Financial Services and Markets Act, whereas it used unscrupulous lenders? In some sense, there is a to have regard to competition, it should now have tendency to drift into discussions about more complex regard to diversity. Then perhaps, because they had matters pertaining to the City and the way it works, that as an objective, it would mean that the regulators and the different parts of macroprudential regulation, focused more on understanding how mutuals work. but this is a very basic thing, which is relevant to Do you think that would help? millions of people, and it seems to me we haven’t got Sir o al Cruicksha k: I’m going to say something it right. quite scurrilous now. Every time Parliament enters a Sir o al Cruicksha k: I don’t think anything has plea that a regulator, or some independent body, changed from my chapter on this in the report. We should have regard to something it may satisfy the concluded here that what we call “the basic banking Members who are pursuing that but it means nothing service” would provide a perfectly acceptable return to the regulator—absolutely nothing. So unless you to the banks if they provided it. It is something that have the statutory objectives right, the “having regards the CPMA, if armed with licensing of money to” have a trivial impact on the way they behave. The transmission systems, could help with enormously, regulator can go about his business under the threat of because that would push the banks towards more cost- judicial review, which is what you’re always under. reflective pricing of current accounts, and it would Perhaps it is not scurrilous; I see lots of nodding emerge that basic banking service was a perfectly around the table. reasonable thing for them to be doing. Therefore, the In any legislation with which you’re associated, if you CPMA, armed with these powers, would be able to really want something to happen, never let Treasury investigate and promote sanctions on those banks that officials or anyone else get away with the phrase were refusing to offer it. So, buried away deep in this “have regard to”. Get the statutory objectives right, money transmission system are all sorts of potential and if you really want to pursue something get it in public goods, and making it easier for a basic banking there. Ev 28 Treasury Committee: Evidence
30 November 2010 Sir Donald Cruickshank
Q143 John hurso: Can I just ask one decade. This MOU between the Treasury, the FSA and supplementary question. In this country we have a the Bank was useless, as it turned out. So giving the model where the basic current account is free, and CPMA the competition objective— therefore the cost of banking is hidden in a series of Chair: Why was it useless? I’m not disagreeing with cross-subsidies. Should we look at charging for you; I just want you to clarify why it was useless. current accounts and, if that were desirable, how does Sir o al Cruicksha k: There are a number of one achieve it since if only one bank chose not to it reasons. It allowed the Treasury to pretend that the would destroy the others? Bank and the FSA together could deal with systemic Sir o al Cruicksha k: With the current regime, issues. It didn’t make it clear to the Bank what where the banks have a joint complex monopoly authorities it would have operating independently of interest in obfuscating the cost of a current account, the Treasury, or what resources it might reasonably because it’s so important to them, I don’t think a ask for or create to do that job. It ignored the fact regulator could tackle this, and get into determination that the FSA was flawed in its strategy objectives and, of prices and the transparency that would be helpful. therefore, in the way it worked and the way it was If we had a licence system for money transmission led. It was just sitting there waiting for a problem, in systems, and one of the obligations under that licence the full knowledge of Treasury officials that when was cost-reflective pricing, that would push the banks there was a problem it would end up on their desks in towards charging the actual cost of running different the Treasury. In a sense, that is what you would want, sorts of current accounts. When I say “different sorts”, but it didn’t end up on their desks in a timely way. It I mean current accounts with different incidence of should have been on their desks a lot earlier, if it had direct debits, cheques, deposits and complexities. You been clear about who was responsible for what. would get something close to free if you were a good Chair: I apologise for diverting you from the customer and didn’t give them any problems, while question, which was the answer to your own there would be a high price for those who gave them challenge. systematic issues. But the money transmission system Sir o al Cruicksha k: The CPMA with the regulation would promote that and I think that’s the statutory objective to promote competition—we used most effective way of doing it. It would still be more precise wording in 2000, “to minimise the enormously difficult, because the cost to the banks of impact of prudential regulation on effective running a current account depends crucially on how competition”—is the way it would have to be framed much money you have in it. for banking. But may I say as a preamble that I do not understand what is being proposed; the Treasury’s Q144 John hurso: Can I ask you to comment on consultation document is very weak. To the extent that how desirable it is? Is it something that we, and I do understand it—that there is a political regulators, should pursue as an objective or is it a determination, in particular, to give the Governor of distraction from the bigger picture of the money the Bank these authorities—then it should be clear transmission system that you have been talking about? that it is the Bank of England, not the PRA, the FPC, Sir o al Cruicksha k: I think cost-reflective or the CPMA, that has the authority to make the trade- pricing—to use the jargon—is a good thing for off. That technically, I guess, would be the Governor consumers. Those of us who want to use cheques and the Court. However, I would note that the could pay for it, instead of being told in six years’ Treasury can instruct the Bank of England on anything time we can’t use cheques at all. Nonsense. Those except monetary policy. So there is a line of who don’t want cheques, or can find other ways, will accountability right back to the Treasury, but that is a have a cheaper bank account. So I think cost-reflective political issue as to how much you want to leave with pricing is good for consumers and in the long term it the Governor of the Bank of England and how much would be good for the banks as well. Their resistance you want to formally give to the Chancellor. to anything that will erode the inertia surrounding current accounts will be enormous. Q146 Chair: Just to be clear, in the trade-off between prudential regulation and competition, the Governor, Q145 Chair: Can I just come back to a point you being in charge of the Bank of England as a whole, made earlier? In one of your answers you threw out a should be responsible for deciding how that trade- challenge yourself that we need to sort out how the off— regulators will reconcile the requirements of Sir o al Cruicksha k: Making that trade-off, yes. prudential supervision on the one hand, and regulation Chair: With ultimately the Treasury being responsible to stimulate good business conduct and competition because they can instruct the Bank on everything on the other. In a nutshell, could you say how you except the work of the MPC, and even that with an think the authorities should answer your own override? challenge? Sir o al Cruicksha k: Yes, that needs to be made Sir o al Cruicksha k: They, or the legislation to clear. be precise? Chair: Andrea Leadsom has one burning question. If Chair: In this case it would be legislation in she can ask it in one sentence and you can answer it consultation with the Bank of England, which is why in one sentence, we will take it. I used the word “authorities”. Sir o al Cruicksha k: Yes. The legislation needs Q147 Andrea Leadsom: It is very relevant to what to be clear about the “how” and the “who” in relation you were saying, Chairman, and it is simply this: if to trade-offs. That is what was missing in the last the CPMA is to have a statutory competition Treasury Committee: Evidence Ev 29
30 November 2010 Sir Donald Cruickshank objective, how will it enforce that? Do you envisage from a consumer’s council, or whoever it is. That is it carrying out its own investigations and then making what would happen, and that is what was missing in recommendations to a committee of the Bank of the last seven or eight years up to 2007 08. England for action? Chair: Sir Don, your evidence today has been Sir o al Cruicksha k: My experience of statutory extremely valuable to us and we are very grateful that objectives is that precisely what they are influences you have come in. Perhaps there will be things that the behaviour of the leadership of the organisation. you have heard today that have stimulated further That would be the real impact. The technicalities of thoughts on your part. If you do have any, please, do how trade-offs are made and whether references are get in touch with us. We may, in any case, be coming made to the Competition Commission are secondary. back to you in writing for points of clarification. As I It means that the leader of the organisation has the say, we are very grateful to you for the work you have statutory objectives in front of him or her when put in on this subject over many years. Thanks for they’re thinking about the judge and the challenge your evidence today. Ev 30 Treasury Committee: Evidence
Tuesday 7 December 2010
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Jesse Norman Mark Garnier David Rutley Andrea Leadsom John Thurso Mr Andrew Love Mr Chuka Umunna Mr George Mudie ______
Examination of Witnesses
Witnesses: Eric Daniels, Group Chief Executive, Helen Weir, Group Executive Director, and Patrick oley, Chief Economist, Lloyds Banking Group, gave evidence.
Q148 Chair: Order, order. Welcome to this hearing Q152 Chair: That was not what I was asking, of the Treasury Select Committee. We have quite a though, all I am asking is what proportion this 35 is number of questions to get through and I am hoping of the total cost? my colleagues will help by asking brief questions and l ir: Sorry. That would barely cover our costs certainly brief, direct answers would also be valuable. of running a current account. I would like to ask initially a question to Helen Weir. You told the commission that the vast majority of your Q153 Chair: We are still not really getting to the customers do not pay anything for their current answer to the question. Why don’t I try asking it a account services. What proportion of customers do different way? The OFT report said that the total end up paying for their current account services? revenues on personal current accounts was £8.3 l ir: Approximately 30% of our customers billion in a normal year, that was 2006. That is a figure will pay fees associated with overdraft because they you are familiar with? make use of an overdraft. So about 30% of our l ir: Only from the OFT report, obviously, I customers use an overdraft. About 70% of customers don’t see— don’t go into overdraft at all, therefore effectively they have credit balances in the account. Q154 Chair: And the OFT report showed that net credit interest was half that, almost exactly .1 billion. Q149 Chair: When you use the word “paying” do Are those figures similar to your own bank’s? you exclude the money that in a normal year they l ir: The foregone credit interest would be make of net interest credit? approximately half of the total income on personal l ir: In that particular context I was talking current accounts. The typical amount a customer pays specifically about fees and overdraft interest. Clearly for their current account, including foregone interest, there is— is approximately the same as a cup of coffee a week, Chair: So they do pay? which is significantly lower than, for instance— l ir:—an interest foregone. For a typical customer with an overdraft balance—about 70% of Q155 Chair: Let us have another go at going around our customers will have an overdraft balance of less these numbers. There is £ billion coming in on net than £1,000—they will typically pay, in foregone credit interest according to the OFT, out of £8.3 billion of total revenues coming in on PCAs, personal interest, about £5 a year currently. current accounts. You are saying that your ratio is roughly the same as those overall figures for the Q150 Chair: That is at the moment, what about in a industry. But you have just told me that in a normal typical year? year you only collect £35 of net credit interest, so l ir: Yes, and if the base rates went back to therefore the figure that you should be giving me for 3.5% they’d pay about £35 a year of foregone interest. the total cost is £70, twice the £35. l ir: I’m sorry; I didn’t follow your logic. Q151 Chair: What is the overall cost of running a Could you please repeat that, my apologies? typical account? l ir: The cost of a current account is quite Q156 Chair: Well, let us start again, I will have one significant, as you’ll appreciate. There are a number more go and if we do not get anywhere you will have of services that go along with that. Typically the cost to write to us or come back again. There is £8.3 billion of the branch network, the cost of providing ATMs, coming into the industry, about half of that is derived cheque facilities, the debit cards, so there are a from net credit interest, £ .1 billion, you have told me number of services that go along with the current that your ratios are pretty much the same as the ratios account. I think a number of people have looked at between those two numbers for the industry. You have the current account market, a number of regulators, told me this morning that you, in a normal year, only and found that overall customers in the UK get a good obtain at your bank, on average, £35 from each deal compared with other countries. current account? Treasury Committee: Evidence Ev 31
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
l ir: £35 from a customer that is in credit. 25% or 30% of that, say £1.25 billion of net credit That’s the foregone interest was the £35. interest? Chair: That is the foregone interest? l ir: There or thereabouts, yes. l ir: Yes. Q165 Jesse Norman: There or thereabouts across 2 Q157 Chair: So what is your equivalent figure for million customers, so that is the way of working out the net credit interest figure given by the OFT in their what the average amount is? report, the £ .1 billion? l ir: Yes, but don’t forget not all of those l ir: It’s approximately equivalent to our customers will be customers in credit. broad market share, so that’s between 25% and 30% of that number. Q166 Jesse Norman: No, but if we were trying to work out what the total amount of money derived per Q158 Chair: What does each customer on average customer, for someone who is in credit or not? pay? What is represented by that for each customer, l ir: For foregone interest, yes. roughly? l ir: Of the foregone interest? Q167 Jesse Norman: Then there would be charges on top of that? Q159 Chair: Yes. How much is each customer on l ir: For customers who are in overdraft there average paying in interest foregone on his current will be account charges which will vary depending on account, on average at Lloyds? their usage of the overdraft and also interest. l ir: It depends on obviously what the interest rates prevailing in the market are. Q168 Jesse Norman: What is the aggregate amount Chair: In a normal year. of additional charges that you raise on those 2 l ir: In a normal year that £35 that I was million customers? talking about. l ir: The income on current account splits broadly 50 50 foregone interest and charges and fees. Q160 Chair: That is the £35 figure? So we are back where we started. Q169 Jesse Norman: Right, so it is roughly about l ir: That’s the foregone interest for £2.5 billion in total from those 2 million customers. customers in credit. l ir: Thereabouts. There or thereabouts. ric a i ls: But I would clarify that would be in a Q161 Chair: In which case the figure for the total normal year. We’re hardly in a normal year. value of personal current account revenues, on average per account at your bank, is £70 a year? Q170 Jesse Norman: No, no, absolutely. I am just l ir: You’re talking about all customers, trying to get a sense of this. That is helpful we may sorry? come back to that. ric a i ls: Yes, including all charges. Can I ask, given that the true cost of current accounts l ir: Including all the charges. is not visible to 70% of your customers who you use Chair: Yes. “free” banking, how are the different firms competing l ir: Yes, not just customers in debit, sorry. against each other in this part of the market? l ir: I think on a current account there are a Q162 Chair: It is £70. Are you making profits on a variety of different ways in which firms compete. For standalone basis from your current accounts? most customers the cost or otherwise of the current l ir: Our current accounts are profitable but account is not the most important thing, it’s the not excessively so. So there are no abnormal profits. availability of branches, the availability of ATMs that We’re getting a hurdle benchmark rate of return on they can use, the other services that we provide, the the capital that’s employed in that business. So it’s not service they have in branch and a variety of other excessive on that product. things of that type are the main areas that cause Chair: I think we may have to come back to you for customers to choose. If you look at the factors that further information on some of these numbers. customers take into account when they’re looking at l ir: Absolutely. the choice of current account providers, price is Chair: Because I think there still is some confusion relatively low down because it is a relatively between us, even though I am using the figures that inexpensive product. As I say, the average cost to a are published by the OFT. We might come back to it customer is approximately the same as a cup of coffee later in the hearing. Jesse Norman. each week, so significantly less than many other things that they use. Q163 Jesse Norman: Thank you, Mr Chairman. Can I just ask you to remind me, Ms Weir, how many Q171 Jesse Norman: Do you think there is a case current account customers you have? for separating out the payment transmission in order l ir: We have about 2 million current to allow more, as it were, current account portability? account customers, including 5 million social l ir: A different question. I think in terms of banking customers. account portability, I’m not sure about separating out payment transmission, I think there are a number of Q164 Jesse Norman: So if you have a market share ways in which portability can be improved or equivalent of net credit interest you would have about switching can be improved. That said, I think the Ev 32 Treasury Committee: Evidence
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley experience of customers today in terms of switching Q175 Chair: Just before I pass on questioning to has been significantly improved already. We have a John Thurso, back to Helen Weir for a moment. You switching service where we have individuals who are have been prepared to tell us what you are deriving allocated to particular customers who will switch all in revenues from current accounts, why not tell each the direct debits as a named contact. Typically the individual customer what they are getting? greatest problems arise with non-financial services l ir: Well we are as of next year going to companies in terms of switching; so switching direct be disclosing on the statement the amount that each debits from utilities and other third party services. customer is paying in terms of the various items that they are incurring in terms of charges, interest and Q172 Jesse Norman: But you are committed to so forth. making that happen, effectively? l ir: Absolutely committed to making that Q176 Chair: So that they can arrive at a bottom line happen. for the revenues you are deriving from their account? l ir: They won’t have all the information but Jesse Norman: Thanks. they will know what they’re paying. l ir: Just, if I may, on the point of portability, there are a variety of forms that portability can also Q177 Chair: What information are you withholding? take. There’s the very—an absolute portability where l ir: They won’t understand the cost of funds. sort code and account number and so forth all get They won’t have that information but beyond that, ported, but there are a number of other results or a yes. number of other approaches that could be taken which would have a similar kind of result. So I think there Q178 Chair: In that case we will then be able to are a variety of different options there. The first that I introduce some price-based competition into current talked about is probably the most expensive and that’s accounts, will we not? a cost that probably would ultimately be borne by the l ir: I would argue that it is a very price- customer but I think there are a number of other competitive market right now. Santander is offering approaches to account portability that could be used. £100 to get customers to switch. There’s a lot of We are very committed to improving the account competition going on in that market already. switching. Q179 Chair: Yes, that is because there is inertia once Q173 Jesse Norman: Thank you very much. We are clients are obtained. It has nothing to do with ongoing very short of time, just a very quick question for Mr competition. People cannot tell what price they are Daniels. It has been suggested to this Committee that buying a product at in any subsequent year, can they? it might be helpful as a regulation of the banking l ir: I think most customers would have a sector if executives were paid in subordinated debt pretty good idea of what they’re paying for their rather than in equity, is that a view you would current banking, certainly our research— support? ric a i ls: Subordinated debt rather than equity. I Q180 Chair: How much do you pay? think that was the suggestion from Lord Myners and l ir: In terms of my foregone interest, quite a from others. I think that what is important is that the bit of money. idea that executives should be paid at the market, in other words it should be a market based set of pay, Q181 Chair: But you do not know? first, second I think that the concept of deferral so that l ir: No. we can recognise whether there was a additional risk Chair: But you are expecting most customers to have taken over a more extended period is important. The a pretty good idea and you are the Chief Executive actual instrument, whether it’s debt or equity, I think and you do not know. I think that is, if I may say is a lot less important. I think the principles are— so, a ludicrous remark. The overwhelming majority of people do not have a clue and that is one of the reasons why we are engaging in this investigation. Q174 Jesse Norman: But you recognise the point the l ir: And that’s one of the reasons also why Governor of the Bank of England made to us, which we’re committed to making that information available is that there is an implicit subsidy in having an equity on our statements next year. compensation scheme because it encourages people to ratchet up the debt in the balance sheet knowing that Q182 John hurso: Thank you, Chairman. Mr they can take— Daniels, I wanted to ask you a couple of questions ric a i ls: No, I’m not quite sure I agree that. I about the comments you made in the article in the FT think that there are pros and cons to each kind of on 25 November, but can I first ask regarding the parts instrument and there’s not a one-line answer. What the of the group that have to be sold off to meet the thinking had been among many banks was that, and requirements of the European Commissioner. Did you many companies—it is not simply banks—that by consider the possibility of taking the Bank of Scotland having more equity in the compensation programmes and hiving that off, not Halifax but just the Bank of that it would align the executive with the shareholder Scotland? If not, why not? so that they would be more aligned. That had been ric a i ls: Yes, what we did when we were the prevailing thought, whether it was an industrial negotiating with the European Commission was we company or a bank. presented a series of alternatives to them and then Treasury Committee: Evidence Ev 33
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley worked together with them collaboratively to try and Those are still very much—we are subject to them, as arrive at a solution. is every other bank, and there has been to date no issue with the competition authorities. Q183 John hurso: Was that one of the alternatives? ric a i ls: What we presented to them was, again, Q187 John hurso: Looking at that point of a variety of alternatives. competition, if the independent commission were to come back and say that there is sufficient evidence to Q184 John hurso: Was the possibility of the Bank say that Lloyds Banking Group is too big and in the of Scotland becoming a discreet identity one of those interests of competition it should be further reduced alternatives? in size, what would your response be to that? ric a i ls: I don’t believe that was an alternative ric a i ls: I think that’s a hypothetical question. considered. We are just, at the moment, giving evidence to the International—Independent Banking Commission, Q185 John hurso: Why is it that is so important excuse me, and I think it’s very premature to judge an whereas the TSB branches in Scotland you are happy outcome. What I will say is that this is an enormously to—or prepared to see go? competitive market and I’m not sure that dividing ric a i ls: I would hardly term the divestiture as banks up further will give any better outcome. As you happy. suggested, we are already divesting a fair number of John hurso: Yes, I did correct myself. branches and current account share, and that will lead ric a i ls: But what I would say is that one of to the creation of the seventh largest bank in the UK. the things that’s terribly important to us is the brand I think every independent study has shown that UK identification by our customers. The Bank of Scotland consumers get a top quartile, or at worst a second is a very powerful brand in Scotland, it’s a 300-year- quartile, value deal and that concentration does not old name and the customer identification with it is lead to lack of competition. In other words, the UK, very strong, and we thought that that in fact was a as many other concentrated markets, are very brand that had more resonance with the Scottish competitive. I think if we look at the discounting that customers than the TSB brand. happens, that is one of the signs that the OECD uses to determine how competitive a market is, and this is Q186 John hurso: Coming back to what you said, a market that discounts very heavily indeed. you responded to Clare Spottiswoode’s suggestion John hurso: Thank you. that the Independent Banking Commission might reverse the whole merger, really by saying the present Q188 Mark Garnier: Thank you, Chair. Carrying on Government should honour the promises of the last from this point, Mr Daniels, just looking at these Government. Why do you think that is particularly numbers. You have personal current accounts; you important? have a 30% market share leader; savings account ric a i ls: Well, I didn’t respond specifically to 13%, number two in the market; mortgages 28%, Mrs Spottiswoode’s comment, I basically said it is number one in the market; unsecured personal loans what it is. It was an introductory remark that she had 25%, number one in the market; credit cards 2 %, in the public hearing. In terms of how I feel about number one in the market. Do you know what your the current arrangement, very clearly what happened investment products market share and market during the economic crisis or the banking crisis was position is? that there was a thought that HBOS could in fact go ric a i ls: We would certainly be among the top down. It was in very, very bad shape, as we all know. three, I don’t know exactly. I think the prevailing thought was at the time that were it to happen—and this was on the heels of Northern Q189 Mark Garnier: Maybe not number one. SME Rock having gone down and having seen the business? disruption that could cause—that it was a far ric a i ls: SME we would be among the top three preferable thing if a bank were able to take it over again, but not number one. and have continuity of service and not have the pretty dramatic implications of a bank being either brought Q190 Mark Garnier: So definitely not number on in into Government ownership, or falling. either of those two? On that basis the Secretary of State introduced a new ric a i ls: I don’t believe so. criterion which basically said that the concerns about stability were paramount and then Parliament in fact Q191 Mark Garnier: It would be very helpful if you agreed with that and passed that. would get back to us on that. Talking about putting a John hurso: Reluctantly, I was on that statutory lid on competition is just a nonsense really; you have instrument. this monumental dominant market share on just about ric a i ls: I beg your pardon? every area. How can you possibly justify being the John hurso: Very reluctantly. biggest bank in everything or nearly the biggest bank ric a i ls: I can understand that, but nevertheless in everything? it was passed by Parliament. So on that basis we went ric a i ls: Well, in the first place I’d be very happy ahead with the deal. Now this never was meant to give to get back to you with our market position on both us a permanent waiver for competition, on the SMEs as well as investment products so we’ll write contrary all the rules around competition still prevail, to you separately. But again, I think as I was saying whether it’s market abuse or use of size and so on. before, this is a very highly competitive market and— Ev 34 Treasury Committee: Evidence
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
Q192 Mark Garnier: How? How is it competitive? ric a i ls: Be happy to. ric a i ls: Well, if I may? We really have five different markets, if you will. If you take the mortgage Q196 Mark Garnier: The other thing is, on SMEs, market, for example, there are about 60 competitors. you are not at all sure what your market share is on Over half of mortgages are basically sourced through the SME? brokers, through IFAs. So what happens is the IFA ric a i ls: Our SME market share is industry, which is very large and, again, accounts for approximately 20%, somewhere in that over 50%— neighbourhood.
Q193 Mark Garnier: The IFA industry is about to Q197 Mark Garnier: 20%, and you are one of the be— biggest players? ric a i ls: Excuse me, I’m sorry. ric a i ls: We would be among the top three Mark Garnier: The IFA industry is about to be certainly. RBS and Barclays would be larger probably. constricted as a result of RDR so presumably you see RDR as now being anti-competitive? Q198 Mark Garnier: In my mail bag the vast ric a i ls: I’m not quite sure what form the RDR majority of complaints I get from SMEs about having will take yet but if I just may continue for a second. trouble finding loans, comes from Lloyd Bank Mark Garnier: Yes, sorry. customers. Do you think that is because you are ric a i ls: The independent broker determines offering the worst product or do you think it is which is the best deal for the customer, and in fact because you are one of the biggest players therefore I mortgages are very, very competitive. There are, am going to get a selection more from Lloyd Bank again, 60 different providers. If— customers than anybody else? ric a i ls: I’m very surprised at that statistic Q194 Mark Garnier: Sorry, I do apologise for because in our own research we find that the great cutting across you, but if you have 30% of the majority of our customers are satisfied. We have made personal current account market, one of the great a commitment to our customers, approximately two advantages of having this big ownership of the current years ago, that any customer with a creditworthy account market is that you have access to 30% of the proposition will, in fact, be funded. We will extend market. You have 28% of the mortgage market, those the credit. numbers are pretty much identical and you are both dominant market share. How can you possibly say that Q199 Mark Garnier: To what extent has that it is IFAs that are going out and sourcing these things creditworthiness changed then in the last three years? when you can get in touch directly with 30% of the Because there are a great many people who are your market through those current accounts and go straight to them and sell them a mortgage product? What is customers who were getting credit prior to the the correlation between current account customers— collapse and are not getting credit now and it’s the correlation coefficient I want—and mortgage stifling business. customers? ric a i ls: I beg your pardon but I don’t believe ric a i ls: It’s very low; it’s at less than 25%. that’s the case. What is very typical in this marketplace, and again I Mark Garnier: Well, I can certainly bring them know it’s a lengthy answer but this is a complex around to come and meet you, if you would like to subject, there are five different markets. It’s personal meet some of these people. loans, mortgages, current accounts, savings and credit ric a i ls: I would very much appreciate that— cards. Each one has different competitors, each one Mark Garnier: We will see what we can do. behaves differently. The cross-over among them is ric a i ls:—because we have not changed our very, very small. So I think that if we were to look at credit criteria or our pricing over the last three years. a typical consumer it would be very normal for them Mark Garnier: You would be amazed at some of the to have a mortgage with one bank, a credit card with stories I can tell you and I will happily pass them on yet another and a current account with a third to you. institution. That’s very normal behaviour. ric a i ls: Please do, because again I would say If we look at the comparisons, if you look at Europe that we have not changed, on the contrary, we last year and other international comparisons, the concentration helped 100,000 new customers start up businesses. We of a customer’s wallet—in other words the number of are very, very mindful that we have a role to play in products they buy from an individual institution—is the recovery of the economy. much higher in Europe than it is in the UK because customers shop around for different banks, different Q200 Mark Garnier: Just one last question. I have products. a current account cross-selling conversion rates by product, I just want to know if you are finding that in Q195 Mark Garnier: Can I ask you what the the case of Lloyds Banking Group this agrees with correlation is then between personal current accounts how you are finding things. So the cross savings and investment products? between current accounts and savings account is 88% ric a i ls: Personal current accounts and and credit cards 53%, cash is 2%, unsecured personal investment, I’d have to look it up, I don’t have it to loan 2% and, as you say, mortgage about 27%. Are hand. you finding that that is the case in Lloyds Bank? Are Mark Garnier: Could you get back to us on that. you finding that roughly 88% of people who have Treasury Committee: Evidence Ev 35
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley current accounts are opening a savings account with transmission systems over which all financial you as well? transactions take place.” ric a i ls: I don’t believe that’s the case. Helen, Patrick ol y: I understand he said it last week, but I would you— have read his evidence and what he pointed out, I l ir: No, those numbers sound very high to think, on a number of occasions to the Committee was me. his review was done 10 years ago and he had not been close to the banking system since then. As I say, I Q201 Mark Garnier: Again, it would be incredibly think the money transmission system and its helpful if you could come back with the cross-selling governance has changed quite a bit in that time. from personal current account into your other products, it would be very helpful if you could do that. Q205 Michael allon: Yes, but you still have an l ir: Absolutely, we can come back. influence over it, do you not? ric a i ls: Again what we can tell you is that— Patrick ol y: No, I think the banks generally own and we will be happy to write to you—the the system or have access to the system but there’s no concentration of purchasing from an individual barriers to— institution is less in the UK than it is in most other places, and that’s because customers do shop around Q206 Michael allon: Well, do they own it or have and each one of the markets behaves differently with access to it? different competitors. So the mortgage market has 60 Patrick ol y: They have access to the system but different competitors, the current account has about there’s no— 30, and there are about 80 competitors in the savings market. So you have a very wide variety of players Q207 Michael allon: They do not own it? Who do that are offering different products. The number of you think owns it? mortgage products is absolutely phenomenal in this Patrick ol y: I’m not sure of the ownership structure marketplace so customers have real choice, and there of the system, to be frank, but there are no barriers is real value by any independent standard. to new— Mark Garnier: Try saying that to a 30 year old trying to get their first mortgage. Thank you. Q208 Michael allon: But you are the Chief ric a i ls: If I may respond to that. In fact in the Economist at the bank, you must know who owns the UK, first mortgage purchasers are generally in their money transmission system? early 30s,. In the Continent and other places they are Patrick ol y: Well, I am the Chief Economist, I am not an expert on the governance of all the systems. generally in their late 30s, early 0s. We make better availability on better terms, easier terms, for first time buyers than virtually any other marketplace. Q209 Michael allon: Well, who did you think owned it? Mark Garnier: I believe in the 1 80s first time Patrick ol y: That is not the point, the point is do buyers were around 22, 23, but thank you very much. companies—do new entrants have entry of—are able to enter or exit the money transmission system, and Q202 Michael allon: Mr Foley, you are an can the existing players stop them? The existing economist, would British banking be more players cannot stop them entering and, indeed, the competitive or less competitive if you did not retain OFT in their barriers to entry study said that the control of the money transmission system? money transmission system was not a barrier to entry. Patrick ol y: Well, I don’t think we have control, I don’t think the banks have control of the money Q210 Michael allon: How many have entered over transmission system. There’s free entry and exit from the last 20 years? the money transmission system so I don’t think it Patrick ol y: That is nothing to do with the money would make any difference to what is a very transmission system, I think that is to do with a very competitive marketplace. competitive UK marketplace. It doesn’t make it an attractive marketplace for some entrants to come in. Q203 Michael allon: But Don Cruickshank told us Michael allon: Thank you. last week that control of the money transmission systems was the major source of banks’ market power. Q211 Chair: You said in evidence just a moment Patrick ol y: I don’t think he’s correct, and I think ago, Mr Foley, that a lot has changed in 10 years since to be fair to Mr Cruickshank it was 10 years ago he Cruickshank wrote his report. In fact what he said to did his review and a lot has changed in the money us in evidence, and I have it in front of me—written transmission system and the way it’s governed since evidence—“Nothing much has happened. So not that time. surprisingly nothing much has changed.” uite the opposite to the impression that you have just given. Q204 Michael allon: It was last week he sent us a Patrick ol y: No, well I think that’s his observation submission saying, “I wouldn’t allow Google to from outside the industry, but he hasn’t been close to manage the internet, we wouldn’t allow BT to re- the industry for 10 years, since he wrote his review. establish control over the numbering system or terms of access to its dominant network, why do we allow Q212 Chair: Yes, but a moment ago you said that he banks” he said, last week not 10 years ago, “acting in himself was, in evidence, suggesting that a lot has concert almost absolute control over the money changed in 10 years. 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7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
Patrick ol y: No, no, please don’t misunderstand Andrea Leadsom: That there would be many new me, all I was saying was he said he had not been close players coming into the market. Why do you think to the industry since he did his review 10 years ago that is not the case? and therefore was not in a good position, in my view, ric a i ls: Again, I do believe we are seeing a fair to judge how much the industry had changed. number of new players entering into the market. As little as three years ago there were 16 mortgage Q213 Chair: So your primary criticism of providers in this marketplace, today there are around Cruickshank is that he is just not up to speed, out of 60. So you see an awful lot of entry and exit into date and— the marketplace. Patrick ol y: No, it’s not intended as a criticism at all, it’s just he has not been a close observer— Q219 Andrea Leadsom: Into the mortgage market, yes, but we are specifically talking about the UK retail banking market here and, as I understand it, there has Q214 Chair: What weight should we attach to Mr only been one new banking licence granted in the last Cruickshank’s evidence? three years, I think was the evidence we had recently Patrick ol y: I think Mr Cruickshank was very close from the FSA. to the banking system 10 years ago, he wrote a very ric a i ls: That was with Metro Bank. But what I interesting report at that time, but the industry has am referring to, when you refer to the retail market, changed a lot since that time and therefore what he again I think there are five separate markets starting concluded in his report 10 years ago is not particularly with current accounts, savings, mortgages, credit cards relevant to the industry today. and personal loans. If you look there are a large number of competitors across each one of those Q215 Michael allon: But he told us last week, “A markets, as I said, and I think you’re probably regulator armed with independent authority over thinking of the personal current account market. There money transmission systems would make a huge are 30 providers of personal current accounts in the difference, certainly in retail markets where the market today, so it’s very competitive. current account market is key.” Why is he wrong? Patrick ol y: I don’t see what difference that Q220 Andrea Leadsom: So then why do you have regulator would make. I mean there is free entry and such a huge market share? Why is there so much exit to the money transmission system so I’m not quite concentration—I think it is over 60% in the top five, sure what difference a regulator would make. or is it three players in the personal current account market. There are 73% share amongst the four largest Q216 Andrea Leadsom: Thank you. Mr Daniels, players. It does not to me, with my knowledge of would you say that your retail banking activities are economics, sound like a mature highly competitive profitable? Would you say it is generally a profitable low margin business that you are suggesting it is. It business? sounds to me as though there is something in at least ric a i ls: Yes, it is. the PCA market that means that four banks are able to generate this enormous market share to make monopoly profits and to keep out new entrants. Q217 Andrea Leadsom: So why then would you argue so strongly that it is highly competitive and that ric a i ls: Well, I beg to differ. I think if you look at the concentration in the UK market it, in fact, is there is free entry and exit of players? less than many markets. If you look at Australia, or ric a i ls: I’m not sure that profitability is you look at Canada or France, for example, you would associated with competitiveness or lack of find even greater concentrations. The US and competitiveness. What we’re seeing is, in fact, that Germany are often looked at as markets that are more over the past 10 years there has been huge movement fragmented and would display more of the kind of in terms of market shares, for example. What we have behaviours that you had suggested. In fact they are seen is, for example, Nationwide triple their market every bit as concentrated if you look by region. So if share over the past decade. We’ve seen Virgin enter you looked in California, for example, and you looked the market, we’ve seen Tesco enter the market and at the concentration levels there, they would in fact be we’ve also seen a fair number of foreign banks in the higher than the UK. credit card markets, for example, NBNA, Cap One So it depends on which region you look at. I think the and others enter this market, so it is highly facts are that if you have a market where you have competitive and customers get very good value from several different competitors and there’s high it. concentration but there’s high contestability—in other words players will seek to gain share and therefore Q218 Andrea Leadsom: But evidence from the FSA will fight very hard on service, on advertising, on suggested that there have been very few new entrants trying to reach out to customers—that that leads to to the UK retail market. You are saying on the one very good customer outcomes and that’s, in fact, what hand it’s competitive, on the other hand it is profitable, we’re seeing in the UK market where you are seeing on the next hand there is free entry and exit of market first quartile value in most cases for banking products. players. Anybody with any grounding in economics would expect then, for more new entrants into that Q221 Andrea Leadsom: But, excuse me, sir, that is market. Why do you think that that is not the case? not borne out by the experience because customer ric a i ls: I’m sorry, anyone would expect? inertia, the likelihood of individuals moving their Treasury Committee: Evidence Ev 37
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley bank accounts is very low, is it not? There isn’t an the most expensive to implement but it is a viable enormous amount of switching going on. form of account portability. ric a i ls: No, no, that’s not in fact the case. That’s one of the pieces, I think, of perceived wisdom that is Q227 Andrea Leadsom: So you would allow any not true. If you look— customer that wanted to to take their sort code and account number with them? Q222 Chair: Are people changing their bank l ir: That is a form of account portability. accounts the whole time, are they? Every year— ric a i ls: People in fact are changing their bank Q228 Andrea Leadsom: But would you allow that accounts— to happen? If I said to you I want to move my bank Chair: And the figures we have been given on the account from you, take it to Barclays and I want to rigidity in the market is— take my account number and sort code with me, Andrea Leadsom: Enormous customer inertia. would you let me do that? ric a i ls: If I may answer the question. If you l ir: At the moment I couldn’t do that because look at the switching behaviours of PCA customers, of the way the system is set up, the sort code is very personal current account customers, it is somewhere specific to a particular banking institution as I am sure between 7% to 11% of the customer base every year. you are aware. There are various ways though which Within Lloyds we have to attract in a million new switching can be made easier without going the full current accounts every year to make up for the way. attrition that we experience. So 7% to 11% is very high. That’s about the international norm. If you look Q229 Andrea Leadsom: I want to specifically deal at the switching behaviours in mortgages and in with the idea of account portability, it is a very savings accounts, in fact the UK switching is much particular point that Sir Don Cruickshank raised which higher than the international norm. So customers in was very interesting. Going back to the point about fact do shop, they are well informed and they are very who owns the money transmission system, if I want willing to switch. to change my account number and my sort code, what is stopping me? Is it not the case that it is the fact that Q223 Andrea Leadsom: Can you tell me, how long the banks own the money transmission system and it does it take if I want to move my current account is the banks who have decided that I cannot do that? today from your bank to another bank? How long Just to give you an analogy, Sir Don Cruickshank, would that take, roughly? when he was leading Oftel, saw through legislation to ric a i ls: I’d ask Helen to answer. make telecoms companies allow number portability l ir: It will very much depend on your third which previously was absolutely impossible and never happened before and so on. Is there any technological party direct debit providers, that is the critical path reason why that could not be the case in the banking time. Sometimes they can take up to two months to system? transfer the direct debits. Typically within the banking ric a i ls: If I may, and this is again one of those system most of the change could happen within two that is very hard to give a one line answer. The to four weeks. purpose of a sort code is so that in fact the money can find its way to the appropriate bank and to the Q224 Andrea Leadsom: So if I am paying my appropriate branch and then to the appropriate account utilities monthly I instantly have one massive problem number. So there is a unique sort code that allows the to transferring my bank account. One of the things transmission to be successful. If you in fact have a that— homogenous sort code for example then it would l ir: Sorry, could I just pick up on that? cause an enormous ripple in the money transmission Andrea Leadsom: Yes. system, money wouldn’t go to the right place. l ir: No, as I say we offer a switching service Andrea Leadsom: As it currently is, yes. which means we manage that through for our ric a i ls: So what we would have to do is to customers. completely redesign and rethink how a money transmission that’s been around for many, many years, Q225 Andrea Leadsom: So you would pay my gas how it would operate. Again, that’s not something that bill even though there is no direct debit set up? can done from one day to the next. l ir: We will work with the providers to make Andrea Leadsom: As Oftel did, yes. sure the direct debit gets moved, even when the utility ric a i ls: No, telephone numbers are completely directs it to the wrong place. different. Telephone numbers are independent of whatever switch. Technology has changed all that but Q226 Andrea Leadsom: For the convenience of the the sort codes are not, they are very specific customers, would you support the idea that if the identifiers. So, again, this is not something where I customer wanted to take their bank account number would venture an answer in two minutes or two hours. with them that they might be allowed to do so? I think it requires much more profound study. l ir: I’m happy to pick that up. I think there are a number of different forms that account Q230 Andrea Leadsom: But would you agree that portability—which I think is what you’re referring the technology exists to be able to do that? to—can take. One is where the sort code and the ric a i ls: I think if we were willing to completely account number go with the customer, that is probably rethink how money transmission systems work, it’s Ev 38 Treasury Committee: Evidence
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley not beyond the wit of man to figure out a different ric a i ls: What I would tell you—and I’d ask system, but I’m not sure that you would ever be able Helen to give you a better explanation in terms of to justify that investment. As Helen suggested, I think our overdraft charging mechanisms—that by and large there are much better ways to improve portability. overdrafts are a very low return product. They’re not something that we make a lot of money from. We use Q231 Chair: Just to be clear, you are flatly the product as a service to our customers, but it’s not contradicting—and happy I presume on the record necessarily something that we would greatly enjoy. In flatly to contradict—the OFT, who in their other words, it’s not a high return product. But, Helen, conclusions on this issue say, “We have found perhaps you can give a fuller explanation. significant challenges in attracting personal and SME customers through a combination of low levels of switching”, and they go on to other things. Q236 Mr munna: One moment, Mr Daniels, I ric a i ls: Through a combination of? asked you how you could possibly justify charging 38 Chair: “Low levels of switching, high levels of brand times the Bank of England’s base rate, are you saying loyalty and consumer’s preference for providers for a to me you think that is justifiable? branch network.” ric a i ls: If I may, and again I’ll refer the ric a i ls: I would absolutely disagree with that question to Helen, the Bank of England base rate has conclusion. nothing to do with our cost of funds and that’s something that’s commonly not understood. The Q232 Chair: They just got it completely wrong? actual cost of funds that we have is considerably ric a i ls: I believe that the OFT in their same higher. We can’t borrow money from the Bank of report, said that 80% of customers in personal current England at that rate, nor can anyone else. So that’s— accounts are satisfied. That’s their research— Chair: But just take 3% off the figure and you get to Chair: They are also ignorant of how much they are your cost of funds. So you move down the yield curve. paying. Mr munna: So let us say it is not 1 % but 16%. ric a i ls: Of the 20% that are not, about a third to a half of them switch every year. Certainly in the Q237 Chair: So now if we re-pose the question, can SME market what we’re seeing is switching of you justify 16%? somewhere around 20% per year. Part of that is ric a i ls: And again, if I may, we then have to because you have, again, in SMEs a very high deduct the losses. This is the highest loss product of morbidity rate, and so what you find is a lot of people any that we issue. So every time we extend an exiting the market and a lot of people entering the overdraft we in fact incur losses at some point down market and that gives them new choice, as well as the road. In addition to that you have administration switching among the existing players. costs, so the total return on overdrafts is, in fact, not So I think that the switching behaviours are much higher than I think the report would lead you to very good. Helen? believe. l ir: No, that’s exactly right. The typical losses on our overdraft product are somewhere of the Q233 Mr munna: Thank you, Chair. Mr Daniels, order of between 11% and 13%. So when you take could you just—very succinctly if you can for the that and you take the cost of money and you take the record—confirm for our benefit the size of the cost of provision of the branch network and the Government’s stake in your group? servicing of that you can— ric a i ls: It’s approximately 0%. Q238 Mr munna: So are you saying that if you Q234 Mr munna: Do you think it would be fair to look at the income you get from levying overdraft say that without the assistance and support given by charges across the board, you are not making a profit the UK Government over the last two or so years, from them? your business, as it is today, may not exist? l ir: Overall on the current account product— ric a i ls: I think there are two things that have to Eric has already said that overdraft is not a be understood. That in the first place I think all banks significantly profitable instrument for us. Likewise, have received assistance from the central banks and the current account is not a significantly profitable— from Government, so this is not unique to Lloyds. Mr munna: I am not suggesting it is. Q239 Mr munna: But that was not the question I ric a i ls: And that very clearly when the liquidity asked. The question I asked is if you look across the markets froze that all banks were very grateful for the assistance that was given. So I think that would be the board of the income you get from levying overdraft point that I would make. charges, authorised overdraft charges, are you saying that you are not making a profit? Q235 Mr munna: Could you therefore explain l ir: It will very much depend on how a how you can possibly justify charging—I am talking customer uses a particular overdraft. We do make about the UK Government providing support but some profit on overdraft but— really its UK taxpayers—those UK taxpayers who Mr munna: Well, hang on— bank with you a 1 .3% charge for an authorised l ir: No, I am answering your question. We overdraft facility, which is more than 38 times the do make a profit on overdrafts but I’m saying also that Bank of England’s base rate. it is not a product that delivers excessive returns. Treasury Committee: Evidence Ev 39
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
Q240 Mr munna: Right, but you are still making Can you tell us how many left as a result of you a profit through charging these exorbitant interest rates levying the new charge? to people up and down this country? l ir: I can’t tell you off the top of my head l ir: We are making a profit. I think we’ve although I could make that information available; I outlined already the numerous costs against which the can write to you afterwards if you wish. We know that income we get from those customers has to cover, some customers did leave as a result of it. We also including— know that quite a few customers also changed their behaviour in terms of how they operated their account. Q241 Mr munna: Does that factor in the, I think it But overall our satisfaction levels with the account is, £5 a month charge that you levy on top of the have gone up. interest? l ir: For customers who use their overdraft. Q246 Mr munna: Right, but presumably if you are We also have the costs of capital which we have to carrying out a survey, a satisfaction survey, you are hold against these overdrafts because we are required not really going to be getting opinions of the people through the capital regime to do that. So there are who have left, are you? significant costs also of— l ir: No, that’s correct.
Q242 Mr munna: Can you understand why Q247 Mr munna: Right, so in truth you do not customers may be feel that they are being ripped off really know the satisfaction or not that there was when by you? you introduced this new pricing structure, because all l ir: I’m concerned that’s how customers feel those people who left as a result of you introducing it, you do not know their views? and I do believe that it’s important that we are l ir: Well, I’m assuming that the people who transparent with our charging so customers understand left would not have been happy with that charging what they’re getting. However, back to my original structure. point, the average customer pays—and that’s including foregone interest—less than a cup of coffee per week for their banking. For that they get access Q248 Mr munna: Yes, and you also are not able to tell me off the top of your head how many people with our group to over 3,000 branches, a wide ATM left as a result of that pricing structure? network, money transmission service, use of debit l ir: Yes. card and so forth. If you compare that with things like mobile, with Sky and a number of other things that’s good value. Q249 Mr munna: So, in fairness, you do not really know how satisfied people really were when you were introducing the new structure? Q243 Mr munna: You keep using this cup of l ir: What I know is we lost relatively few coffee comparison as if—a cup of coffee, if you get customers and the vast majority of our customers are coffee here, about £2, something like that. It is still happy with the product. We’ve seen an improvement about £100 a year at least which is actually quite a lot in customer satisfaction and a very, very significant of money to many of my constituents. The rates and reduction in complaints. the charges that I was just citing there are, of course, Mr munna: Thank you. Lloyds rates and you are responsible for Halifax as well. I think I am right in that, am I? Q250 Chair: Can I just be clear, are these overdraft l ir: That’s correct, yes. facilities profitable or loss-making? l ir: I’ve said that they were profitable. Q244 Mr munna: And obviously about this time last year—I am a Halifax customer—you changed Q251 Chair: So when Mr Daniel’s told us that the your overdraft pricing structure from charging interest high interest type of overdraft facility was not at a rate of 1 % to this £1 a day daily fee. So a £1 profitable, and that you do not particularly enjoy daily fee, for example, on an overdraft of £250 would providing it— be equivalent to like 1 6% APR. How have your ric a i ls: No, what I said is it is not a particularly customers reacted to this new overdraft pricing high return. I believe those were my words. So I didn’t structure? deny profitability at all. It is profitable but I don’t l ir: The response from our customers has think they give us the kind of returns that we get from been very good. We widely researched the charging other products. structure before we implemented it. Customers told us Chair: Okay, that is fair enough. I think we have they liked it because they felt they understood it. It nailed this. was very clear—back to the earlier point—they understand what they were going to get charged for. Q252 John hurso: Can I just follow up on this The level of complaints that we have seen has fallen question? I have fondly been borrowing large amounts very significantly. of money from the Bank of Scotland for a very long time thinking that I am a profitable customer. Is there Q245 Mr munna: Have you done any analysis of a difference, just to get clear, between the overdraft how many customers—we have had read reports in you have been talking about which are typically small the media that tens of thousands of customers left as in size and then carry costs for not a great return, and a result of you introducing this new pricing structure. the larger overdraft that might be arranged with an Ev 40 Treasury Committee: Evidence
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
SME or a larger customer? Is what you are saying that ric a i ls: I think it would be perfectly reasonable the lack of profitability is down to the complexity of to believe that they are. The banks speak with small overdrafts rather than big, or are you just saying Government on a wide variety of issues with fair that overdrafts is a not very profitable area of frequency, I imagine it must be happening. business? ric a i ls: I think it’s important to distinguish Q257 Mr Mudie: Would you be willing to between corporates, including SMEs, and individuals. participate in these talks if you were invited, if part They are much different markets. What happens is in of the talks was the question of limiting bonuses to the case of an SME or a corporate, what we do is we your staff? arrange a facility, so we tell the entity that they can ric a i ls: I’m sorry, would I be pleased to speak borrow up to a certain amount and that the pricing on to Government about bonuses? Is that the question? it is prearranged. That is a much different equation. It generally tends to be individual lending and it’s not Q258 Mr Mudie: Well, I said would you be pleased the more formulaic lending that you would have to an to attend and would you be willing to look favourably individual using credit scoring and models. So they on limiting bonuses to your staff? tend to be much different. ric a i ls: Well, I think that there are a couple of things. Yes, I would be pleased to have any Q253 John hurso: Somebody comes to see me conversation, but in the case of Lloyds I think that we once a year, for which I am extremely grateful, and have to be very clear, we are not an investment bank. we decide how much I need to borrow and that facility We are a commercial bank. The average salary of our is put in place, a fee is charged, it is perfectly employees is about £25,000 a year. The average bonus straightforward and an amount over Libor is paid. But payout is somewhere around £1,000 per employee so what you are talking about is not that kind of arranged we are not in fact an investment bank, we are a personal overdraft— commercial bank. We serve customers, that’s what ric a i ls: That’s correct. we do. John hurso:—you are talking about relatively small overdrafts, which are required by people who are Q259 Mr Mudie: So I presume you will not have probably on quite low incomes and who are dipping anyone employed by your bank earning more than in and out as a result of small cash flow movements. you? That is what we are really talking about here. ric a i ls: No, that would not be the case. We have ric a i ls: If I may characterise it somewhat specialists and, as you would expect, people who have differently. Yes, they are completely distinct but what very specialised skills that are much in demand for the we find is that the overdraft is a service or a facility market, have, in fact, a different market comparator so for our customers so that when a customer doesn’t we could very easily have people making more than think about how many debits are coming into the I am. account because they have standing orders—for gas, electricity, the supermarket, whatever—and they don’t Q260 Mr Mudie: How many? manage their account as prudently as they would wish ric a i ls: I don’t know off hand. to, we extend the facility of allowing them to not have their payment rejected, with all the issues that are Q261 Mr Mudie: Mr Daniels, you are the Chief related to that, so it’s a service, it’s a facility. It Executive and you do not know how many people in happens to be a very costly one and results in a lot of your bank are earning more than you? I find that hard losses, which is the reason why we’re not enamoured to believe. with the product, although we do view it as a key ric a i ls: I wouldn’t be able to give you a number service to our customers and that’s the reason why we off the top of my head. offer it. Q262 Mr Mudie: You would not wish to, or you Q254 John hurso: But you are still making money would not be able to? on it, though. It is a low return product, that is what ric a i ls: I would not venture a guess. you have been saying, just to be clear? ric a i ls: Correct. Q263 Mr Mudie: Well, I will be happy for you not venturing a guess but can you send the information Q255 Mr Mudie: There are talks reported by the through to the Committee in writing? BBC between banks and the Government on bonuses. ric a i ls: I’d be happy to. Is this a fact that talks are going on? ric a i ls: I have not spoken to Government to— Q264 Mr Mudie: Lovely. Seeing we own 1% of the Mr Mudie: Sorry? bank, I see from your—and I accept that you are not ric a i ls: I have not spoken to Government accepting bonuses, I hope I am not putting words into regarding bonuses. your mouth, but that is my understanding? ric a i ls: I beg your pardon? Q256 Mr Mudie: To your knowledge are talks Mr Mudie: You are not accepting bonuses, was it last going on? year and is it this year? ric a i ls: I beg your pardon? ric a i ls: For the bonuses that would normally be Mr Mudie: To your knowledge, if you are saying you paid out in 2010 I did not accept it and in 200 I did are not involved, are you aware of talks going on? not receive a bonus either. Treasury Committee: Evidence Ev 41
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley
Q265 Mr Mudie: Oh good. Well, I see your shares, Q271 Mr Mudie: But that has continued in each could you just tell me these shares, I had the figures year, 200 ? somewhere, yes, December 2008 you had 23,000, in ric a i ls: By and large my contract has been February 26 you had 607,000 shares listed in the largely unmodified, save for the normal increases that accounts. Are these shares you have bought or were happen periodically. these shares given by the bank? ric a i ls: No, those are shares that have all been Q272 Mr Mudie: I notice in the question, but I am purchased. not sure whether you are preoccupied with tax Mr Mudie: Have? allowances, you left the education allowances out. I ric a i ls: All been purchased. am not sure about the education allowances. How much were they, and what were— Q266 Mr Mudie: You have purchased them yourself ric a i ls: I don’t recall what the education and you have to list them? allowance is. Certainly I’d be happy to write to you if ric a i ls: That’s correct. it’s important.
Q267 Mr Mudie: Now, in the same accounts, these Q273 Mr Mudie: The difference between the two have moved to 2.5 million. Is this a restructuring of figures year-on-year is £30,000, so they would be the shares? Because it seems strange that you go from considerable. 23,000 to 2.5 million at December 200 . Even you ric a i ls: I don’t know offhand, but again it was could not have bought that number of shares. part of the Director’s remuneration report. It’s easy to ric a i ls: Yes, Mr Mudie, in fact I did. What look up and it’s public information. I no longer happened is— receive that allowance. Mr Mudie: 2.5 million? ric a i ls: If you recall, Mr Mudie, we had a rights Q274 Mr Mudie: You certainly seem vague for a offering, a very significant capital raising in December major Chief Executive. of last year, November December of last year, and ric a i ls: Well, perhaps I spend more time then each one of our shareholders had the right to worrying about the bank than I do about my personal exercise their rights and purchase additional shares, affairs. which is, in fact, what I did. Mr Mudie: If I was on a £1 million salary, I would probably be the same. Q268 Mr Mudie: How many other shares do you have that you have purchased, including share Q275 Mr Love: You drew the distinction earlier on options? between an investment bank and Lloyds, which you ric a i ls: I really have not a clue. have characterised as a commercial bank. In those Mr Mudie: I am sorry? circumstances, I think you were drawing the ric a i ls: I don’t have a clue off hand. You’re distinction that you do not have the excessive salaries giving me more information than I had at my that have been complained about. Would that mean fingertips, so you’re better informed than I am about that you would be perfectly happy to disclose my personal finances. according to the Walker principles? Mr Mudie: You must have a fair number if you do ric a i ls: I believe that what Mr Walker not know how many you have. recommended was that there be disclosure among ric a i ls: I don’t know off hand. several tranches of compensation, but I also believe that Mr Walker has recommended that not be done Q269 Mr Mudie: Do you not know the share options unilaterally, for fear that the UK would stand out from you received last year? other countries. So we are much less affected. We ric a i ls: No, but I’d be happy to provide them. have many fewer employees who would be in those They’re in fact in our directors’ report on tranches, although we do have some. But I think that remuneration and they’re included in every annual the recommendation from Mr Walker at the moment report so it’s public information. is that the UK should not act unilaterally, and I believe that’s right. Q270 Mr Mudie: Just a minor point, again speaking as somebody who contributes to your bank through Q276 Mr Love: What is wrong with Lloyds acting tax. Why do you get cash to pay your tax planning unilaterally? After all, you are telling us that what that and, in particular, in 2008 in the annual accounts you would show is how few among your senior executives have got an education allowance? are in these pay packets. Would that not be of benefit? ric a i ls: When I came to the UK they were Would that not reassure your customers that excessive costed in making the move. Part of the contract, and salaries were not being paid? it was simply part of the compensation, were a ric a i ls: I don’t think that our customers are number of features, including some tax planning. particularly concerned. They’re concerned must more That’s not at all unusual. It was one of those things about value; about good service; about convenience. where, instead of including it in my salary, which Those are the things that matter to them, and that’s would then have meant that my pension and all the what we strive to do. rest of those would be higher, the bank chose to allocate a certain amount of my compensation to those Q277 Mr Love: I am quite surprised at you saying allowances. It’s pretty much normal. that your customers are not concerned at the level Ev 42 Treasury Committee: Evidence
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley of—and I cannot trace it directly back to customers of ric a i ls: I’m not sure what the shape of that Lloyds Bank, but I think there is a very strong public interest has to be, so I would find it very perception and there is real concern out there among difficult to answer the question. the public about the level of bankers’ remuneration, especially in the context of what has happened over Q282 David utley: Could I just ask one question, the last few years. Do you not think that Lloyds have going back to the profitability or the low returns on a responsibility to try to address those concerns? PCAs, which is what I think you have given evidence ric a i ls: What we believe in Lloyds is that we on. You will be familiar with the 2008 market study are very much a part of this society and in fact we by the OFT on PCAs, and it says the OFT estimated take pride in terms of being good corporate citizens, banks earned £8.3 billion in revenues from personal whether it is our carbon footprint; whether it is the accounts in 2006, equivalent to £152 per active amount that we donate to charity through our current account. It broke it down by saying that these foundations; whether it’s the activities of our profits were generated by five sources: net credit employees for worthy causes in their communities. So interest, the difference between interest paid on credit we are very proud of our corporate citizenship. We balances to consumers and income derived by the are very attuned to the debate that is going on bank from those funds; net debit interest, interest paid regarding the role of banks in society and the role of by consumers minus the cost to the bank of lending bankers in society, so I would say that we are these funds; insufficient funds charges; package fees responsive and we’re certainly listening to what is and ancillary charges. All that comes together in 2006 happening, with what our customers feel as well as to £8.3 billion for all the banks. This seems a rather the broader public. profitable business, and I am rather concerned when I also see that the OFT believe that the PCA revenues Q278 Mr Love: Let me ask you: you drew are bigger than savings and credit cards combined. So attention—quite rightly in my view—to the fact that if the PCA generates more cash for you guys than savings and credit card products, why are you telling you pay bonuses to some of your less well- us that you are doing us all a favour providing PCAs? remunerated staff. What is the total level of your bonuses last year and this year, and how does that ric a i ls: I’ll ask Helen to comment as well, but I think that you’re looking at only one component of compare with dividend payments in those two years? the profit and loss statement. In other words, you’re ric a i ls: It is no secret that we did not pay any looking at the revenues that are coming in. Against dividends over the last two years. We are prohibited those revenues we have losses on the overdrafts, from paying dividends until January 2012 through our which we have mentioned before. We have branches, agreement with Europe. So any bonuses that were we have ATMs; we have thousands and thousands of paid—if we did pay bonuses—would be infinite in employees who serve the PCA market. So I think that comparison to the dividend. if you were to look at the net—in other words, you take the revenues, less the costs, less the losses—then Q279 Mr Love: I would like to move to a completely the return against the PCAs tends to be at the lower different subject: about the disposal of your 600 end of the range of the banking products that we do branches. I wondered whether you had had any offer. discussions, as yet, with UKFI, particularly in relation to achieving their objective of enhancing competition Q283 David utley: Finally, Chair, I would like to as a result of that disposal? just clear this up, because it is suggesting here that ric a i ls: We certainly meet with UKFI on a savings and credit cards together generate less revenue regular basis and we certainly talk about not only the than active bank accounts, and I understand that you financial condition of the business but also some of are saying that when you net off the cost of ATMs— our clients, going forward, as we would with any large but there must also be similar costs for savings and shareholder. So we continue to have ongoing credit cards? discussions with them. ric a i ls: Yes and no. For a credit card, for example, most credit card providers don’t use Q280 Mr Love: During those discussions have they branches, so—I think there are something like 60 expressed any preference about selling to a new credit card providers, perhaps 30 to 60, I’m not sure entrant? Has there been any discussion about whether which, but there are a fair number of credit card it is just a case of getting the highest price possible, providers—the majority of them don’t have branch or is there any discussion about bias towards new networks so, in other words, their cost dynamics are entrants into the marketplace to enhance competition? much different. They tend to use the mail; they tend ric a i ls: It would be totally inappropriate for to use direct marketing rather than branch sales, so UKFI to have a view on who a potential buyer could that changes their dynamics. be. Their role as shareholder is to maximise the value for the taxpayer. Q284 David utley: Is it true of savings products as well? Q281 Mr Love: There is some talk about a public ric a i ls: There are approximately 80 savings interest test on the sale of the 600 branches. How do competitors in the marketplace. Many of them are you view that? Should there be a public interest test direct. that UKFI should ensure is complied with in this David utley: I think what we would find useful, disposal? Chair, is if we could have a written breakdown of Treasury Committee: Evidence Ev 43
7 December 2010 Eric Daniels, Helen Weir and Patrick Foley some of the evidence you have given about the Andrea Leadsom had one quick point that she wanted profitability and the margins on PCAs for your bank, to come in on. if you could provide that. ric a i ls: We would be happy to give you what Q292 Andrea Leadsom: Yes, bearing in mind the information is available. substantial size of the Government shareholding, how long do you think it will take, once the Government Q285 Chair: Thank you very much. Before you go, decides to divest, to sell all of those shares and place Mr Daniels, could you give us a view on when you those shares in the marketplace? What is your think the Government’s shareholding should be sold? professional view of that? ric a i ls: I don’t have a particular view on that. ric a i ls: I think there are various models. There That is very much up to UKFI and the Government. is one, for example, a city in the US had the Government sell down in a relatively short period by Q286 Chair: At what price? having a fairly large sale and then a scheduled sell ric a i ls: The price currently is above the break- down over time. So it could in fact be done very even point for Government. So, in other words, the quickly. There are other types of sale where there are taxpayer is in the money. large holders, for example large pension funds that might be interested in purchasing blocks, so I think it Q287 When the taxpayer gets substantially “in the is something that will depend at the time the money”, do you think that Government should Government wish to sell. They will have to decide consider divesting itself or some or all of that holding? whether they wish to sell down all or some and the ric a i ls: That’s very much a decision for rapidity with which they wish to do it, but that is— Government. Q293 Andrea Leadsom: Are you on the lookout for Q288 Chair: Does the company have no view on this buyers yourselves? Do you see that as part of your at all? role? ric a i ls: No, I think the company’s view is that ric a i ls: It is not my shareholding so it would the management’s purpose is to serve our shareholders be inappropriate for me— well; to serve all of our stakeholders, and that’s really Chair: Andy Love had a very quick question. our job. Any one of our shareholders, whether it is some of the more traditional names that you would Q294 Mr Love: It is going back. I am sorry to do it, expect, such as Standard Life, L&G and fidelities, or but I think we need to press you on this matter. It is UKFI, have the absolute ability to be able to buy and about the public interest test. The consumers’ sell when they wish to. organisation will be suggesting that that public interest test should look at what the effect will be on Q289 Chair: But your preferred position must be competition of any sale, and whether it will enhance zero Government holdings, must it not? competition. If that was a public interest test, would ric a i ls: Certainly, I think that the presence of it be something that Lloyds could support? any abnormally large shareholder impacts the stock ric a i ls: As you know, one of the conditions of and impacts the other shareholders, so— the European accord was in fact to sell to a party that Chair: Yes, but I am talking about a Government had no more than 1 % current account market share. shareholder here. So I believe there is already some thought toward ric a i ls: So it would be— trying to create a new competitor in the marketplace. Chair: Thank you very much for coming before us. Q290 Chair: What about the presence of a I know that for bankers before the Treasury Select government shareholder? Does that not have Committee it is often not an easy ride. I have to say, particular significance? we have heard some very interesting evidence, and ric a i ls: It would be my desire to have a much some surprising evidence: the idea that customers more evenly balanced shareholder base. have a pretty good idea how much they are paying for their current accounts will be met with something of Q291 Chair: Therefore, how quickly do you think a loss of credulity among many of them, particularly, the Government should get its holding down to if I may say so, since the Group Executive Director something that you are describing as a more even herself did not know how much she was paying. shareholder base? Thank you very much for coming before us today. ric a i ls: Again, Mr Tyrie, I think that’s a ric a i ls: Thank you. decision for Government. Chair: We will now take a five minute break. Chair: We have had a few witnesses recently who have played a straight bat and certainly that was one. Ev 44 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer
Examination of Witnesses
Witnesses: Stephen Hester, Chief Executive, RBS Group and Brian Hart er, Chief Executive, UK Retail, Wealth & Ulster, RBS Group, gave evidence.
Q295 Chair: Thank you very much for coming public domain, as I am sure you know, and perhaps it before us this morning. Before taking further issues might help if I suggest that you do look at this and on competition, I would like to ask you about the come back to us in writing with an answer to the report into the collapse, which is technically not a question I have just asked. That you ask for it, come report, in any case; it is a series of findings by the to a view and come back to the Committee. FSA. Just to clarify, am I right in thinking that you St ph st r: Sure. have not seen it? St ph st r: That’s correct. Q302 Chair: Could I ask what discussions you held with UKFI about the disposal of 318 branches to Q296 Chair: Have you asked for it? Santander? St ph st r: No, I don’t think we have asked for St ph st r: We would have at regular times it— when we see any of our shareholders. We obviously see UKFI more because they’re a larger shareholder, Q297 Chair: Do you not think it would be a good but we generally would update people on how we idea? Because there must be some thoughts in there were going about selling it and the conditions that that might be relevant to making sure that we do not bounded the sales process, and then obviously they have any repetitions. saw the press release when we issued it. St ph st r: I would believe that the matters that they looked into were largely based on information Q303 Chair: Do I take it from the answer to that they received from RBS. Obviously they would have question that your relationship with UKFI is exactly formed their own judgements. In other words, they the same as it would be with any other shareholder? had access to our committee minutes and all the St ph st r: I think that the relationship, because different things in there. of the size of shareholding, would mean much more Chair: I am sorry, could you speak up? frequent contact and probably at a greater level of St ph st r: Yes. The subject matter that they detail as a result of the times— looked into was clearly stuff that I have done very little else other than think about when I was brought Q304 Chair: But is it a fact that the Government is in to try and rescue the bank, and so I think that we feel within the bank—and I feel—that I have a strong irrelevant? command over the things that were done right and St ph st r:—and secondarily, there inevitably wrong, and why. are parts of the conversation that could be thought to be non-strict shareholder matters, but UKFI’s explicit Q298 Chair: Still, do you not think it would be charter, as I understand it, is to behave as an engaged worth taking a look? commercial shareholder, and I feel that one of the St ph st r: I suppose that in my order of successes of the process has been that they have priorities I don’t put it very high. largely stuck to that charter and that the focus of their conversations with us are on matters of strategy and execution that are designed to get the taxpayer its Q299 Chair: Given that it is of such limited value, money back successfully, as opposed to the other as you see it now, to the commercial future of the company, are there any corporate reasons why you interests. Of course we have many engagements with would not be happy for the FSA to make more of this Government and regulators, not just UKFI, when material public? many of the other public interest matters are raised. St ph st r: It’s hard for me to answer that because without knowing specifically what is in it, I Q305 Chair: I want to concentrate on UKFI. Have don’t know if there are any issues of— you had any meetings with the Chancellor of the Exchequer to discuss Government holding at which Q300 Chair: That is why I began by asking whether the Government’s holding have been discussed? you wanted to take a look at it, to which you said—I St ph st r: Not that I can recall. am summarising and I hope I am not putting words in Chair: But surely you would be able to recall whether your mouth—it will be of such residual value, given or not you have discussed your holding with the that you have been working on these issues incoming Chancellor of the Exchequer? intensively, that you might get around to it or you St ph st r: I’m trying to remember the meetings might not. I’ve had with the Chancellor of the Exchequer. The St ph st r: But my honest answer to you is: I majority of them are— don’t know whether there’s anything in it that exposes us to any kind of risk, or anything like that. I don’t Q306 Chair: How many meetings have you had with know the answer to that, but what I do feel— the Chancellor of the Exchequer? St ph st r: In his current capacity, I’m going to Q301 Chair: Under FISMA rules, you are in a very guess four or five, but they tend to be group meetings. strong position to decide what can be put into the I think I might have met him once, other than— Treasury Committee: Evidence Ev 45
7 December 2010 Stephen Hester and Brian Hartzer
Q307 Chair: Just to be clear, have you discussed the specialist business models in specialist areas. The lists Government’s holdings at none of these meetings? of people that want to come into the UK in a St ph st r: There hasn’t been a specific agenda mainstream banking full service way—which is what item that had any depth in terms of what the we are offering—is short to negligible. I always Government should do with its shareholding in a thought that this would be sold to an in-market player specific meeting I’ve had with the Chancellor. Of and that there wouldn’t be demand, other than at course, I don’t think that means that he has or hasn’t knockdown prices, which would be a straight spent a lot of time on it, he just hasn’t with me. giveaway from the taxpayer to other people to subsidise them, because people from the outside don’t Q308 Chair: Are you keen for the Government to want to accept lower returns that are being made and shed the holding or do you not have a view? Are you don’t see the commercial advantage. completely indifferent or would you rather that they hung on to it? Q313 Chair: So it is the trade-off between the lower St ph st r: I think that clearly, as a matter of our returns the Government would get on a sale to a priorities, our priorities are to manage the company genuine competitor and a sale to Santander, which has and indeed our legal duties for all shareholders not increased competition. Do I have that right? regardless of who they are, big or small. We must treat St ph st r: I think Santander will prove to be a them all equally, and we’re trying to do our best and stronger competitor because they have significant cost focus on that. However, I guess I would be guilty of synergies as well as expertise, and when they put misleading you if I didn’t say I had an opinion that those things together I think they’ll compete very goes beyond how we’re explaining our duties. strongly with us. But my observation to you was that there was not, and is not, a queue of people trying to Q309 Chair: What is that? enter the UK market— St ph st r: My opinion is that the successful sale Chair: No, I heard that. Yes. of the Government shares in RBS, and in particular St ph st r:—other than what I’ll call “cherry the beginning of the successful sales—since I think pickers” who are coming in with specialised business there will likely be more than one—will be a very models or from different angles—you’re seeing Tesco important positive for both the nation and RBS. I this afternoon. So there are a series of people coming think that because it would create money for the from different angles, but in terms of a “Let’s do the public purse, which I think is better used for schools, same”, there aren’t people who want to do that. hospitals and roads, than being invested in RBS on an Chair: Okay, we have that onboard. ongoing basis, which I would think is a— Q314 Michael allon: In your submission you say, Q310 Chair: Although that was a very well “Larger, more diversified companies—banks—have constructed and well balanced reply, the answer is— the ability to achieve greater synergies and create if I may interrupt, because I think I have the kernel of the reply—you would like the Government to get shot economies of scale”. Was that the position RBS was of these holdings at the earliest convenient time, at just before the crash? looked at from the corporate perspective. St ph st r: I believe strongly that we shouldn’t St ph st r: I think it would be a symbol of get ourselves into a position where only one business Britain’s recovery; it would help the public purse; it model is the right one, and this is a monopoly of would be a symbol of RBS’ recovery and it would wisdom. I think part of the importance of modern help all sides. market economies is that different people can try different things, with different amounts of success, Q311 Chair: Thinking back to that disposal of 318 until you see what goes. So I certainly wouldn’t branches to Santander: did you discuss that with the advocate that the RBS business model, or any other Chancellor? one, would be the right one or the sole one that should St ph st r: No. compete, and it isn’t. However, in the remaining core businesses we have after our huge restructuring—and Q312 Chair: Do you think it has increased part of the thing I did when I came in was to look competition? around and say, “Where do we have businesses where St ph st r: I am on pretty clear record that it we’re not advantaged?”—in the businesses that are was far from obvious to me why the EU sanctions, as part of our core, going forward, we do believe that the a whole, were applied, but nevertheless they were and scale that we have allows us to compete more we had no legal choice but to accept them. With successfully and to offer customers a better solution respect to breaking ourselves up in this regard in the and, therefore, to be better ourselves for the different SME and branch area, there were clear Competition constituencies we serve. Clearly, you could not say Authority requirements on that process, and there are that in a sweeping way before the RBS that I inherited clear EU requirements on how we ran the process. So , which is why we have had to undertake what is we have sold it to someone who came within those probably the biggest corporate restructuring ever seen requirements. However, what I would observe to you in the world, which we’re in the middle of. is that while I regard the market in these areas as strongly competitive—and I’m sure we’ll go into that Q315 Michael allon: We had some very banks in as our meeting continues—some of the competition this country, relative to the size of our economy. I just expressed itself in people cherry-picking with need to be clear whether you thought RBS at the point Ev 46 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer it crashed was too big, because your submission says Q318 Michael allon: But Hector Sants told us that that banks should be very big. Was it too big or not? there would be benefits from reduced concentration in St ph st r: Forgive me, you have the piece of certain parts of the retail market. Do you agree with paper in front of you and I don’t. I don’t think— that? Michael allon: This is your submission. St ph st r: The retail market in the UK is not St ph st r: I don’t think that we do say that big particularly concentrated by global standards, banks are the only model that should exist. I think certainly if you compare like-sized countries or what we would have said is that in some business regions of countries, and we do not see evidence that areas, size can give economies that allow you to be you can walk down a High Street with 10 banks that more successful in your offering to shareholders and has particularly greater competition than one with customers. I do personally believe that size is a red five. We do think there is a lot of competition, which herring and that both large banks and small banks can obviously we’re happy to talk about. be well run or badly run, can be risky or not risky, and then one has to look elsewhere than size to find Q319 Michael allon: So what is the level of the answers to some of the questions. concentration that would impact negatively on consumer outcomes in competition? Q316 Michael allon: This paragraph does not St ph st r: I think that’s hard to answer mention competition or new entry or anything like academically, because clearly we see markets in many that. It says, “Larger, more diversified companies have industries around the world with different levels of the ability to achieve greater synergies and create concentration and different consumer outcomes. The economies of scale. This enables banks to provide supermarket industry would be an interesting one, services at lower cost to the consumer”. You do which has obviously been much pored over by believe that size is the best way of delivering value to competition authorities in the UK where, to date, they’ve found good consumer outcomes, obviously the consumer. from a much more concentrated market than banking. St ph st r: No. I don’t think we— Michael allon: That is what you say. Q320 Michael allon: But that is with a second tier St ph st r: No, with respect, I think we’re of competition underneath the main players that does saying an advantage of size, if it is size in particular not exist in banking, does it? marketplaces, as opposed to size thinly spread St ph st r: Your previous testimony pointed to everywhere, can be those sorts of economies that 60-odd credit card providers or 80-odd savings allow you to offer customers more. So that is an providers. There are obviously plenty of second-tier advantage. It doesn’t mean to say there are no players in banking. disadvantages and it doesn’t mean to say that if you’re small you can’t come at it from different ways, but I Q321 Andrea Leadsom: Mr Hartzer, how long does do believe that our scale, when properly configured it take to move a personal current account from RBS and used—which it wasn’t in all cases before; we to another bank? hope it will be in the future—can be an advantage to Bria art r: The advice that we give customers is our customers and our shareholders, and we try hard that it will take somewhere between four to six weeks to do that by economies of scale. from start to finish, but we try to do that a lot faster. We’ve brought in things like a switching service and Q317 Michael allon: So it was not the sheer size we’ve made a number of changes, both as an industry of RBS before the crash that was the problem, it was and as RBS, to try to speed that process up. In our the configuration. Is that what you are telling us? view, switching is a good thing. If we can improve St ph st r: Obviously, it’s a very long subject as our market position and make it easier for people to to what was wrong at RBS and needed to be corrected, switch then we think in the long run we’ll be winners and we’re very hard at work doing that, but I would out of that. say that one of the key issues was leverage, which is not size but the amount of debt you have relative to Q322 Andrea Leadsom: Anecdotally, I have had your equity. You can have a high leverage whether letters from constituents saying that when they switch you’re big or small. You saw that with Northern Rock, banks it is never quite clear who is facilitating the that was much smaller, and you saw that with switching, whether it is the bank they are leaving or Bradford & Bingley and so on. So one of the key the bank they are going to, and the banks seem to issues was on the funding side, on the leverage side. argue among themselves about whose job it is to make Another of the issues was on the lending side, and sure the direct debits are set up, and so on. What is we’ve seen you can make spectacularly bad lending your attitude in RBS? Is it your responsibility to decisions regardless of your size. And there was a facilitate the move? third, where I do think there are areas in which RBS Bria art r: Certainly we try to help customers do had diversified that it was not going to be a successful it. The switching service is about getting authority manager of, and that was a managerial mistake. But from the customer, but there are certain bits where the again, small institutes: Dunfermline Building Society bank that is technically managing the direct debits or diversified into commercial property lending and that the standing orders has to implement some of those was a mistake. So again, I don’t think any of these changes on authority for the customer. But we do are, per se, about size. everything in our power to make it easier for the Treasury Committee: Evidence Ev 47
7 December 2010 Stephen Hester and Brian Hartzer customer to get that authority through to the people study says. And it’s what our own research suggests that have to provide it. as well: that the reputation of the industry may be under-challenged but, at an individual customer level, Q323 Andrea Leadsom: How many PCA customers they generally have a pretty high level of satisfaction do you lose and gain every year? What is the with the staff member that they deal with in our bank. turnover? Bria art r: We’re seeing switching at the moment Q327 Andrea Leadsom: So why do you think that at about % of accounts, which is, I should say, about there has only been one new bank licence awarded in 50% higher than my previous market, which was the last three or four years, according to the FSA? Australia. So we think this is a pretty active switching Why are there no new players coming in if it is a market. We opened a little over 1 million new PCA lucrative and competitive market? accounts last year; about one quarter of those were St ph st r: I think the fact that it is profitable people switching banks to us. doesn’t necessarily mean that the returns are so high as to attract lots of new entrants. I think, as Stephen Q324 Andrea Leadsom: What is the extent of cross- said, our view is that over the cycle this is a business selling with your PCA customers? What product that is very capital-intensive, investors want to earn a penetration, in terms of other sales, are you successful reasonable return on that capital and over the cycle, with selling to those customers? the returns on capital are adequate but not so exciting Bria art r: Cross-selling is certainly an important as to want to bring new competitors in. I think the part of what we’re trying to do because in the end— other thing I would add, perhaps, is certainly that the and as Stephen said, there are banks that have quite more regulation that gets applied, and the more reasonably different strategies on this—our strategy is complicated that complying with that regulation gets, to try to be a full service provider, and to differentiate that obviously becomes a bit of a challenge for people ourselves by having good strong relationships with as well. customers that mean they trust us and want to bring more of their business to us over time. I would love Q328 Andrea Leadsom: So do you think regulation to say we were incredibly successful at that, but one itself could be a barrier to new entrants? of the things that we need to do at RBS is get better Bria art r: I think you have to take all these at that. At the moment about just under 0% of our things in the round, and when you add up the capital customers only have one product with us, and so we requirements to compete in the business, the level of think that’s a pretty big opportunity, and about one- returns that are available over the cycle, and in some third of customers have two products with us. So that’s something that we’re continuing to work on. cases some of the regulatory issues, and so forth mean that one needs a reasonable amount of capital and cost. If you want to do a full service bank, that’s a Q325 Andrea Leadsom: So would you say that your challenge, although as Stephen said, there are still a retail customer business is profitable? number of opportunities for people to come in and Bria art r: Overall the business is profitable, yes. cherry pick particular aspects, and we’ve seen that continue to happen. That puts a challenge on the Q326 Andrea Leadsom: Overall, okay. Bearing in model for a full service bank like us. mind the evidence of the level of concentration—73% of PCA accounts are held among four banks—would you accept that it seems when you take into account Q329 Andrea Leadsom: Mr Hester, one last the OFT’s assessment that there is very little switching question: would you support the idea of giving and that there is a great deal of customer inertia, it customers the opportunity of taking their bank account looks as though there are barriers to entry and it is not number and sort code with them? Clearly that requires a highly competitive marketplace? big technological change, but would you consider that Bria art r: I wouldn’t accept that it’s not a highly that might allow more switching and less customer competitive marketplace. As I said, I came from inertia than is already the case? Australia where the market was more concentrated St ph st r: I think that generally we support than here. I can tell you, even in Australia, we fought competition, the ability of customers to move, and very hard among ourselves to try to gain market share transparency in banking. All of these can be moved and found that to be a very competitive market. Here forward and, indeed, part of Brian’s strategy is to do we have more competitors. There are six major so. Of course there are sometimes specific measures players on the High Street at a minimum that we when the benefit can be outweighed by the disbenefit. compete against, plus a number of smaller players and I’m not a great technical boffin but, to date, my new entrants. understanding is that the specific issue around sort As I said, switching is 50% higher than it was in my codes would be so chaotic as to have such massive previous market, and we’ve seen the industry and disbenefits that the incremental ease of switching ourselves make a number of changes to reduce the wouldn’t be worth it, but certainly we’re always barriers to switch. It’s interesting; if you look at the willing to look at issues like that because we would OFT study that just came out on switching, even that like our customers to be with us for positive reasons study says that 80% of people don’t switch not for negative reasons. fundamentally because they’re satisfied with their Chair: Yes. Can you get your boffins to write a paper bank. That may not be popular and what the popular for us on that? press likes to talk about, but that is what the OFT St ph st r: Happy to. Ev 48 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer
Q330 John hurso: Mr Hartzer, you and I have among different customers and it can vary over time. discussed the concept of free banking. Lord Turner What I have said again in another market is that told us that he thought it was a barrier to entry for transparency, taken to the extent of trying to charge new businesses. Before I ask you to comment on that, for every individual transaction according to those is the nub of the problem not that whatever anybody particular costs, brings with it some disbenefits as in any bank thinks about the concept of free banking, well, in that customers sometimes start to say, “This unless every single bank is going to move to a priced is all getting a bit hard”. So the balance that we need model, it only takes one outlier to stay a free banker to strike is an appropriate level of transparency so for it to be impossible for all the rest to move? people get the right signals and can compare and Bria art r: I think the first thing I would say is contrast things, while also not getting to the point that we agree with the statement that, in a sense, where we’re asking people to have to think too hard. banking has never been free. It’s extremely expensive to run a full service model. In our case we have a Q332 John hurso: In the last session—I do not branch network with over 2,000 branches. Our know if you had arrived and heard it—Eric Daniels technology is very complicated; we have tens of told us that basically the whole question of overdrafts thousands of people delivering service every day. So was barely profitable, and it was very low return banking has never been free. The challenge, of course, business. Is that the case for RBS as well? Do you is how you recover the costs in various ways. The make money from overdraft provision? model in the UK evolved over time, to something that Bria art r: Well, it’s interesting. I’m glad you was relatively unsustainable, which is why over a year raised it, because I think this is obviously an issue that ago we took the first step in dramatically reducing has gained a lot of attention and it’s a very important overdraft fees, because there was a cross-subsidy one. Certainly when I arrived 18 months ago, it was model that had developed. very obvious that the market had developed in a way We are very much in favour of things that bring more here where there was a real lack of transparency and transparency and that send the right signals to tremendous complexity in the way that those fees customers. Charging already exists in many ways for were charged, and that is part of why we led the way packaged accounts, and so on. There are a variety of on reducing the number of types of fees that were different ways that banks can recover the costs. charged, and dramatically reducing—in one case one Certainly at the moment with interest rates being very of the fees went from £38 to £5. So I think that we in low, what had traditionally been an important source the industry have moved a long way on that issue. of revenue is at least temporarily not there. What I would say is that you must separate the two As to the question of how the market changes, I’m issues, quite importantly, between an unarranged not sure I would accept that everybody has to change overdraft and an arranged overdraft. An unarranged something in order for it to change, because we see overdraft is one where someone accidentally goes a number of competitors already charge for current overdrawn, and in our case we have a buffer, for accounts. There are various models that are out there. example, of £6, where if somebody goes overdrawn a But I think it is certainly the case that it is a bit they don’t pay a fee. We have tried to simplify competitive market and that any change that we make those fees for those people. The second bit is the around something like pricing is going to have regard arranged overdraft. That is not there for people to use to what we think the competitor response might be, as a long-term borrowing tool. It’s there to give people and how we deal with the retention of our customers. some flexibility in their cash flow. When you consider that in both cases the overdraft is a component of a Q331 John hurso: It seems to me instinctively, if I broader banking relationship, being the current have transparency on the product I am buying—take account which gets advantage of the branch network, buying a car, if somebody bungs in the Road Fund the ATMs, the phone, online banking, people and all Licence it is pretty obvious I am getting that. I can that, and when you actually allocate the cost to that, see it is part of the marketing. But then they tell me and have regard to the fact that the loss rates on that I also get free petrol, insurance, repairs and all overdraft are pretty high, and if you add in the cost of sorts of other things. I know that there are costs in capital and reasonable amount of cost, then in our case that and I do not know what I am paying for, which we would say on a standalone basis that overdrafts are bit of it, and that is the problem we have looking at the a loss product. personal account. Would you not instinctively prefer a system that was more transparent so that people could Q333 John hurso: You have obviously grouped in pay more easily for the things they actually want to that loss figure both arranged and unarranged, and— use, and you could recover costs for the bits that cost Bria art r: But we would say both would be a you more? loss— Bria art r: We’re all in favour of transparency, John hurso:—so, with an arranged overdraft with a and that is why we’ve made a number of the changes client of some substance you’re doing them a favour? we have. Transparency is an important part of the Bria art r: We’re not saying we’re doing them a customer charter that we launched about six months favour. We’re saying that we don’t think it’s the right ago. way to think about it, in a sense, to look at just that One subtlety I’d put on the example you raise is that single product, because those customers are availing in our case we have a very large cost base that themselves of a broader product suite. So when we different customers use in different ways, and so the take all that into account, if you were to simply slice actual costs for any individual customer can vary off the piece of the relationship that was that Treasury Committee: Evidence Ev 49
7 December 2010 Stephen Hester and Brian Hartzer overdraft, on average, strictly speaking, we would say extensive in its own right, that our retail activities in that would be a losing proposition. However, we the UK can indeed—across a cycle—cover their costs continue to offer it because our hope is—and it varies of capital. But that is partly by us becoming more by client, and so forth—that in a broader relationship efficient and reducing costs; it’s partly by the biggest with the current account, the way the customer is in reinvestment programme we’ve ever had in the retail credit, out of credit, on balance we would hope over bank and technology and so on. So we believe that, time that we would make a reasonable return. managed well, it will be a good business for our customers and our shareholders. Q334 John hurso: Sorry to keep coming back to this, because I think there are quite a lot of us who Q337 John hurso: One quick question because I are a bit surprised to discover that we have been don’t have too much time, which is this: when you subsidising the banks through our overdrafts. It seems are talking about the cost of capital, are you talking almost incomprehensible that the overdraft product, about the cost that you have had to go and acquire it which is a core British product for many people, is in the market, that is, Libor, or are you talking about not profitable. I can understand if you said to me that the cost of capital as in equity? In other words, is it is low margin, but that it is not profitable I find the loss he is making after 15% equity return cost or extremely surprising. whatever Libor might be? Bria art r: I can see why, if people focus purely St ph st r: It depends on which bit of the on the interest rate, they might think, “Okay, well, conversation we were talking about, but— that’s all there is to it”. But the overdraft only exists John hurso: Brian has just said that when you take because we have a branch network and a current the cost of capital into account, overdrafts and so on account functionality, online banking, and all those are broadly loss making. Is the cost of that capital the other things. So the overdraft on its own, as a thing, equity burden or the 15% return on equity? can’t exist without the other things, and therefore St ph st r: When we’re talking about profits when we allocate the costs associated with the we’re always talking after the cost of us getting behaviour of the people who have the overdrafts, as money as well as our other costs, so the costs of us we do to other things—which by the way is more of getting money is where we— an art than a science—on the basis of our best allocation of costs our view would be that, looking at Q338 John hurso: What is your cost of capital at it on a thin slice like that, it’s unprofitable. RBS? St ph st r: And if we’re talking about economic Q335 John hurso: Okay. I would like to ask you profit, as opposed to absolute profit, then we would one last question, which is: what is profitable? be talking also after a notional charge on our equity Bria art r: What is profitable? that would be the hurdle rate that we’ve set across John hurso: Well, if you have this loss leader that cycles: 15%. you obviously do a great deal of in order to attract John hurso: What is your cost of capital at RBS? people, what are the bits that make the money? St ph st r: It’s an academic subject but we Bria art r: First of all, profitability tends to slosh think it’s— around in a bank from one thing to another, depending John hurso: I don’t know; When I was Chair of the on where interest rates are and how people behave, PLC and I was asked that question I could answer it and so forth. At the moment, as interest rates have with a direct number. fallen, what has happened is that the profitability of St ph st r: Sure, if you let me finish. deposits has become probably break-even at best and John hurso: All right. in some cases a loss, and the margins on mortgages St ph st r: Thank you. We calculate it in a range and some loan products are wider, so in a sense are between 12% and 1 %, and so that is why we round— contributing to a larger portion of our profitability. If John hurso: That is the number that Brian— rates rise that situation could very easily reverse, and St ph st r:—to 15% and what I’m saying to you it’s one of the things that—for someone like me— is we believe that, if we manage our retail bank well makes the banking industry kind of interesting, which and are successful with customers, we can hurdle is that profit dynamics are constantly in flux. across cycles at that level, which will mean sometimes we make a lot less than that, as we did last year and Q336 John hurso: Just to pursue this, can I ask, the year before; sometimes we’ll do better. And that’s Mr Hester—that is a fascinating conversation about our management challenge. the current state of retail banking, which sounds like Chair: The assertion that overdrafts are not making it is very hard work and there is not much money in much money even though the spread is huge will, as it—does that make it difficult for you to make a go John suggested, surprise quite a lot of people. In your of RBS? answer, Mr Hartzer, near the end of your series of St ph st r: The lens through which we set about answers you said that it is an art not a science; that is, restructuring RBS was that the businesses that we the allocation of the fixed costs across the provision wanted to keep and invest in were ones that if we felt of other services from the mortgage side. I recognise we did a good job we would—across a cycle—cover that there are problems of commercial confidentiality our shareholders’ cost of capital, and we simplified here, but I think it would be extremely helpful if you that and set a 15% return on equity target. It is our could set out a credible illustrative example for us in belief that, if Brian and his team are successful in written form of how you are performing this art their restructuring of our retail activities, which is very because we do need to get to the bottom of this Ev 50 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer subject. This is one of the key subjects in the whole unhappy at the lack of transparency and, if I can put issue of competition in retail banking. it that way, the amount of small print there is in relation to what people are charged for unauthorised Q339 Mr Love: Perhaps I can try to, in a small way, overdrafts? get to the bottom of unauthorised overdraft charges Bria art r: Again, if you look at the changes that and that is what I wanted to focus on. According to we’ve made as part of our commitment to the OFT a third of current account revenues are from transparency, which is part of the customer charter, unarranged overdraft charges. Let me just start with a we certainly find through our research that customers simple question. Would you accept that is probably, are much happier with the simplicity. In a sense, what on balance, where it is with RBS? we say is, with respect to unarranged overdrafts, the Bria art r: I would say—well, let me just think only thing you need to know about pricing for RBS about it. I’m reluctant to give you a specific number and NatWest is £6. There’s a £6 buffer. There’s a £6 without going away and checking it but— fee. That’s all you need to know. There’s no more fine Mr Love: Broadly speaking. print than that. And for an arranged overdraft, there’s Bria art r: I’m just trying to think how to break no fee. There’s simply an interest rate. So I guess our down the piece. Of the revenue that we get at the view would be that that’s a positive development for moment on current accounts, I would say that number the industry and for customers and we are supportive would probably be in the ballpark. of everybody in the industry trying to take steps to improve transparency and simplicity. Q340 Mr Love: Let me then go on to ask you what is it—you mentioned that you had now entered a Q347 Mr Love: I think the OFT does accept that buffer of £6. For somebody that goes over that buffer, there has been an increase in transparency, but there what is the charge for an unauthorised overdraft? are still claims that this is unfair. The British Bankers Bria art r: The new charge that we’ve just Association and, I suspect, RBS have been resistant announced would be £6 per day and then they would to a change that would allow the OFT to investigate pay £6 for returned items; so that is cheques that we whether these charges were unfair. Would that be don’t honour. something that you would reconsider in order to clear the air in this particular part of the banking world? Q341 Mr Love: For each of— Bria art r: Well, I guess from our standpoint, as Bria art r: Yes, although there’s a limit on the I said, I don’t know what more we can do to simplify number of items that we would charge on. our fees other than reduce them to one simple fee, which we’ve done and reduced it dramatically. As Q342 Mr Love: And how much does that cost the relates to what other banks are doing, that’s a matter bank to administer? for them and, as relates to the investigation, there was, Bria art r: I don’t know the answer. I think, a very extensive court case that was resolved as you described. I don’t know about you but I don’t Q343 Mr Love: And what is the cost structure for particularly have a lot of appetite for going through someone who has an unauthorised overdraft? that again. Bria art r: Again, I don’t know the exact answer on that but we’d be happy to try to give you some Q348 Mr Love: I do not think anyone has, and I sense of it. think it needs to be subject to negotiation. What I am trying to do is—for many they still characterise Q344 Mr Love: Well, would you accept that there is unauthorised overdraft charges as being a penalty a big gap between the two? charge. Would you accept that definition? Bria art r: Well, again, that comes down to a Bria art r: No, I don’t think I would accept it question of how we allocate the broader costs of and, again, we’re providing a service for people who running the current account and the fixed costs haven’t taken the time to arrange an overdraft. We associated with that. also give customers the ability to opt out if they don’t want us to honour any of their accidental overspend. Q345 Mr Love: Ever since the court case in relation To me, that’s a pretty reasonable capability that we’re to unauthorised overdrafts, the OFT have been in giving people in managing their money. I don’t think discussions with the British Bankers Association and it’s unreasonable to charge them for it and I think what British banks. Has that made any material difference we’ve done is try to simplify that charge, make it to the charging structure that you operate? easier to understand and encourage people who think Bria art r: Well, a year ago, not long after I they’re going to avail of it to set up an arranged started, we reduced the unpaid item fee from £38 to overdraft. £5 and we did that because we thought the old pricing model was unsustainable. We believe that further Q349 Mr Love: Can I just ask you, finally, Mr transparency and simplicity is in everybody’s interests Hester, in a sense the same question that I asked a and have continued to try to lead the industry on that. moment or two ago? There is still considerable consumer unhappiness in relation to this. While I Q346 Mr Love: Would you consider that think everyone accepts that there has been some consumers—I mean there is a very large number of clarity, simplicity and greater transparency entered them, as we know, that were backing the court case— into this, there is still the accusation that there is a are happier now or do they remain, in your view, massive difference between the penalty charge and the Treasury Committee: Evidence Ev 51
7 December 2010 Stephen Hester and Brian Hartzer cost to the banks of unauthorised overdrafts. Would as determined by the bank members themselves, can you be sympathetic to allowing the OFT to investigate access.” What is all that about then? whether these charges could be defined as being Bria art r: Well, obviously, part of our approach unfair? in retail banking is we’re trying to help people with St ph st r: Obviously, I think it’s up to the OFT the broad range of their financial needs. That’s our what they do and don’t investigate. But from my own strategy. As we’ve discussed earlier, there are other point of view, I would like to use this as a point of banks that take more niche strategies. So one thing competitive difference and I don’t want to have that helps us in providing competitive credit for lawyers telling us what we can or can’t do. I’d like customers is the value of the relationship, which is Brian to be able to compete and win customers on the embedded in some of the data that we get. So certainly basis of having reduced fees, made them simpler and when we make a credit decision about somebody we reap the benefits of that. The whole reason we bring try to take into account what we know about their in people like Brian to change our business is to make behaviour and that helps us. What I would also it better and to make it better for customers. And if observe is that, if the suggestion is that that data other people don’t follow, great; we’ll get more should be shared, I find it rather interesting coming customers. So, personally, I’d much rather the from Tesco that talks about how important it is that competitive work its way towards us on this than a they have data on everybody’s shopping, which they bunch of lawyers spend time doing it. use in their promotions.
Q350 Chair: There is a strong plea for competition. Q356 Mark Garnier: Do you not worry; we have Did you think that the HBOS merger was Tesco coming in next. I want to deal with you guys uncompetitive? first. The important point here is what Tesco is St ph st r: I had the—I won’t call it “privilege”. suggesting is that the big banks are sharing this I was right in the middle—as you know, I was just information among each other to do exactly what you asked to joint RBS at the point that was coming on just said, which is to make swift and much better and we were so engaged in trying to rescue RBS that decisions as to whether or not you can lend money. I didn’t spend a lot of time debating that one to Bria art r: Okay, I understand your question a bit myself, I’m afraid. better now. So there are credit bureaux that are third party companies, which we provide data to and which Q351 Chair: Okay, but you have had plenty of time we get data from, which is one of the elements that to think about it and you are now in direct we use when we’re making credit decisions. Those competition. How do you feel about it now and would databases are available to any credit provider who you like to see it broken up? chooses to pay to access them. St ph st r: I think that, from a public policy standpoint, obviously that’s something that the Q357 Mark Garnier: Yes, but this is the whole point competition authorities and yourselves and so on must that Tesco are saying and this is quite an important think about and I have complete trust in you on that. point. If they are correct on this, we are talking about a cartel among the big banks, which is essentially squeezing out the little banks because what it is—and Q352 Chair: But I am asking your view, Mr Hester. I will read it again just so you are absolutely clear, St ph st r: From our view, we believe that we “The established banks routinely share current can compete successfully in the market as we see it, account data on income and expenditure, as well as for all its warts and so on. That doesn’t mean to say wider product holdings, through a closed user group, that the market isn’t capable of improvement, but we which only those with a sufficiently large current are not here saying that somehow we are under an account base, as determined by the bank members unfair cosh of competition against us. themselves, can access.” Bria art r: I don’t believe that’s accurate. My Q353 Chair: Fine, but what I am asking you is understanding is there are credit bureaux that are whether HBOS is one of the warts. available to any credit provider who chooses to pay St ph st r: Yes. I’m afraid I don’t think it’s right for that data. We certainly— to be drawn on that, in a personal opinion. Q358 Mark Garnier: I just want to be absolutely Q354 Chair: So you might have a view, but we are categorically clear. You are saying that this does not not going to get it. happen; there is no cross-sharing of information St ph st r: Yes. among a closed group of the bigger banks. I would Mr Love: That’s fair enough. like to know what your next stage is. With an Chair: Well, I am not sure it is fair enough, but it is accusation like this from someone like Tesco, how are certainly clear enough. you going to deal with that? Bria art r: My understanding in what they were Q355 Mark Garnier: I just want to read you a small saying there, when I read that, was I thought they piece from Tesco’s written submission, “The were—and I might be wrong on this. My established banks routinely share current account data understanding of what they were saying was that they on income and expenditure, as well as wider product were alluding to the fact that a major bank has data holdings, through a closed user group which only that it’s able to use in its decisions, within itself, those with a sufficiently large current account base, across different product categories. It is true that we Ev 52 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer provide data to credit bureaux but my understanding Bria art r: If it’s helpful, we’re happy to go back is that credit bureau data is available to anyone who and write to the Committee and verify that statement. chooses to buy the data and is a suitably authorised lender. As far as I know there is—I don’t know why Q364 Mark Garnier: I think it is important. It is we would frankly share some of that data with direct quite a big accusation they have made. competitors. So I’m absolutely unaware of anything St ph st r: We will make sure that we’re not like that happening. mistaken and we’ll write to you in any event on it.
Q359 Mark Garnier: Very simply, because that is Q365 Mark Garnier: Fantastic. Then getting back, the whole point of a cartel. If you can do this among just very quickly, to this cross-selling thing, are you yourselves then you can exclude other smaller players regularly using information that you have on current coming into the marketplace, thereby keeping those account data to cross-sell, for example, things like things— savings accounts? I completely take your point about Bria art r: The only sharing of individual credit checks for one to get a credit card and that customer data that I’m aware of is through the third simply makes sense. But if you suddenly see a whole party credit bureaux, which are available to any lot of money coming into someone’s current account lender. many, many witnesses have come before here and Mark Garnier: To absolutely anybody. Yes, okay. I people have totally said you bank a bit of money for think I might leave that one because I suspect that this a daughter’s wedding or something and suddenly you could go down quite an interesting route somewhere have a salesman phoning up out of the blue saying, “I else and I’ll check this with Tesco who come in next. see you have £15,000 or £20,000. Would you like to But what I do want to talk about is what you thought buy a savings product?” Are you using that I was talking about earlier, which is this cross-selling, information regularly to cross-sell? in effect, among yourselves. Bria art r: Yes, we do. Our objective, as I said earlier, is to broaden our relationship with customers Q360 Chair: Mr Garnier, before we go on to cross- and part of that is being able to figure out how we selling—I am very sorry to interrupt, Mark—but just help them in other ways. Certainly, the information to be clear what you said on that previous point is that that they provide in the case of leaving lazy you gave us a categorical denial. I would just like to balances—if you like to call it that—in a current be clear. Are you categorically denying what they had account, that’s an obvious thing we can talk to a told us in evidence and saying that this is completely customer about how we can help them with a better wrong? savings offer. Bria art r: As far as I’m aware, there is no—it’s Chair: We are beginning to run slightly behind possible there’s something I’m not aware of but, as schedule; so quick questions and quick answers, far as I’m aware, there is no sharing of credit data please. among the big banks other than via the credit bureaux who make that data available to people who— Q366 Mr munna: Can I just perhaps point out to Chair: I just felt that it was important. you a report that appeared in the enin t n in May about a group of investment bankers who Q361 Mark Garnier: Just following on from that, correctly bet on the outcome of the election and then Mr Hester; you have not denied it. celebrated their huge pay-out by running up a £60,000 St ph st r: Why would I? We’re colleagues. bar bill? They were consuming these vast quantities Why would I saying anything different? I’d just parrot of drink, Cristal and the rest of it, chanting, “Down what my colleague says. with Brown, down with Brown”. Would you accept, Mr Hester, that the investment banking fraternity is Q362 Mark Garnier: I am sure you would be not exactly known to be shy in coming forward about delighted to step forward and reinforce your the huge amounts that are earned in the sector? colleague’s absolutely categoric— St ph st r: I think anyone who would behave St ph st r: I have no greater awareness and, as like that in any walk of life I would consider to be far as I was aware, Tesco’s great claim to fame in stupid. trying to penetrate financial services markets is their incredible database, which is no doubt proprietary to Q367 Mr munna: Okay, but would you accept that them, with the tens of millions of people who shop there is not necessarily a culture in the investment with them, which they intend to use to attack our banking fraternity of being shy about the amount that market. I think that’s terrific. That’s their competitive one earns? edge. Let them use it. It will keep us on our toes, but St ph st r: I do think that, among high-earning it seems to me it’s much more likely to be the other professions, in all sorts of professions, it can often way around in terms of benefit of access to data. lead to behaviour that many of us might find That’s why they’re coming into the market, to use distasteful when dramatized. And some of these are that. cultural issues that many of us who have the debatable joy of managing high-octane cultures work very, very Q363 Mark Garnier: You have not categorically hard on trying to reduce the bad bits of the culture denied though. and move forward. Obviously, successful banks have St ph st r: Whatever Brian’s words are, I want more success in doing that and then sometimes one to use the same. Consider it repeated. doesn’t have perfect success. Treasury Committee: Evidence Ev 53
7 December 2010 Stephen Hester and Brian Hartzer
Q368 Mr munna: Thank you and I appreciate the you could be discriminated against as an institution, honesty of your response on that. Could you tell us the this wouldn’t rank very high up my list of hot buttons. number of high-end employees, including executive If you said to me, “You can be discriminated against board members, whose total expected remuneration in on capital or tax or on disclosure”, I’d pick disclosure respect of the reported years are in the range of £1 all day, every day, but of course we’d rather not be million to £2.5 million and in the range of £2.5 discriminated against on any subject and it would be million to £5 million and then the £5 million band better for the UK if there is a level playing field thereafter? Would you be able to give us that against which we can successfully compete within the information? context of high standards. St ph st r: I guess my view on this would be that, if the whole industry were to be in a position Q371 Mr munna: Could I just finish by asking you where—I think what you’re referring to is the how much in the last financial year did the highest Wa e e t. paid employee at RBS earn? Mr munna: Yes, I am. St ph st r: I think I’d revert to the previous one. St ph st r: If the We e twere to be I’d be very happy to disclose that as soon as that’s implemented for the whole industry, I’m not arguing what everyone else discloses, but it’s not— against it. I have no great problem with the issue of Mr munna: So you would be happy to provide to transparency and would have no difficulty. What I the— don’t want to do is unilaterally give a whole bunch of St ph st r: If that was a basis of disclosure that people, if you like, a field day just on RBS alone. So everyone made. I’m not afraid of disclosure. I just you will not hear me being one of the bankers that is don’t want to handicap RBS asymmetrically. making a great campaign on this subject. I don’t have a problem with transparency, but I’m not going to put Q372 Mr munna: Do you know the figure for the RBS, solo, at a disadvantage. highest paid person in your organisation? St ph st r: Near enough; yes, I do. Q369 Mr munna: And that is understandable. When you say “whole industry”, do you mean Q373 Mr munna: But you would not be prepared domestic, European or international? How would you to disclose it in this forum here? define that? St ph st r: No. St ph st r: I think that, generally, one wants to Mr munna: Okay. Thank you. look at the context in which a business or an industry operates. So there are some businesses and industries Q374 Chair: Are you aware whether UKFI has the or parts of businesses that operate on a closed authority to require disclosure? domestic basis. Obviously, a very large amount of St ph st r: I think that UKFI has, in this RBS is—what we’re mostly here today to talk context—as opposed to obviously the Government, about—the retail bank. I think you can make lots of which has any authority it likes through the law- rules that are UK-specific and it doesn’t matter so long making process—the authority that any shareholder as they apply to all the UK players because there isn’t does. So I assume that— a lot of leakage. Chair: So the answer is no? If you’re talking about bits of industries—and this is St ph st r: Well, I assume they could fire the true of advertising and technologies of banking where board or insist on the board doing it. the market is a fluid global one—then I think you have to have regard, if you like, for the marketplace against Q375 Chair: It has been put to us that they do. which you’re competing and then it would be St ph st r: My guess is, through the mechanism desirable that the rules of your marketplace reflect the of insisting that the board does or firing it, probably marketplace, i.e. they’re global. So that’s why they can exercise their majority right. I don’t know generally we try and put a lot of effort into the whether that would be consistent with their charter, international discussions that try to establish level but my guess is that would be the route. playing fields. But, as I think I was quoted in some newspaper the other day, generally my stance since Q376 Jesse Norman: Thank you, Mr Hartzer and Mr coming into RBS nearly two years ago has been to try Hester, for your very interesting responses and concise and increase global standards as opposed to the other ones. Can I just ask, picking up on the point of way round. bonuses: what is going to happen at the moment? Because we are looking at a situation in March or Q370 Mr munna: Obviously, the focus tends to be April where very large numbers will start to come out; on the investment banking divisions of the large there will be enormous public reaction. It has all the groups because that is where huge sums are earned. makings of an impending train crash. Are there steps Obviously. Sir David Walker has changed his position in progress to try to head that off? Is that something on this somewhat. Do you think if we adopted a that you are engaged in or interested in? disclosure scheme unilaterally—in terms of St ph st r: On one level, this topic is difficult unilaterally as the UK—it would put us at a huge but on another level I’m glad you raised it because it disadvantage if that was not followed by our gives me the opportunity to point out—and I think it European partners? is very apposite to this Committee’s remit and what St ph st r: I think there are a series of grey areas you’re talking about today—that the vast majority of and I have to say, for me, in all the different areas that people who work in financial services and in banking Ev 54 Treasury Committee: Evidence
7 December 2010 Stephen Hester and Brian Hartzer do not work in investment banking. In the case of Q379 Jesse Norman: But you would be supportive RBS, we employ more or less 150,000 people around of the instinct to try to take some costs out of the the world; something around 10% of whom are in the situation, if we could, and support the taxpayer? investment banking unit and 0% of whom are not. I St ph st r: Well, I’m suspicious of artificial think it is most unfortunate when this subject colours subsidy in saying, “Well, PFI should be subsidised all debate, all argument, and we don’t have a into something else”. I’m naturally suspicious of those recognition of the 0% of our people, i.e. well over things, but I do think that if we can get markets 100,000 people, who have a different characteristic functioning well, that’s desirable for the economy and and profile in terms of the jobs that they do, the I think legitimate finance for PFI—based on, if you markets that those jobs operate in and so on. like, transparency of who’s providing what—is a positive financing tool. Q377 Jesse Norman: On that, would you support the idea of separating out the disclosure of the bonus pot, Q380 Jesse Norman: A very quick final question of so people could see that the vast majority of your Mr Hartzer: obviously, one of the reasons for the large employees do not— UK bail-out of Ireland was the situation of exposure St ph st r: Personally, I think that the “bonus” to Ireland through Ulster Bank; am I right in thinking word is a red herring. To me, what I’m interested in that you are the Chief Executive of that part of RBS? is the total cost of an employee from whatever source Bria art r: I have responsibility for Ireland— that cost comes and I think it’s wrong to just focus on bonuses. And so my focus is on the total cost of Q381 Jesse Norman: Since we have not covered it, employees against what they do for us and for our could you just tell us how matters progressing in terms customers and our shareholders, and we do disclose, of taking control of that loan book, making sure that every single quarter—I think we’re the only bank in you are comfortable that the taxpayer interest is the UK that does this—the total cost of our employees served, preventing the repetition of any kind of by business segment across all our banks. So I don’t further bailout? think any of our competitors give you that level of Bria art r: Yes. Well, obviously the situation in disclosure. Forgive me if I’m traducing them, but we Ireland has been quite regrettable and been a serious do. issue for the group. The way we’ve dealt with it is as we’ve done all of our restructuring. We’ve separated Q378 Jesse Norman: Thank you. You have the bad loans or the parts of the business that we don’t mentioned that it would be helpful to schools, think are sustainable into our non-core division. And hospitals and roads if, as it were, the Government in the case of Ireland that’s primarily about were able to sell down shares in RBS. The other area, development lending for property development and obviously, where RBS is very big that bears on this— so forth. and it is something that I feel very strongly about and many of my colleagues do—is the private finance Q382 Jesse Norman: And that is roughly how much initiative. I mean is that an area where you think there of the £ 3 billion? would be some scope to take a lead in reducing costs Bria art r: £10 billion. and trying to support the taxpayer? St ph st r: Here is one of the rich ironies of Q383 Jesse Norman: Right, okay, so it is a debate around the financial system. I recall meetings substantial amount of money. on this subject about a year ago when the evils of St ph st r: I would say there’s about 0% of the securitisation were being widely debated and pilloried total size of the Irish balance sheet that, if we’d been in the newspapers and, of course, all the regulatory having our time again—of course we weren’t at the action has been to make securitisation very bank at the time—we wouldn’t have done and that’s uncomfortable for banks to do—much more capital, the bit that we’re putting on one side and running off. much more risk, and so on and so forth. And, of course, financing PFI is exactly that; it’s securitisation. Q384 Jesse Norman: That is very helpful. 0% of Securitisation is not limited to people in caravans in £ 3 billion is a huge number. far states of the United States. Basic things like North St ph st r: But let’s be very, very clear: that Sea oil projects, financing schools and hospitals doesn’t mean to say that’s the amount of money through PFI—this is securitisation as well. Indeed the we’ll lose. mortgage market—we can argue it was a bad thing Jesse Norman: No, no, no. I understand that. house prices were able to rise as much as they were, St ph st r: Those are loans, whether good or because securitisation stepped in and funded that gap. bad, that we would— So we just have to think through these ironic topics. Now, I believe that securitisation as a technique is a Q385 Chair: That is where they are making some valid technique. Like many pieces of technology, it impairment. can be misused, but that doesn’t mean it doesn’t have St ph st r: And a subset of that there is good uses. I think PFI is a good use and I very much impairment. We’re losing significant amounts of hope that, as the financial crisis recedes and the new money, but they’re nowhere near multiples of that, if rule-making is made, securitisation isn’t obliterated as you see what I mean. And I think it’s very important a tool to help things like PFI by the new regulatory to be clear that there are no investment bankers rules or by the markets. anywhere in sight in Ireland. This is bog-standard Treasury Committee: Evidence Ev 55
7 December 2010 Stephen Hester and Brian Hartzer lending that went wrong from small banks. But in the people are earning in excess of the Chief Executive case of our bank in Ireland, obviously, we’re not does not seem to me something you needn’t getting any help from Irish Government, but it’s part necessarily to disclose. of RBS, which of course was propped up by the UK St ph st r: I tried to be pretty clear earlier on Government and which is why we’re trying to change that in the list of things I get upset about this isn’t one. all these things. Mr Mudie: You tell us and we will just keep it to ourselves. Q386 Jesse Norman: Just for the avoidance of St ph st r: But one of my jobs is to try to help doubt, the loan book is something like £ 3 billion, RBS recover and, to give people extra things to beat £16 billion, sorry, 0%— us up on that they can’t beat anyone else on, I just St ph st r: Our total assets in Ireland are 50. don’t see how that helps my job. My job, by the way, Jesse Norman: Sorry? is to help the state get its money back. St ph st r: Our total assets in Ireland are more like 50. Q391 Mr Mudie: As an old trade union official, I Jesse Norman: Right. So £20 billion at risk, as it think you are in a lovely position where you are able were— to say, “Well, I’d give you this, if only those St ph st r: No, not at risk; in our non-core. So, Americans would do the same”, and you know that in other words, we think that the sustainable size of the Americans have no intention of doing it. So your our Irish bank should be much more closely shielding behind the Americans, are you not? proportionate to the sustainable amount of deposits St ph st r: Well, let me— that we can raise to finance it. And the Irish banking Mr Mudie: I think that is a bigger fear, across the system, in common with the British banking system— regulatory field that we are all taking shelter behind Bradford & Bingley, Nationwide, Northern Rock, “we’ll do it, if they do it”. RBS, Lloyds—borrowed more than there were St ph st r: Well, I’m very glad that you ask the deposits and the nation borrowed more than it point and thank you. I feel very strongly that one of deposited. Ireland has the same problem in spades that the big reforms that the financial services industry the UK has and so we’re having to shrink back to a needed to make, perhaps still needs—I believe this of sustainable size and restructure that bank, in Ireland all companies, by the way, not just banks—is high dramatically, in many parts of the world equally levels of transparency. And under my leadership, RBS dramatically. has moved to be the most transparent bank in the UK and probably in the world in terms of its frequency Q387 Jesse Norman: And that would be about a £30 and quantum and detail of financial reporting. billion balance sheet at the moment? My view is that, unless it’s commercially sensitive, if St ph st r: Our target end state would be, order it’s important to you understanding the bank’s risks of magnitude, 30 to low 30s. being a shareholder—either from a risk perspective or Jesse Norman: That is very helpful. Thank you. a shareholder’s perspective—we should tell you it and Chair: That was a very helpful, open reply. Thank we do and, by the way, that’s 300 pages, at least, four you very much, Mr Hester. times a year. So we have been absolutely unafraid and I think it is right to take a lead on areas of Q388 Mr Mudie: Going back to Chuka Umunna’s transparency where we think it helps the business in question, are you the best paid person in your bank? terms of people’s ability to assess our risks and St ph st r: No. shareholders’ ability to assess whether they’re going to get their money back or make profit on their Q389 Mr Mudie: Are you prepared to tell us how investment. Where I’m not so excited about it is if I many people earn more than you in your bank? Now, don’t think it does any of those things and then, fine, before you say “no”, Eric Daniels was vague about it, if we all publish then let’s all publish. but promised to write to us and give us details. Now, Mr Mudie: Yes, okay. are you going to be even better than Eric Daniels and Chair: Thank you very much indeed for coming to tell us? give evidence this morning. I know there are St ph st r: My intent would be to stick to the colleagues who still want to come in, but we want to same disclosure that is made available by all banks. If keep roughly to schedule. You have been asked to all banks disclose that information, I’d be delighted to supply quite a lot of written material and we will look do it. I have no objection to it. I don’t want to be the forward to receiving that. Of course, it needs to be only bank that does it. said that if we feel we do not have the answers we were hoping from the written material, we will have Q390 Mr Mudie: No, but I could understand if we to ask you to come back again, but with a bit of luck were asking for posts and even the Walker formula, we will get what we need. Thank you very much, both the bands and so on, but simply to disclose how many of you, for coming and for being so clear. Ev 56 Treasury Committee: Evidence
7 December 2010 Benny Higgins
Examination of Witness
Witness: Benny Hi ins, Chief Executive, Tesco, gave evidence.
Q392 Chair: I am very grateful to you for coming current accounts. That number rose to £ billion in in. I do not know how much of the earlier evidence 200 . The split of that revenue was: 50% came from you heard, but we have just had a rather interesting credit balances, and 38% from unarranged borrowing exchange with respect to some of your evidence. If from fees or rates—mainly from fees—and the I can just read the relevant passage, you said, “The balance came from a variety of other sources. I established banks routinely share current account data wonder if anybody in this room knows how much they on income and expenditure, as well as wider product contributed to the £ billion. So it seems to me that— holdings, through a closed user group.” Could you tell Chair: Sorry, I wonder how much— us what is this “closed user group”? Byiis:How many people in this room Byiis:Yes, I can indeed, Chairman. would be able to say, even as a wild guess, how much Unequivocally, there is a closed user group made up they contributed to the £ billion in 200 . So what I of the large banks and some of the other banks. The would say— eligibility condition is that you need to have one million current accounts and it’s used primarily to Q399 Chair: I asked a senior executive of Lloyds assess affordability because clearly, in order to assess that question this morning and she was unable to do affordability, you need to know the income and so. expenditure of the customer involved. So it certainly Byiis:I think you’ll find that very few is a closed user group and that is the eligibility. people are able to do so and I think it strikes at the heart of the issues around competition within current Q393 Chair: Have the OFT looked at it? accounts. The issue is around transparency— Byiis:I’m not aware of that. They may or transparency and also the perceived and real obstacles may not have. to switching.
Q394 Chair: Have you brought it to their attention? Q400 Chair: And are you going to provide that Byiis:I haven’t personally but I’m sure transparency unilaterally? they’re aware of it, but we certainly can do that.1 Byiis:Within Tesco Bank? Chair: Yes. Q395 Chair: Bearing in mind that you are a would- Byiis:Yes. Well, we plan to launch current be market entrant, do you not think this is something accounts and at the moment we’re working through you might want to have high on their agenda? the way in which we should present current accounts Byiis:Yes, no, absolutely, I agree. to customers. We’ll follow the ideology that has always been true within the core Tesco business. We Q396 Chair: So I am rather surprised that you have follow the customer. We’re setting out to be simple, not raised it with them. to be transparent and very straightforward. That’s Byiis:They are aware, certainly, but we certainly our focus. certainly will pursue it further. Q401 Chair: So can we expect customers to be told Q397 Chair: What should be done about it? what they are really being charged including interest Byiis:I think that it’s not about sharing foregone when banking at Tesco? proprietary marketing information, which would be, I Byiis:Absolutely, yes, we operate in a think, inappropriate for competitive purposes. What competitive environment. I hope that it won’t be too it’s about is understanding affordability and that is, I long before the initiatives that have been driven by think, for the greater good. And so I think anyone who is lending in the UK should have access to that the OFT will in fact drive much greater transparency affordability data. across the businesses.
Q398 Chair: Do you think it is reasonable and Q402 Mark Garnier: Barriers to entry in terms of possible for consumers to be told how much they are the regulatory process: we had Hector Sants and Lord being charged on their current accounts, the real Turner in a couple of weeks ago and I was getting charge, including the interest foregone? stuck into them on this particular point. They Byiis:Well, what’s quite interesting is that absolutely categorically denied that the regulatory I think it’s the great Scottish enlightenment thinker, authorisation process is a barrier to entry. How are David Hume, who said that a wise man proportions you finding it? Do you agree that it is no problem? his belief to the evidence. Well, let’s look at the Byiis:If you don’t mind I’d like to broaden evidence as far as your question is concerned. The the question to say what are the barriers to entry. OFT found that, in 2006, £8.3 billion of revenue came Mark Garnier: Yes, of course. from consumers to the banks in respect of personal Byiis:In fact, I think a much more useful expression is “what are the barriers to success?” 1 te itness: uestions 3 —3 6 were misinterpreted. “Barriers to entry” sound like a very, if you like, black To clarify Tesco Bank have raised this issue with the OFT in written evidence submitted in response to the review of and white outcome, but “barriers to success” barriers to entry. discourage new entrants. If we were to identify the Treasury Committee: Evidence Ev 57
7 December 2010 Benny Higgins number of issues that would act as potential barriers But I don’t think that we should consider it a criticism to success, I would list them as follows. of the regulatory process. Firstly, financial services is a business where it is necessary to invest in a huge amount of infrastructure, Q404 Mark Garnier: You do not see it as a Catch- whether it be IT or specialist skills. It does mean that 22 where investors will not invest into a business it’s unlikely that a new entrant can be very successful where you are not getting return on your equity for and be very small, whereas in other businesses it’s potentially up to a year? You do not see that as a— possible to be small and well-formed and successful. Byiis:I don’t think that is a leading issue. I So there has to be an aspiration for some scale. The think the leading issue is the matters I’ve already second is around regulatory issues. uite rightly, the listed. capital requirements are much greater than they have been before and they will act as a discouraging factor Q405 Mark Garnier: No, no, that is a fair comment. for potential new entrants. The regulatory process Just one last question, because you actually seem to itself, I wouldn’t say, is a discouraging feature in be a relatively happy customer. “Every little helps”, it respect of how the regulations— seems, where the FSA is concerned. Would you give Mark Garnier: You wouldn’t say. them a good reference, if you like? If somebody was Byiis:I wouldn’t—in the way it’s pursued. to ask you how the FSA has treated you going through However, the FSA themselves have acknowledged this regulatory process would you say, “Yes, they’re that the level of intensity of regulation is greater than fine. There’s no problem with that. They’re doing it’s been, and that brings with it cost because for every okay”? pick-up in the intensity of regulation and contact there Byiis:We go through an annual appraisal is greater effort required within a business for of the FSA to the FSA and it’s not so long ago we compliance. So that is certainly an issue. However, I did. We have a very good relationship, a very open would say that the two biggest issues that could easily and co—operative relationship, with the FSA. There discourage a new entrant are, one, the lack of are times when single issues may seem to be handled switching in current accounts. Now, it’s not just about in a disproportionate way, but actually we have a very current accounts because the nature of the current strong relationship with the FSA and can’t complain account in financial services transcends the products about the way in which they have handled our process itself. What the current account acts as is a fulcrum of going through change of control. We announced the for all of the other products that banks sell. So for acquisition of the other half of the business from RBS example, 88% of savings products will be sold by the in the summer of 2008 and we completed the process bank that has the current account. So it goes beyond in December 2008, which required us to go through a just current accounts. change of control process and we thought it was Mark Garnier: I do know some of my colleagues are handled very professionally on both sides. going to pick up on exactly those points a bit later and I just really want to— Q406 Andrea Leadsom: Mr Higgins, we have had Byiis:Okay and, just finally, I think one some very interesting complete conflicts of opinion thing I would like to explore is the economic model this morning where we have had both Lloyds HBOS where there is fierce competition from new business, and RBS claiming that the PCA market is highly supported by incumbent banks, by profitability of their competitive, that there is very little cross-selling, that existing business. Therefore, any new entrant has to the cross-penetration is not high, that there are no confront the challenge that they’re entering a market barriers to new entrants and, indeed, that they fall over where new business is fought on slim terms, but backwards to accommodate the switching of personal actually the profitability of incumbents is supported current accounts. I think you are hinting at the fact by their existing business. that that is not the case in your opinion. And your view would be shared by Sir Donald Cruickshank who Q403 Mark Garnier: Just drilling down, as I say, gave evidence to this Committee saying that he into this regulatory issue and the process. As I say, believes that the barriers are those of new accounts, those other points you have raised will be covered so new current accounts. And indeed that would appear do not feel I am skirting round what are very to be shared by the OFT, who think that there is not important points. But there are a number of people enough competition, that switching is very low, that who, anecdotally and otherwise, have made comments there is great customer inertia. So just by way of the that, for example, if you are about set up a new bank, background there, there are these enormous conflicts you have to put a huge amount of regulatory capital that have come out today. into that organisation and then have it sitting there What is your opinion? Sir Donald Cruickshank told doing absolutely nothing for the next nine months us that the banking industry should be stripped of its while you go through the process. I mean for someone control over the shared network infrastructure. Do you like Tesco where you have a strong balance sheet, that agree with that; in other words, that they should not is probably not a problem. But, again, with your any longer be allowed to own and manage money experience having gone through this process, do you transmission services on their own to their own rules? think that is a fair criticism of the regulatory process? Byiis:I don’t think that is the issue. I would Byiis:I wouldn’t say it’s a fair criticism of rather go back to some of the points you made earlier. the process. I think it’s a fair reflection of the need to Let’s address the question: is the market for current have large amounts of capital to be in financial accounts competitive? Well, if we go back to first services and that itself will act as a discouragement. principles: what would make a market competitive? A Ev 58 Treasury Committee: Evidence
7 December 2010 Benny Higgins market would be competitive if there was a sufficient of our earlier witnesses were suggesting it takes four number of suppliers offering a sufficient range of to six weeks to switch accounts, which is an choice to customers in an environment where the extraordinarily long time. Sir Donald Cruickshank customers are well informed through transparency and suggested to us that the key to changing this was to full availability of information and where there are no have a new licensing regime for money transmission perceived or real barriers to switching. If we address systems—CHAPS and BACS and so on—that would the PCA market against that level of criteria, I think require that banks allowed complete account it becomes very clear that we don’t need to hint at portability, rather akin to what he achieved when he a conclusion. It’s an unequivocal conclusion that the was leading Oftel with telecoms—taking your phone market is not competitive. number with you. What he was suggesting is that you We shouldn’t look at the market shares. They’re should able to take your bank account with you. actually not the issue here. What we have to ask So, in other words, it would be for the banks to find ourselves is: what is it about the customers’ a way to enable you to take your bank account number behaviour? What is it about the companies who serve and your sort code with you so that you did not have those customers’ behaviour that tell us the answer? to re-establish your direct debits and your standing And if we look there we find that the FSA did a study orders and so on. Could you comment on, one, only, I think, last year where 3 % of customers said technologically is that possible—obviously it is not that all banks’ products were pretty much the same: today, but is it possible? Secondly, would that then the same price for the same outcome. Now, that’s solve the problem? I just want to be very clear: this palpably untrue. It’s untrue for individual banks, never would be consumer choice, because a number of mind across different banks. So there is a lack of people have commented, “Well, that smacks of Big transparency. We already have discussed in brief the Brother: an account number cradle to grave”. amount of income that flows to the banks in respect Obviously, it is about consumer choice. You can of current accounts, but that’s not something that change your bank account number if you want to but, customers are aware of, so there is a distinct lack of equally, you do not have to. So with that in mind, transparency and disclosure of information. could you comment on that, please? Byiis:Many things are possible at a price. Q407 Andrea Leadsom: So would you highlight What I would find it very hard to gauge is just how transparency—in other words, the customer knowing expensive that particular initiative would be. My best what their current account costs them or, conversely, guess is it would be very expensive and so, while I what the profitability of their current account is to think it should be explored because it certainly has the their bank? Is that the one key thing that would make embryo of a very good idea, it has to be fully costed the difference? and understood what the implications are. But, beyond Byiis:There are two that will make the key that, the real question is: is there a real energy to make difference. One is full disclosure. Now, there is an switching straightforward, whether that’s a solution or OFT initiative to do so. I just hope that in three or some other one is? four years’ time progress has been made and it’s just not a bunch of initiatives that never come to fruition. Q409 Andrea Leadsom: So when you say, “Is there But there are initiatives that will bring greater a real energy?” do you mean your suspicion—I do not transparency to this particular question. want to put words in your mouth but is your suspicion The other is the question of how easy it is to switch, that the banks will collude to avoid this happening perceived and real. Again, we can look at OFT data because it would, at a stroke, remove barriers to entry where a quarter of customers who switched said they for new market participants? wouldn’t do it again. A third of customers who Byiis:No, I’m just simply saying that this switched said they wouldn’t recommend it to a friend is not a trivial problem to solve. It will require a great or member of their family. So unequivocally, I think deal of focus and momentum and I’m saying no more what we have here is evidence that there is an absence than that. of proper transparency and disclosure and there is a perception—and indeed there is a reality. A quarter of Q410 Andrea Leadsom: Okay, but then, if those customers who do so also say they encountered some obstacles were overcome, do you think that that would difficulty during the process. It’s not all the bank’s create a radical difference in the competitiveness of fault because the direct debit originators are involved, the retail banking sector? but there needs to be creative energy and momentum Byiis:If you look at other aspects of to solve the problem. Until these two factors are financial services where there is greater transparency, resolved, you cannot describe the market as where there is a much easier switching process, you competitive. see much higher activity around switching. The number that is quoted for current accounts is usually Q408 Andrea Leadsom: Yes, and I completely agree around 7%. In fact, I saw some data the other day that with you there, and certainly have had a lot of letters suggested, if you take out secondary accounts, the real from constituents who have had a complete nightmare underlying switching is probably more like 3%. It’s trying to switch accounts from one provider to very, very low. another. In particular, what they have highlighted is However, if you look at credit cards, for example, the that it is the argument between the bank they are UK Cards Association has just published some leaving and the bank they are going to as to who numbers showing that in the last 12 months no less should do what that causes the hold up. Certainly, both than 27% of customers have either taken a new card Treasury Committee: Evidence Ev 59
7 December 2010 Benny Higgins or a first card and, indeed, 1 % of them closed the they were just offered only of the average of the top card that they had. So in a market where there is an 10 products across those market segments? ease of switching, where there is transparency around Byiis:They’re foregoing interest. Now, in what you get charged and what you get, customers any market you don’t get perfect mobility where will be more active. Customers will switch. One of people make the perfect choice. There are many the tests in competition, I would suggest, would be: is reasons for placing money, around trust and so on with there evidence of customers having a product which, different institutions, but what we’re talking here if they were to look at what they were charged and about are very similar products. what they got, don’t move despite the fact that there Jesse Norman: Right, so is £10 billion what you are alternatives there that would serve them much would call a very high level of friction, which better? Against that test, I think current accounts fail. suggests that there are institutional inertial factors that are preventing the markets from operating? Q411 Jesse Norman: We have heard one very Mr i i s: And I would suggest it’s lack of interesting piece of testimony already that you may information. have noticed, Mr Higgins, which is that RBS were apparently not concerned about the anti-competitive Q414 Jesse Norman: Okay. That is very interesting. effects of the Lloyds HBOS merger, which suggests Can we just go into more detail about what you are either that they regard Lloyds HBOS as a staggeringly proposing to do on areas where you think there should uncompetitive organisation as a whole, or that they be more transparency? So take, for example, the are very self-confident about their own ability to personal current account where we know that free compete. I want to ask you about two things. The first banking, as such, does not properly exist. Would your is: do you not think it is possible that switching could view therefore be that the banks should charge the make banks more profitable, for two reasons? One is correct price for that service or that they should that it siphons away customers off whom the banks disclose how much in income the person’s foregoing are earning relatively little money, whereas we know by using it? in fact they are earning an enormous amount of money Mr i i s: I would suggest that if there was proper on the overdraft and charge side. The second is disclosure of information and there wasn’t a because it siphons off the grumpiest customers who perception that switching was difficult, then actual might be expressing their voice within the institution behaviour of markets would bring about the right level for more transparency and lower charges. of pricing and the accompanying profits. Byiis:Well, first of all, I think the issue is: should the personal current account market and, Q415 Jesse Norman: But for the avoidance of doubt, beyond that, the retail banking market be more there would therefore be a bit of paper where someone competitive and what would be the characteristics of would say, “In opening this account, you are a competitive market, regardless of the profitability essentially agreeing to pay us £100 to £150 a year”, today or tomorrow? But if I could give you a statistic or whatever the true embedded price is for that kind I think to illustrate— of account, “which will be paid in the form of foregone interest earned”. That is the kind of Q412 Jesse Norman: Sorry, we can rephrase my disclosure you have in mind, is it? question. It is whether or not switching might in fact Mr i i s: Yes. The difficulty is some of the income make the market less competitive for the reasons I that flows from the customer to the bank is partly have described. dependent on the behaviour in a particular period of Byiis:A lot more switching is an unlikely time and so it wouldn’t always be this; you know, it characteristic with a market that’s less competitive. wouldn’t be possible to this accurately predict. But I The freedom to switch between suppliers is a think what is important is that disclosure of the cost necessary component of competitive markets and, as is very clear. Now, as I’ve said already, the OFT have I said earlier, I think disclosure, full information being initiatives to pursue this. It is, in my opinion, very available and there being the minimum number of important that the execution of it is such that it barriers to switching is what you need to have a resolves the issues as far as possible. competitive market. But if I could illustrate a point, in savings, for example—and I quoted a point Q416 Chair: Jesse’s question is: how can that be earlier—88% of savings are with the current account best made transparent? And we need an answer to provider. If we were to take the £1 trillion that sit on that. deposit in the UK—now, there are a range of different Mr i i s: Well, the answer is that we need to show, products ranging from instant access through to fixed I think, with a sufficient frequency, how much is being term deposits—and we were to ask the question, paid by consumers to banks. “How much more would transfer from the banks’ profitability to the households that make those Q417 Chair: So do you mean how much interest deposits if all of those customers placed their deposits foregone? at the average of the top 10 for that particular Mr i i s: Well, some basis of interest foregone. I segment?”, by my calculation you get to £10 billion mean, I wouldn’t like to over-simplify the disclosure. annually, quite easily. What we have at the moment is it’s quite difficult for people to understand the combination of the charges, Q413 Jesse Norman: So that is £10 billion that the fees, interest foregone. I mean, it’s best, I think, customer is paying that they should not be paying if illustrated by the concept—we still talk about free Ev 60 Treasury Committee: Evidence
7 December 2010 Benny Higgins banking all the time. I would go further and say that venture organisation, it’s the new platform that we free banking is a myth. In-credit free banking is a will be in a position to launch current accounts from. myth, because as I said earlier that £ billion that was In terms of mortgages, it’s a separate kind of platform, received by the banks in revenue from customers— because mortgages are run differently. But mortgages it’s the only source—50% of that was around in- will be first and that will be in the middle of the year. credit balances. Q424 Mr Mudie: No, but just in the context of the Q418 Jesse Norman: That is very interesting. It was, discussion here, nothing is preventing you in and we have heard that already. But just for the principle, apart from your timetable. You are doing the avoidance of doubt, the kind of schedule you have in mortgages first and then you are going to do current mind is one which would allow a Wi or someone accounts. There is nothing stopping you doing those similar to rank 50 bank accounts, show what the two things, is there? interest foregone would be, show what the costs Mr i i s: No. I mean, at the end of the day it’s would be and show, as it were, the additional cost of rarely that something stops you doing it. I think the a marginal mortgage product or some savings product; conversation that we’ve had so far would say that it would be that kind of thing. So someone could look there are issues that make it difficult to go into the down and go, “Okay, I see. This is really current account market. We’re certainly very uncompetitive. I need to be going with Harry” and say determined that when we do, we will do so in a way where they would, for example, with an ISA or some that is consistent with the Tesco values and the of these other— Tesco business. Mr i i s: Yes, I mean, in the first instance, you would know how much you pay today and you would Q425 Mr Mudie: No, I understand that, but we are be able to look at what you would pay if you made looking at what is stopping people like yourself come an alternative choice. in quickly and get established and get running and giving competition. You see, the transparency side, I Q419 Chair: Why do you not write down in some go on confused.com and all that if I am looking at detail how you think the industry should be required insurance and things like that, and I will have to go about this, rather than persisting with questions everything listed and they will compare each of the now? It is not an easy subject. It is quite complicated, providers, and I will be able to look down the list and but it is a very important one. think, “Well, this is important. This looks good”. Now, Mr i i s: I agree, Chairman. I wouldn’t understate why can you not do that on retail banks then for the complexity of it, but there has to be a considered effort to make sure that the breakdown— current accounts? Mr i i s: It’s just at the moment, it’s more difficult to have a simple comparison that’s supported by the Q420 Jesse Norman: The key point about this is by all means sketch two or three different alternatives, disclosures that banks make around current accounts. but please work them out so we can actually see what it would look like, because it is only the working out Q426 Mr Mudie: Right, but you were at RBS, and that one gets a real sense of the complexity of it. you were at one other bank in a senior capacity, Mr i i s: No, the expression of transparency is HBOS. Now, you were in retail there. Is it impossible easier than the execution, but it’s important that we for anyone to do it outside those banks? It is not even are focused and creative in doing so. a question of disclosure. They are withholding Jesse Norman: That is helpful. information that would permit a comparison; is that what you are saying? Q421 Mr Mudie: Just taking your report, can you Mr i i s: No, I’m not. What I’m saying—and first tell us just—because it touches on where you do not of all, I’m here exclusively to discuss Tesco Bank do current accounts and mortgages—are you wishing today, that’s who I represent, Tesco Bank—I’m happy to do? to make comments on the industry in general. I’ve Mr i i s: We’ve already made public our desire to made a number of comments already which I think launch more— are genuine— Mr Mudie: Could you speak up a bit, please? Mr i i s: Sorry, apologies. It is. We’ve expressed Q427 Mr Mudie: Now, Benny, you have been very our plan that we will launch mortgages in the middle good, and you have been the most important witness of next year. we have had. They have all been defensive. You are actually somebody who has been trying it, gone along Q422 Mr Mudie: Which one? the road, seen the difficulties. Well, let me put it: if I Mr i i s: Mortgages, mortgages. wanted to set up or Martin Lewis wanted to do Mr Mudie: Mortgages? something in terms of current accounts, “Come on my Mr i i s: Yes. website and I will show you the most competitive in terms of current accounts”, could he do that with the Q423 Mr Mudie: What about current accounts? information that is in the public arena? Mr i i s: We don’t have a very fixed date yet. The Mr i i s: I think it would be quite difficult at the reason why we’re able to do mortgages first is moment. because, as we’ve been migrating our business away from RBS systems, which was part of the joint Q428 Mr Mudie: Not impossible, but quite difficult. Treasury Committee: Evidence Ev 61
7 December 2010 Benny Higgins
Mr i i s: Nothing is impossible if there’s enough but from our perspective we have a good relationship energy and focus. and we are systematically working through the things that we need to do. Q429 Mr Mudie: Right, okay. Now, Mark—and I One thing I would say is you do need the right think you have been exceedingly generous to the expertise to be working on this. You need the right FSA—he asked you a question about how you got on access to capital. This is not a straightforward with the FSA and you said you have had some business to enter. I listed earlier what I thought were wonderful reviews from them. Your evidence— the headline potential barriers to success and, Mr i i s: No, I’m sorry, I didn’t say that. What I therefore, potentially issues which would discourage said is we appraise them of how our relationship is new entrants. None of them are barriers to entry. It’s working and it was very— why I would prefer the expression “barrier to success”, because nobody’s getting told they can’t Q430 Mr Mudie: Yes, but we are more concerned enter. It’s just that there are issues that you have to about how your initial dealings were with the FSA, overcome and one of them is the regulatory burden— and they sound to be as fraught as we fear they will I’m not saying it’s inappropriate—the regulatory be, that they would be and are. I mean, I just read capital burden, which is becoming bigger. It’s about someone taking up a post in the City who important that regulation is robust and proportionate. waited two years to be told he was not fit to take a job I think that is very important. with the FSA. We are picking up long delays and— Mr i i s: Well, all I can do, I’m afraid, is express Q432 Mr Mudie: Did you read or see our session how we experienced the changes. You have to with Don Cruickshank? remember that the business that was initially Tesco Mr i i s: I have seen it. I read it some time ago, Personal Finance, now Tesco Bank, was established but I can’t remember it in detail. in 1 7, and it did have its own banking licence as a joint venture with Royal Bank. When Tesco acquired Q433 Mr Mudie: His evidence was astounding in the other half, what was required was a change of terms of how difficult it is to set up a bank in the UK control through the FSA, and it does require a very now. Did you come across those passages? detailed regulatory business plan. We went through Mr i i s: Yes, I mean, we are in the process of that process in the summer and autumn of 2008 and creating what we hope is a very successful bank that all I can say is our experience was very good. will serve Tesco customers well. I mean, I should say Mr Mudie: Your experience was very good. one of the things I hoped to be able to cover was that Mr i i s: Yes. what we aim to do is to serve Tesco customers well by being a very prudent, traditional bank, but by applying Q431 Mr Mudie: I am struggling to find it, but you modern methods. If we can do that, we will, I think, are less happy with them in your description in your make a big contribution to the financial welfare of paper on various aspects. Tesco customers. Mr i i s: Well, let me just make sure that there is Chair: That is very, very helpful evidence you have no doubt about this. What I have said is that intensity supplied us with, not always in accordance with the of regulation is greater than it was. The FSA have evidence we have heard earlier this morning. That is acknowledged that. I think it’s an appropriate response why we take evidence from a variety of witnesses. to the last few years. When one gets a change in Thank you very much for coming this morning—we intensity, change inevitably brings some teething have appreciated it—and for waiting out until the end. issues. Change also means that there’s more activity, Mr i i s: Thank you. so what I would say is that there can be more clarity, Chair: Thank you. Ev 62 Treasury Committee: Evidence
Tuesday 14 December 2010
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Andrea Leadsom John Thurso John Mann ______
Examination of Witnesses
Witnesses: Vernon W Hill , Vice Chairman, Metro Bank, and Anthony homson, Chairman, Metro Bank, gave evidence.
Q434 Chair: Thank you very much for coming to survey of 67%. No retailer over time can survive with see us this morning. You are that rare thing, a retail customer dissatisfaction rates that high. banking entrepreneur. We don’t have many of those To get back to the question, we saw an opportunity to in the UK. redefine the model, to reinvent how retail banking is V r o ill: You have one now. delivered and that’s what the Metro Bank model is Chair: We are going to have an interesting exchange about. I hope on what your plans are and what you think about the UK retail market. Can I just ask you, what Q437 Chair: Okay. Well we will be coming on to led you to conclude—and you are quoted as saying some of the points you have raised, for example, price this—that the British hate their retail banks? “Hate” versus service, later on. Could you just say a bit about is a pretty strong word? the SME market in the UK? Do you think that that is V r o ill: Thank you, Mr Chairman. We’re happy well served by the existing bank networks? to be here this morning. I’m pleased to answer the V r o ill: When Metro Bank opened about five questions. I just want to make one statement first; I’ve months ago, I had read about, and all our British been involved in four new banks in America and this management team—and our entire management team is my fifth new bank. I’ve had a lot of experience is British—had informed me about the general level in America, so I look through these questions to my of dissatisfaction and non-service in the SME. I was American experience and now my British experience. shocked by the level of SME response we got, both We want to make it clear, first of all, that this is an in opening cash management accounts and in credit. investment in the future of Britain. We could have We frankly had understaffed to serve the response we done a new bank in Chicago or LA or other parts of got to SMEs and we all heard the same story from the world, but we’re very excited about the various sources, “The big banks don’t want my opportunity here. The reason we chose to do this business. The big banks can’t serve my business.” I venture in London, there are many reasons but to your would say in America, as in Britain, it’s almost a rule point exactly, our model is built on convenience and that the larger the bank the more poorly they serve the service, not product sales and price. The customer SME segment. In America, where there are still 8,000 dissatisfaction rates in Britain for banks are at the banks, most small business credit is supplied by the levels that I had never seen in America. The midsize and small banks. It’s difficult for large banks customers say in many ways in many surveys that to be effective in the SME world. they’re very dissatisfied with the British banking tho y homso : It is interesting to observe that of system. the SMEs that have approached us, by far the majority are approaching us because they want service, and Q435 Chair: The picture is mixed, is it not, Mr Hill? they want a human being to talk to. Very few are V r o ill: No, not that I can see. actually seeking credit.
Q436 Chair: I have one of the surveys in front of me Q438 Chair: So the shortage of credit is— here that’s showing 50% to 60% of satisfaction for V r o ill: That’s a much wider issue in Britain the conventional accounts and 80% satisfaction with about shortage of credit. I’m sure your Committee has internet accounts. It would be helpful for you to give been briefed on the general shortage of credit; a your view. problem I predict gets worse in Britain. Your question V r o ill: Yes, Sir. One survey that’s available— was more about how credit is delivered to the SME and I’m getting it out as we talk—is on customer segment, and we would repeat that it’s not just the dissatisfaction rates and I believe the latest one was credit side, it’s the cash management, and it’s the put out by MoneySavingExpert in 2010. This survey regular current account side of the business, which in says, “In Britain 2% of the customers are dissatisfied many cases is more important to an SME than the or very dissatisfied with their banks.” Then we look credit side. It’s difficult to open an SME basic account at the reports about the dissatisfaction rates with each with a large banker. bank, and by my American experience they are very, Chair: Okay, well, we will be exploring some of these very high. Santander has a dissatisfaction rate in this issues over the next hour. Treasury Committee: Evidence Ev 63
14 December 2010 Vernon W Hill II and Anthony Thomson
Q439 Jesse Norman: Mr Hill, the British banking I would note one other difference here in Britain and market, as you know, is extremely concentrated listening to your hearings. The American model overall in these segments, and yet when we have had developed—and ours would be the extreme version— its executives up they insisted it is highly competitive as a consumer centric model. We focus on information in many different regards. Particularly Mr Hester of and service to a customer. Here, it’s developed as a RBS suggested that you do not get any greater product-driven model, “What products are we going competition with 10 banks than you would with five. to sell to our customers?” The simple idea is that the Could you tell us a little bit as to why you think there bank would have what we call single client view: you is a great opportunity here for you, and whether that can pull up one computer screen and look across the claim is true, or whether in fact the British banking whole screen and see all the interrelationships you market is rather uncompetitive? have. That’s vanilla in America and most of the large V r o ill: I did see that hearing and I did see his banks here don’t have it. I would say that this is a comments. Let me repeat, I come from the American different view of life. model where there are still 8,000 banks in America. tho y homso : If I may just add to your point When I started my first bank, there were 2 ,000 about competition, Mr Norman. Vernon said we think banks, so you could almost look at the Anglo-Saxon of ourselves as a retailer. The UK retail market is banking model as developing in two extremes: Britain highly competitive, so retailers are open from early in has developed very few, very large banks and America the morning until late at night, they are open seven still has a large number of relatively small banks. days a week, which is our view, if you like—we’re Somebody asked me, “Well there’s going to be some open from eight until eight Monday to Friday, eight new names in British banking, and isn’t that going to until six Saturday, 11 until four Sunday. The existing make it tougher for us?” I went back and checked in banks are open from nine until five. I think if there was a competitive market we would see changes in the New York market, where there are 173 different that. banks. Frankly my opinion of the idea that this is a very competitive banking market, from my experience I do not find that to be true. I think it’s about giving Q441 Jesse Norman: Do you think that this preoccupation with product causes banks to ignore the customers choice, freedom of choice, and my view is customer, disinvest in branches and adopt inhuman that all the major banks are essentially offering the approaches? Is that the kind of thrust of what you same products in the same way. are suggesting? V r o ill: Yes, yes and yes. Q440 Jesse Norman: Thank you. It would be good at some point in the questioning to explore what Q442 Jesse Norman: Could you just explain how aspects of the banking system inhibit freedom of that works? Why should that be so? choice at the moment, and how that could be opened V r o ill: If your model is product-driven and not up and that has been a topic we have discussed as a service-driven, you design your whole model around Committee elsewhere. But what I would like to focus that—you design your IT around product sales, you on now, if I may, is the basis of your own competitive design the compensation around product sales, you offering, which of course seems to be built on service don’t design it around service. In our model, for rather than on pure price competition. Could you talk example, we don’t compensate our people for product about how that is going to work, why it is going to sales. We reward them for delivering our model and be effective, and where the weaknesses in the current the service results they deliver—how big we build the system are? entire model. In America, for instance, in our bank, V r o ill: Yes, I’d be happy to do that. Let me go we didn’t do outbound sales calling. I don’t believe in back to my American experience. When I was outbound sales calling. relatively young I started a bank from scratch in Is your focus about building your model on what America with one office and a staff of nine, and it product you’re selling this week, or customer service? grew to 500 stores and became the 18th largest bank Our model in Britain, as it was in America, is this in America on a very simple model. Customers in the idea of building customers as fans. Great companies retailing business—and we see ourselves as a retailer build fans who stay with the company and recommend that happens to sell bank products—care about the them to a friend. Again, Apple is a great example. whole experience, and we would define that as service Those of you who have an Apple product here are and convenience. convincing everybody you know to switch to Apple. Customers care about pricing, they somewhat care That is the core of our model. about rates but that’s not the most important thing. I Jesse Norman: A final very quick question, Mr use this example all the time: people don’t buy Apple Chairman— phones because they’re the cheapest phone; they use V r o ill: Could I just answer one other thing other determinants to decide they like an Apple phone, here? and Apple has reinvented the phone business, we Jesse Norman: Yes, of course. could say. There has been a lot written about my V r o ill: One of the things that was surprising, experience in America. They often call us the anti- when I came here, is that the real core of a customer bank bank. We do things in a reverse way. We care relationship is the current account, and you would about service. We care about convenience. We care measure that in deposit balances per store. In about hours. We care about call centres with human America, we have to report our deposits per branch beings. It’s almost the anti-banking view of life. on a public website—so I know all the deposits per Ev 64 Treasury Committee: Evidence
14 December 2010 Vernon W Hill II and Anthony Thomson branch at every Chase office in America—because transmission centre. In both countries, it’s always been that tells you the strength of that store and the controlled by the major banks. relationship. The British banks don’t even know the deposits per branch and have very limited information Q447 Michael allon: Will you have any ownership about how it all relates together. When we recruit of it at all? Do you have a stake in it? people—and as you can imagine, we’re recruiting V r o ill: No, we do not. only British people—all we hear is product sales, Michael allon: You have no stake at all in it. product sales, product sales. V r o ill: No, we clear through one of the major four. Q443 Jesse Norman: So it would be a pro- competitive move for us to explore the question of Q448 Michael allon: Do you think there will be whether or not deposits should be made public for any benefits to consumers from reforming the money branches across the UK? transmission system? V r o ill: First of all the banks don’t know their V r o ill: I just don’t know enough on that deposits per branch, so they can’t make it public until question to be helpful to you. they know it. My point is, not only is it not public, tho y homso : I think the challenge is making but they don’t know it because that’s not an important the account-switching process smoother. That’s what number. It would be like a retailer not knowing sales needs to be addressed. per store—we’d never run a retail business that way. Michel allon: Thank you. If you could make it available, as we do in the States, V r o ill: On this account, of course that’s what that would be certainly a pro-competitive move, but we want. We want to make it easier to switch I’m not sure it can really happen here. accounts. What makes it structurally harder in Britain than in America is the direct debit system you have Q444 Jesse Norman: Thank you. Finally a very or standing orders. That doesn’t exist in America so quick question, in your model, will you still have to it’s easier to move accounts. When people move to do things like credit scoring for customers or for us—and they’re moving every day to us—we have to clients? line up their direct debits and their direct credits to V r o ill: You do credit scoring as a positive, not make it happen. It takes more effort and it takes more a negative, and I will give you an example. When time. We do it by doing it for the customer but your you open an account with Metro Bank—and tens of system of direct debits does inhibit accounts moving. thousands of people have already—we open your account in 15 minutes or less and you walk out with Q449 Michael allon: But if the whole money your debit card and your credit card. It doesn’t come transmission system was policed by an independent in the mail. Your pin number is not mailed to you. It regulator, rather than being indirectly owned by the all happens in real time. We are doing the credit major banks, would that not at least be a start to checks and the anti-money laundering checks in real making all this easier? time. V r o ill: I might agree with you in theory. but In that sense, credit scoring is a plus, because it allows I’m not sure of the mechanics. I’ve read some of the you to give instant reaction. It’s what you do with the hearings here about the fact that all your account credit scores that don’t meet the first hurdle. Do you information would be in one central place and you can automatically say, “No” or do you give it to a human move your account from bank to bank with the same being to decide what the next step is? So credit account number. I think that’s a good idea, but I think scoring itself I believe is a plus, it’s how you use it. it’s very unlikely to happen. We all have different IT Jesse Norman: Thank you very much. systems, they’re all based differently, so that would be a major job. Q445 Michael allon: Mr Hill, Donald Cruickshank told us in evidence last week, “Making it easier for Q450 Michael allon: But on the principles—we do new entrants into retail banking may be missing the not allow telephone companies to own a telephone fundamental point.” He suggested to us that really it transmission system, or electricity distribution is the control that existing banks exercise over the companies to own the grid—should major banks money transmission system that needs to be tackled. really exercise any degree of ownership over the Do you agree with that? transmission system? V r o ill: I read his report and there is some truth V r o ill: Let me answer it a different way. If you to it. I wouldn’t say that has been a particular problem want freedom of choice in a retail banking market you for us. The money transmission system is controlled have to get new players into the market and whatever by the major banks. It’s not controlled by the banks the Government can do to make it easier and more in America except in an indirect way. I don’t think convenient for customers to switch banks will help the that that’s a major issue. Our people haven’t pointed new players. that out to us as a major restraint. Michael allon: Thank you.
Q446 Michael allon: Will you share in that Q451 Andrea Leadsom: Thank you Chairman. Can I influence over the money transmission system now just press a little bit further on that, Mr Hill? Customer that you are licensed? inertia is a big problem in the UK. You have said V r o ill: I’m sure we won’t, just like the small yourself our system of direct credits and direct debits banks in America don’t share in the money makes it rather more difficult to switch accounts than Treasury Committee: Evidence Ev 65
14 December 2010 Vernon W Hill II and Anthony Thomson in the States. What do you put customer inertia down accounts may have eight numbers; Harrods may have to, because certainly a lot of the evidence we have nine numbers; another bank may have seven numbers. heard does suggest that it is the complexity of We all have completely disparate IT systems and switching accounts, and that therefore the answer switching things over is not easy. might be to be able to transfer your account number with you, in spite of the immediate technological Q455 Andrea Leadsom: Is it harder than changing difficulties? to the euro in 1 , or preparing for the year 2000? V r o ill: Of course all the things we’re talking V r o ill: I wasn’t here; I’ll have to leave that to about are half-truths, so we put a couple of halves you. Probably not. together and maybe we’ll get a truth. It is a little harder to switch, but the basic core of the reason for Q456 Andrea Leadsom: Is it of that order of people not switching in Britain, in my opinion, is that complexity? Is it a three or four year IT project, would they’ve had no choice. The major four banks offer the you say, or do you not know the answer to that? same product. You need entrants in the market, such V r o ill: I don’t know the answer to the euro as us, offering a different choice. This is about question but I will repeat this—I’m sure you’ve heard freedom of choice. it. The FSA said to the major banks that they had to My bank in America, before we sold it, was opening be able to give the FSA, on request, a list of their 150,000 accounts a month. They were all coming, account holders and their account balances. That is switching from Chase and Citibank and all the names the definition of what a bank is; I’ve just defined a that you know, but even then it was hard to get people bank for you. The banks said it would take five years to switch banks—it’s work. No matter what we do and at £800 million, so that’s a simple example. no matter how easy we make it, no matter what people we give them there is a little bit of work involved, Q457 Chair: The suggestion that there are wonderful but the situation, in my view, in Britain is completely synergies obtainable from scale are likely to be different; you have no choice. outweighed by the fact that many of these banks don’t really know what is going on inside them and what Q452 Andrea Leadsom: How long would it take if I their customers are really doing anyway. moved my account today to Metro Bank? What sort V r o ill: There’s no proof that scale gets you of length of time would it take? economies of scale. V r o ill: We open your account in 15 minutes or less—you walk out with a debit credit account. To Q458 Chair: You flatly dispute what RBS said when move over all of your direct credits and your direct they told us, “Large or more diversified companies debits and standing orders, it takes four to six weeks have the ability to achieve greater synergies and can to line that all up. The customers are scared to death create economies of scale, enabling banks to provide that something is going to go wrong. The story we service at lower cost to the consumer.” hear all the time is, “Oh, my God, the Sky TV V r o ill: Let us look at that statement: they fail, payment is not going to get moved over, my Sky is they don’t provide service and their cost is higher. going off.” There’s no proof in America that these large banks On the particular issue of Sky, we guarantee we’ll pay can deliver better service at lower cost—in fact the the Sky bill if you miss a month. Those are the issues reverse is true. you have to deal with. In America, it’s somewhat different in that we don’t have direct debits but online Q459 Chair: Just to be clear on cost, can you bill paying serves that purpose, so in America we have describe the typical customer that you are looking for to help them move their online bill paying. I don’t and the income of a typical customer, and then tell think we’re ever going to come up with a reason or us how much it is going to cost you to service that way for people to switch banks without some work straightforward account per annum? involved. V r o ill: No one knows what it costs to service an account per annum, and any number you get from Q453 Andrea Leadsom: Would you agree that the any bank is based on assumptions that have little way to do that is to be able to transfer your bank meaning. account number with you? In other words, the money transmission system could be changed—clearly the Q460 Chair: You mean this whole industry goes technology exists because it has happened in other forward without ever knowing what its true cost base sectors—so you could be able simply to have an is? That must be unique. account number and if you choose to transfer V r o ill: Let me just talk about British banking, everything, lock, stock and barrel, with all the direct if I can, for a minute, and again, I have an American debits in place and so on, to another bank. perspective. The IT systems of British banks are V r o ill: As a new player in the market we would incredibly bad, and when they tell you about love that to happen—make it happen tomorrow efficiencies and cost numbers there’s just no proof of morning for us—but I think that that’s very difficult. that whatsoever. If you were going to ask me, “What’s the biggest barrier to being a new bank in Britain?” I Q454 Andrea Leadsom: Why is it difficult to make would say it’s the IT side of the business. it happen? In America, there are outsource providers that are V r o ill: It’s the IT systems. Just to give you a ready to put you in business almost immediately, here simple example, Lloyds account field for current you almost have to build it from scratch. I just don’t Ev 66 Treasury Committee: Evidence
14 December 2010 Vernon W Hill II and Anthony Thomson think there’s any support on either side for the one banker, whether they’re based in a store or based comments that RBS made. You asked me about the in a centre in London, who handles their entire customers we’re seeking: first of all, our business over relationship, and they’ll bring experts in to talk about time should be half-consumer and half-SME. That’s foreign exchange and so on. That is a completely what it was in America and we certainly hope it is different model from the one you see in large banks— here. whether large banks in America and Britain—and it’s We do not believe there is such a thing as a high-profit why the American small banks end up serving the customer or a low-profit customer. First of all, we majority SME segment, because the customer wants a can’t tell what’s a high profit customer and what’s a banker and not a phone number. low profit customer, and RBS can’t either. We believe tho y homso : I can add an anecdote that might every customer has real value. They may have low amplify that point. We had a small business come in value when they are students and they may have to open an account—two individuals—IT consultants higher value over time but we’re out to serve as wide who had come together and formed a limited a market as we can get, from wealthy people to company. Over three months, they had amassed a students. I just don’t believe that there is a number of cheques. They had been unable to open a segmentation strategy that has ever been proven to bank account with one of the large banks over a three- work. month period. One bank at least was able to acknowledge that they had an application in, the other Q461 John Mann: There is a segmentation strategy, bank couldn’t find their application. based on where your branches are. What percentage They were able to open an account with us on a of your branches is going to be in and around London? Sunday and bank the cheques. They had not been able V r o ill: You have to start some place and, as a to draw any money because they had all these cheques retailer, we know the more stores we put in the same they were unable to bank. However, we were able, on market, the better those stores all do. You wouldn’t do a Sunday, to open their account and give them their a model in New York, with 10 stores in New York, 10 credit. I think the challenges facing SMEs, as you say, in Chicago and 10 in Los Angeles. You would are quite complex. There are some very fundamental concentrate in certain markets, build them out, then issues to resolve first, such as just giving them service, begin the next one. We had to start some place in giving them a human being to talk to who can address Britain and London is the obvious place. their issues. V r o ill: We approach these issues from a Q462 John Mann: Where will you end with your fundamentally different view of life. We are not going business model? to tweak the products; we are not going to be a little V r o ill: I don’t know where we’re going to end. bit better on this. We are fundamentally changing. We’ve announced that we’re going to put 200 to 250 When I started this process several years ago with my locations in the Greater London area, and there’s no partner Anthony, I was shocked by the concept here, reason we’re not going to go north and south. But and it is more true in the SME segment, that the banks again, the more stores you put in the same market the here have the concept of a customer applies to open better each store does. an account. The American concept is you have money you want to deposit, you are not a crook, give us your Q463 John Mann: In terms of the small business money, we will get the account open. It is a market, one of the complications here is the issue of fundamentally different view of life. currency transactions and expanding into foreign markets for small businesses, because the more you Q464 John Mann: If you are in the SME sector here, expand the more you hit currency issues. The banks in a micro-business, it is worse than that because of have been notoriously bad at doing anything other course a majority of the banks will refuse to give you than profit hugely from giving advice on that. How an account. Are you going to turn down people who will you be different? We’re talking about the micro- apply? businesses, one to 10 people who are beginning to try V r o ill: Only if these people don’t pay us the and expand outwards into overseas markets. What is anti-money laundering cheques that the FSA makes us the difference that you would make in dealing with do, or if they have particularly bad credit. This idea those complexities? of turning down a business because it is new is foreign V r o ill: I have to admit that I am certainly not to my way of thinking. the expert on currency exchange in Britain. That’s something we’re going to have to deal with in Q465 John Mann: One final question. Your view is America, and we’d be happy to provide you with the interesting, because it is an issue that seems to information from our management team. Let me preoccupy parliamentarians here at the moment, so answer the question in a completely different way. For well beyond this Committee. As a new bank what the SME segment—and in fact the middle market future do you see for the cheque? Do you see it having segment—their first concern is not about the price. a future? What they care about is—and we have a phrase— V r o ill: Again, I come from the American view “local lenders making local loans”. They want an old- of life where cheques are still very strong. Our fashioned banker who handles their £1 million credit, philosophy is we want to deliver banking and banking their house mortgage and their kid’s car loan. services in any channel that the consumer or the SME Our model in America and our model here is going to wants. If they want cheques, I’m thrilled to give them be an SME segment. As you go up it’s going to get cheques. If they want credit cards, we are thrilled to Treasury Committee: Evidence Ev 67
14 December 2010 Vernon W Hill II and Anthony Thomson give them credit cards. My outside view of life—this experience, we were growing 25% a year for ever. So is just an opinion—is that this drive to kill the cheque the typical big bank model is relatively high cost of appears to be maybe a self-serving effort by the main funds, relatively low cost to deliver, no growth. Our banks. We print your cheques in the branch when you model was lower cost of funds, higher cost of open your account. delivery, high growth.
Q466 John hurso: Mr Thomson, a little earlier on Q468 John hurso: Okay, let’s go to the one that I you said that what people want is a human being to think is one of the most difficult issues—the current talk to, and listening to you, Mr Hill, it is quite clear account. The UK model is basically free current that your model relies on intelligent human contact as account banking. Interestingly I think you have the heart of service delivery. You also went on to say chosen to go down that same route. Why did you that in this country, all the banks are producing the make that decision to follow the big banks, with free same product the same way—they are product driven. in-credit banking? That is to say that they are trying to get rid of the V r o ill: You are correct; the current account is human beings. What I am interested in goes back to the core relationship with the customer. It wasn’t so the Chairman’s question on cost, because it seems to much that I followed the major banks here—that is me that the typical British institution, which does not the model we use in America too. Our bank was free value human service, sees the human being as a cost cheque-ing, free current accounts, almost from the and is seeking to drive that cost out, whereas anybody beginning. I have always believed that is the correct from a background in service sees the human being as model, so that has just been our experience. the deliverer of profit. Is that an encapsulation of the model that you are seeking? Q469 John hurso: So where is the cost of V r o ill: Absolutely 100%. Let me just go one delivering that recovered? Typically if we talk to, as step further. When we started this process and I talked we did, RBS, the lady told us it is the cost of a cup to the press, I got the same question all the time. How of coffee, or whatever it was, to run it a week, and can you deliver service and still make money? I finally they get it from cross-selling the products. Where do said to some reporter, “The banks have you convinced you seek to make your return? that the only way they can make money is to deliver V r o ill: We expect to make our return, as we did bad service”. Our model in America was the most in America, in two ways. The net interest margin— rapidly growing model in the country in the banking the cost of the yield on our investment less our cost business, and one of the highest performing stocks in of money gives you the net interest margin—I would America. There is no truth in the assertion that you argue has historically been too low in Britain, which have to endlessly cut costs to deliver returns and gives you some of these problems. Then you make service. You said it—it is the disinvest issue. If you some up on fees. So it’s those two things. believe you are in a no growth model, the major We are not a product seller generally, but if somebody American banks to major British, you are going to try wants a product we’ll sell it to them. The fees are to cost-cut your way to prosperity. If you believe that current account fees and commercial loan fees and you have a differentiated growth model you can invest those kinds of things. That is the basic business. This and over-invest in your model, and that is how we is business is not as hard as they represented to you. build our model in America and that is what we expect This is the business of taking deposits and making to do here. loans. tho y homso : I think your American experience Q467 John hurso: This strikes a lot of chords with suggested that if people come to you for service they me because I am from a hospitality industry are prepared, as Vernon said, to accept a slightly lower background. What we sought to do was not rate on their money. More importantly, they stay necessarily cut costs but to understand it and control longer. We have the funds for a longer period of time. it because you have to be aware of your costs—you What was the average in America? cannot let it get out of control. You are clear that you V r o ill: We knew that the average life of a are putting people in, people will deliver your profit; current account in America was five to six years, yet where are your costs? How do you control them, how our current account life was 13 years. That is a do you measure them? tremendous difference and has major ramifications as V r o ill: There are two costs in the banking you build your model. business that matter. Remember—and I should have started this earlier—we are in the old-fashioned Q470 John hurso: I almost hesitate to ask this simple core banking business. We accept deposits and question, because it’s the opposite of everything we make loans. That is our core business. Everything you’re saying. Of the big banks that we have seen, it else is noise. In the core banking business you have is very clear that the current account is like a hook two costs—you have your cost of money, what you with a worm on it, in the hope that they’ll trap the fish are paying on deposits, and your cost to run. Our with some financial products that they’ve got dangling experience in America is that customers will accept a around the place. Basically, it’s “Let’s get hold of somewhat lower return on their deposits within a band them. It is something we have to do.” What you have for this whole service experience. So we had a lower been saying is the core of banking is the core of the cost to money and accommodation, offset by a higher service you give and you’re not product driven. So cost to run; operating costs and hotel costs. In that how are you not missing out on those lucrative sales model, because we were delivering this different they are talking about? Ev 68 Treasury Committee: Evidence
14 December 2010 Vernon W Hill II and Anthony Thomson
V r o ill: We believe you can make more than a Q473 Mr Mudie: Have you given evidence or are fair return on the core business of accepting deposits you intending to give evidence to the Vickers and making loans. We believe people will buy other Commission? products from you if you have fair products—not if V r o ill: The Independent Commission on you are aggressively out to sell them, but because they Banking? Anthony was there last night. have faith in your brand. I go back to Apple again, if tho y homso : I was there last night, yes. I’m Apple comes out with a new product, because it’s very happy to contribute if asked. We’ve certainly Apple you just go out and buy it. So in America we been attending their meetings and observing and had a cross-sell rate just as high as Wells Fargo which contributing where we can. is the king of cross-selling in America, aggressively cross-selling, because our customers would come to Q474 Mr Mudie: When you were in the States, at us when they had a need, and we had people there to one stage you were described as a regional bank; did take care of the need. But it was not, and will not be, you break out of being a regional bank at the end? through a product driven market. V r o ill: We had 500 locations on the east coast tho y homso : On Mr Thurso’s point specifically of America. Other than the top three or four banks, on current account opening, a report by the OFT said almost all the banks are regional or community banks that only 7% of people move their current account in America. because of rate, for 3% it’s around service and convenience. So the banks, I think, seem to have Q475 Mr Mudie: Are you bringing that regionalism persuaded everyone that this is a rate driven to Britain? I see in the today you are expanding, environment. The reality is it is not rate driven. People but instead of going north, where the real wealth is want value, they want fairness, they want transparency and the real people are, you seem to be going east. and value is an amalgam of many, many different V r o ill: I get asked that question all the time. things, not just rate. Retailers know the more stores you build in a market John hurso: What the French call “rapport qualit - the better each store does. So it makes sense for us to prix”, I think; the relationship between quality and concentrate in London and build a group of stores here price. before we go to Manchester or Birmingham or even V r o ill: Correct. further north. So it’s not a question of ignoring those markets—the more you group the stores over time the Q471 John hurso: At the heart of it, if I have this better they do. right, you are saying get the basic model of cost of capital right; create trust in the relationship between Q476 Mr Mudie: You’re intending to come the your people and the customer; and the rest looks better parts of the UK? after itself? V r o ill: No place in Britain is safe from us trying V r o ill: That’s almost it. to change banking.
Q472 Mr Mudie: From an American perspective, as Q477 Mr Mudie: I see in the paper you have a someone coming in, have you a view on whether the Yorkshire Terrier called Duffy. existing banks, for competition reasons, should be V r o ill: I have a Yorkshire Terrier—I should broken up? In the same question, have you a view on have brought him here today. whether the HBOS Lloyds merger was good or bad Mr Mudie: I think you should commend the idea of for their customers? taking him back to his homeland, and having a look. V r o ill: I’m not really qualified to comment on V r o ill: And I will come and see you. the Lloyds HBOS merger, it is just out of my sight tho y homso : I should declare that I’m from and my realm. Generally, I believe that the larger a Newcastle. retail bank is, once they get past a certain point the poorer they serve the consumer. The numbers in Q478 Chair: Just on this question of switching, when Britain say that, the numbers in America say that. people find themselves switched as a consequence of Breaking up banks involves lots of different things. divestment, on the evidence that you have, are they Does breaking up banks mean you are selling part of happy or unhappy? a bank and the sign is painted blue instead of green V r o ill: They’re very unhappy, and we’re and nothing else changes, so what have you really hearing about Santander and RBS right now. gotten? I think we would say you should look at Chair: That is why I asked the question. differentiated models. If Santander gets part of the V r o ill: We are hearing about it on the SME RBS Group, what have we really gotten but new segment first. That is where you’re going to hear it signs? first. Let me go back to the American experience, My outside opinion is—I am an outsider looking in— where we have lots of bank sales and mergers, every you’re focusing a little too much on the parts rather time there was bank merger in our market it helped than freedom of choice. You could look at this in other our growth because customers say to themselves, “Let businesses—the hotel business is a good example. see, my account’s going to be moved, let me make the Everybody serves the hotel segment in a different choice. Do I want to go to where I’m being moved to way, at different price points, and customers have a or do I want to make my choice?” Customers are not real choice whether they want a low-price room or a happy with having their account moved, and we like high-price room. Here you really have very little it. It gives them another opportunity to think, “Is this choice. the time to switch banks?” Treasury Committee: Evidence Ev 69
14 December 2010 Vernon W Hill II and Anthony Thomson
Q479 Chair: So maybe your answer to the Vickers America and in Britain is running from the store up. Commission all round is, “Leave things just as they The action happens first at the store. are, we will pick up the crumbs”? V r o ill: There is some truth to that. Q483 Mark Garnier: Sure. Can I talk a little bit Chair: Yes, that is what I was beginning to worry about your funding capital as well? about. I think you have £75 million in capital. V r o ill: We have just raised another £50 million. Q480 Mark Garnier: I just want to follow up on Mark Garnier: So you have £125 million. something which John Mann talked about a bit earlier. V r o ill: Correct. You’ve made a great deal about this idea of local Mark Garnier: And you are anticipating an IPO in bankers making local loans, which I think is very 2013 raising £250 million? much the US model. For us in the UK, we are not V r o ill: Correct. Something like that. necessarily that familiar with the concept of how this works. Can you talk a bit through the nuts and bolts Q484 Mark Garnier: But between now and then of how you devolve that lending process to an you’re going to be expanding, notwithstanding that, individual manager? an extra £50 million out of organic growth. However, V r o ill: Well, you have them at different levels because you are not going and buying in loans—you depending on the size of the loan. You train your store know, other banks making acquisitions—it is all going managers to make the smallest of the loans, then you to take quite a lot of time. Do you see that as a have a group of people based in a region, let’s say the problem? west of London, who would handle the next size up, V r o ill: My experience in America started with and then you’d have a group that would do the very one store and grew slowly, and then we got the large loans. I had a 30 billion loan portfolio in machine rolling and it grew to 500 stores buying America, and 5% of the loans were made at the local almost zero. My opinion is that great retailers never level—one of those three levels. grow by acquisition. They refine their model and learn to roll it out over time. If you see yourself as a retailer Q481 Mark Garnier: The traditional model 20 or 30 delivering an unusual service, acquisitions are the years ago was one in which the local bank manager easiest way to kill your model. So, yes, it is slower, would go and have a drink with the local accountant although we are growing at a fairly rapid rate here in after work, and they’d chat to the local lawyer and new stores. It is slower, but you get what you want at this kind of thing, and they all had good intelligence the end. You get a group of locations and a group of about the local situation. people running your model, not somebody else’s V r o ill: Correct. model. Mark Garnier: Is that what you are focusing on? V r o ill: Yes, it starts like that. You can’t train a Q485 Mark Garnier: And you are certainly not store manager to make £10 million loans, but you can buying anybody else’s problems by accident. train them to start the process, handle the smaller V r o ill: You’re buying nobody else’s problems. relationships, then move it to a local team, maybe even based in his branch, to deal with it. What you Q486 Mark Garnier: How has it gone? I think it said about intelligence with the local accountant, the was 2 July that you opened. local lawyer, that’s the essence of our model. It’s the V r o ill: Great, unbelievably well. community bank model in America. The community bank model means not only what you said but it Q487 Mark Garnier: Are you ahead of time? means the high street branch manager is back, it V r o ill: Holborn was our first office and I’ll give means we’re engaged in the local community, its you an example. We made it public that our plan was means we’re supporting a local event. I was at Earls to open 2,000 deposit accounts in the first year. That Court last night where we had an event with 70 or 80 branch opened over 3,000 in the first month. I have people. We talked about local people and local been very pleasantly surprised by the level of businessmen and their needs. That’s very much the acceptance at all of our locations in Britain. community bank model and, and as you point out, that is the American model. Q488 Mark Garnier: Is that growth continuing? V r o ill: Oh yes. Q482 Mark Garnier: I have certainly seen some of the bigger banks such as Lloyds Bank holding charter Q489 Mark Garnier: So it is going at the same sort events, I think, with customers a year ago, which of rate. So you are well ahead of target? seemed to be simply in response to the Government V r o ill: Well ahead of target. putting pressure on them to go out and engage. But you are seeing this very much as the core of your Q490 Mark Garnier: Are people coming to you business model. because they are excited by this concept or are they V r o ill: That’s our model. Let me just make one coming because they are so fed up with the other other comment that might be helpful to you. Great banks? retailers run their business from the store up— V r o ill: Yes and yes. They’re coming for choice. hoteliers run it from the store up—but big banks run I sit down and talk to them when they’re opening their model from the top down. That’s a accounts, and I ask them why they’re switching. The fundamentally different view of life. Our model in press, when we first opened, made a big deal, because Ev 70 Treasury Committee: Evidence
14 December 2010 Vernon W Hill II and Anthony Thomson we’re not the highest rate payer on the high street— Q494 Mark Garnier: No, no, sure. I was just very we’re not and we’re happy to say that. They would interested, because I was asking Hector Sants about say that on TV and then they’d go to the people sitting this last week and I said it’s taking 18 months and he at desks opening new accounts, and they would say, said, “No, that’s not correct, it takes seven months”. “You know Metro’s not the highest rate” and they So he was lying, was he? would say on TV, “We don’t care. We want a bank tho y homso : In our case, it took us 18 months. that understands us, that we can call up on the phone and get something done”. So it’s a combination of Q495 Mark Garnier: In your case it took 18 months, total dissatisfaction and this model. right, that is fantastic. The OFT has also referred to tho y homso : Nine out of 10 of our customers a—I suspect you are going to say the answer to this who open accounts would recommend us to a friend, is no—catch-22 situation whereby anybody who and eight out of 10 people who open accounts wants to set up a new bank has to raise the capital to currently are recommendations. go into it and then has to get a banking licence V r o ill: Let me get this point in. As you gather, afterwards. So therefore you are stepping into the I’ve been doing this for a long time, and over the abyss without necessarily knowing you have got a years there have been lots of marketing studies and landing point. the one that I’ve come to learn from the most is this V r o ill: If I may answer. That was a flaw in the idea of net promoter score. What percentage of your approval procedure and they chatted with us and I current clients will recommend you to a friend? This believe they have changed it. They made us raise all is the essence of what a service business is about. the money, build the whole IT system, tested the IT Would our current customers recommend us to a system, and then gave us the final licence. They know friend? In America, Commerce, which is a very large that’s a procedure that cannot work. I believe they bank, 67% of its customers would recommend us to a have gone to the procedures with some steps along friend. The typical big bank in America is in the teens. the way. They give the applicant a “minded to” letter Already at Metro Bank our net promoter score, on a subject to conditions and then you can begin to raise very small base, is 8 %. money and do all the things you have to do. Let’s talk about the net promoter scores in Britain. In our case, I had to invest a very substantial amount None of you will be surprised that the bank most of money in leases and IT, with people not knowing loved in Britain is First Direct, where 57% of that we were sure of getting the licence. That is an customers recommend it to a friend. Lloyd’s number absolutely anti-competitive way to do it and I believe they have changed that already. is minus 1 %. I had never seen a minus number until I came here. Barclays is minus 35%. These are incredibly bad numbers. I’ll be happy to leave those Q496 Mark Garnier: So the good news out of all of with you. this is that they are learning by their mistakes. V r o ill: That’s what I hear. Mark Garnier: It would be very helpful if you heard Q491 Mark Garnier: We had Lloyd’s in last week otherwise if perhaps you could let us know. and, well, I’ll move on. This is question is probably more for you, Mr Thomson, as it is about the regulatory process—I am slightly changing the Q497 Andrea Leadsom: Just to be completely clear about this, do you think that the FSA, the regulatory subject. How have you found it with the FSA getting environment, creates any barriers to entry? a banking licence? V r o ill: Of course, there is a barrier to entry in tho y homso : I think the FSA was extremely this business. This is a very hard business: you need good to deal with. It was really an application of three capital, you need technology, you need trained people, parts. There was the pre-Lehman Brothers period— you need compliance, you need experience. This is the period about three months post-Lehman Brother,s not an easy business to enter. We had a unique set of where I think they had bigger issues to look at, and facts, with people and capital and experience. You’re then post that, I think we are the first new bank for never going to have lots of new people, no matter how almost 150 years. So there were some changes they easy they make it. Even in America, in the best years, needed to make internally. we only got 100 to 200 new banks a year. So is the FSA a barrier? Absolutely. Should they be a barrier? Q492 Mark Garnier: So they did not know how to Absolutely. Should they approve applications that process a new banking application until you came make sense? Absolutely. But they have to do it in a along? way that encourages applications that have merit to tho y homso : No, they had a series of move forward. processes, some of which I think needed to change slightly. We found them very positive and very Q498 Andrea Leadsom: And you feel that they do? responsive. V r o ill: Well, that’s what I hear. We haven’t engaged in that, but that’s what they tell us. The Q493 Mark Garnier: That is very encouraging. How American model is you apply, it takes four or five long did the process take? months, they review your plan, they look at your V r o ill: It took about 18 months. people, they give you a “minded to” letter and then Mark Garnier: It was 18 months. you get serious. V r o ill: That’s not different from the American tho y homso : I think immediately post- experience. authorisation, the FSA did come and ask us to feed Treasury Committee: Evidence Ev 71
14 December 2010 Vernon W Hill II and Anthony Thomson back to them our experience of the process, and from Q501 Jesse Norman: That is helpful. So that is a our perspective what would have made it easier. So very interesting analysis. Can we just talk very briefly they’ve certainly talked to us about that. about why it should have happened—why the banks V r o ill: They were fair and open with us during have converged on this model? One of one’s worries this whole process and, as Anthony mentioned, this is might be that you could have a nominally competitive during the Lehman crash where the world was going system in which essentially all the players are to end, so I have nothing but good things to say about signalling to each other that they will be happy to the FSA. settle on a certain set of rates. V r o ill: It does seem that way, doesn’t it? If I Q499 Jesse Norman: Mr Hill, returning to one thing may answer that question. Our view is completely my colleague Mr Mudie said, we have seen the impact different from that of the major banks in America and of putting two Scotsmen in charge of the Scots Britain. The major banks have turned this into a banking system, and if you would ever like to come commodity business where pricing is the only to Hereford where I come from we will show you a element. Our view of life is it can be a service non- very warm welcome. commodity business as I described, and people deal V r o ill: Thank you very much with you for non-commodity pricing reasons. Jesse Norman: Can we focus back on the issue? You said something extremely interesting en passant, Q502 Chair: Could you do a bit better than, “does which was that one of the reasons why the British seem that way”? That is bureaucratic speak, is it not, system had become so product driven and product for “There is an oligopoly out there”? dependent, was because of structurally thin net V r o ill: That’s so unlike me to use that kind of interest income. Can you talk about why that should speak too. be the case? Chair: That is what was worrying me earlier. V r o ill: The net interest margin is the difference V r o ill: We have a very concentrated market between what you earn on your assets and what you with a small number of banks essentially offering the same products and the same services, and the pay on your fund, and it’s the key number that drives customer has very little choice here. You can judge the banking business. In America, I would say that the what I just said but those are the facts. net interest margin is about 100 points higher than here. Q503 Jesse Norman: Just a quick follow up Jesse Norman: Basis points? question. Are you aware of any serious service-based V r o ill: Yes, basis points—1%. This is an innovation in British retail banking over the past 20 observation I’ve made, not a scientific analysis, so years? don’t ask me too many hard questions about this. It V r o ill: Of course, they always relate to First looks to me that here, as in some parts of America, Direct as a service innovator, and some of us may the banks inflated the cost of deposits and deflated the remember that was a Midland Bank innovation. First interest rates on loans. What happened in America is Direct is a good example of how they started as a rate- they gathered deposits and then the corporate loan based model and moved to a service-based model and guys made all these large corporate loans at prices that their customers love them. Everybody knows they’re made no sense, because all the glamour in the banking not the highest rate payer in the market, but they like business is making the £100 million loan, not the £1 to talk to human beings on the phone. This is not a million loan. The margins never got as compressed hard business. I think First Direct is maybe the only in America as they are here, but when you compress change I can point to. margins by demanding higher deposit rates and the borrowers demanding and getting lower loan rates the Q504 John hurso: Can I ask about the thorny effect is you’re depressing margins. question of remuneration and bonuses in banking? Now, the banks have to earn a profit. The generally What is your policy regarding the people you employ accepted number is we had to earn 1% on our assets on remuneration and bonuses? over time. If we don’t earn something around that V r o ill: First of all, let me make a comment number you’re not going to have a bank, you’re not generally about remuneration—and I have watched going to have a banking system. So we have all this your hearings. Commercial banking and investment talk about pricing and fair pricing; the banks have to banking are two entirely different businesses, and I earn a return on their capital or they have no capital, listen to you talk, and you merge the two together. I as we’ve seen. So everybody looks at it in a different think you do a disservice to this discussion by talking kind of way but that’s my view, if you like. about bond traders as opposed to branch managers. In America, the banks aren’t in the investment banking Q500 Jesse Norman: Just a point of clarification on business as much as they are here, and I think that we that. You have just said that you have to earn 1% have to look at those two groups; it is completely percent? different. V r o ill: 1% of the assets and somewhere—that’s on assets. Another way to look at it is return on Q505 John hurso: If you have read my questions capital, and the numbers have generally run from 10% you will see that is what I have always been trying to to 20% return on capital. If a bank, like every other do—separate the two. company, doesn’t get an acceptable return on capital, V r o ill: Right. To answer your question, we the capital goes. bonus our people down to the branch manager level Ev 72 Treasury Committee: Evidence
14 December 2010 Vernon W Hill II and Anthony Thomson on a subjective basis. When I had 15,000 people shares, our total shareholding. So over time they working for me in America, we did a subjective would ramp up to 5%, 10%, and we would give analysis on every store manager upwards; about how options in the year on 2% or 3% of the share account. they did on their plan, how they delivered service, That’s generally what the investment community how they recruited people—a whole measure of looks at. subjective things. We rewarded them with salary and cash options. But I may be the last person in the world Q510 John hurso: Would you go into the market to believe that stock options are the key to delivering to buy the shares or would you issue them? a unified customer experience. They get their options V r o ill: I issued new shares. Remember I was based on their performance, but the value of the a rapidly growing company. If you’re not a growing options is determined by how the company does as company and you’re worried about the share count, a whole. you might go into the market. I might add that the British system discourages stock options because our employees are taxed when they Q511 Andrea Leadsom: I just want to check you are receive the option. In America they are taxed when talking only in your proposal to remuneration about they exercise. So if there was one change I would the retail banking sector? make in the compensation system, it would be that. V r o ill: The commercial banking sector, not the investment banking sector. Q506 John hurso: Broadly speaking, what percentage of a salary might somebody be able to earn Q512 Andrea Leadsom: Exactly, because I just want on an annual basis through incentive plans or to come back to your point on options. Obviously one bonuses? Would it be a multiple of salary or a of the attractions of being taxed on the way in, rather percentage of salary? than at the end, is if you think the stock price is going V r o ill: It would be a percentage of salary. It to go up, then your tax bill is lower if you pay it up would be a percentage of salary. The American front than on realisation of the capital value. tradition is more that way than the British tradition, I V r o ill: That’s not right, because you award the might say, but my American experience is a bonus for options at the current market price, so there is no a high performer might be 20% or 30% of his salary. value when you go in. So for your point to be right, the employer would have to buy the shares then? Q507 John hurso: Looking at the top end of the Andrea Leadsom: Yes. company, as you grow, you will start to have V r o ill: That’s not what happens. executives. What is your view on what the executive package should be? Q513 Andrea Leadsom: So you just award them and V r o ill: It should be salary, discretionary cash they do not buy the shares until the end? bonus and options. If I had my way, I would make the V r o ill: Until they have a value. majority of it in options. John hurso: Thank you. Q514 Andrea Leadsom: So what are they paying tax V r o ill: Mr Chairman, I just want to repeat the on at the beginning? value of stock options. The number of options they V r o ill: Here, they’re taxed on the value of the get is based on their performance. The value of the shares. I’m not an expert on British taxation, but I options over time is based on the company as a whole. believe they pay value on the gross number— shares That encourages people to work across lines in times price. different segments to support the company as a whole rather than their particular line. Q515 Chair: We will come back to this perhaps, but I don’t think we’re going to go too deep into the Q508 John hurso: Just to follow up, I think it is detail. very interesting you are keen on options. There is a V r o ill: Yes, right, and I’m not an expert on that. view, but it is probably to do more with investment But I know my Brits don’t like options as much as the banking than retail banking, that the person who puts Americans do. the capital in should get the return. Every time you Chair: Yes, there are some good reasons for not give away stock options you are giving away the favouring them, but we are not going to go into them capital I have invested in your company. now. V r o ill: Of course, that’s true. Q516 Jesse Norman: I am sorry to keep coming Q509 John hurso: So how do you work out the back on this. A couple of very quick questions. One balance between handing out the stock options and of the things that has been suggested to this diluting my return? You can look at some big Committee on several occasions is that commercial American companies and you could consider that bankers are best paid in subordinated debt rather than remuneration committees have pretty well looted the in equity, because that, as it were, focuses their eye shareholder interest in stock options to senior where it should be, and also that there’s a tacit subsidy executives. if you pay people, even directly or indirectly, in equity V r o ill: Well, using the American example, take because people just ramp up the balance sheet and the tech guys out of the equation, they’re on some take the profits. How can we prevent that happening? other planet. In a financial segment, we would get V r o ill: I don’t know about the debt side—the options outstanding no more than 5% to 10% of our subordinated debt, I’ve never heard that theory and I Treasury Committee: Evidence Ev 73
14 December 2010 Vernon W Hill II and Anthony Thomson don’t have any comment on that. But your theory are not so big that you cannot do that. So it is just a about options assumes that nobody’s at home running matter of the entrepreneurs getting in there and getting the bank. Obviously, all these things have to be on with the job? managed and they have to be done right. For instance, V r o ill: Yes, on that part, for sure. But there are if you pay commercial loan options on loan barriers to entry in the market; we’re a unique set of production, you’re going to encourage them to make facts. I think you should provide more freedom of bad loans. So you have to design your system where choice to the customers with new entrants, and I think you have controls and you pay them over time, not this focus on product and pricing, not only by the only on what they produce but the quality of the banks but by this Committee, is not focusing on the credit. So all these things can be used to the extreme real issue. but they have to be managed. Chair: Well, you had better drop us a line with some further detailed evidence about exactly what you do Q517 Jesse Norman: So you accept the possibility think we should be focusing on. We will be listening of the hazard, if you like, of leveraging up a balance very carefully. We are also very interested in the sheet. survey you have done. V r o ill: No, I don’t. V r o ill: I’ll leave it with you. Chair: Anyway, let’s not go down that way any Chair: It appears to contradict a good amount of the further just now. I just want to end by telling you we other material we have received. Thank you very embarked on this inquiry because people have told us much for coming before us today and we wish you a that this market is fundamentally flawed, but you are merry Christmas, whether you take it here or in the disproving this, aren’t you? What you are showing is States. that the market has imperfections, but you’re going to V r o ill: Thank you. pile in and take advantage of them and the barriers Ev 74 Treasury Committee: Evidence
Tuesday 11 January 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Stewart Hosie Mr David Ruffley Andrea Leadsom John Thurso Mr Andrew Love Mr Chuka Umunna John Mann ______
Examination of Witnesses
Witnesses: Bo Diamond, Chief Executive, Barclays, and Antony Jenkins, Chief Executive, Global Retail, Barclays, gave evidence
Q518 Chair: There seem to be quite a lot of people very closely with the FSA on just that. I know people here this morning. There are a few chairs right in the talk about the need for regulators to be able to unwind front row, but I somehow think that there won’t be an institution in short order, and we agree with that many takers for those from the audience today. ambition. Thank you very much for coming, Mr Diamond, and There are really two choices for regulators, and that happy new year. Congratulations on your is not to have large complex banking organisations, appointment. We have quite a lot of ground to cover— and our view is that the reason why we need those is on remuneration of course, on the question of for jobs and economic growth. The reason why we systemic risk and bank regulation, and also on retail need banks such as Barclays is that our clients are banking competition. Could I just begin by asking you bigger. Our clients are more international: more of the whether Barclays is too big to fail? business they do is in China, India and Africa. So Bo iamo : No, we don’t think so. First of all, what we do need is a plan to be able to resolve banks Chairman, happy new year to you and to the that get into trouble, and those are the plans that we’re Committee as well, and thank you for your comments working out with the FSA. about my new role. I am very, very excited. I am incredibly honoured. Barclays took its first deposits in Q519 Chair: If Barclays did get into trouble, how the City of London in 16 0. That’s a daunting 320 would you as the chief executive lose out? years of history, and I’m both honoured and very, very Bo iamo : I think it is clear that, if any banking motivated in the new role, so thank you. institution got into trouble, where you look first is at No, I don’t think Barclays is too big to fail. That’s the the chief executive and at the risk management of the simple answer; let me give a little bit more colour institution, and I think that has been the case when around it. I think the business model that we employ we’ve seen banks fail—whether it’s here in the UK or of the integrated universal banking model is an around the world during this period. important starting position. It gives us great Chair: Okay, but how would you lose out? diversification of earnings, great diversification of our Bo iamo : I would assume I would lose out by clients, but also great diversification of our deposits, both losing my job and losing any shares that I had in both institutional and retail, and of our funding the company. sources; we just raised money in dollars in the US late last week. So that diversification is a very important Q520 Chair: This is under the claw-back agreement part of being financially stable. that you have signed and that is disclosed in the The second thing I would say is that—and I’ve said company accounts? this consistently—no bank should ever be a burden on Bo iamo : Yes, I think that is how the the taxpayer, so we have to make the system safer and compensation programmes work. Correct. sounder. I think that’s about risk management. With banks that failed, if there was something that was Q521 Chair: The public’s liability, though, is consistent it was poor risk management, and I think unlimited, but your liability is limited to the claw- we’ve done things around risk management and back. Isn’t that right? around regulation so that there is less risk of outsized Bo iamo : I would like to back this up just a little losses at banks. bit, if we can. I think the important thing in discussing Secondly, I think it’s about the capacity to absorb the business models of banks, talking about losses, and that goes behind a lot of what the competition and talking about choice, is that Barclays regulators have been focused on, in terms of Basel III has very strong risk management and Barclays has an and Dodd-Frank. Even when there is a bank such as appropriate business model—the integrated universal Barclays, which is so strong and so well diversified, banking model. So any discussion here that Barclays “What if?” is the question that the regulators would could get into trouble is surprising. have—“What if the worst happened and that bank got into trouble?” Then we need resolution and recovery Q522 Chair: It may be surprising to you, but we plans. I can tell you that we at Barclays are working have just had several banks go down and as a result Treasury Committee: Evidence Ev 75
11 January 2011 Bob Diamond and Antony Jenkins the taxpayer has footed a huge bill, so I think it’s not Chair: I’m not saying that it should; I am asking you surprising that we’re discussing it, is it? whether you think that is something that we should Bo iamo : Chairman, in direct answer to your consider. question: is there a process for regulators in place Bo iamo : I think that is something that our going forward to resolve financial institutions that get owners should decide. into trouble? I think that is a function of supervision and how banks manage themselves; it’s a function of Q526 Chair: Have the shareholders been in touch the new capital rules, the new regulations and the with you about the remuneration and bonus package changes that have been made in terms of the financial this year? architecture, and I think it’s about resolution and Bo iamo : We haven’t made decisions on recovery. bonuses for this year. The board will be meeting over I was in Basel over the weekend, where there was a the next couple of weeks on pools and allocation of meeting on just this subject with the G20 regulators pools. But having said that, our owners—our and Finance Ministers. Central Bank Governor shareholders—are continuously involved from the Draghi, as you know, was chairing the FSB and point of view of how we govern it and how we run chairing just this initiative, and I think this is our businesses. They, ultimately, approve the important for the regulators in the industry to resolve. remuneration report.
Q523 Chair: You do accept, though, that the risks to Q527 Chair: But are they engaging with you in a the senior executives are limited, whereas the risks to discussion about your bonus structure this year? the taxpayer are unlimited? Bo iamo : In terms of the structure, we have had Bo iamo : Yes, and we also agree that it’s not continuous discussions with the shareholders and I okay for taxpayers to have to bail out banks. Banks would like to back up a second to explain that more. should be allowed to fail. If banks have bad So, what are the kinds of things that we discuss with management, then they should be allowed to fail. We the shareholders around compensation? Compensation completely agree. is pay for performance, not pay for failure; compensation is in line with G20, with FSB and with Q524 Chair: Would you examine risky deals in FSA guidelines. We were early to adopt those; many exactly the same way if your shirt was on the line? of those we had in place already. We discussed with Bo iamo : I’m sorry? our shareholders the governance process in place at Chair: Would you examine risky deals in exactly the Barclays, which is that we have an independent same way if you had unlimited liability—if your shirt remuneration committee of the board that approves was on the line? those. Bo iamo : Sure. I think what you’re coming back to is: at Barclays or at a financial institution, how do Q528 Chair: May I just ask a more specific question: we manage risk, both in terms of the governance of do the shareholders have available to them at present risk appetite and the scale and scope of the risk that the information of the type that Sir David Walker we’ll take in various businesses? thinks should be more widely disclosed? Have they I think what we look back on is that in the most asked for that information? difficult times of the financial crisis, when the UK Bo iamo : We haven’t determined the pools or stressed banks, Barclays stayed above minimum the allocation of pools yet. capital requirements. When Europe later stressed all Chair: Yes, but if they are going to be engaged in the the banks, Barclays was the only large bank whose discussion, as you suggested earlier, then presumably capital increased under the stress. So I think we’re they need the information before you take the board consistent in agreeing that risk management is the decision. single most important thing that we can do, along with Bo iamo : I think they get the information just strong regulation, to ensure that taxpayers never have the way I described. Chairman, are you asking about to put money into banks again, and then—sorry— the Walker review? Chair: Yes. I’m asking you whether that level of Q525 Chair: You have said you would take exactly disclosure has at least been made to the shareholders. the same approach to risk if your shirt was on the line. Bo iamo : No, that’s not part of— Don’t you think it would give the public reassurance if the top CEOs, and others at the top of banking, did Q529 Chair: So the shareholders don’t know what have their shirts on the line—in the way they used to, you’re considering paying in bonuses, and they don’t with unlimited liability? know the structure of the bonus scheme that you are Bo iamo : I agree with you. I think there is going to announce? significant risk for chief executives and senior Bo iamo : As I said, the shareholders know the executives, in the way the compensation programmes philosophy, which is pay for performance, and that we work, in the way the shares in the company work and don’t pay for failure. They know exactly how we’re in terms of losing their jobs— going about compensation, which is in line with the Chair: Yes, but I am suggesting an increase in that UK regulations of the FSA, in line with the G20 risk. Are you agreeing with me that that risk should regulations and in line with FSB. They know how the become unlimited? governance works and the most important thing that Bo iamo : I think we have many people— our owners know, Chairman, is that a strong Barclays Ev 76 Treasury Committee: Evidence
11 January 2011 Bob Diamond and Antony Jenkins in a strong business is what they’re monitoring most want to make absolutely certain that you aren’t going closely. to have some rogue trader sitting in Canary Wharf who is going to suddenly do something completely Q530 Chair: How can shareholders exercise ridiculous and blow the bank up, which we have seen judgment and restraint on remuneration if they don’t happen on a number of occasions—Soci t G n rale even know the numbers? recently, Barings before. Bo iamo : I think, from what I’ve said, you know How can you reassure my constituents—indeed that the shareholders are very involved in terms of our everybody, including the taxpayer—that that cannot philosophy, about how we determine the pools and happen? You obviously run a very tight ship when about how we run the businesses. you’re running BarCap, but other chief executives don’t necessarily do that. Q531 Chair: But we have established that they are Bo iamo : Let me take a crack again at a couple not going to know the numbers until you have of things that I think will help you see why we don’t determined what they are at board level. Is that feel that way, and Antony will pick up again as well. correct? If you look at the failures in the United Kingdom, Bo iamo : The board has not determined the whether it was the Bank of Scotland or a combination pools— of the Bank of Scotland and Halifax, whether it Chair: The shareholders won’t be informed until the happened before the integration with Lloyds or after, board determination? there was no rogue trader, there was no derivative and Bo iamo : No, they won’t be given the disclosure there was no proprietary trading. It was vanilla that you’re referring to. lending. It was a lack of risk management. It was an overexposure in some cases to commercial real estate. Q532 Mark Garnier: Mr Diamond, you have come It was traditional vanilla banking business that created out in the past saying you are very much against the issues of failure in the United Kingdom. I think having a functional separation of the retail and it’s unfortunate that people use terms like “rogue investment banking side of your bank. Would you not trader” and “casino banking” when the truth is that at agree, though, that having a functional separation Barclays we exited proprietary trading in 1 8. I would result in greater financial stability in your couldn’t be prouder of the business that we’ve built at organisation? Barclays Capital. The clients are the very centre of Bo iamo : It’s a very good question because it’s everything we do. the one that we get asked the most in terms of I would love to have an opportunity for members of separation of retail and investment banking. Let me this Committee to come in and spend a day in our give an overview, and then I’d ask Antony to make a operation, starting in the morning with flows of comment, particularly on the retail banking side of deposits from central banks in Asia, seeing the how that works. business that we do with pension funds in the UK It is interesting—and I started on this earlier—that the and helping them earn returns above the almost zero integrated universal banking model gives us far more interest rates we have with risk-free returns. It’s a financial stability because we have deposits, both customer-driven business. institutional and customer, from a broader group of When I talk about financial stability, I think the best investors from a broader geographic reach. We have example I can give you is the following. In 2008, revenue pools that come from around the world; we during this period of incredible crisis—and listen, I’m have funding sources—both equity and debt—that the first to say that this is a difficult environment to come from around the world, so the financial stability manage through—Barclays made about £6 billion. In of Barclays is stronger as a result of the integrated that year, about £ billion of the £6 billion of earnings universal banking model. came from retail banking and £2 billion came from We see that in our funding spreads, our ability to raise other activities, including investment banking. We money in the market, and that allows us to have haven’t produced results for 2010, but if you go by greater capacity for lending and to lend at better the analyst expectations, their expectations are about terms. So we think, both from a financial stability £6 billion in earnings in 2010, about £ .5 billion of point of view and from a customer service point of that coming from Barclays Capital or investment view, that it’s a positive for Barclays to have the banking in a very tough year for retail banking integrated universal banking model. because of provisions around housing, commercial to y ki s: One of the things that we saw real estate and other areas. That balance is through the course of the crisis was that customers tremendous. This is fair to say, but if that balance had brought their money to Barclays because they had been there in the Irish banks, would the situation have confidence in Barclays to be there through the travails been different? So there is the diversification of of the crisis. So customers do have confidence in earnings. Barclays as an institution. But the other thing is that it’s not appropriate to talk about casino banking and Barclays Capital; it’s not Q533 Mark Garnier: That is very reassuring, but the appropriate to talk about rogue trading and Barclays problem is that there are a number of other banks, as Capital. We do take risk. We take risk on behalf of have already been referred to, that failed with our clients. We have clients that need to raise capital investment banking operations. Now, if I’m talking to and manage risks. I had a conversation just yesterday my constituents and they are expecting to go along with one of our newest clients, a farmer in Wales. He and deposit money with Barclays, they are going to has just moved his account from one of the other UK Treasury Committee: Evidence Ev 77
11 January 2011 Bob Diamond and Antony Jenkins banks to us, and one of the reasons was the level that recognised as very good for business and very good we can lend at, and I can come back to that in a for talent. People have enjoyed living here, but it has second. One of the other reasons is that we’re able to been much more about companies feeling that this is help this farmer hedge the EU subsidies out through good for business, it’s good for raising capital and it’s 2012. With so much uncertainty in the world, the need good for attracting talent. to remove as much financial risk from the price of There are some issues. I think the Prime Minister, the fertiliser, the EU subsidy, the currency exposure on Chancellor and the Business Secretary have been very the EU subsidy, so he could focus on his sheep- focused on some of those issues in terms of cutting farming and not have to focus on all the other risks, Government spending, reducing the deficit, focusing was something that’s very important. on debt, and recognising that we have to pass the mantle for growth because we are going to have a Q534 Mark Garnier: Your chairman Marcus Agius reduction in some employment areas, particularly as has referred to the possibility of Barclays relocating public spending comes down, but we have to hand the abroad. If the Independent Banking Commission mantle of growth to the private sector and to banks. I comes up and says that you have to split, would that think they recognise that there was a period of be a deal breaker for you? Would you feel you would remorse and apology for banks. I think that period have to move abroad? needs to be over; we need our banks willing to take Bo iamo : Let me be crystal clear: we took our risks, confident, and working with the private sector first deposits in the City of London in 16 0; we have in the UK so that we can create jobs and we can 320 years of history in London as the premier improve the economic growth. That’s very important financial centre in the world. We have absolutely no for the United Kingdom. intention of changing that. We’re going to work There are some challenges now in terms of some of constructively with the Independent Banking the actions that have been taken, super equivalency Commission to show that giving customers the choice and regulation. That is not shaking our position at all. of an integrated universal banking model as well as I think we’re still working through a lot of these, but others, and the financial stability—we respect the it would also be good if we had a bit more clarity and decisions that they will arrive at. We have a lot of confidence. The confidence in Barclays is there, but respect for the process the Independent Banking it’s not that there aren’t challenges. Commission is going through. They have very serious to y ki s: I think it’s important to note that we people who are taking their job very seriously, and have 66,000 colleagues in the UK; we have 10 million it has implications for the United Kingdom and the credit card customers; we have 12 million retail bank economy in the United Kingdom for many years to customers; and we have 1 million SME customers. come. This is a very big important business for Barclays and But our starting position is very clear: we are going will continue to be so. to be here in the United Kingdom, and this is the place that we want to succeed. It’s really important, this Q536 Michael allon: Mr Diamond, what would be question, because— the impact on Barclays if the Independent Banking Commission recommended keeping universal banks Q535 Mark Garnier: Can I just ask you, in support but insisted on greater geographical subsidiarisation of your answer— along the HSBC model? Bo iamo : Okay. Remind me to come back to Bo iamo : It’s difficult, because we respect the that. Independent Banking Commission. We have had an Mark Garnier: Could you list why you think opportunity to submit written evidence. John Varley, England is such a good place to be? I mean, it’s like Chris Lucas and I have had a chance to testify. I don’t a bit of positive news coming out. You can go want to pre-judge that, but our view is public record, through: is it the regulatory regime? Is it the tax so I’ll repeat our view as opposed to what I think they system? Is it the fact that we speak English? Is it the will rule, if that’s okay. Our view is that the integrated fact that we’re the centre of the world in terms of time universal banking model is the right model, and one zone? What is it that makes the City of London so of the things it does is that it improves our ability to terrific, and why would you stay? And if you did ever fund and that— have to move, or felt you wanted to move, where Michael allon: Sorry, I understand that. Time is would you go that would provide as good an short. What would be the impact, though, if you lost opportunity? that argument and they recommended Bo iamo : Let me go through the advantages, as subsidiarisation? you have asked, and then try and give some balance Bo iamo : There is a form of subsidiarisation. to the discussion, because there are some issues out The difficulty is the nuance. Subsidiarisation is a very there and I think it would be disingenuous to say that broad term. If there was an extreme version of there are no issues. Then I’ll ask Antony to come in subsidiarisation, in essence it would be the same as as well. separating retail and commercial banking. You mentioned the English language. It is certainly an advantage. The time zone is certainly an advantage, Q537 Michael allon: You don’t think the taxpayer but over time there has been no city in the world that interest would be better protected by more has benefited more or been more supportive of foreign subsidiarisation than we have at present? trade and flows of business in and out of the city than Bo iamo : I don’t. I feel strongly that the model London. So London has become a place that is that we employ is best for financial stability. I can Ev 78 Treasury Committee: Evidence
11 January 2011 Bob Diamond and Antony Jenkins throw out a few questions for you that you have Q539 Mr uf ey: You accept that you are receiving certainly had to wrestle with in the United Kingdom, a subsidy. Does that mean you feel you have a social but the best example would be Barings. The Barings responsibility to Britain to lend more, so that operation in Singapore was a subsidiary. It was the economic growth can take place? extreme of subsidiarisation, but it didn’t prevent the Bo iamo : Listen: absolutely. We think being a taking down of Barings. responsible banker is important, so if I gave any I think last year we saw an example where HSBC had impression otherwise, I apologise. We need to be real issues over a couple of years in their portfolio in responsible. We need to do a better job of explaining the US with the acquisition of Household, and to people in the United Kingdom— certainly we didn’t see HSBC walk away from that. So I think we have to focus much more on what the Q540 Mr uf ey: Okay, let’s cut the generalities. If implications are in terms of funding. There would be we are going to get something from you for all the a significant increase in the funding levels for a firm taxpayer subsidy we give you, many people— modelled such as Barclays, and that has implications including in my constituency of Bury St Edmunds; in terms of the capacity for lending as well as the small businesses—want banks like you to lend more. price of lending. What did you lend last year to business in Britain? In general terms, how much did you lend last year? Q538 Mr uf ey: Mr Diamond, the Bank of Bo iamo : Sir, I completely understand the need England have pointed out that because you’re too big for bankers to be responsible— to fail, and because the taxpayer stands behind you, Mr uf ey: No, sorry, how much did you lend last you’re much more creditworthy and therefore can year? borrow money much more cheaply than if you were Bo iamo : In 200 we increased lending in the standing alone. The Bank has calculated that that is UK by £35 billion. What we talked about earlier in the worth £100 billion a year to the “Big Five” banks. year was setting a target of £11 billion. We exceeded it Are you grateful to the British taxpayer for substantially. In 2010, we have increased lending in subsidising you in this way? the UK by £35 billion for the first nine months of the Bo iamo : There are a couple of answers to this year, so it would be larger on a full-year basis. We’re question. very committed to lending. Mr uf ey: No, are you grateful to the British taxpayer? I need to point something out, and I think it’s really Bo iamo : We are very grateful to the— important: lending is what we do. The United Mr uf ey: To the British taxpayer? Kingdom is our single most important market. We like to lend. It’s our business. It’s what we do with our Bo iamo : May I answer? We are very grateful to the central banks around the world and to the customers and clients. I think, Antony, you can give Governments around the world for the actions that many examples— they took. Mr uf ey: No, I’m talking about the British Q541 Mr uf ey: I don’t want to speak to Antony; Government, who stand in the shoes of the British I want to speak to Bob on this occasion. In the public. They say—and this is accepted—that you’re this morning, it is suggested that in return for the too big to fail, and the taxpayer stands behind you. Government going easy on bonuses, on not throwing That makes you more creditworthy and means you the book at you, you will be asked to pledge to lend can borrow much more cheaply than if you were a more next year. The figure suggested—floating stand-alone organisation. Now what I am asking you, around—is all the “Big Five” banks lending up to Mr Diamond, is: are you grateful to the British public? 10% more next year than last year. Bo iamo : Can I ask you one question? What figure do you have in your mind? Share it with Mr uf ey: Can you answer that question? I ask the the Committee, because we’re asking the questions on questions, you give the answers. Are you grateful to behalf of small businesses and the British taxpayer the British public? here. How much more are you going to lend next Bo iamo : Part of what you said— year? You must have a notional figure in your head. Mr uf ey: Are you grateful to the British public? Bo iamo : Well— Chair: Let Mr Diamond answer. Mr uf ey: Do you? Bo iamo : We are very grateful to the central Bo iamo : We have had discussions with the banks; we’re very grateful to everyone; we’re very Government. I have not read the article, so I’m not grateful to everyone that has helped the financial aware of it. system get back— Mr uf ey: It’s this morning’s. It’s a good read. Mr uf ey: The British taxpayer? Bo iamo : We increased our lending by £35 Bo iamo : We’re thankful for everyone. But if I billion in 200 ; we did new lending of £35 billion in can just point out— 2010. Can I have a chance to— Mr uf ey: Does that include the British taxpayer? Mr uf ey: Going forward, yes. Bo iamo : What you just said, sir, is that because Bo iamo : It is important. It’s not a simple of the implied Government support— question. There has been a— Mr uf ey: You are accepting that. Good. Mr uf ey: Yes, it is a simple question. What are Bo iamo : But last week, we raised money at you going to lend next year? about 50 to 100 basis points lower in yield than the Chair: Let Mr Diamond answer the question you Government guaranteed banks in the UK. posed. Treasury Committee: Evidence Ev 79
11 January 2011 Bob Diamond and Antony Jenkins
Mr uf ey: He’s not doing terribly well at the is what our responsibility is to create jobs and create moment. Go ahead. economic growth. Bo iamo : So, we are committed to increasing Mr uf ey: Okay, but you’ve overlooked— lending. The “Big Four” or “Big Five” UK banks are Bo iamo : We have an obligation to our owners; in discussions. No decisions have been made, but we we have an obligation to our clients and our customers are committing to increase our lending in the UK. to do what they want; we have an obligation to Those are the discussions that— 150,000 employees around the world, over 60,000 of them here in the UK; and we do have an obligation, Q542 Mr uf ey: Yes, okay, “discussions”—can as you said—I agree with you—to give back in the you put a figure on it? The figure floating around is communities where our banks are, both by lending 10% more for the “Big Five”. What increase will there and by being better citizens. We agree with that and be in lending next year to help the British economy we are doing that. grow? This is what we’re talking about. Bo iamo : Yes, absolutely. Q544 Mr uf ey: Yes, it isn’t just to shareholders. Mr uf ey: Small and medium-sized enterprises are You have a moral and social obligation to the British the backbone of UK PLC. Now, what I want to know taxpayer that gives you this implied subsidy that I is: what sort of increase in lending? Don’t just say, described earlier. Let me just conclude by saying, “More lending next year”. You’re a highly paid will you— businessman, okay? Share with this Committee in Chair: One very last quick question. general terms what increased percentage in lending Mr uf ey: It is the last question. next year you’re going to contribute to the British Chair: And a quick reply, if possible, please. economy. Mr uf ey: Some chance. Will you make yourself Bo iamo : We have not yet made a decision. accountable by promising—now, today—to resign if Mr uf ey: You haven’t? you do not significantly increase lending in the Bo iamo : No. coming year, so that Britain can grow and British economies can borrow on sensible terms? Q543 Mr uf ey: Why not? We’re into 2011 Bo iamo : Well, we can’t do— already, as you’ve probably noticed. This coming Mr uf ey: It’s a “yes” or “no”, because the year, what are you looking at? Chairman wants a quick answer to this. Bo iamo : Can you give me a second to give you Bo iamo : Well, the— an answer? I’d really appreciate it. Mr uf ey: No? Mr uf ey: Well, just give me an answer. That would Chair: Just let Mr Diamond reply. be nice. Bo iamo : I am going to give a full answer; I Bo iamo : Just a couple of minutes, and then I’m apologise. You’re going to get a full answer, and I happy to take follow-ons. We’ve seen a withdrawal— think there are some things that we can all learn to your point, because it’s a very good question. together. This is an opportunity to learn. This is about Mr uf ey: It is. choice in competition and banking, and I respect the Bo iamo : We have seen a withdrawal of foreign inquiry. No bank should ever make a specific banks and non-banks from lending in the UK, and commitment to how much they’re going to lend over the last couple of years the UK banks have without looking at the creditworthiness of the picked up the capacity that was removed from the UK. borrower. That is how the UK banks, the Bank of We have been very clear that we are committed to Scotland and a number of other banks got into trouble. lending to our businesses here. Our best business is We’re not making the United Kingdom a better place doing lending with our corporate clients in the UK: with weak standards around credit. small businesses and large businesses. Having said that, we are a bank. We are a British- We have seen demand reduce. We have seen our based bank; we like to lend to our customers. I talked approval rates stay steady or increase at 80% to 85% to a number of our business customers yesterday who of small business loans being approved, which is are very active in increasing their employment and equal to or slightly better than it was before the crisis. increasing their business because they have access to We will continue to focus in this area. We think it is lending, so I think there is much more agreement, good business and we want to be a part of the David, between us. We do feel a responsibility to jobs economy growing. But what I would point out is that and economic growth in the UK. the best thing that Barclays can do for the UK economy and for UK jobs is to have a strong bank Q545 Andrea Leadsom: Mr Diamond, I worked for and strong risk management. Barclays and B W for 10 years, including in the Barclays has performed very well during three years investment bank’s team when Barings went bust. I of financial crisis, having made profits in every single would just like to correct you on that specific point on reporting period and having increased our lending to subsidiarisation because, in fact, Barings Treasury, the customers. I think Antony and I would say that in group, was lending limitless sums of money—and that almost every line of business we’re doing more is what made them go bust—to a Singapore subsidiary business with more clients, and it’s that strength—as that was not capitalised at all. So it wasn’t really the Chancellor said in his editorial last week, weak subsidiarisation; it was “cock-up”. Forgive me for banks are a drag on the economy across Europe and correcting you. weak banks are a drag on the economy in the UK. What I would like to talk to you about is Strong banks working together with the private sector accountability, and it is this: having been in banking Ev 80 Treasury Committee: Evidence
11 January 2011 Bob Diamond and Antony Jenkins for a very long time, I completely understand and services company again; incidentally, in the Barings have authorised and paid very significant bonuses to collapse, people were banned from ever holding a traders on very specific briefs that they have met. financial services post again. That simply hasn’t That, to me, seems at the core of our capitalist happened, and what I would like to know is: what are society—wealth creation and so on. we to say to our constituents who write to us in rage But really, it is the accountability that is the question and absolute frustration that they will almost certainly I have, and that is: when you are the board member— lose their £20,000 to £30,000 per year jobs, and yet whether you are the chief executive or the head of the chief executives who effectively, as far as they’re risk, or whatever—who authorises the level of concerned, got us into this mess, are carrying on leverage that enables those traders to make those business as usual and about to take home very profits using extreme levels of leverage that, in effect, generous bonuses. broke our financial system, who should be Bo iamo : I think that we do understand the accountable? How do you think we can hold those mood of some people, and I think there are two senior individuals accountable in the future? answers to that from a Barclays point of view. I think Bo iamo : There is a host of ways, and I think it there is a difference between an institution taking is the right question. I think leverage throughout the direct investment from Government and taxpayers and banking industry and throughout society was probably the things that were done by central banks and at levels that were too high before the crisis, and Governments. Chancellor Darling did a tremendous hopefully it is one of the lessons we have learned. In job during the crisis. Let’s be honest, that benefited Barclays, our leverage has gone from about 3 or 35 all of us. That benefited Governments; that benefited to 1 down to 20 or 21 to 1, so we have changed the banks; that benefited companies. It was really the way we’ve done business. financial system, and it was about being the lender of In terms of producers, risk managers or traders, last resort. depending on how we refer to it, we have always We are very appreciative of the moves that have been judged them based on their risk-adjusted returns. So I made by everyone that was involved in making sure think the quality of their returns, whether there is a that we have a global economy and an economy in completely— nte ti n or there is residual tail the UK and an economy in the US. On the other hand, risk, how much leverage they’ve used, how much it is true—I’m just going to say this—that there are capital they’ve used: all those things have to come 150,000 people at Barclays that are very proud that into account. And then, to your point, I think adhering they never failed a stress test and that while we all to the G20, the FSA and the FSB principles, in terms made mistakes—I certainly made mistakes—we never of compensation, claw-back and deferral: those are all put the bank at risk or the system at risk. ways that we try and get at the question that you Andrea Leadsom: Okay, can I— asked. Bo iamo : Let me finish, please. Andrea Leadsom: Okay, but looking specifically at Andrea Leadsom: Yes. the issue of accountability, there has been no real Bo iamo : I think that the fact that we never took accountability for the financial crisis, has there? a single penny of taxpayer money from any country Forgive me, you have said yourself that Barclays anywhere in the world, the fact that we were— didn’t take taxpayer money, but of course all banks Andrea Leadsom: But that’s not true, is it? That’s did. It was the Central Bank’s action in the interbank not true on that point, sorry, that— market that saved the banking system from total Bo iamo : I allowed you to ask a complete collapse—including Barclays, even with its strong question; I would appreciate it if you would allow me capital ratios and so on. There is no question about to give a complete answer. that; you also benefited from taxpayer bailout. But So it was about how we managed our risk and how there has been no accountability. Many chief we performed in stress tests in the most difficult time. executives didn’t take a bonus for a year, but now It was about being profitable in every single reporting they’re presuming business as usual and they’re period. Most importantly, it was about being close to moving on. Very few people even lost their jobs. our customers and clients. During the worst of the There were certainly no bans. Even Sir Fred Goodwin crisis in 2008, there were days when we had a four or didn’t lose his significant pension, now being funded five times increase in the amount of foreign exchange by the taxpayer. So where is the individual transactions from central banks in the UK and Europe accountability going to be? and Asia who had to hedge out risks. So we are very Bo iamo : If I start with myself, I take my proud of how we performed. That doesn’t mean that accountability—and we have to be a strong bank that we’re also not extremely grateful for the support that is supporting economic growth and job creation while, was given by regulators, by central banks and by at the same time, recognising that mistakes were made Governments, in terms of monetary and fiscal and that we need a safer and sounder financial system, stimulus. and we worked on both sides of that. So there are Our obligation, though, and that’s what I want to get changes in banks. Barclays today carries 10% core to, is to run a great bank. Our obligation is that equity; it was closer to 5% before the crisis. Barclays has to be a part, now that we’ve had some Andrea Leadsom: Yes, I understand that the bank has answers—not complete—on making the financial changed but I’m talking about the accountability. As system safer and sounder, and we have been a very the Chairman was saying at the start, there are no big part of working with the regulators in the US, the shirts on the line, nobody has gone to prison, nobody UK and Europe on that. Now our obligation is very has been banned from ever working in a financial clear: it’s time to pass the mantle to the private sector. Treasury Committee: Evidence Ev 81
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That’s where growth, the economy and job creation is Bo iamo : I don’t have that number with me going to come from. It’s not going to come from the either. private sector, and it should come from the private sector. Q551 Mr munna: The number is 38. Can you tell So I want my feet held to the fire: can I operate me how many subsidiary companies of your group are Barclays in a new environment that’s safer and incorporated and operating in the Cayman Islands? sounder, with higher capital ratios and lower leverage, Bo iamo : The same answer. and still serve my clients, whether they’re operating in China, India or Africa? And we still serve them in Q552 Mr munna: You have 181. Now, of course, all the things that they need to manage their risks, all of these are well known tax havens which are used invest their pensions and raise capital. That is the best by companies, and a cursory reading of your group help we can give the United Kingdom because there return shows that you have over 300 such companies is an issue that is being addressed here in terms of operating in tax haven jurisdictions around the world. high spending, high taxes and high levels of deficits, Could you confirm that while you headed up BarCap, and we all want to make that situation better over the bank’s structured capital markets division sat time, so the best thing we can do is to run a fantastic within BarCap? You, if you like, had oversight of it. Barclays. Bo iamo : Yes, I did.
Q546 Andrea Leadsom: Okay. One last very quick Q553 Mr munna: So that division runs tax question. Could you just comment on the structured arbitrage for your bank for high net worth individuals, organisation Protium and the fact that it, I gather, for companies, which enable you all to avoid the holds toxic assets of the bank? Could you just payment of UK tax. comment on whether that is an appropriate—in your Bo iamo : That’s not correct. opinion, clearly it is—thing to be doing with poor assets of the bank, and what the impact will be in Q554 Mr munna: That’s not correct. Why? terms of separating non-performing assets from the Bo iamo : Structured capital markets are part of bank’s general balance sheet? our overall financing operation. It is our obligation, Bo iamo : Protium is a transaction that you refer when we do financing for clients, to do it in the most to. We had some illiquid assets that we sold, so tax-efficient way. So it’s an institutional business and Protium is not a part of Barclays. So we did have it works within our financing. I’ll give you a very some sticky illiquid assets that we sold, and it’s good example. When the United Kingdom decided to something that the regulators and the FSA were aware develop the Canary Wharf area, they created—I forget of. I think all banks came through this period the exact phrase—a tax-free zone, so in order to recognising that, quite frankly, we had some assets on encourage people to move to Canary Wharf and to the balance sheet that were less liquid than we had build buildings, they did it with tax benefits. hoped and were more difficult to move. One of the things that we have done is that we have been at the forefront of leading financing of many of Q547 Andrea Leadsom: Is your personal those buildings using the expertise in the area that you remuneration in any way tied to the performance of talk about with our financing capability, and so we’re that subsidiary? doing things that are completely in line with Bo iamo : No, it’s not owned by Barclays. Government incentives. They want people to move; they want people to go to Canary Wharf. They’re Q548 Mr munna: Good morning, Mr Diamond. using tax incentives to do it. I’d ask AJ to speak as Just picking up on the reference to the benefit of well. It’s no different than ISAs. ISAs are a stimulus for the sector. You said in your CBI speech Government incentive for tax-efficient savings. in October that you were grateful for the stimulus and that you recognised the benefits and accepted that Q555 Mr munna: Sorry, Mr Diamond; I don’t have obligations went with that. Would you say that one of that much time and we want answers, not speeches. If the ways companies meet their obligations to society I just ask you this question. If it wasn’t engaged in is through the payment of tax? Yes or no? tax avoidance, why then did your bank injunct he Bo iamo : I think payment of tax is an important a ian in March 200 when they sought to disclose responsibility of businesses, yes. the activities of that division within the bank? Bo iamo : Again, that’s not why we did it. I’m Q549 Mr munna: Could you tell me how many happy to explain. The information that he a ian subsidiary companies your group uses and are released had two features to it: first, it was already incorporated in the Isle of Man? known to HMRC that it had the documents; we had Bo iamo : I don’t have that number with me. I sent them before the transaction. Our injunction was would be happy to look into it and get back to you. because someone stole confidential client information, which is against the law. Q550 Mr munna: According to the return that your Mr munna: Okay. Obviously, the payment of tax group company put in last year, you have 30 by banks in the sector is of great interest to everybody subsidiaries operating in that jurisdiction. Can you tell and we’ve all been— me how many subsidiary companies you have Bo iamo : We paid £2 billion in tax last year to operating in Jersey? HMRC and over the last six years we’ve paid about Ev 82 Treasury Committee: Evidence
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£12.5 billion in tax. I think that’s the number you’re Q560 Mr munna: If I could perhaps ask one last looking for. question. One of the things that contributed to the crash, I think it is generally acknowledged, is reckless Q556 Mr munna: Of that £2 billion, what and perhaps risky behaviour in the sector. In some percentage were non-payroll taxes? senses, there is a big question mark over your head, Bo iamo : I don’t have the percentages. Mr Diamond, because obviously you sought to try to purchase ABN AMRO at the same time as it was Q557 Mr munna: So it could be that most of that purchased by RBS. You may well have ended up is actual payroll tax paid by your employees, but in being the Fred Goodwin of the crash, and luckily for terms of the corporate tax we don’t really know the you that didn’t happen. figure, do we, Mr Diamond? You also pushed very hard to purchase Lehman some Bo iamo : That’s the payment from Barclays to time before it filed for a chapter in bankruptcy, and HMRC. you are also a great fan of exchange-traded funds, Mr munna: Yes, but what percentage of that was which are also being questioned a lot at the moment. non-payroll tax? How do you respond to that, and do you understand, Bo iamo : I don’t have the percentages. perhaps, why people don’t think you are suitable to be running one of the biggest banking institutions in Q558 Mr munna: Then we don’t know what, as this country? a corporate entity, you’re paying. Obviously, you are Bo iamo : I appreciate the opportunity because signed up to the new code of practice for tax that there is no substance to the accusations, so let me the Government has put in place, and that requires take them in their piece parts. They are very serious compliance with the spirit and not just the letter of the questions and they are very serious accusations. law. Will you commit today to reducing the number of So ABN AMRO: I was not the chief executive, but I offshore companies you are currently using to transact was on the executive team that proposed that deal, and business, to demonstrate that you will comply with let’s walk through it carefully. In March 2007 we had that code? an agreed deal with the board of ABN AMRO. That Bo iamo : We have signed the code. We are deal was going to be paid for in shares of Barclays, complying with both the spirit and the letter of the not in cash. There was then a hostile bid that broke law. That was what was asked of us, and we’re happy up our bid by three parties led by Royal Bank of to do it. Scotland, who paid in cash, not shares. We paid in Mr munna: So, will you commit to reducing your shares because if there was a market event and our use of offshore companies to transact business? shares traded down, the price we paid would flex Bo iamo : I’m happy to look into the numbers down. RBS chose to have another bank, Santander, that you gave. I didn’t have them, and it would not be come in and take the Italian operations and the appropriate for me to agree to something that I’m not Brazilian operations, and I recall John Varley being sure of the facts of. I am happy to look into it and interviewed saying we would not do a deal without write to you and the Committee if that’s helpful. But the Italian operations or without the Brazilian it’s not a— operations, and that we would not do a deal in cash and that we would not raise the price to their level. Q559 Mr munna: You will understand, Mr So we walked away. Diamond, if you look at the facts I have just presented, The Italian bank was sold for €10 billion within two they would suggest that your bank is engaged in tax months, and today the market value of the flotation of avoidance on a grand scale, would they not? the Brazilian operation is greater than the market Bo iamo : I can assure you that Barclays is not value of Royal Bank of Scotland. To compare those evading taxes. I can assure you that it is our two deals the way you just did is inappropriate and obligation— not based on fact, and it’s not appropriate to the Mr munna: Sorry, that wasn’t the question I asked. reputation of Barclays and Barclays management. I said “avoidance”. I was very careful not to use the In terms of Lehman Brothers, we were in consultation word “evasion”, Mr Diamond. both with our own regulator and with the US Treasury Bo iamo : I think “tax evasion” is a very clear and the US Federal Reserve, and what we proposed phrase, and it’s a space we would never go to. on the Saturday morning before bankruptcy is that we Mr munna: I know, and I didn’t use the word. would be interested in buying and we would make a Bo iamo : I chose the words “tax efficiency”, proposal under three conditions—and this is which is our obligation, and it is something that is in documented. Our condition 1 is that the 60 billion in line with Government policy. difficult-to-price toxic difficult assets, illiquid assets, Mr munna: Your “efficiency” may be our the illiquid private equity in the commercial real “avoidance”. Can I just perhaps— estate, were taken out of the deal, and that was agreed. Bo iamo : I don’t think that is the case. The second condition is that we would have a Mr munna: You don’t think that is the case. guarantee from the Federal Reserve Bank of New Bo iamo : I will answer the question directly: I York for clearing and funding on Monday morning for have a high degree of confidence in the integrity, in as long as it took for us to get a shareholder approval the governance and in the people that follow both the that we could provide that guarantee. If those two spirit and the letter of the law in terms of doing the things were approved, we would then recommend the right things in this space. deal to the FSA. Treasury Committee: Evidence Ev 83
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The first of those two was finalised: the exclusion of December you are backdating salary increases and the 60 billion in toxic assets, illiquid assets and hard- you have more than doubled the basic salary cap. It to-fund assets. We did not get a guarantee for funding strikes me that the shareholders are coming off very and clearing. We worked until Sunday morning and poorly here, as the staff continue to be rewarded in therefore we never proposed a deal to the FSA, but large measure by bonuses. Why are the shareholders we were very careful of our risks in doing the deal being treated like this? that we were ring-fencing away from Barclays, and Bo iamo : I think we have to continually come away from any UK risk, the assets that were back to compensation and, listen, I understand there’s troublesome. So I think that’s a much different a lot of debate in the area of bonuses. There’s a lot of perspective on each of those two transactions than sensitivity. I am committed as chief executive to being you gave. responsible and to providing any restraint I can. I can assure this Committee that bonuses aren’t taken Q561 Mr munna: Just in relation to the second of lightly and that we pay what is appropriate to pay for those, didn’t you say to a court over the summer in the reasons I went through, and to have the best New York that, frankly, you didn’t know what you business that Barclays can have. were buying when you bought Lehman? You said I wish I could isolate bonuses and say, “I’m going to there were huge gaps and misinformation. have a good Barclays Capital and I’m going to have Bo iamo : Well, if you take the complete testimony that I made, because of that we priced them a good Barclays retail bank, but I’m just going to accordingly. There were many assets. If we couldn’t decide at the end of the year not to pay anyone”, but tell what was there, we would price them at zero. So it’s not that simple. This is a business where all these we didn’t take risk for our shareholders or risk for the pieces integrate together. UK in doing it. It was why the pricing of Lehman We had a mention of B W earlier. From big bang in Brothers ultimately reflected the volatility in the 1 86 until 1 6, the investment bank of Barclays was market. There were other assets that we took where B W. I’ll be frank; it didn’t pay very big bonuses. I’ll we did know the market price and felt that there was also be frank; it never earned its cost of equity. It liquidity that we could transact at those prices. was a business that had a weak client base, a weak Chair: Thank you for those full answers. international position and had a lot of pushback from shareholders who said, “We don’t want you to be in Q562 Stewart Hosie: Thank you. Mr Diamond, the that business”. I am so proud of Barclays Capital. It’s bank needs to look after the interests of and benefit the only global investment bank that’s been successful its shareholders, staff and customers. How would you that’s been built from scratch. prioritise these three groups? In 1 7, we began building that business and today Bo iamo : Shareholders, staff and customers—I it’s in the top three in the world in fixed income. It’s don’t know how I could prioritise them other than in the top three in the world in commodities. It’s in saying they’re all number one. the top three in the world in raising funds for corporates. It’s in the top three in the world in debt Q563 Stewart Hosie: They are all number one. capital markets. It’s growing. It had an absolutely Okay, but shareholders have seen the dividend go fantastic deal with Lehman Brothers to make it an down from 3 pence a share in 2007 to 2.5 pence in even stronger organisation. It’s client-based. It’s 200 , and you have paid out 3 pence only in 2010— client-focused. It deals with the pension funds in the a peak-to-trough fall of 0%. What’s happened to staff UK, it has been profitable every year since 1 8. It’s remuneration over that period? been at the top of the table in terms of returns on Bo iamo : I certainly don’t have the figures, but capital, returns on equity and a lot of the investors in we don’t relate directly staff remuneration. As I said Barclays are investors in Barclays today because of earlier, the remuneration of staff is a function of the success of Barclays Capital. paying for those people that perform and not the Stewart Hosie: Mr Diamond, finish the answer. people that play up. It’s in line with the G20 principles Bo iamo : I will wind it down, I apologise. and the FSA principles. It has governance from our Stewart Hosie: No, finish the answer. No, it’s all board and the objective is to have the best businesses right. that we can have. Bo iamo : I know it’s long, but I will try and In terms of dividends, it’s a difficult environment for dividends, as shareholders know, because the finish. This team could not have built Barclays Capital regulators would prefer that most financial institutions if we couldn’t commit to our people that we’re going would build their reserves and build capital, so it has to pay for performance, not failure, and that we’re been difficult for investors who are relying on going to do it in line with the competitors. Barclays dividends. Capital doesn’t compete with Lloyds or Northern Rock. It competes with JPMorgan, Deutsche Bank, Q564 Stewart Hosie: I understand the need to back Credit Suisse, Morgan Stanley and Goldman Sachs. the balance sheet. I understand the capital So we can’t isolate bonuses and say, “Let’s leave requirements. Let me tell you what you did in terms everything else in the business the same and just take of total staff costs. In 2007, you paid £8. billion, £7.2 out bonuses”. billion in 2008, £ . 5 billion in 200 and it is pretty Stewart Hosie: Mr Diamond, I understand and I’ve likely the figure won’t be much different from that for allowed you to speak about Barclays Capital. 2010. It was reported also by the ee in Bo iamo : Thank you for that. I apologise. Ev 84 Treasury Committee: Evidence
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Q565 Stewart Hosie: You’re obviously very proud Bo iamo : If you’re asking Antony and me if we of it, but the fact remains that it is the shareholders have a job to do to continue to increase the share who own this. Is it not the case that in terms of price, we do. It’s a high focus of ours and we should bankers as a whole, the bonus pot will be bigger than be held accountable. the shareholder dividend? Is that not the case? Bo iamo : I can only answer it the way I Q570 Stewart Hosie: Can I just ask one final answered it before, which is that there is not a direct question, just on the bonus? relation between those. Our shareholders are very Chair: A very quick one. supportive of Barclays Capital as a business and the Stewart Hosie: Very grateful. You said that you don’t returns it’s given them. take bonuses lightly. You said that bonuses are not Stewart Hosie: I’m sure they are, but if don’t have taken lightly. Do you understand how toxic this issue that information to hand, we can move on. is in the real world, when people can’t get mortgages, Bo iamo : But if you’re sure they are then you when businesses can’t get credit lines? When they would understand why we can’t isolate one piece of hear about £7 billion or £8 billion bonus pools across how we run the business. the banking sector, do you understand how toxic this is in the real world? Q566 Stewart Hosie: I understand your universal Bo iamo : We are sensitive. We are listening. I integrated model perfectly well. I’m simply trying to think one of the reasons I was looking forward to understand why the shareholders are receiving a 0% today was to have an opportunity to try to put some reduction in their returns while the bonus pots have balance and some understanding. I think one of the remained rather significant. Can I ask you: do you things I have to hold myself accountable for, and as decide on the bonus pools before the dividend? an industry, is we’ve done a very poor job over the Bo iamo : The dividend is decided during the years of explaining how the compensation process is year, quarter-by-quarter and half-by-half, so I would integrated with all the other aspects as I talked about. We’ve done a poor job of explaining how investment say it’s actually the other way around. But it’s not banks, in particular, contribute to society and quite fair to say that because bonuses are managed contribute to our clients. I certainly pledge to do more and accrued during the year, so you have some line of in that regard. sight. I think it would be fair to say that they are both I am very, very proud of our 150,000 employees managed in a similar time frame. around the world and how they performed in three very, very difficult years. The reason I’m most proud Q567 Stewart Hosie: Okay, do you think the balance of them is how they have increased their client between the bonus and the shareholder dividend is business and client service. I’m sure you’d like to say right? a few words. But that doesn’t mean for a second that Bo iamo : I don’t think there’s a direct relation we have everything right. I’ve certainly made between the two, but let me answer it a different way; mistakes. I think banks have learned during this I think I’ll ask Antony to speak as well. If you’re process. I think we’ve had positive changes in the asking us whether we are happy with our share price, regulatory environment, but there’s no lack of effort we think there’s a lot more work to do to get the share on our part to recognise and be responsible in terms price up. of being sensitive to this issue.
Q568 Stewart Hosie: Let me just finish on the share Q571 Chair: Before passing over questioning to price issue, because that’s very interesting. The late John Mann, could I just clarify one thing? In response Sir Brian Pitman told the Future of Banking to questions from Chuka Umunna, did you agree that Commission that bankers should be rewarded for you will provide us with a breakdown of corporate tax generating long-term sustainable increase in pay versus payroll tax? shareholder value. Do you agree with that, and what Bo iamo : I didn’t, but I’m sure we can do that. length of period do you consider to be “long-term”? What I was committing to also is—I wasn’t familiar Bo iamo : I think that there’s many measures that with the numbers you had. we should be held to. There was a period of time when Chair: You are going to come back on that, as well? TSR, total shareholder return, was held as the best Bo iamo : I will come back on that, yes, sir. judge of management performance. I think we would say that that probably doesn’t have as much Q572 Chair: Would you also at the same time come acceptance with our owners and shareholders today as back on what you consider to be your fiduciary duty it might have years ago, so we’re shifting and going with respect to maximising tax efficiency? You don’t to shareholders this year on more of a balanced need to answer that now, but that seems to be a scorecard, where it’s return on risk-rated assets, return relevant question in that area of the cross-examination on equity risk management in terms of loan losses, that was not covered. and, most importantly, corporate and social Bo iamo : We have signed—I forget the responsibility. phraseology; I think it is a business practices code. Chair: Come back to us in writing on it. Q569 Stewart Hosie: Does that cover up an Bo iamo : Yes. embarrassment that the share price, which was at 5 8.75 pence in 2001, was set at only 272 pence on 5 Q573 John Mann: Mr Diamond, on how many January this year? occasions have the Prime Minister and Chancellor met Treasury Committee: Evidence Ev 85
11 January 2011 Bob Diamond and Antony Jenkins with you personally, looked you in the eye and asked for our owners and our shareholders, good for our you to feel restraints in the size of your bonus? clients and customers and employees. Bo iamo : They have not. Q578 John Mann: We have had RBS in and we Q574 John Mann: They have not. Can I ask you a questioned them. You and they were after the same philosophical question? Why is it easier for a camel thing. You said at 11.03am today that it was your duty to pass through the eye of a needle than a rich man to “to show any restraint that I can”. So will you agree enter the Kingdom of Heaven? to take no bonus this year? Bo iamo : Do you have another question? Bo iamo : I haven’t been offered a bonus and that’s a decision that the remuneration committee will Q575 John Mann: I have another question if you be taking over the next few weeks. can’t answer that one. You will have heard of the John Mann: Of course it will, but what you stated at banking term “moral hazard”. Have you heard of the 11.03am is that it was your role “to show any restraint new banking term “moral haze”? I can”. So I repeat the question: if offered a bonus this Bo iamo : I have not. year, will you agree to take no bonus this year? Bo iamo : Last year I made a decision to waive Q576 John Mann: Moral haze is Barclays Bank my bonus. The year before that, as you know, I made freezing the accounts of its Jewish customers during a decision to take no bonus. At this time last year, I the Second World War. It’s Barclays Bank in the had not been awarded a bonus and today I have not 1 80s trying to pay for anti-apartheid activists to go been awarded a bonus. The process has not taken to South Africa in order to whitewash the apartheid place yet. I know it is a long-winded answer. regime. Moral haze is not just about paying excessive John Mann: Of course it hasn’t, but if you are offered salaries and bonuses when you helped to create the crisis, but then shrouding them in secrecy. It’s the use one, will you agree this year to forsake it? As you say, of backdating. It’s the use of independent offshore your role, to quote yourself, is, “to show any restraint companies and the loaning of money to such I can”. companies to buy toxic assets. It’s the use of Bo iamo : I think the best answer I can give you supplementary salaries. My question of you, Mr is to go back to how the process works, and if I was Diamond, is: why are you worth all the money that going to make a personal decision I’d make the you are paid? decision with my family, as I did last year. Bo iamo : I wouldn’t know where to begin; you threw an awful lot of accusations out there. I think Q579 John Mann: Some people would like to know you ended with a question. All I can say on my own why, after the sanctions-busting of Barclays with Iran, remuneration is that’s a decision that the board takes. Sudan, Burma and others, there aren’t Barclays I don’t take it. executives in prison. But I want to know whether John Mann: I threw in a lot of facts—not there are any supplementary salaries being paid by accusations, facts. Barclays to try and mask the overall pay and Bo iamo : I’m not sure of that. remuneration of your top people? Bo iamo : You’re not a big fan of Barclays, are Q577 John Mann: You’re not sure? Well, they are you? facts, recorded known facts. You gambled and you John Mann: I am a big fan of getting answers from won. Somebody had to win. Somebody had to lose you. and the rest of us lost. Some banks lost, but the Bo iamo : What question would you like an taxpayer lost. People who are losing services or losing answer to? There’s no secret compensation. I’ve been jobs in this country, across the world, lost. But you through the governance structure; the shareholders were partly responsible, weren’t you? I mean, you ultimately approved the remuneration report. We have tried to bat the question of your role with, for an independent board remuneration committee that example, ABN AMRO, but you were part of the decides all compensation matters. To be quite honest, bidding war. You were part of the cheerleading, in the middle of it, but the media cheerleading alongside, in I’ve been through the governance and the process and order to try and expand the size of the bank. You were the adherence with the principles of the G20 and the up against some that were even more reckless than FSA. My obligation is to run the best business I can you. Those are the facts, aren’t they? You were part of run for the benefit of our owners and shareholders, but the problem that we all now have. Isn’t that the case? also for the benefit of society. Bo iamo : No, we don’t think so. I understand Frankly, the biggest issue for Antony and I is: how do you’re coming at it from a different direction, but we we put some of the blame game behind us? There’s felt our obligation was to our owners. Our obligation been apologies and remorse from bankers. Today, how was to our customers and our clients and our do we get banks in the private sector? We have over employees, our regulators, and we had complete £1 billion of cash sitting on the balance sheets of UK transparency with all of them on our ambitions for corporates. They don’t have the confidence in the ABN AMRO. We felt a number of things, but in economy. They don’t have the confidence in banks particular an opportunity to invest in an outstanding being back and confident and willing to take risk. We retail bank in Brazil and expand our retail banking need a dose of confidence. We need to think about operations, which are in Portugal, Spain, a little bit in what’s best for the economy in the UK and what’s Italy with the Italian operations, were very positive best for jobs in the UK. Ev 86 Treasury Committee: Evidence
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Q580 John Mann: Can I take it from your answer targets is much more weighted towards the salary, that you’re assuring us that there is no use of whereas if you look at banking, the salaries are backdating? This year there will be no setting up of smaller and the bonuses are much, much bigger. Why independent offshore companies? There are going to is it that bankers—not surgeons, soldiers, be no supplementary salaries paid by Barclays? manufacturers or anybody else—need to have so Bo iamo : Our governance is very strong and I much performance-related remuneration in order to do don’t know— their job? John Mann: Whether it is transparent is the question. to y ki s: If I might make one point: in the Bo iamo : I’m having a hard time following the retail bank, for which I’m responsible, we employ question; I apologise. There are no secret about 35,000 people in the United Kingdom. The compensation arrangements—I can assure that, yes, median salary for those people is about £25,000. That and there haven’t been in the past. is about the average. The bonus component would be between £1,000 to £2,000. So for the vast majority of Q581 John Mann: Let me finally ask you the our colleagues within Barclays it is exactly as you’ve question I asked before. Why is it easier for a camel articulated. The philosophy of compensation at to pass through the eye of a needle than a rich man to Barclays, as Bob has said, is very much to pay for enter the Kingdom of Heaven? performance. We use that £1,000 to £2,000 to Bo iamo : I’m still stuck on that one. incentivise our colleagues to go above and beyond in John Mann: We call it business ethics. the course of the year. Chair: People have been stuck on that one for many thousands of years now. You did provoke it though, Q584 John hurso: I do not want to ask you Mr Diamond, by starting with 16 0, and you would specifically about Barclays—and we have this number expect the Committee to move back a bit further than of £7 billion; it might be £6 billion, or whatever—but that when you get on to historical analogies. Can we how much of that big pot is going to the people you have John Thurso please? describe? Because obviously if you have a great many small amounts, you can get to a big number. How Q582 John hurso: Can we look at bonuses—not in much of that big pot is going to the guys who get relation to either you personally or to Barclays, but the telephone numbers that everybody reads about in just to be a little theological about it all? There is this the headlines? big number of £7 billion as being a pot that is out to y ki s: As a rough guide, between 8% and there, and there is a civil war that has been going on 10% of our total employment costs in the retail bank between Government and banking and between around the world goes in what would commonly be politics and banking, which is probably not terribly referred to as bonuses. That is for the retail bank. The useful to either politics or banking. So I would just retail bank around the world is about half the total like to try to get to understand what the bonuses are employee base of the Barclays Group. and why they are necessary in banking. Who gets a bonus and why? Q585 John hurso: I understand that, and I’ve also Bo iamo : If we step back from that for a second, looked at the numbers of all the banks, and no matter what role you have in Barclays, 150,000 people, whether you’re entering orders from clients in remuneration varies between about 35% and 5%, but Glasgow, whether you’re working in Bangalore, in that includes the bonuses. But my question was not one of our service operations or whether you’re a actually that. My question was: how much of the total trader on the gilt desk in the UK, our objective is to pot goes to those kinds of people? Say it is £7 billion, evaluate and put people in that role who are the best for the sake of argument. Is £5 billion being paid out possible people for that job in that location at that in £1,000 bits to hundreds of thousands of employees compensation level. around the world and £2 billion going to people who When we’re hiring those people, we’re always get very big amounts? What is the relationship, thinking, “What’s the appropriate compensation for roughly? those people in that job, in that country, in that role?” The point about this is that if we are all screaming at Whether it’s in operations that Antony runs in Africa you for £7 billion, and it is made up of lots of small or India, or whether it’s in operations here, that’s our amounts to lots of deserving people, then maybe we starting position. I think a lot of the noise is in need to rethink, but if 10% is going to those people investment banking where some of those positions and 0% is going to 100 people, then maybe you need have higher benchmark compensation. As I said, in to rethink. building Barclays Capital, we never had an objective to y ki s: I understand the question and the of paying more than was necessary to pay to do the visibility that I have is into the businesses that I am business. responsible for. I don’t have the same detailed visibility, as you would understand, into other parts of Q583 John hurso: Can I ask you as part of that the group. I think it would be fair to say, though, that answer to say why it is that bankers need so much our piece of the total compensation bonus pool would performance-related pay? If you do an analysis of be relatively smaller than that of Barclays Capital, for senior executives in many other companies, the obvious reasons. The point that I did want to make, amount that is paid as salary to just do the job because though, is— you’re a competent professional and the amount that Chair: Perhaps you can give us a rough percentage. is paid for doing particularly well and achieving Can you do that for us, please? Treasury Committee: Evidence Ev 87
11 January 2011 Bob Diamond and Antony Jenkins
Bo iamo : I think, to your point, the majority of And if you want to be here, you’ll have to pay them what is often described in the industry as “the pool” here. So the question is much more of a one for is in investment banking. I think that’s what you’re society: do we want that? If we don’t want it, then asking. I don’t have the percentage off the top of my we have to give up merchant banking and investment head, but it’s the majority. banking in the UK. That’s the choice that is before us. John hurso: But probably more than half? Bo iamo : Yes, but I think it’s a bit more nuanced Bo iamo : Yes. than that. Would you feel the same way if it was a Chair: Perhaps you could provide it. We recognise US-based firm with people located here, as it is with the competitive aspects to this, for you as a firm, so a UK-based institution with people located here and in you can put it roughly. New York? Many of our high-paid people in Barclays Bo iamo : I think I can give you a rough Capital don’t reside in the United Kingdom and don’t breakdown, yes, without compromising the do business here; they’re in the US, Japan or China. competitive nature. The benefit to the United Kingdom of having Barclays Capital are all the benefits that come from having us Q586 John hurso: The question I come back to is: located here because we are doing business in China. why do bankers in that area of investment banking That works in a couple of ways, John. That works need so much remuneration? Supposing they were with our UK corporate. If you look at the FTSE 250, getting £2 million a year, will they work harder for over half of the revenue of the FTSE 250 companies £ million or less hard for £1.5 million? Or are they comes from outside of Britain. We’re able to work competent keen professionals, like you, who probably with our closest clients, because we are the number wouldn’t work any harder or any less hard whether one investment bank for that UK client base, when you doubled it or whatever? I am trying to understand they’re doing business in China and in India. Tesco is why it is necessary. a good example. Almost all of their job growth and Bo iamo : They are questions we ask all the time, investment has been in China and India—or a large and that’s why we benchmark all the time. As I said, portion of it; I shouldn’t say “all” of it. That’s an most of the higher-paid people have no guarantee in overstatement, and I apologise. terms of their compensation. To your earlier question, Equally—and this is a very important thing— which is, “Why is it a smaller salary and a higher traditionally, if I said, “Where are the 500 biggest incentive?” it is so that we can be flexible, based on companies in the world located?” everyone here performance. would kind of think, “US, UK, maybe a few European I think the situation we face is that in order to build a countries”. And that’s been true. Five years ago, only business like Barclays Capital, in areas like equity 8% of the top 500 companies in the world were capital markets, we’re competing with Goldman located in Asia. Today, it’s almost 25% and by 2015 Sachs, with Deutsche Bank, with JPMorgan. One of it’s going from one third to 0% of the 500 biggest the things that our remuneration committee stays very companies. close to, and we have outside consultants that help Some of those are UK and US companies relocating, provide it directly to them, is to benchmark both the but many of them today are the SMEs or small performance and the compensation. One of the tough businesses in China or in India that are growing. I questions—and I said this earlier—is you can’t just think, in the UK, we want a bank that has the capacity isolate compensation and assume that all the other to service those people, as well as service a farmer in performance is there. Wales and a small business, because the farmer in The other option is that we don’t have investment Wales needs access to the kind of things that we can banks located in the UK. I don’t know how that makes do and the skill sets that we have, because of those the system safer or sounder if we have firms from the operations. I do think that this is ultimately a decision US flying in doing business here and then going back of: why would the United Kingdom not be proud to to the US or going back to Germany. I do believe have one of the world’s best investment banks located that having a UK-based investment bank in Barclays here? But there is an option to say we only want Capital, competing for the best talent in the world, foreign investment banks doing business with our doing business with our UK companies and our UK UK business. corporates and being located here, is an advantage to the UK. It’s not a disadvantage. I don’t know how Q588 John hurso: At the end of the day, the point the system would be better if these people were just for policymakers is that it isn’t the plain vanilla choice located offshore. of having jolly good merchant banks, but we won’t pay them bonuses. Q587 John hurso: What we’re getting to the heart Bo iamo : Right. of is that you at Barclays and no other bank can get John hurso: We either have to accept your bonus off the bonus treadmill. If you wish to exist, and if culture, because we can’t change it, or we end up you wish to exist in the UK, you will be competing without the banks. That is the actual nub of the with all the people you’ve named throughout the question. world, because that is the system. Bo iamo : And accept that it’s competitive. It’s It’s not about money; it’s just about measuring how benchmarked. There is good governance. There’s good they are. It’s just a way of getting more brownie good management. There’s claw-back. All the things points, almost. If you want the top guys, the guys who that we’ve talked about we can do: the FSA measure themselves, whether it’s in Learjet options or principles. But I think you got to the heart of the in whatever it is, you’re going to have to pay for them. question, yes. Ev 88 Treasury Committee: Evidence
11 January 2011 Bob Diamond and Antony Jenkins
Q589 Mr Mudie: Can I just put it to you a different Chair: Just to be very clear, George’s question is why, way, less friendly—not unfriendly, but more blunt almost uniquely, does this industry require such huge than John? A teacher or a nurse, or even a surgeon bonuses? listening to this conversation would wonder why you cannot motivate people other than by paying them Q591 Bo iamo : I don’t think it’s uniquely this huge bonuses. I’d like to put it this way. You’re into industry, but I think that doesn’t matter. I think the football. Last weekend, Sir Alex Ferguson, Fergie, question is: why this industry? And I think the market was playing hell about agents. He said, “Do you know and performance are what determine it in certain roles what one of them tried to do? We went to sign this and certain jobs in the industry. striker. We offered him the usual Premier League wage for a good striker and his agent said, I want a Q592 Mr Mudie: Okay, I think that’s probably about bonus for every goal he scores’ and Fergie says to the the best you’ll get, but I think you’re doing yourself directors, What the hell are you thinking about? Why a disservice. You said you were sensitive, you’re did we pay that money for him and why are we paying listening, you understand. We’re going to go through that salary? We expect him to score goals’.” the worst year we’ve had for decades. Hundreds of Now that teacher, that nurse, is baffled by this because thousands of people are getting their redundancy if you offered them a million quid and said, “Go notices as we speak. The public sector is cutting; the through that wall”, they’d go through the wall; they’re Health Service is cutting. People are going to get very going through the wall now for a pittance. Why do angry and there is a lack of transparency and you have to pay these obscene bonuses to these self- straightforwardness for the banks who, your own styled masters of the universe to do a job when you’re chairman accepted, played a very great part in landing paying them a very decent remuneration in the first us where we are. If you’ve had a tough year and you place? Are you lacking something, Mr Diamond, in think you’ve had some criticism, you haven’t. When terms of motivation that you cannot pay someone £2 ordinary people are on the street, losing their houses million or £3 million and expect them to deliver for and cannot look after their kids, you’re going to get £2 million or £3 million? worse. Bo iamo : George, it’s a question I’ve been asked I can’t understand why you are simply not more before. I myself have recognised, with now becoming upfront in terms of the information. When you were chief executive, the number of references to me as an asked about bonuses and income levels, you said, “It’s “American investment banker”; I think it has become nothing to do with regulators; it’s nothing to do with Government; it’s a market and it’s a matter for the one word now, not three words— shareholders”. The Chairman took you through it. “Americaninvestmentbanker”. So you should know You’ll tell the shareholders everything except the level who I am, because I’m very different than that and I of remuneration for the bonuses you’re going to give understand what you’re saying. I grew up in a small to people. You’ll tell them after you’ve given them. town in Western Massachusetts. My great-great- Now, Bob, put it in straightforward terms. If I were grandparents on both sides of my family emigrated one of your shareholders—a big institutional one, from Ireland to Massachusetts. I was the oldest son mark you, because you’d pay attention to me rather of nine children. My mum and dad were both school than if I owned some shares—I own the business and teachers in the local community at the local schools. I trust you and I’ve appointed you, but I’d still like I learned at a very early age, earlier than I would like to scrutinise what on earth is going on. Specifically, to admit, that if I wanted a new shirt or a football or shareholders, on what you’ve said today, cannot a bicycle, I was going to have to pay for it myself. scrutinise pay below board level. They also cannot When I had an opportunity to go to a private college, have information on pay levels and structures of any I was the first member of many generations to do it. I staff earning more than the members of the board. Do paid my way. you think that’s a way to treat the owners of the firm? Bo iamo : George, I would treat a small Q590 Mr Mudie: This is very nice, but it’s not shareholder the same as a large institution. I certainly getting to the point, is it? You have me with tears would for you. We are sensitive to the issues you coming down my cheeks. “My Irish-Scottish raise. It is going to be a tough environment. Any way background”—oh, it’s wonderful. I can hear the you look at it, it’s likely to be reduced employment in bloody bagpipes going, but how does it— the public sector. We support the moves and honestly Bo iamo : I understand the benefits that I have believe that the best thing we can do is to run this had in terms of career opportunities. I understand the bank so well and to work so closely with our benefits that people have had in terms of financial customers and clients, that we’re doing everything we rewards. But I’m going to come back to the point, and can to help shift— it was a point that has been brought up a number of times: one can’t just isolate bonuses and say we’re Q593 Mr Mudie: No, but what about your owners? going to have all the other benefits of business, but If I were a big institution—the ABI has said on behalf just exclude those, because in certain businesses we’re of their members that they want this information. You dealing with a global talent pool. are saying to the owners of the firm, “None of your Chair: Yes, okay. George’s question is— business, I’ll tell you when you read it in the papers”. Bo iamo : What we can do is we can have good Bo iamo : We’re not saying that. governance. I’m trying to get to the answer, Chairman, Mr Mudie: That’s not acceptable. which is it’s benchmarked about— Bo iamo : We’re not saying that. Treasury Committee: Evidence Ev 89
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Mr Mudie: Well what are you saying then? of them declared themselves “satisfied” with the Bo iamo : What we are saying is that our owners service they received and current accounts. This is and our shareholders approve our remuneration report you, Antony. Direct and Virgin received 88%. Then and are very supportive of us running the business the we move to, “Would you recommend this bank to a way we are. friend?” Minus 35 was your score. Some of the other banks didn’t come out so well either, so I’m not Q594 Mr Mudie: Where is the level of individual having a go at Barclays, but is that not just an bonuses for the investment side? I’ve gone through indication of the lack of competition—the lack of your remuneration report. It’s not there. It doesn’t tell being able to switch, of publicity about switching and you anything about the levels of bonuses you’re going publicity about charges et cetera—that you can treat to give to individual people, how many people are your customers like this and still retain them? earning more than £1 million and who is the highest to y ki s: Thank you. I’m very glad to be earner in the firm. It’s not you, surprisingly. So who asked a question on this point. Firstly, let me say that is it? How many millionaires do you have on your the data that you are referring to from Wi does books? Now, those are straightforward questions that not agree with our own surveys. Our own surveys I as an owner would say I’d like to know. Is that not would suggest that about 0% of our customers would reasonable? say they are satisfied. Can I just ask you something? You might think I’ve been a bit hard with you, and I have been, but you’ve had the opportunity and Walker has put it on the table. Q598 Mr Mudie: Antony, when I was in local I accept a bit of the argument about competition and government, every survey we did said we were competitors and so on. I accept part of that, but is perfect, and I learnt very early on not to pay any there any middle ground between your present attention to your own surveys, but there you are. position which is, “I’m not telling you”, and Walker to y ki s: The surveys that I’m referring to are saying, “Put them in bands of specific”? It seems to conducted by an independent third party. me as an old negotiator that there’s a hell of a lot of Mr Mudie: So was ours. We paid them, though. space between you and Walker. It would be very well to y ki s: Let me answer your question. received, and you would be leading if you started to Mr Mudie: Yes, sorry, aye. put some proposals on that said, “Yeah, we’ll give you to y ki s: About 0% of our customers would a bit more transparency”. say they are “very satisfied”, “satisfied” or “somewhat Bo iamo : I appreciate you saying that and I satisfied”. 5% of our customers would say they are think, as Sir David said, the proposals that he made “dissatisfied”. About 80% of customers would on banded disclosure, which I think you’re referring recommend us to a friend or colleague. However, let to, would not be appropriate to be done in isolation me say that, firstly, I believe that the basis of without the European banks and the Americans. competition in UK banking—UK retail banking, the purpose of this inquiry—is intensifying around both Q595 Mr Mudie: No, I heard that, but I just put a service and product provision. Competition is clearly position to you. You’re in Britain leading one of the there around price. It is our intention, in Barclays, to leading banks. There is going to be hell on the streets continue to improve the level of satisfaction that our in the months we have, and for you to say, “Yeah, I customers have with what we do, because we know understand—never mind Europe—I can live with this that that’s a competitive advantage. Ultimately, that’s sort of transparency”. At the moment, there is no good for our customers, but it’s also good for our transparency. Your position up to date, speaking to the shareholders and our colleagues. Chairman’s first questions, was: “and there’s not going to be”. I don’t think that’s a sensitive listening approach, especially when there’s a fair bit of ground Q599 Mr Love: I want to come on to project Merlin that you can move on without damaging your in a moment, but let me refer back to a question that business. Mr Ruffley asked earlier on about the Banking Bo iamo : I hear you. I do think that we’ll find Commission. Would I be correct in interpreting what consistency across the G20 and Europe over time, but you said to the Committee as being that regardless of I suspect it won’t be this year and we have made a the recommendations of the Banking Commission, or decision, for commercial and competitive reasons, that indeed any legislation that might follow, Barclays we didn’t want to act alone, but I certainly hear you. headquarters will remain in London? Bo iamo : I think what I’m saying is that’s our Q596 Mr Mudie: Bob, the great advice from intention. One can never make a guarantee, because anybody on this Committee is do not wait for you never know what’s going on, but I think that if Europe—do it yourself. You said that you were led by there was any concern in this Committee that our your customers, “I run a customer-sensitive bank”. intention to was move out of the UK, that’s certainly This is not an attack on you. You are supposed to be not our intention. We always have— here answering questions on competition and choice Mr Love: So all those media reports are inaccurate? in retail banking. Bo iamo : That’s what I’m saying, but I’m not Bo iamo : I was hoping you’d bring that up. giving an iron-clad guarantee. One never can on something like that, because you don’t know what’s Q597 Mr Mudie: We are there at last. Wi happening, but I want you to rest assured that this is suggested that, when they asked your customers, 53% the place where we want to be. Ev 90 Treasury Committee: Evidence
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Q600 Mr Love: How do you respond to the Q602 Mr Love: If I may say so, there are lots of unanimous, I may say, headlines in today’s reports going round. The view that has been taken in newspapers? I will choose one to quote from, but they the City is that the time for gestures has passed— are all pretty similar: “Ministers cave in to City over “gestures” meaning what happened to bonuses in the bank bonuses”. Is that recognition that the last two years. You are signalling nothing today that Government has no role in this area? real restraint will be exercised. Are you going to give Bo iamo : I think there is, whether we like it or leadership in relation to this? You are the chief not, a role for Government in the banks that have a executive of one of the four or five biggest banks here significant shareholding by the Government. It’s their in the City; it is incumbent upon you, if you so right, since they have that. I think in terms of choose, to exercise restraint and I would ask you to governance and all the things that I’ve talked about, tell this Committee in which ways you will give there’s a role for Government, but I think we should leadership in exercising that restraint. be running our businesses in the best interests of our Bo iamo : I think I’ve answered the question owners, of our clients and customers, of our very directly, and I’ll do it again. I think we have to employees and also our regulators, who are a part of balance the responsibility we have and the recognition the Government here. So I think it’s a balance of all of the environment we operate in. I think we have to those things, yes. recognise that the system needs to be safer and sounder in terms of how compensation works, but I Q601 Mr Love: That is going to place additional also think it’s in the best interests of everyone in this responsibility on Merlin, these meetings that are country that we shift the mantle of growth to the taking place, but I will come back to that. Mr Thurso private sector and that banks in the private sector have mentioned earlier on that the speculation is that the competence, work together and are willing to take overall level of bonuses will be about £7 billion, risk. I don’t agree, sir, that I can isolate bonuses and which is slightly less than last year because of market assume that actions on those have no consequences conditions. The Government, through the Prime on the rest of the business. I have to balance it. That’s Minister, has been asking for further restraint. my job as chief executive. Barclays is estimated at £2.5 billion. It is suggested that your bonus might be somewhere in the region of Q603 Mr Love: Well, let me come to project Merlin. £7 billion to £8 billion. Now, you have just taken over These are the meetings that have been taking place as the chief executive. What leadership are you going between the chief executives of large banks and to show in exercising restraint in all of those areas? financial institutions and the Government. Your Bo iamo : I think most of the numbers that predecessor was very prominent and in a lead role in you’re referring to are speculation of the press as relation to that. Do you intend for Barclays to opposed to anything that we’ve reported. As I said, continue to play that lead role, and what discussions— the businesses will meet with the remuneration I was rather surprised to hear in an answer earlier to committee and the board over the next couple of Mr Mann that you have not had any meetings with weeks to determine first the allocation of remuneration either the Chancellor or the Prime Minister in relation in general and then allocation to individuals. to Merlin or what it’s choosing to do. What role are Mr Love: Well, I understand that. You said that you going to play in Merlin? earlier on. What I’m asking you is you are now no Bo iamo : I apologise if I answered the wrong longer the chief executive of BarCap; you’re the chief question; I thought the question was directly about my executive of Barclays PLC. That puts you in a compensation. I have had meetings on Merlin. I’m leadership role. You have to exercise leadership. What very involved, but as you mentioned, John Varley has leadership are you giving in relation to the request, taken the lead in those discussions and there certainly made through Merlin, that banks exercise restraint in have been discussions between John and other banks terms of the bonuses that they will pay this year? and both the Chancellor and the Prime Minister. I will Bo iamo : Well, I think there are a couple of say that this was all secret, so no one knows about things. I think, as you know, there is a public record it—or private, I should say—but it’s certainly been in of compensation arrangements for the time that I’m the papers, so I don’t want to avoid having the chief executive going forward; that’s on public record, discussion. and I think it is in line with what would be expected I’m pleased to say that John, although he’s handed for that role. Both Antony and I have also said that over the reins as chief executive, has agreed to stay we recognise the need to be responsible and show on, working with both me in my role as chief restraint. We have no intention of paying more in executive, and the board, around issues just such as bonuses than is necessary to balance all the things, this. He is still very active, with my full support and and to all of you, we’re reaching out to say we our board’s total support, in the spirit of trying to get recognise the importance of a safe and sound financial an agreement on Merlin. So yes, we do hope to system, but also the importance of jobs and economic continue in that regard. I’m operating through John, growth. We can’t isolate bonuses completely and but I don’t mean that in any way to mean I’m pretend that the actions on that would have no uninvolved. It’s just wonderful to have John, who’s consequences on the rest of the business. We have to taken a leadership role, to stay with the bank, to help balance these things, and we’re going to make us both with the Independent Commission on Banking decisions that we believe will be in the best interests and the information that they may need over the next of the United Kingdom. few months. Treasury Committee: Evidence Ev 91
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Q604 Mr Love: I respond to your answer with some Bo iamo : Well, I’ll give Antony a chance to dismay. I would have thought that if Merlin was to be speak to that as well, because it’s an important given the high priority that Barclays has given it up question. I hope today was an opportunity for me to until now—this is no comment on Mr Varley; I know give a different perspective and for me to give a that he continues in a role within Barclays—but it perspective that, although I would like to be able to needs the current chief executive officer to be totally isolate bonuses and solve an issue around bonuses engaged in that process. It comes as a surprise that without consequences on the rest of the business, you are not. that’s not in my gift. I ask you again: are you intending to give a lead in I’m a businessman. I’m running a business. And what relation to Merlin, and not only in relation to the bank I can pledge to you is that we’re trying to balance bonuses? Earlier on, Mr Ruffley asked about finance what our owners want and our shareholders want with for small businesses, which is probably more critical, what’s right for our clients and customers—whether a although perhaps less a current issue amongst the farmer in Wales or a businessman in Manchester— public. On those two issues, surely you must be with 150,000 employees around the world, and a directly involved? responsibility to the communities in which we work. Bo iamo : Well, going with the small businesses, At Barclays, we are very responsible to our again, you’re absolutely right, and I hope we were as communities. positive as you wanted us to be. It’s hard to give I know—and I’m aware, and Antony’s aware and specific targets, just because of the risk management everyone’s aware—of the emotion around the issue of issue, and you can’t predict demand or who the bonuses. So what I have pledged is that we recognise customers are, but if I left any doubt that we are the need for as much restraint as is possible within the committed to serving the small businesses in Britain, context of the other issues, and that we are responsible I apologise, because it’s a business that’s extremely citizens of the world and citizens of the United important to us and we recognise our obligation. Kingdom. We do pledge that. Maybe you can say a few more words on that. to y ki s: And if I might, we opened 100,000 Q607 Michael allon: When you were awarded your start-up accounts last year for small businesses. That’s own bonus—I think it was £6.5 million in 2007—did the largest number of start-up accounts we’ve opened the then Labour Government ask you to forgo any in the last five years. of it? Bo iamo : In 2007? I don’t recall anything to that Q605 Chair: How many did you close? effect, no. to y ki s: We closed very few indeed. We’re there, supporting our customers, lending money. As Q608 Michael allon: When you decided to waive Bob has said, though, demand for credit, particularly your bonus in 2008 and 200 , was that at the formal in the SME sector, has contracted because customers request of the then Government? are less confident about the future. Bo iamo : No, sir. Bo iamo : But Chairman, we have the capacity to lend if there’s demand. We have a willingness to lend, and it’s not just because it’s the right thing to Q609 Michael allon: In fact, did the last do—it is the right thing to do—but it’s also our core Government ask you to forgo any of your business. We like lending to our customers. remuneration over the last four years? Bo iamo : Personally? Q606 Mr Love: I have one final question. I would Michael allon: Yes. say in relation to small business finance that I’ve been Bo iamo : No, sir. bemused: on one side the banks are saying there’s Michael allon: Thank you. plenty of credit out there available, and small business organisations are saying exactly the opposite. We have Q610 Chair: While we’re on remuneration— now had the Bank of England, in a very forthright Mr Mudie: That was a party political broadcast on report, saying the terms of much of the finance that is behalf of the Conservative party. available are too onerous for many small businesses, Chair:—and trying to be a little less partisan, I want and I do think the banking sector needs to look to clarify the position on information to shareholders. carefully at that. I hope it will do it through Merlin. Can I be clear that shareholders have not asked you There is a final question I want to ask you, and in a for any information at all about this year’s bonus sense it’s a plea. It reflects the two main public round, and that you have not been in discussions with responses to what has been happening in our banks, them about this year’s bonus round? and in particular in relation to bonuses. We are always Bo iamo : Other than the ongoing discussions we told, “We’re all in this together”. The Deputy Prime have with major shareholders around the issues I Minister tells us that banks live in a parallel universe talked about in terms of the process, the governance— to where everybody else lives, and I think that’s been Chair: Yes, we’ve discussed that. reflected around the Committee today. What can you Bo iamo : Yes. Sorry, I didn’t want to give an say to us that will get us to understand that you incomplete answer. Other than that, there’s been understand exactly what the public feel about the way nothing specifically asked for by shareholders, but I in which these issues have been handled by the would remind you that we haven’t determined bonus banking sector? pools yet. Ev 92 Treasury Committee: Evidence
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Q611 Chair: Do you not find it surprising that Jesse Norman: So in other words, the retail side of shareholders—and you yourself have said that the bank—the 75,000 employees of the bank, half the shareholders should play a major role, and that you employees of the bank—earned, or can expect to earn are accountable to them with respect to if the compensation pot is about the same now, about remuneration—in this year, of all the most sensitive 6% of the total bonus pot, and % goes to the 75,000 years, should not have even asked you for this people who are not on the retail side of the bank, on information, still less tried to influence your decision? those numbers? Bo iamo : The conversation is more nuanced, I to y ki s: I think the math may not be quite as think, than we’re letting on. There are— extreme as you’re articulating, but I’m— Chair: Well, it’s pretty straightforward, is it not? Jesse Norman: Well, I am just drawing it out. I’m Facts are what they need. not making a claim. Bo iamo : No, there are conversations all the to y ki s: As we previously discussed, the time with shareholders around how we run the majority of the variable compensation regarding business, and cost and compensation are a part of that, bonuses would accrue to the Barclays Capital so I think to jump to the conclusion that they’re colleagues, and the reason for that is exactly what uninterested—please don’t assume that our Bob’s been saying about pay for performance and the shareholders aren’t incredibly involved, incredibly nature of the market. bright and good at what they do. They’re very focused Jesse Norman: Right, but it does look as though, just on evaluating Barclays as an investment. I think cutting through it, the least well-off employees in the you’ve talked to many shareholders as well, so— bank are getting 6% to 7% or 8% of the bonus pot, and the most well-off employees of the bank are Q612 Chair: They are interested, clever and getting %, or around about that number, of the uninformed; I think that would be a correct summary. bonus pot. You do not disagree with roughly those Is there any aspect of what I have said there that you numbers? would like to correct? to y ki s: Well, of course the logic is that the Bo iamo : I think they’re very informed about people who get more of the pot will be more well off, how we run Barclays. that’s right. Chair: But on bonuses, they don’t know what you’re paying. Bo iamo : They don’t have disclosure of Q614 Jesse Norman: Mr Diamond, you have talked individual numbers, that’s correct. very eloquently about the bank taking deposits in Chair: And they have not asked for them—so they’re 16 0 and you have said that you could not be prouder recumbent, half asleep. of the build-up of Barclays Capital. You must have Bo iamo : Well— been thrilled to become CEO. Chair: Okay. That is a matter for corporate Bo iamo : Yes. shareholders. Jesse Norman: Having not, as it were, the last time Bo iamo : I don’t agree with how you round when John Varley was appointed. All the more characterise our shareholders, no. so for that feeling of running the business in the interim, the culmination of— Q613 Jesse Norman: Mr Jenkins, did you say that Bo iamo : John Varley was appointed, and I was there were 75,000 employees in the retail business a big supporter of John’s, so, no, I was delighted. I around the world in Barclays? said earlier it’s both an honour and I’m very to y ki s: There are about 70,000, yes. motivated. Jesse Norman: And their bonus compensation would be of the order of £1,000 to £2,000 on average per Q615 Jesse Norman: Would you have done the job person? for nothing? to y ki s: On average, yes. Mr Love: A leading question. Jesse Norman: So the average comp for them would Bo iamo : Again, you’re asking about decisions be about £150 million to £200 million on that side of that are not mine to make. the business. Do I have that right? 75,000 times Chair: So these bonuses were forced on you by the £1,000 is £75 million— Remuneration Committee. to y ki s: You’re talking about the variable component. Q616 Jesse Norman: I raised the topic in a serious Jesse Norman: Yes, the variable component. spirit. We are looking at a car crash potentially taking to y ki s: Yes. place in front of our eyes over the next few weeks and Jesse Norman: Yes, absolutely, so it’s the bonus side, months in the clash between public expectations and if you like. What was the bonus cost for the whole outcomes in this issue, and I have sought to be very bank two years ago, Mr Diamond? serious about it. And I think the public is not just Bo iamo : I do not have the number. I know the looking for the usual answers or guarantees of future compensation— well-being. It is looking for some kind of payback Jesse Norman: Of the order of £2 billion to £3 and some kind of recompense. I want to ask you, Mr billion, pre-crash? Diamond, whether you would support the idea of a Bo iamo : Prior to the crash? big society community fund into which your Jesse Norman: Yes. employees could be invited to voluntarily put, say, Bo iamo : Probably in that order. 10%, or a proportion, of their bonus—as a gesture Treasury Committee: Evidence Ev 93
11 January 2011 Bob Diamond and Antony Jenkins of the kind of community leadership you have talked And I recognise it’s not pleasant for us at Barclays about before? that so many of the people just say, “All banks are Bo iamo : There are 60,000 of our employees bad and all banks made all the mistakes”. Banks did who are actively involved in giving their time back make mistakes. But I think we’re very proud that we personally to the communities in which they work. managed through this period profitably, improving the The amount of money that’s raised by putting a lives of our customers and our clients and improving percentage of what we earn into our communities here the financial ratios of the bank. I think that’s a in the UK and around the world, and the incredible different position to be in. amount that our employees give, both of their time and of their compensation, is something we’re both Q618 Andrea Leadsom: Mr Diamond, over proud of and we encourage. Christmas I read my seven-year-old ee I think it’s difficult in a public hearing like this to talk We s t es. I feel very sad about this, because about any specific initiative away from all the things having a great fondness and a great familiarity with that are done at Barclays, and the way that we want Barclays, I think there is some kind of fantasy story our employees to have a choice about those. going on here. You talk about universal banking, and Obviously, the big society has been part of discussions certainly I recall from Barclays days, the dream was in Merlin, and I don’t feel comfortable in discussing to get a multinational corporate global banking—very it, but in spirit, do I think our organisation should be rarely, if ever, achieved—and your argument for giving back to their communities? I certainly agree maintaining the status quo there is that multinational with you on that and I’d love you to come and spend organisations need multinational banks, which I just some time on some of the things 60,000 of our do not agree with. employees do. It’s amazing. We give awards each Your argument about attracting the greatest talent: year, and it’s wonderful to see. Whether it’s in Africa everybody knows in every organisation you have or whether it’s in Scotland, it really is around the perhaps 2% or 3% of true talent and the rest are all world, so I think we agree in spirit. I don’t think it’s fungible. We could have countless discussions about appropriate to discuss specific initiatives here. that, but there is not that massive talent. Through 25 Jesse Norman: Well, I would be grateful for the years in banking, I can absolutely vouch for that, as opportunity to do that and to put a specific proposal, I’m sure you would over a few bottles of wine, in if I might, to you in this area, because I— terms of, “Banks are going to move. If we’re nasty to Bo iamo : I’d be happy to spend that time them, they will move”. offline, yes. The evidence doesn’t stack up. There is no evidence that suggests that banks are all going to move. You Q617 Jesse Norman: A final question. It is evident said yourself today that Barclays is a UK bank and is from a corporate governance perspective that there has likely to stay here. I’ve had similar discussions with been a colossal failure of governance in the banking lots of other banks. It’s extremely disappointing. You sector over the last few years, from which Barclays seem to just argue for the status quo for its own sake. has largely been, shall we say, exempt, but many of You were in denial to David Ruffley about the extent them were run in the interests of their employees, to which the taxpayer has supported you. You say that rather than the shareholders. Now, in the venture you are run by your shareholders, and yet we capital world, the normal practice is that the investor absolutely know that is not true. Corporate gets their money out before anyone takes any profit. I governance, particularly in the banking sector, has don’t know if Barclays has a venture capital business, simply not been strong enough. They do not have but I am sure that would be true of its business if enough information. You are denying a lack of it did. competition in the UK and you are claiming high Do you not think that is a more appropriate model levels of customer satisfaction—hugely challenged within which some of the compensation arguments throughout the industry—and you’re claiming to that are taking place should occur? Government support SMEs, which the CBI and the FSB do not should get its money back, the public should get their agree with you on. It just seems to me that the money back, and then the issue of taking a profit or emperor has no clothes. sharing any profit should take place after that? When we talked about bringing in a banker, I was Bo iamo : Jesse, let me make one thing perfectly jumping up and down and saying, “Oh, can we have clear. You and I don’t disagree in concept on many of Bob Diamond?” in the real hope that you would, as these things, but I’ve been heard to say many times an investment banker, have a very clear, cynical and over the years that strong banks want strong thorough perspective on what’s going on in the regulation, and at first people would look at me like, banking world, but you have given us nothing. And “What are you talking about?” Being Barclays or going back to what Jesse was just saying about who being HSBC, where in this country a couple of large gets paid out first, surely the reason why bonuses are banks did fail and needed a direct investment from the so obscene dates back to the days of the small taxpayer and from the Government—in the public’s investment banking partnerships, where liabilities eyes, too often we’re all the same. They throw all were unlimited. That has simply gone, but the banks as bad, and there’s very little differentiation remuneration is upside only. It’s like playing between them and Barclays or HSBC, who never put blackjack: you keep playing and playing until you their organisation at risk and were profitable through blow up, because there is no downside to you difficult cycles and stayed close to their clients. individually. Is that not the case? Ev 94 Treasury Committee: Evidence
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Bo iamo : No, I would disagree with many things can’t do that. I can’t do that as a job. It’s not within you said. my gift. Andrea Leadsom: Oh, good. Bo iamo : I apologise, because this is going to Q619 Chair: That was a very broad question and you sound like I’m pushing back a little bit, and I suppose gave a very broad answer. Can I pick up on just one I am. To be perfectly frank, I don’t think your point Andrea raised, which was about unlimited experience of B W wouldn’t support exactly what I liability, and link it to what you said right at the said. It was a very small domestic post-big bang UK beginning, a couple of hours ago? What disadvantage investment bank. In its entire history, it never made do you think would pertain to banking, if chief any money outside of the UK or outside of its core executives were subject to unlimited liability? UK business, and frankly, it was trampled by the US While you’re thinking about the best reply to that, it bulge bracket firms. is worth bearing in mind that you have now said When I began with Barclays Capital and we sold parts yourself that there is anger against bankers that needs of B W and used parts of them to fold in, and because to be addressed. From the public’s perspective, might you talked about competition as well, one of the this not be an approach that should be considered? problems of B W was there were only about 2% or Bo iamo : Well, I think hopefully today is a good 3% of people that deserved their compensation. What start at trying to see the other side of the story of the I was shocked at in my first year there was that over bonus debate, of why it is important to get balance 30% of the people in B W received no bonus. It was and why this is important for job creation. I think if my first year, so I said, “We have to peel back the you start to think— onion. Something’s going on. If we give them no Chair: On the unlimited liability point, which is the bonus”—and you’d expect me to say this—“they’re question that I’ve asked. going to leave”. So we peeled back the onion, and of Bo iamo : Let me take on the issue of unlimited the 30% of the people that received no bonus, most liability, but let’s take Bob Diamond out of it, take me of them hadn’t had a bonus in four or five years. They personally out it. were unemployable and there wasn’t a focus on talent Chair: I said “chief executives”. and there wasn’t a global talent pool. Bo iamo : You own, you have a majority When we began in Barclays Capital, I was very ownership in two UK banks. I think you hired a frustrated that Barclays, this prestigious 2 0-year-old terrific person to come in and turn around Royal Bank bank—if I have my math correctly—was not even in of Scotland in Stephen Hester. Would you be able to the top 25 in foreign exchange in the world of doing attract someone of that calibre if there was unlimited transactions. And worse, I went to the UK corporate liability? That’s the question you have to ask. You just clients, Tesco, BT, and they were doing all their hired another outstanding individual—his contract is foreign exchange with Morgan Stanley and with also on display, it’s very similar to the others—at Goldman Sachs, and I can see how wide the spreads Lloyds in Antonio. Would you be able to have hired are. By investing in technology—the BAR him? What would have been the best decision for the platform—which gets straight through processing to United Kingdom to get the best person with a track our corporate clients, by tightening the spreads so they record like Antonio with a competitive compensation get a better deal, we’re the first bank in three decades package, which is what he has—his is very similar to that’s moved into the top three in foreign exchange. mine, and it’s very competitive. I think he is the best We’ve wrestled back the UK corporate business from guy. As a competitor, I say Lloyds just hired a great the US bulge bracket firms, and our customers are chief executive. It’s going to be tough on me. That’s getting better business. the right thing to do for the United Kingdom— So yes, I do disagree with you. I think your experience Chair: I understand. of B W supports exactly what I’m talking about in Bo iamo :—is to get those banks turned around, terms of talent, about focus and pay for performance, get them back into the private sector. Chairman, can I and we need to recognise that actions have say one more thing? I don’t know of a single example consequences. in history—and I’d love to hear from all of you— We do recognise that there is anger against bankers, where a nationally directed financial institution, over and I have said we’ve made mistakes. I’ve certainly time, didn’t end in tears: the Landesbanks we’re made mistakes, but I also feel I’ve been part of an seeing right now in Germany, the Cajas in Spain, organisation that has been incredibly successful Fannie and Freddie in the US, building societies to during a very tough period and now wants to be part some extent here. Nationally directed financial of driving economic growth, driving job creation and institutions are not the right way to go. working more closely with the private sector. Chair: But just to be clear, your answer to my We also support the UK Government. When they question is you wouldn’t get the chief executives— issued gilts to finance the deficit, those gilts aren’t Bo iamo : I don’t think you’d get a chief bought by UK pension funds, they’re bought by the executive. Bank of Japan, they’re bought by banks in China, and Chair:—you need for the job, and therefore, in that takes an operation like Barclays Capital. It’s why Andrea’s terms, we have to carry on playing we’ve been the lead manager of, I think, five of the blackjack’? last eight gilt operations or funding operations. Bo iamo : I really resent the fact that you would I think, as I have said, we can’t isolate bonuses. We refer to this as blackjack or casino banking or rogue would like to isolate bonuses and say, “Make this go trading, and I’ve given the reasons why I resent that. away and let’s have everything else the same” but we I think it’s wrong, I think it’s unfair, I think it’s a poor Treasury Committee: Evidence Ev 95
11 January 2011 Bob Diamond and Antony Jenkins choice of words. You have some fantastically strong to y ki s: It is one of the fundamental financial institutions in this country—and frankly, they questions that this inquiry is trying to address, and let deserve better. me try and talk about it from a few different Chair: I’m sure you understand that we’re articulating perspectives. First—and I think Mr Daniels made this many of the things that have been put to us by others. point—there are many providers in the categories of personal current accounts, SME, savings and so on. Q620 Mr munna: I think the thing is, Mr The basis of competition in the UK is price; it’s also Diamond, in some respects most people just think the on product feature functionality and on service. If you system is screwed and we should change it—for want opened up the financial press over the weekend, you of putting it a better way. You’re saying to us, “That’s would have seen that many of the papers were talking the system as it is” but I think if you— about a war for personal loan prices, certain mortgage Bo iamo : No, I’m not. That’s not true. categories getting much more aggressive, savings Mr munna: You’re not? You recognise— rates improving, so you do see evidence of price Bo iamo : Let’s just talk about the changes in the competition. last three years. Three years ago—I use Barclays as I would also say on service—and I would just like to an example in the industry—Barclays operated on 5% refer back to Andrea’s point—we are in no way happy equity. When the RBS transaction was approved, I with the level of satisfaction of our customers at think it was 2% or 2.5% equity, with their ABN Amro Barclays. We see that as a competitive advantage, and transaction. Today we’re at 10% equity. Our leverage that’s why we’ve just, for example, retooled our debit was 35 to 1. Today it’s about 20 or 21 to 1. card reissue process and collapsed the time it takes The liquidity we hold on our balance sheet was £20 from seven to eight business days down to 8 hours. billion to £25 billion in cash or cash equivalents to The consequence of that was one of our customers make the system safe and sound. Today we’re running actually went through that experience and wrote to at £150 billion plus in cash or cash equivalents in the he n a i es saying what a great experience it balance sheet. The way we do business, and one of was. my big challenges and AJ’s big challenges and our Why did we do that? Because we think we can get management team is how do we operate this more customers, and serve more customers over time. institution—to your point on small businesses—with I think whether it’s pricing, service or product feature much higher cost of capital or much higher levels of functionality, we have over 170 open branches in the capital and therefore higher cost of credit? How do UK—with open counters, no bandit screens, no glass we keep credit flowing to consumers and to small between us and the customer, and customers really businesses, because you’re right, they’re reacting, and like that. By the time we’ve done with refurbishing the terms of lending are much higher now than they the branch network, there will be 00 branches with were a few years ago. That’s how we have to go that facility. We have 8 million contactless debit and forward. We have to find ways to get that flow of credit cards in issue in the UK. That’s four times— credit back to business, even though the cost of credit five times—what any other bank has, so we’re has increased. competing on price, we’re competing on service, Mr munna: Can I ask again? You’re probably—I we’re competing on product feature functionality. The mean, I’m slightly bonused out right now. question is, in a sense, is it getting more intense or Bo iamo : That’s not a bad thing. less intense? Because I do think economic wisdom Mr munna: You’re probably feeling exactly the would suggest that you at least have to ask the same. question when a market consolidates. Chair: It is the last question? Mr munna: I recognise some of what you said, not least because— Q621 Mr munna: I want to actually move on to to y ki s: And the final point I would make— choice and competition. When we had Eric Daniels Mr munna: Sure. here from Lloyds, he was, to the incredulity of the to y ki s:—and I’m sorry to be long-winded, majority of the Committee, asserting that your sector, but the final point I would make is, empirically, if you across different markets—whether it’s credit card look at some of the other witnesses to your inquiry, in providers, mortgage lending or personal current their evidence, they are interested in entering this accounts—was very competitive. This despite the market, and in many cases are entering this market; increase in consolidation and market concentration and they’re also picking off pieces of the market that that you’ve seen, and despite the fact that generally, they find particularly attractive. So my view is that in all of the different parts of the market I have just the answer on the competitive nature of the market is mentioned, there are five or six large providers that actually quite complex, and we are probably seeing have a much greater share of those individual markets competition increasing with some of the new entrants as compared to, say, in other countries—Germany, the that are coming into the market. US and France, for example. Now, in the written submission that you put in on this Q622 Mr munna: As I said, I recognise some of point, you noted the significant change in what you say. One of these branches you have just consolidation in retail banking over the last few years talked about has opened in the centre of the universe, that I’ve just talked about, but yet you conclude that which is my constituency. But I am not sure I buy the landscape remains competitive and dynamic. In what you’re saying, partly because if you, say, look some sense, that is exactly what Eric Daniels said to in the personal current account market—and this is us. How on earth can this be, Mr Diamond? something that Andrea’s brought up with various Ev 96 Treasury Committee: Evidence
11 January 2011 Bob Diamond and Antony Jenkins people who have given evidence—there is very little to y ki s: Again, another topic here. On switching by customers. Are you seriously saying that portability, our view is that the switching process has the disappearance of so many firms and the been made much easier. Now, of course it is possible consolidation that there has been has not had and to create a portable account number for customers. would not have an impact on competition? There is no doubt about that. With enough time and to y ki s: I’m saying that the question is quite money, the technology exists to do that. However, in a subtle one, so let me just talk as a practitioner, as my view as a practitioner, the cost of doing that would somebody who is out there doing business every day. be very significant—at least in the hundreds of It doesn’t feel easy for me to go and win a current millions, probably in the billions. account, to win a savings account, to win a mortgage That cost would have to be recovered; ultimately, it from customers. We have to go and compete on those would have to be paid for by the customer. The real things. The question of switching, which I know has question is whether the benefit of improving the been discussed extensively at the inquiry, has become switching process outweighs the cost. Our view would better and has in fact led to an increase in the rate be that it would not. Essentially, in addition to the of switching. investment required to retool the whole payments Mr munna: It’s from quite a relatively low base, is infrastructure, there would be a massive opportunity it not, Mr Jenkins? cost in the deflection of technology and resources to to y ki s: And I would say that most that sort of activity, away from some of the customers would find that process relatively innovations that I was referencing before in terms of straightforward. Again, there was coverage in the branch refurbishment, mobile, internet, contact lists financial press over the weekend making that very and so on. point. The other point on switching, of course, is that Chair: Perhaps you can give us any further thoughts most customers have 2. accounts. Many of those are you have on that particular issue, which is of with different institutions, so they try before they buy. particular interest to one or two of us—several of the Committee—in writing. Q623 Mr munna: How long would it take for me to y ki s: On account portability in particular, to change my accounts, say at NatWest, to you at yes. Barclays or vice versa? Do you know how long? One thing that has come out in the evidence that we have Q625 Stewart Hosie: Bob, you spoke about the received thus far is that it is incredibly difficult to increase in the tier one capital to 10%, the liquidity change and switch and it takes some time and isn’t so buffer increases to £160 billion and the leverage ratio easy, partly because of the transmission systems that reducing from 35 times to 20 times, and that’s all are in place. good. But in your submission, he act to y ki s: Yes. My evidence is that switching e at e n C etiti n, you said that would take between five to 10 business days to close prudential reforms to strengthen financial stability the account and open the new one. There may be a “will make it more difficult for banks to achieve target period of two or three weeks after that when the direct returns on capital that are acceptable to shareholders”. debits get switched over, which is a process that is I’m just wanting to check: you would not intend or operated by the originators of those direct debits. At seek to roll back Basel III in any way, would you? Barclays what we do is make sure that the customer Bo iamo : No, not at all. It’s a good question. is not disadvantaged in that process. What we are saying, though, is that—the only For example, we provide an interest-free overdraft for difference I’d say to what you said would be it was 0 days while everything settles down and the salary core equity we talked about, not tier one. But if I said cheque comes into the account and so on. So the that to you, I want to apologise. industry has, I think, come a long way in terms of Stewart Hosie: No, it’s okay. making the switching process easier for customers. Bo iamo : It’s hard to say did Basel come out We do see switching in the UK, and in many perfectly—and you’ll get different views from categories of product we see intense competition. For people—but we think by and large these higher capital example, Barclaycard right now has a 17-month ratios do make the system safer and sounder, and we balance transfer offer out in the market. That’s the can operate within them. I would give a caveat that longest balance transfer offer that there is out there. there are still some things that haven’t been certain. Is We’re very competitive on mortgage, on savings and there an additional buffer for counter-cyclicality? Is so on. there an additional buffer for strategically important financial institutions where we think we would fall Q624 Mr Love: I wanted to ask you a general within that? So it’s not final. question about barriers to entry, because others have The other thing that’s been terrific, I think, is it has come to the Committee and said that the implicit been truly a G20 co-ordination. As you know, the US subsidy, the fact that there is such concentration banks weren’t even on Basel II, so to have the US makes it almost impossible for them to enter the banks in a different capital ratio—so we are broadly market. But the question, in a sense, that I want to put pleased. But what I would say—and I think this is to you is that it was ultimately put to us that if you important for the Committee to understand—is that if had portability of account numbers, this would make you look at bank returns on average before the crisis, the difference to switching and make it much easier. they were kind of at 15% to 20%, but that’s not real. How does Barclays respond to portability of account That was for a period of—what we all look at now numbers? and see, is it was, kind of, excess liquidity, very easy Treasury Committee: Evidence Ev 97
11 January 2011 Bob Diamond and Antony Jenkins monetary policy and if I can say it this way, bank Stewart Hosie: In the knowledge that these new returns weren’t as challenging. So on average there capital requirements will be there? were 15 to 20. to y ki s: Yes. But if you look over 20 or 30 or 0 years, bank returns averaged more like 12% to 1 %—10% to 12%, 12% Q627 Mr munna: One very quick question on to 1 %. If we take into account the changes in the Basel III. Obviously, I think a 7% by 201 capital macroeconomics, deleveraging of consumers, requirement seems quite low to me, and I think deleveraging of corporates, that’s going to reduce the Greenspan had suggested 15%, if I am not mistaken. returns. If we look at the impact of Basel capital, that’s Would you welcome having even more stringent going to reduce returns, I would say by 3%, % or capital requirements and what do you think about, say, 5%. So you’re looking at if there are no actions—and 15%? 7% seems very low to me. there will be actions—then you’re down to, kind of, Bo iamo : Well, keep in mind that we don’t know % to 6% in terms of average returns, and that’s the yet whether or not there will be an additional buffer issue. And the challenge will be for banks to learn to for SIFIs—strategically important financial operate in the new environment with higher capital. institutions—and certainly we would expect in the UK Now, one of the challenges our shareholders really that a couple of us would be considered. Now, what push me on is to convince them that Barclays can earn the US regulators have said, what Secretary Geithner above the cost of equity, and that will be one of the has said, is that he doesn’t think they should add to things I talk about when I give the results presentation the 7% and he thinks it’s perfectly adequate. If you and my first chance to talk in February. So, Stewart, I asked the US banks how they’re operating, they would think your question is the right one. This will put say that 7% feels more like 10% or 11%, because no pressure on banks, and if I can say it this way, it’s bank is going to risk going close to those levels. So going to be particularly difficult for banks with a weak on balance, I think it would be a mistake for the UK to model or a model that has weak performing units to it. be super-equivalent in terms of increasing the capital So the difference between the returns of strong banks requirements for UK banks above the Basel rules in versus weak banks—banks maybe that have a bad whatever is agreed. business model or just a weak client base or carrying Mr munna: Do you think the US guys are right businesses that had sub-par returns—will get more on this? and more challenging. So I do think, probably not as Bo iamo : I would like to see clarity and definity, much in the UK, but I would expect across Europe to and to some extent we feel like we can operate in any see significant restructuring of financial institutions. environment, as long as it’s the same for all of our competitors. My sense is that 7% is a pretty good Q626 Stewart Hosie: That’s helpful, and I am sure change, and that if banks were operating with a we might want to come back to that, but not today. cushion above that, at kind of % to 10%, that that Antony, in the same submission, talking about capital would be a much safer and sounder financial system, ratios and the rest, it said, “it would make entry into but still allow us to be increasing capacity for lending the banking market less attractive”, but you have said and doing business. So as usual—and I know you in your last answer that you felt the competition was know this—it’s a balance between the two. It’s been increasing. What would you do to mitigate the risk a balance between how we make the system safer and that regulatory reform would be a barrier to entry for sound and how we encourage jobs, economic growth, new entrants, or do you really think that’s the case? lending and healthy risk-taking. to y ki s: Well, of course if you have to hold Chair: Thank you very much for coming before us more capital to enter a market, it’s going to make the this afternoon. It has been a marathon session of two bar higher to get into that market, and I think that’s and a half hours. We’ve ranged widely and we are what the paragraph was referring to. What I was very grateful to you both for coming. We perhaps have referring to in my remarks was that, what we see is not done as much on competition as we should, but empirical evidence of new players entering the we’ve certainly touched on a number of important market, not only in the consumer market, but also in issues for the public outside. In normal conditions, the SME market, where we have some very focused some of the questions might have been considered a players now coming back in—Aldemore, little intrusive, but I am sure you understand that these Handelsbanken and so on—that are starting to are not normal conditions. underwrite significant pieces of business. So Bo iamo : No. notwithstanding the increased capital requirements, Chair: And we are very grateful for your evidence there are competitors who are either in the market, or today. seeking to increase their position in the market, or Bo iamo : Happy to be here, Chairman, thank seeking to enter the market, because they believe they you. can extract profitable returns from certain segments of to y ki s: Thank you very much, Chairman. the market. Ev 98 Treasury Committee: Evidence
Tuesday 18 January 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon John Mann Mark Garnier Mr George Mudie Stewart Hosie Jesse Norman Andrea Leadsom Mr David Ruffley Mr Andrew Love John Thurso ______
Examination of Witness
Witness: Jayne-Anne Gadhia, Chief Executive, Virgin Money, gave evidence.
Q628 Chair: Thank you very much for coming to they were being properly invested in, that the capital see us this morning and to help us with our inquiry was very safe and we, as customers, would know that, into retail banking competition. In a letter to the as a bank, the right decisions were being taken. in n i i es recently, you challenged comments Chair: Those are points that, I’m sure, Sir John made by Stephen Hester and Eric Daniels, which they Vickers will have heard, or will hear, when he sees made to this Committee, that retail banking in the your evidence. UK—I think this is their phrase—was “enormously competitive”. Do you disagree strongly with that, and Q631 Stewart Hosie: Just to follow up on that, if so why? obviously Virgin Money sees that Tesco Bank is ay - a hia: I do disagree strongly with that, growing, the Metro Bank exists and Santander is Mr Chairman. I think the comments are surprising growing. Do you not see any hope for more because, in my mind, one of the most significant competition through organic growth and the creation barriers to entry, competition and consumer choice in of these new institutions? the UK is what is, I believe, an effective oligopoly of ay - a hia: I do, and I think that we the five big banks, and while I’ve seen in evidence welcome all that competition very strongly. I think my that a number of the big banks have said that the point really, Mr Hosie, is that I was thinking, as I was market is very competitive, when you look at the thinking about this session, that one of the constituents facts—and I think they’re important—that those five that I think is being undeserved in so much of the big banks together operate almost 0% of the current review of the banking sector has been consumers account market and more than 0% of the SME themselves. market, I think that it’s hard to say that the market that We have talked about taxpayers, which is very customers should be enjoying is, in any way, properly important. We’ve talked about bankers’ bonuses. competitive so that consumers get the best deal. We’ve talked about investment banking, but I’m not aware—working for Virgin, we aim to be the Q629 Chair: What key raft of changes do you think consumer champion—that the consumer has perhaps are essential if we are to get to a point where what had enough of a look-in within some of this analysis. you describe as the oligopoly is broken down? I was imagining being a consumer in the High Street ay - a hia: I think that, at the end of the today. Many High Streets have a Santander, an RBS, day, making sure that consumers have choice of a Lloyds and so on, often all together, so how would product and that the financial system is confident that I make the decision which one to go into? What do I it has safe and secure banks are important, and to that judge on? Colour? The products seem very similar, end, in my mind, we have to make sure that there is the offerings seem very similar, the publicity is very no bank that is too big to fail. I do believe, therefore, similar, and I think that the banks that you describe, that banks should be smaller than the very big banks such as Tesco, ourselves and Metro, bring genuine are today. choice and a different approach to banking that I think is extremely important. Q630 Chair: So you would favour breaking up some The problem, I think, certainly for me as a new of the big banks? entrant, and perhaps for them too, is that, faced with ay - a hia: I think it’s a difficult argument, the sort of oligopoly that I referred to, it’s very but I would certainly favour looking at reducing the difficult to achieve scale to provide real competition scale of balance sheets, both across the banking sector for a large number of consumers in the marketplace and potentially within some of the bigger banks. For as we grow, and I think that’s very important. example, we have all been reading the discussions around whether or not investment banking and retail Q632 Stewart Hosie: I have a slight difficulty; I am banking should happen in the same institution. If it’s trying to get my head around this. I can think of some concluded that indeed that is acceptable, then why not High Streets where there will be a Clydesdale, an do it through separate balance sheets that are RBS, an HBOS, a TSB, a Santander, a Nationwide, separately capitalised, have separate risk management and I can think of other communities where all the systems and separate management teams? In doing so, banks pulled out many years ago—their physical the retail banking customers could be confident that presence—and I am not quite sure where the balance Treasury Committee: Evidence Ev 99
18 January 2011 Jayne-Anne Gadhia lies. Stephen Hester claimed the UK retail market was broken down quickly in terms of people switching not particularly concentrated; in certain High Streets quickly? that is reflected, but in others it is not reflected at all. ay - a hia: I think switching is an What’s your view on the concentration? Do you really altogether different kettle of fish. I do think that think that there is an oligopoly between the five big there’s brand loyalty to all sorts of brands—there banks? certainly is to mine—and all well and good, providing ay - a hia: As I say, I think that the key that loyalty comes from great service and good product in retail banking is current accounts, and I’m products. I don’t think it should be blind loyalty, and sure we’ll get on to discussing them, and when 0% transparency will make sure it’s not. I’ll know that I of that market is held by those five big banks, I think like my branch, like my bank, like my bank manager it’s very difficult to argue anything other than that, to and get a good product, and I think that’s very be honest. important. Moving on to switching, I think it is really, really Q633 Stewart Hosie: In that case, in terms of this essential that we find a way to make switching in the competition, is it a lack of competition between banks UK much easier. Again, I’ve seen people saying, themselves, or between products and product “Well, 7% to 11% of current accounts switch a year. availability, or between the pricing of the products? Isn’t that good?” I don’t believe it is. I think that the Where does the balance of the lack of competition lie? underlying rate of switching is probably less than 5%. ay - a hia: I think in the eyes of the That’s because people find it really difficult to consumer it lies in the lack of transparency of the contemplate making that transaction happen. I products, predominantly. Again, as I imagine lining absolutely believe that we should help people with switching and that we should do that definitely by up outside an array of branches, I know, as a member insisting that all banks offer a single common account of the industry, that there are differences between the number for customers, and we would certainly current accounts offered by, for example, Santander support that. and Lloyds, but looking at it through a consumer’s eyes, I think it’s quite difficult to understand what those differences really are. We at Virgin Money—I Q636 Jesse Norman: Ms Gadhia, you are obviously know many of the new banks are equally in this very concerned about the effects on your business of position—are absolutely committed to the transparent the Basel II capital requirements. Can you talk about disclosure of product features in a clear, concise and why that has disadvantaged it, then perhaps you can consumer-friendly way, and I think that’s particularly move on to Basel III? essential in the world of current accounts. ay - a hia: My particular concern isn’t Basel II or III per se, and I think that managing capital within banks has proven to be essential through the Q634 Stewart Hosie: If we have this transparency— crisis. The point that we’re trying to make in our transparency is a good thing in general terms—and submission is that the regulatory capital regime, you can list the features and the costs, does that not understandably in some cases, clearly differentiates offer the risk of more—how can I put this gently?— between the big incumbents and the smaller providers, price-signalling, so we end up with every bank and for smaller providers, therefore, there’s a coming together at the more profitable end of the requirement to hold more equity. market? At one level, I understand that, but if we look at ay - a hia: My view of transparency is that what’s happened in the recent crisis, quite clearly the it should give consumers greater choice. Ten years Basel II regime that has allowed the big banks to ago, I was running a small business called the Virgin reduce their capital requirement because of historic One Account, which was a current account mortgage, experience, has—I would go as far as saying this— so we had some direct and relatively high-volume failed to identify the systemic risks that those banks experience of this, and, effectively, we offered on our themselves introduce to the system, and that capital current account product a tariff of charges so that should be held against those systemic risks, especially consumers could see very clearly that if they wrote a at particular times of the cycle. cheque, or made a foreign exchange transaction, for example, exactly how much that was going to cost Q637 Jesse Norman: Do you think that smaller them. banks or retail financial institutions have been I think the problem today with many banks is that it’s disadvantaged precisely because the assumption is very difficult to identify exactly what those individual they can fail and, therefore, more capital needs to be transaction costs are and, as a consequence, I think held by them, relatively speaking? that free banking is a fallacy. There is no such thing ay - a hia: No, what I’m really arguing for as free banking—we all know that—and I think that is certainly not that we and smaller banks should be customers are being misled to stay with the big banks required to hold less capital; I don’t think that would who claim to offer free banking when actually these be healthy. I think that the current capital regime and non-transparent charges are really what’s making the anticipated capital regime we are broadly very them money. supportive of. Our own capital ratios we intend to hold in excess of all the regulatory requirements, as Q635 Stewart Hosie: If we had all the transparency we currently do. in the world, do you think that the brand loyalty that What I’m really saying is, in order to level that people have—the loyalty to the banks—would be playing field, do we believe that capital requirements Ev 100 Treasury Committee: Evidence
18 January 2011 Jayne-Anne Gadhia are a risk of size trade off, or should they be a risk of and benefits of being seen as too big to fail? How impact trade off too? And that the impact that the does that operate in their favour to the detriment of failure of the big banks could have perhaps wasn’t other banks and potential new players? sufficiently identified in the capital regime, and it ay - a hia: I think that switching of banks should be. When it is, there will be more of an equal has become even less over the time of the crisis and basis to the capital in the system. that’s been unfortunate. As trust has been eroded, I think people have been less ready to take the risk of Q638 Jesse Norman: Because you might expect the switching accounts, so that, perhaps, has locked the big banks to have more capital, as it were, required of market still further. them because they are engaging in lots of very I think, too, that when customers effectively get a complicated, non-transparent and often rather risky sovereign guarantee on a big bank, why wouldn’t they derivative activities? put their money in that bank while the market is in ay - a hia: That’s true. Where I was flux? I think that, as a consequence of the necessary particularly going—to be honest, Mr Norman—was response to the financial crisis—I have to say clearly, this. If I look at the capital requirement for a in terms of financial stability, it was very important— mortgage, as Virgin Money launches mortgages, we competition and the movement of customers have treat mortgages at the 35% risk-rating level to provide been reduced. capital against that. When I worked at RBS and was running a mortgage business there, because of the Q643 Mr uf ey: It’s mainly that is it—the scale of the business and the history of the customer, switching point? the 35% is a much lower number—as low as 17% or ay - a hia: Yes, it’s mainly the switching less in some cases. point, but it’s also to do with the fact that current accounts enable big banks to cross-sell to customers. Q639 Jesse Norman: About half as much capital And, to my mind, the reason that banks want to attract required against the business? current account customers—big banks do—and want ay - a hia: Yes, and that’s not necessarily to talk about free banking is because a lot of the case across all products, but certainly in the profitability comes off the analysis that is mortgage business it’s true, and I think that’s generally subsequently undertaken to enable big banks to sell the trend. My point—let’s face it, regulators have been different products to customers. For example, if I saying it for a very long time—is that while that happen to have a large balance in my account, I might capital requirement has been built up on empirical expect a call to see whether or not I want an historical evidence, we all know that past performance investment product. I think it starts with current isn’t necessarily a guide to the future. accounts, but it broadens out into the wider system.
Q640 Jesse Norman: No kidding. Do you think Q644 Mr uf ey: There are reports this morning banks should be able to use their own risk models? that Paul Tucker at the Bank—and also, I think, Mr ay - a hia: I think that banks should be able Diamond last week—said that it will, in the future, be to assess their own view of risk and then discuss that a good thing if banks fail—in other words, we get rid appropriately with the regulators, or the appropriate of the idea that any institution is too big to fail. How body, to agree whether the external and internal views do you see that playing out? coincide. I think, necessarily, there is a conflict of ay - a hia: I think it’s very important—I’ve interest in running an internal risk model where fully agreed with Bob Diamond that banks are holding more capital is going to reduce profitability allowed to fail. Clearly, we can allow them to fail only or return on equity, and I think that we need to get within a smaller systemic consequence, so I think we that conflict of interest out of the banking system in a need clearly to address the systems and structure of regulated way. banking before that can be allowed to happen. But I think that once everybody is very clear that banks are Q641 Jesse Norman: When with RBS, you were allowed to fail, risk-taking will be reduced comfortable that there was enough disclosure to allow considerably and the reduction in risk will protect the the regulators to make an assessment of the correct system for us all. amount of capital to be held? ay - a hia: If I’m honest, at that point, my Q645 Mr uf ey: Just expanding on that, risk-taking role didn’t really take me to that place with the will be lower, but what consequences do you think regulators. that will have for customers, retail or corporate? Jesse Norman: Okay, thank you very much. ay - a hia: You see, from my perspective I am— Q642 Mr uf ey: Good morning. Mr uf ey: From Virgin’s perspective? ay - a hia: Good morning. ay - a hia: Yes. I am only, and very proud Mr uf ey: I think many of us believe that one of the to be only, a retail banker, so our view is very much problems of British banking is that it is insufficiently consumer focused. Inevitably, there is a lot of risk competitive, so I for one certainly welcome your management that’s essential in making sure that retail participation in the market. Could you just explain to banks perform appropriately, but I do believe—I think us, from your perspective, how the perception that the we all believe—that many of the risks that have been big four banks are too big to fail has acted as a barrier taken in the investment banking arms of big banks to new entrants? What are the particular advantages have meant that the capital consequences there have Treasury Committee: Evidence Ev 101
18 January 2011 Jayne-Anne Gadhia bled over into the retail divisions and, as a editors’ editorials? Who is arguing for it? Who is consequence, have led to under-investment in retail, practically saying, “This will be good for potentially, and a risk that’s been a retail risk and a competition”? You are, but who else? risk to the consumer. I think that that would be ay - a hia: As I say, my own position is eradicated from the system if banks realised that they very much on the retail side of things. I heard a would be allowed to fail. number of people talking about the need to separate out retail and investment banking. I support that, Q646 Mr uf ey: Just one question. You’re a big although, just to be really clear, as I think I said at the advocate of splitting up the big banks so that their beginning, I support that perhaps less radically than investment banking arms are separated from retail. you are implying in that I do believe that single Don’t you think that’s a rather extreme, dislocatory banks—any of the incumbents—could run separate step to take? How would you justify it? balance sheets within their corporate structure for their ay - a hia: For me, it’s extremely important retail and their investment banking, which would that competition is introduced to the system—to build protect the risk without being as extreme as I think trust, to improve financial stability as a consequence, you are implying I am trying to be. to give consumers a better deal and to avoid the issues Mr uf ey: Okay, thank you. that having banks that are too big to fail created over the last two or three years. From my perspective, Q650 Chair: Just for clarity’s sake, have you given making sure that we have a range of smaller banks is evidence to the Vickers Commission, formally or much more likely to give us an active market where informally? there is choice of product, choice of provider and ay - a hia: No, but I’m due to do so in the transparency, and, as a consequence, people will have future. to make a decision based on price and service, and I think that’s where healthy markets operate effectively. Q651 John Mann: Why will risk-taking be lower? ay - a hia: In the future? Q647 Mr uf ey: Do you think the current John Mann: Yes, with your scenario. Government is minded to do that? Are you picking up ay - a hia: I believe that where banks those messages when you speak to Ministers and civil believe that they can fail and not be bailed out by the servants—that they have a plan—or are they actively authorities, there arises a certain additional personal examining the option of splitting up the banks? consequence, if you like, if they— ay - a hia: I’ve not talked to them about John Mann: What’s that? splitting up the banks. I talk to them occasionally ay - a hia: Put it this way, I suppose within about my own business and all I can say is that—as my own organisation, I’m very aware that we’re not you would expect, and many people are in the same too big to fail and, as a consequence, I think the place—I feel a lot of encouragement to all the new detailed understanding of everything that’s in my entrants to grow competition in the market. balance sheet—everything that’s done with my customers—is something that I, with the management Q648 Mr uf ey: This is my final question: what is team, talk about and review very clearly on a daily the appetite among the policy-makers you meet for basis. splitting the banks so that the investment banks become one thing and retail banks another? You are Q652 John Mann: It’s a different matter. Why will in a very good position: you are a respected bank, risk-taking be lower? You’re not suggesting any you’ve been very brave as a new entrant and you’re personal liability. Why will risk-taking be lower? advocating something that’s quite radical. I’m trying ay - a hia: That is a belief of mine in to understand what pressure is coming from banks like that— your own and smaller players for this and whether it John Mann: It’s not based on any evidence, is it, or has any traction, because that’s what we’d like to any structural change in terms of any personal liability know. of any kind? ay - a hia: It’s not an issue that I’ve ay - a hia: From my own position, as I say, discussed with any Minister, so I, as a retail bank, am I’m leading a bank that isn’t too big to fail, and from very focused on retail. That’s what I discuss, to the my perspective I do believe that the requirements on extent that I have those sort of discussions, but on me, as a Chief Executive, put me in a place where your point, Mr Ruffley, that it’s perhaps an extreme some of the risks that perhaps have happened in the solution, I think we’ve seen extreme times, and rightly past and which caused the crisis are not something everyone is looking at what sort of policy that we’d even contemplate. Say, for example— interventions could be made to avoid a similar problem for the future. I suspect that extreme Q653 John Mann: Was Northern Rock too big to problems that we’ve had require some extreme fail? solutions. ay - a hia: If I look back at Northern Rock, before the Northern Rock crisis all of us, Virgin Q649 Mr uf ey: But there is no evidence that I see included, were looking at the Northern Rock model that this is a runner—that this is being actively and saying, “That looks like a good, strong model; is proposed and articulated and argued for—apart from it something that we can copy?” Let’s face it, yourself; you make the point. But is this really a Northern Rock were the markets’ darlings only 12 serious runner or just an interesting bit in business months before they failed. Then we realised exactly Ev 102 Treasury Committee: Evidence
18 January 2011 Jayne-Anne Gadhia what had gone wrong through excessive risk-taking online transactions, so you’ll cherry-pick that end of that people hadn’t understood—where boards hadn’t the market. gone through the detailed risk that may come of ay - a hia: Our model going forwards is to hitting the iceberg. make sure that customers have access to us wherever they want it and wherever our products are appealing Q654 John Mann: It’s got nothing to do with for them. Northern Rock’s size. ay - a hia: I think it has, to be honest, Q659 John Mann: But if they’re not comfortable because the scale of that business was such that the with online banking and you don’t have a bank Government felt that they needed to bail out the manager—you used the term yourself a few minutes depositors. ago—in a branch in the locality, they’re not going to go to you, so you are cherry-picking the top end of Q655 John Mann: It’s because they had depositors the market—the people who read the financial papers, though. Lehman Brothers was allowed to fail and it who use online banking and who tend to work in was rather large. Competition—there used to be lots large cities. of mutuals not that long ago and they all got de- ay - a hia: First, I’d say that 2.5 million mutualised and bought up, so there’s nothing to stop people is not cherry-picking; it’s a significant number that happening with new entrants to the market if they of customers that we have now. From our perspective, are successful here. it’s our intention to grow over the next five years to ay - a hia: That the new entrants could be over 70 branches through organic growth, but you’ll bought up? have read, I’m sure, that we continue to look at John Mann: Yes. possible acquisition opportunities to enhance our branch position, and we’d be very keen to do that if ay - a hia: No, no, I’m sure that’s true— the right opportunity arose. John Mann: That would be competition. ay - a hia: It’s a possibility, but in my view Q660 John Mann: If one of the remaining small we should be making sure that as banks grow, they mutuals that is provincial-based demutualised, you don’t grow above a particular size—I couldn’t tell you would grab it and reduce competition further? what I think that particular size is—and if by ay - a hia: No, not at all. What we would acquisition they reach that threshold, I don’t think that do is bring the Virgin model to the country in a bigger those transactions should be allowed to take place, way, and I think that’s important through acquisition. so— Q661 John Mann: What about an area like mine that Q656 John Mann: You’re saying there should be does not have a great deal of choice. Will you be restrictions on concentrations of the market to stop the looking to access the market in my area? kind of thing that happened with the mutuals, where ay - a hia: Forgive me, Mr Mann, tell me they’ve been bought up by larger predators? where your area is? ay - a hia: I think that’s something that the John Mann: No, let’s say traditional coal-mining Competition Authority should look at, yes, and areas. indeed, let’s face it, that is part of the OFT’s remit on ay - a hia: Of course, absolutely. any M and A transaction to make sure that business John Mann: How? doesn’t become non-competitive, and I think it ay - a hia: Every product that we offer is a important that we continue to do that. bulk standard banking product. We don’t have bells and whistles, we make sure that we’re good value and Q657 John Mann: Allegedly. With the credit card good service, and I think that’s a really important industry, the new entrants to the market, like MBNA, point. We want to give customers access the way that became some of the worst culprits in keeping bad they want it, and that means online, in branches, over practices going, so there’s nothing to say that new the telephone and on digital phones if people want it, entrants are going to be any better. Is it the case that and I think that that gives us great access to all sorts what you will do, if you can get a significant foothold, of areas. is cherry-pick in the south-east of England like Metro bank wants to do? Q662 John Mann: A lot of people in my area, from ay - a hia: Definitely not. From our point my observation, would like access via a branch. That of view—although we are deemed a new entrant and appears to be their behaviour, but there are not many I understand that—we have well over 2.5 million branches to buy up from anyone else and you are not customers already and that’s certainly not cherry- there. How will you offer your facility to my picked. Our customers come from all over the UK and constituents or are you cherry-picking? the reason for that is that we’re very successful online. ay - a hia: I think I disagree with your Although we will be launching branches too, they’ll view of cherry-picking, so we would offer our be distributed across the nation and we’ll continue to products to your constituency if we couldn’t do that have our nationwide presence through our online in branches, and we aim to do that over time and to capability and product sales. grow over time. One of the problems with growing as a new entrant is growing branches, as I think Vernon Q658 John Mann: You will go in a few big cities Hill said here a few weeks ago, is that it takes time, and it’ll be those consumers who are comfortable with but it is do-able and it is our intention to get there in Treasury Committee: Evidence Ev 103
18 January 2011 Jayne-Anne Gadhia the end. But all our advertising is in the newspapers particular brand, but I do think that banks for the and on the television. It gives telephone numbers as future need to find out what their particular position well as online numbers for people to be able to access is in the marketplace—consumer champion, service us. We’ll have call centres—as well as online, as well proposition, price proposition, whatever that might be, as branch, as well as digital technology. The intention or digital branch—and really build on that and give is to be as accessible as possible to the people for customers a great deal as a consequence. But at the whom we’re appropriate. moment, banking seems so homogeneous I don’t think customers have sufficient choice. Q663 John Mann: Final question, do you intend to do any deal with the Post Office? Q666 Andrea Leadsom: Looking at the idea of a ay - a hia: It’s certainly nothing that we’ve diversified group, where financial services is just a looked at. part of it, could that also be partly a solution to the John Mann: It has branches in my area and other “too big to fail” question—in other words, where you mining communities. have other resources, other sources of income and so ay - a hia: Which I think is a great service on to support a particular banking activity? that they offer and something that we fully support, ay - a hia: Well, one of the things that I but we haven’t looked at that. should say before properly answering that question is John Mann: Are you going to? that although Virgin Money is part of the Virgin ay - a hia: Never say never, but it’s nothing Group, that’s true from a branding position as opposed that we’re working on at the moment. to a corporate structure, so we’re not a subsidiary of John Mann: So, no. a big Virgin holding company. Q664 Andrea Leadsom: Ms Gadhia, how important do you think the Virgin brand is, as distinct from any Q667 Andrea Leadsom: So you wouldn’t be bailed other bank? The fact that you have this Virgin brand— by out by any other Virgin entity if you got into a bit like a Tesco brand or something—makes it speak difficulty? of more products than just banking. Do you think that ay - a hia: Exactly. So all our capital and helps your business model? profitability is ring-circled to the banking operation, ay - a hia: I think it does. Indeed, some which I think is entirely appropriate, and so my own objective external research says it does exactly that, view is that, no, every bank should be operating in a so at the moment, although we’re a very small bank, way that means that it’s going to be achieving following our purchase of Church House Trust last sustainable profitability for the long term. year, external analysis—not that we’ve done ourselves—shows that people are as likely to buy Q668 Andrea Leadsom: I think you have said that from a Virgin bank as they are from any of the big retail and investment banking activities should be split five. I think the key to that, to be honest, is that so out—in other words, a sort of re-imposition of Glass- much trust has broken down in the banking sector that Steagall. Is that right, and if so, why do you think customers are looking for a trusted brand, and that we specifically along those lines? The reason for asking believe that trust comes from a package of things. It’s that is that, as my colleague, John, just said, it didn’t our corporate ambition to make everyone better off help in the case of Northern Rock, which wasn’t an with Virgin Money, and for me that’s a mutual model investment bank, nor did it help in the case of for the future. It’s about giving customers a great deal Lehmans, which wasn’t a deposit taker. on price and service, making a fair but not too high a ay - a hia: As I said earlier, my view on return for shareholders, and creating a business where that is not necessarily that we should cut the banks in staff are happy, want to serve customers well and do half, but that maybe one of the banks, which has both a bit of good in the world. That’s what the Virgin those arms, should be operating two separate balance brand can bring to banking. sheets, rather than a consolidated balance sheet, and that capital should be held separately in those Q665 Andrea Leadsom: So if you’re keen to see organisations. I think that would go a long way more competition, would you like it to be along the towards achieving what I’m talking about. The reason lines of an M&S Bank and a Tesco Bank and a Louis that I say it, to be honest, isn’t just because of all the Vuitton bank for the wealthy? Is that where you see it going? arguments that we’ve heard about investment ay - a hia: You mean outside the banks that banking; it’s because I fear that retail banking has we have at the moment? been under-invested for a long time and that running Andrea Leadsom: Outside of banking itself, yes. a separate balance sheet, with separate capital and ay - a hia: Well, let me put it this way: separate profitability, would perhaps refocus despite what I’ve said about the incumbents, the organisations to drive great service for customers and important thing, I think, is that we have the right to compete most effectively in a retail marketplace. expertise in banking. Again, the crisis has shown us that it is important that we have experienced bankers Q669 Andrea Leadsom: Would you like to see the taking the banking business forwards and learning the Lloyds and HBOS merger undone? Would you like to mistakes of the past and creating new banks for the see that split out again? future. I have no view, really, on whether that should ay - a hia: To be honest, I really don’t have be a Louis Vuitton bank, although that sounds like a a view on specifically what should happen in the— Ev 104 Treasury Committee: Evidence
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Q670 Andrea Leadsom: But you do have quite Q674 Mr Mudie: We keep being told by the big four strong views on competition and on the need to or five that there is limited profitability in personal improve competition, and presumably therefore you accounts. Do you accept that, and if so, why are you would be concerned about the market share of the keen to get into this limited profitability market? Lloyds HBOS combined entity? ay - a hia: I think the interesting point is ay - a hia: I think that Lloyds’ current that, without a doubt, having read some of the account share is 30% and their SME share is 20%. evidence, there’s appropriate comment made that That’s clearly significant and something that I’m current accounts should take their fair share of branch certain the competition authorities are looking at. costs, for example, and the invested costs that big Whether or not Lloyds and HBOS should be split up banks have in their 3,000-branch network, for is, I think, a very difficult issue, because of all the example. I guess inevitably when you absorb those work and appropriate focus that is happening there, sorts of cost against current accounts, the profitability I’m sure, to make that integration work effectively, looks lower. I think it’s true too that the costs of and then to turn around and ask them to split it all out transactional banking are quite expensive, and as a again seems to me to be very unfortunate. Lloyds have consequence I don’t believe that current accounts been asked by the EU to sell a package of assets that from a transactional perspective are a cash cow. That will reduce the impact of that big group on said, was it only last year the current account market competition, so from my perspective, making that made something like £ billion for the banking asset sale effective would be going a very long way industry, half of which came from interest forgone, so towards both not wasting the good work that’s been I suspect that there is significant reason for banks to done and creating a more competitive environment. be in the current account market to manage their interest capability, as well as managing the Q671 Andrea Leadsom: But just to press you transactional costs. slightly, clearly Lloyds HBOS is an enormous entity with an enormous market share. You are keen to see Q675 Mr Mudie: But that takes you to the other smaller, fleeter of foot entities and more competition, thing they keep telling us, that it’s a mature low- so, almost by definition, you must want to see that growth market— merger reversed. ay - a hia: It is a? I’m sorry, Mr Mudie. ay - a hia: Well, as I say, I think that it’s a Mr Mudie: A mature low-growth market. matter for public record that the EU have asked ay - a hia: Yes. Lloyds to sell off some branches, including the Mr Mudie: Now, I notice that you’ve been in Cheltenham & Gloucester, Intelligent Finance and the business for 15 years at Virgin Money, and only after TSB brand, and I think that that will go a long way to 15 years are you going into this market, and over the creating some of those smaller entities that you talk next five years you’re intending to have only 70 about, which we genuinely support. branches. That suggests either that you are going to be content to be a small player—a very small player— Q672 Andrea Leadsom: A final question: what do or that you are depending on the Government you think about breadth of product offering in a breaking up some of these big banks. Which are you financial services entity? Do you think it’s important going to be satisfied with? that they do have a wide range of services? Do you ay - a hia: I’m not sure we’ll ever be think that adds to, or detracts from, the risk if they are satisfied with either of them in the way that you mean, offering full service retail and investment banking but in terms of our plan going forwards, we have a services? strong plan to grow organically, which, because of ay - a hia: Put it this way: when I ran the some of the barriers to growth, will be quite slow, and Virgin One account 10 years ago, we found that we our board and shareholders have accepted that that’s were able to be extremely focused by looking only at the case. If we are able to make an acquisition, a very small range of retail products. We were able to obviously we can grow more quickly and bring Virgin do them well, we were able to explain them well, and service and products— we were able to train staff very well. Q676 Mr Mudie: Okay. Sorry to cut you off, but if Q673 Andrea Leadsom: But what about risk you then say, “We are ambitious to grow branch by specifically? branch,” what barriers are stopping you making that ay - a hia: This was a fundamentally retail 1 0 or 250 over five years? product that everyone had full knowledge of, where ay - a hia: There are a number of reasons, we could absolutely work out customer behaviour to be honest. There’s the availability of capital. We from a risk perspective. We very much managed risk, want to be able to grow in a controlled and sensible to be honest. It was a very sound business that was way, and we believe that opening a branch a month is appropriately deemed to be sound by external parties, quite a fast thing to do. If you think about the including the regulator. So yes, I think there’s practicalities of training staff properly, treating something to be said for real focus in doing one thing customers properly and making sure systems work very well, and I think that, perhaps when the eye is effectively—we want to be in this business for the taken off the ball across a range of complicated next 100 years or 200 years. We’re not here to do it subjects, it’s hard to do many things equally well. as fast as we possibly can for any particular reason, Andrea Leadsom: Okay, thank you. so doing it right is really important for us, and we Treasury Committee: Evidence Ev 105
18 January 2011 Jayne-Anne Gadhia believe that means that we have to take it a step at to hold more capital against their systemic risk. My a time. fourth point is about acquisition. If we’re serious about competition and using acquisition opportunities Q677 Mr Mudie: Yes, but we are looking at barriers to enhance competition, we should be applying a to entry to be institutional things, but you are just public interest test to make sure that those acquisitions mentioning capital. That’s a barrier to entry in any are good for competition. field, an appropriate amount of capital. So there’s Those would be my four strategic points: while I’m nothing that is stopping you, apart from your ability saying they’re a barrier to growth, I’m not suggesting to raise the capital and train the staff? they’re going to keep us tiny. I’m just saying that my ay - a hia: I think there are four strategic ambition would be to be the fifth or sixth biggest bank barriers to growth in the marketplace, to be honest. in the UK and to attract customers, give them great The first one we’ve talked about, which is the service and great products, and I want to be able to oligopoly of the other banks and the fact that they aspire to that objective. Those are the four strategic have so many customers locked in. The second is barriers that I will need to find ways to overcome to product— get there. Mr Mudie: Well, they don’t have them locked in. We have had Metro, and he takes a totally different Q678 Mr Mudie: I’d just like gently to press you approach, a different view and different attitude from further. You referred to bank customers being locked Virgin. He just thinks he will win and he’s well ahead in, then you said a bit more gently that 5% of them of his growth plan already, whereas when I read your don’t switch. Looking at the behaviour of bankers, paper, I thought that Virgin’s putting all its money— which has attracted more public attention and real or whatever money it has—on the break up and a anger; looking at the figures on customer unhappiness; chance purchase. looking at the publicity that’s been given to the ay - a hia: I wish Metro every success. I opaqueness of the charges and the fact that that read Vernon Hill’s evidence, and I was inspired by it amounts to over £8 million to customers on personal too, and I think we’ll be in a place where our growth accounts; and looking at the cheapness of property, plans will probably be similar to or exceed those, why on earth is someone like you, or your bank, not because don’t forget, we already have 2.5 million thinking, “This is the time when we can burst this customers. We already are a very significant internet business wide open”? What is the problem with bank, so we’re adding our branches to that, rather than moving so easily? investing all our money in rolling out branches, and ay - a hia: I think as much as anything, that’s very important, I think. there are two things. It takes— You know, 2.5 million customers is not an insignificant business, so we’re not so much a brand Q679 Mr Mudie: Well, no, no—that’s the wrong new entrant perhaps, in the Metro way, as an entrant question. Why the hell are you not taking action—the that’s growing into banking and trying to do that time in the market is now? What is stopping you in properly. I think that’s really important. We want to Virgin getting these customers to switch in great do that in a way that does unlock the current account numbers? If Metro were up in Yorkshire, I would question, and I do agree, and I’m not suggesting that switch tomorrow, and I’ve been with my bank 35 there is no current account movement. I think bloody years, but they are a scandal. Why are you not Barclays and Lloyds said that they both moved 1 inviting us to join you? million current accounts last year—well, they ay - a hia: I’d be delighted to do so, Mr probably moved them between the two of them—and Mudie, next year when our systems are there and that’s significant movement, and for us, to be able to ready in branch to welcome you. One of the issues— attract a number of those customers to our current I know Vernon talked about it, too—is that, as a new account would be extremely attractive. So again, provider, we have to invest heavily and properly in we’re very much talking about growth there. But the getting the IT systems to set up really good banking fact of the matter is that 5% of customers every year systems for the future. We received the capital to fund stick with their current bank, so I believe that’s an our bank in August just gone, so getting to market oligopoly. For me, that’s the first strategic issue that within 18 months or so with a full range of banking makes it more difficult to grow to a really significant products in branches to welcome people like you is scale. That’s my first point. absolutely what we’re focused on. My second point is one about product, and again, we The key issue, though, or a key issue from a transfer touched on it. I really don’t think there’s any such point of view, is, wouldn’t you feel so much more thing as free banking. I really believe that customers confident if you could simply move your account need more transparent disclosure around how current number to me or to Metro and know that all your accounts work, and I believe that we should make it direct debits and standing orders moved with it? I can much easier for customers to move accounts than is talk, and lots of people can talk, about doing that, and currently perceived and is actually the case. That frankly I think it’s groups like this one that need to shouldn’t be beyond the wit of man. When the big make a policy intervention to make that a requirement. banks say it’s impossible, they mean it’s expensive, Mr Mudie: Except, Jayne, not that I have a good and we should be able to overcome that, I think. word to say about Barclays, but the head of retail My third point—again, we discussed it with Mr banking, who was before us last week, spelled out in Norman—is to do with capital and whether we can detail, not the plans, but the arrangements they have level the playing field by requiring the bigger banks to switch people, with financing in between switching, Ev 106 Treasury Committee: Evidence
18 January 2011 Jayne-Anne Gadhia so they don’t lose if something happens to the direct John hurso: Yes, you have to be in it to get in it, as debit. It seems to be possible to do. it were. Can you amplify that? ay - a hia: Yes, and to be honest, in the ay - a hia: The way in which the SME Virgin One account that I discussed earlier, we made market works, particularly because it’s dominated by that happen too, and for us, it took an army of people such a small number of providers, is that there would to make sure that we were managing it appropriately be, we think, negative selection. In other words, for customers, and inevitably, when you get so much businesses that were turned down by the big banks manual intervention, some things go wrong. There’s would be more likely to go to the small banks, as nothing worse, is there, as a customer, if you find that one tries to get into the SME market. Now, that’s not you thought that you were going to pay off your credit universally true, and absolutely there is a need for card bill—let’s say this month, because the standing more competition from SMEs and better service for order should go through—but, because of the process SMEs. I think small business people really want great in the bank, with whatever good intention, it doesn’t service, but the way in which SMEs get service is go through automatically. For me, the real solution to quite complex. The big banks have that tied down to this is not to have to worry about changing them from a certain extent, and it’s one of the reasons why the provider to provider, but to lock those monthly sale of the RBS branch network may have been a bit transactions into an account number and port the of an opportunity lost perhaps, because so much SME account number. And it would change and business went with that transaction that we’ve perhaps revolutionise— locked that SME world into the five banks in the same way that retail banking is locked to them as well. Q680 Mr Mudie: Yes, but we’ve heard that is going to be very expensive, but what is wrong with, as Q682 John hurso: Is that then just a fact of life or Barclays suggest they are doing, putting in a guarantee is there a policy change we should be looking at? that they will fund you between the switch and if ay - a hia: I suspect on the SME side of anything goes wrong, they’ll pick up the price? So I things, it’s less policy and more being able to grow as would switch tomorrow if I thought, “Well, they will an organisation, and again, as I said in response to make the arrangements, and if it takes six months, it’s another question, to the extent that new entrants are nothing to me, because they are taking care of it”. able to acquire smaller portfolios of products such as ay - a hia: Would you really, Mr Mudie? I current accounts and SMEs, it will definitely introduce think that’s fine on paper, and then when you get into competition to the marketplace and reduce this risk of the process and something goes wrong and you’re entering the market from nowhere. stuck with a call centre waiting for 0 minutes for the phone to be answered, the frustration means that Q683 John hurso: How do SMEs suffer as people just give up, and I think that’s what’s customers from the current set-up? happened. It isn’t impossible, I’ve seen it happen at ay - a hia: Because I’m not in an SME RBS and I know that Helen Weir said the same thing, business, I’m talking not from personal experience, but sometimes it can take between two and four but I think that we’ve all heard, and perhaps know weeks. The trouble is that so many people think it personally, people who are finding it difficult to get might not happen perfectly, and, “I need it to happen additional lending or support to grow their business in perfectly and my life’s too busy to worry about my difficult times, and we at Virgin, given that we’re such direct debit.” an entrepreneurial company that has set up so many I absolutely believe that if we can give everybody a businesses, feel that it’s important to support that single National Insurance number, and we’ve been sector—for banks to support that sector as much as able to do that for decades—we can change we possibly can. everybody’s telephone number whenever they want to change between phone providers—we should be able Q684 John hurso: With great respect, those are to change people’s bank accounts. I hear people say wonderfully warm words—like all bankers, they all that that’s very expensive and I’m disappointed to want to lend, but they just don’t do it—but what do hear those people then say, “And of course the they mean in practical terms? What can you do customer would have to bear that cost.” This is from practically that will make me move my small banks that are making billions of pounds in profit. I company in the north of Scotland from its current think that the banks should work together and we home to your bank? What is the advantage for me? would be delighted to do so—of course, we’re in a How am I better off as a consumer? different position—to implement a system that would ay - a hia: As an SME person, do you revolutionise the way in which the banking system mean? worked. John hurso: Yes. ay - a hia: When we were looking at Q681 John hurso: In your submission, you make potentially acquiring the RBS network, we gave some it clear that you believe it’s important to become a full thought to all this, and I think that, like all customers, service bank, offering relationship as well as the owners of small and medium businesses want transactional banking products. You also make it clear proper, personal service. They want people who that that means that you need to go to the SME understand their business, and they want their banking market, but you then come up with this catch 22, to be made easy, and as far as possible, a pleasure, which is that— rather than an added burden in a busy life, when they ay - a hia: You’ve got to be in it to win it. want to be focusing on growing their businesses. Treasury Committee: Evidence Ev 107
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Q685 John hurso: What I want above all is that, that I say that was that we achieved approval to own when I need an overdraft, you say yes. our banking licence only last January, with the ay - a hia: Absolutely. purchase of a small bank, Church House Trust, down John hurso: And it doesn’t cost me too much. in Yeovil. During the last quarter of last year, I and ay - a hia: Looking at credit policy, the team at Virgin Money were going through the FSA lending criteria and having a personal relationship approval—the change of control process as opposed with the bank manager, such that that lending decision to a new banking licence approval. I have to say that is made much more easily, I’m a very big advocate of we found that process entirely appropriate. I found making credit decisions as close to the customer as it demanding and challenging, but particularly given possible. One of the big problems with banks that everything that we’ve gone through, I think we all have grown so big is that credit decisions have been expected it to be such. It certainly didn’t feel like the more and more centralised, and for the poor guys who approach was, “The answer is no, now what’s the are facing the customers in branches, whether they question?” It was very much, “Okay, we understand are SME customers or not, the computer says no. It’s what you’re trying to do. Let’s discuss your business difficult to make the credit decision. plan, let’s discuss how you’re going to get there, who I was very fortunate to work with Sir Brian Pitman are your team, what’s your governance, how is your for two or three years, before his death last year, and capital going to be managed, how do you assess risk?” we talked very much about our banking model being It was only having gone through that entirely back to the future—let’s use new technology to bring appropriate process that, in January, we were old relationship banking back to the consumer and to approved to take ownership of the bank. the SME business, and I think that is definitely a way to change the market. Q689 Mark Garnier: So you’re happy with the FSA? Q686 John hurso: A last question, if I may. Back ay - a hia: Completely, absolutely. We to the future I suppose means you have a human being have a really strong relationship with the FSA and the relatively locally who is empowered to take a time scales that we all believed would be achieved at decision. That was the Bank of Scotland model, and the beginning and they hoped to achieve were indeed the Lloyds model is to do it centrally with a matrix, achieved. and it was Bank of Scotland who got into trouble. Can you prevent that by doing what Metro suggested—by Q690 Mark Garnier: How long was that? each branch having to have its own capital, as it were? ay - a hia: Because it was a change of In other words, having a branch record of deposits control process, I believe it was three months. rather than, as now, the whole thing is obfuscated? Is that a policy measure we should be looking at? Q691 Mark Garnier: Okay, fantastic. Vernon Hill, ay - a hia: I think that that’s a really when he came in—somebody mentioned this a bit sensible way forward. I believe that Handelsbanken earlier—talked about the IT systems, and particularly do something similar, and we admire their model and he was talking about how in America you have off- Metro’s model, such that we have a team within each the-shelf IT systems, which are kind of pre-regulated branch that’s responsible for its own capital, its own almost, whereas here, there’s no such thing and you profitability, its own customer service. have to construct your own. Do you see that as a significant barrier to entry? Q687 John hurso: And then you put the human ay - a hia: Absolutely, definitely, and I being in charge of the risk as well as the reward? think it’s quite interesting. I think that the reason is ay - a hia: Yes, and then you centralise that in the UK we’re focused on developing product, remuneration, and you centralise risk management to and we view systems as manipulated systems to make sure that everybody’s as consistent as possible. I distribute product. I believe that in America, product, think that, in that way, we get the best of both worlds. if you like, comes in the box and then service is the John hurso: Thank you. differentiator that’s wrapped around that, and I think that’s a very interesting model. Q688 Mark Garnier: Can I turn to the barriers facing new entrants to the banking market? You were Q692 Mark Garnier: Is that a regulatory problem or a new entrant in 1 5, when we had a different do you think that’s just the fact that some IT company regulatory regime. Lord Turner came in earlier, and I hasn’t entered the market trying to provide this type specifically asked him about the barriers to entry with of service? regard to the regulatory process, and I think that until ay - a hia: I think it’s all to do with legacy Metro Bank came to the market, they hadn’t regulated systems, and so many of the big banks have very a new entrant. Do you have any views on the expensive legacy systems, as we know. It’s meant that regulatory process? I know it’s slightly difficult for when providers have come in trying to offer it— you to answer that, because you haven’t gone through indeed they have, although off the top of my head, I it as a new entrant, but from your experience of can’t give any particular examples, but they definitely dealing with the FSA, do you think there are any exist—it’s been difficult, or the big banks haven’t issues that you would want to be addressed in respect welcomed them necessarily because they have their of new entrants coming to the market? own systems that they have built on their own ay - a hia: I think I could argue that we platforms over years, so as a consequence, we’ve have gone through it as a new entrant, and the reason ended up with a tangle of IT systems, which means Ev 108 Treasury Committee: Evidence
18 January 2011 Jayne-Anne Gadhia that we don’t have a common model that new entrants it because they like banking online or because they’re can use. Developing IT to get into banking is very looking for an alternative type of banking? Do they complex, very expensive and something that we’re tend to be younger? spending a lot of time on. To Mr Mudie’s earlier point, ay - a hia: No, not particularly. I think our it’s the reason that it would take us from licence to average customers by age—we have 2.5 million being able to welcome you to our Yorkshire branch in customers, so it’s a full range—tend to be between 35 perhaps 18 months, and that’s because we want to be and 2. That is where the focus is. able to offer you the full range of service across the full range of access channels very well. Q696 Mark Garnier: So these are people who are completely computer literate? Q693 Mark Garnier: This also comes on to the ay - a hia: I guess that’s true, and attracted argument of smaller banks, and we have obviously to the Virgin brand. talked a great deal about breaking the banks up to a Mark Garnier: And attracted to the new method of certain extent. Not only do they allow greater banking? competition, but they also create a greater marketplace ay - a hia: And attracted to the new for this type of IT system, should somebody come in. method of banking, definitely. Do you think we are culturally too wedded as consumers to the big banks, and that we’ve got to Q697 Mark Garnier: So you planning to open break through that cultural problem? There seem to branch networks is trying to attract those other people, be so many strong arguments as to why you should such as John was talking about, who live in mining have smaller banks, which is the competition and the communities? fact that you are going to have more off-the-shelf ay - a hia: Yes. Whereas in the past banks systems to go with it, the fact that you’re going to have thought about distributing product to customers, have more direct lending coming through and the fact saying, “We’ll distribute it through branches, or that you can have more local intelligence. You have a through the telephone or online,” we’re trying to bank for Kidderminster, a bank for Retford, a bank create a model that gives customers access to us in for wherever. Do you think that cultural thing is a whatever way suits them best, so they might want to, big problem? let’s say, explore what products we offer online, but ay - a hia: I do. I think that it probably then pop into the branch to talk to somebody about it, happens, and banks are very good at it. Almost from and that’s one of the key reasons that we’re opening university-hood or student-hood, if not from our branch network. childhood, people get their first bank account, and a lot of people probably get their first bank account Q698 Mark Garnier: And you are going to do it by either because it’s where mum and dad were or organic growth, as opposed to the way Santander has because it’s not where mum and dad were, and then done it, by acquisition? you stick with it because it’s such a pain to move. I ay - a hia: Well, organic growth is plan A, think there is a cultural point there, yes. and if acquisition opportunities come along, obviously Mark Garnier: And yet you have 2.5 million we’ll look seriously at them. customers, so you are living proof that you can buck Mark Garnier: And do both, okay. the trend. ay - a hia: Yes, absolutely, and that’s to do Q699 John hurso: Just a very quick question, for with the fact that—as far as possible; we don’t always the record: who owns you and what is your own get it right— 3%, I think, of our customers are either capital structure at Virgin? satisfied or extremely satisfied, which we’re delighted ay - a hia: We are owned roughly 80% by with. I think it’s because we aim first and foremost to the Virgin Group and 20% by Wilbur Ross, which is give customers great service. an American PE firm.
Q694 Mark Garnier: The OFT has also shown Q700 John hurso: Is there a barrier to you scepticism—that it is very difficult for new entrants expanding through raising capital or do you have to the banking market because of the absence of an access to the capital that you need? extensive branch network. Again, that is not really ay - a hia: We have access to capital your experience, is it? through our existing shareholders and the opportunity ay - a hia: I’m sorry, that that has been an to raise capital through other investors at this point, obstacle? but we’re not quoted on the markets, if that’s what Mark Garnier: That that is an obstacle. you mean, at this point. ay - a hia: Yes, as I said to Mr Mann, John hurso: Thank you very much. we’ve been very successful online. I don’t believe that’s cherry-picking. I do believe that’s trying to give Q701 Chair: Can I take you back to your four the widest possible population—understanding the barriers to entry? One was product and you were limitations—access to the product. saying, “We need more transparency in disclosure.” Would that extend at the level of the customer to Q695 Mark Garnier: Can I just develop the point enabling the customer to see how much interest that John was making, which is, do you tend to select forgone is made on his account? your customers because they are techno-geeks? Sorry, ay - a hia: Yes. We believe that it’s I’m probably being very rude to your customers, but is possible to show—certainly against, let’s say, base Treasury Committee: Evidence Ev 109
18 January 2011 Jayne-Anne Gadhia rate—how much interest is forgone. I think there them are not looking solely at the economic benefit of needs to be a lot of work done to understand how best that transaction, but are also appropriately mindful of to communicate that in a simple, clear, straightforward predominantly the competition effect. We also think way. I think there’s a risk that we could confuse that the effect on jobs is important, so in going customers by giving too much information, but our forwards, it’s quite clear that if a big incumbent buys intention certainly, as we plan our current account, is a smaller part of a competitor’s business, it’s possible to be able to show customers the cost of their banking, to reduce costs through reducing jobs, and I think that which is the transaction cost and also the interest that’s something that should be taken into account as forgone on their account. well. Chair: Okay. Thank you very much for giving such Q702 Chair: And another of the barriers you clear evidence this morning, with no banker-speak. mentioned was the public interest test you are We really appreciate it. proposing on the acquisitions issue. What do you ay - a hia: Thank you. think would be added by a public interest test? What Chair: It has been very interesting and added a lot to do you think we would discover? our inquiry. Thank you very much for coming. ay - a hia: What we’re really saying is that, ay - a hia: Thank you very much. as Government assets are sold, we think that it’s Chair: We will now take a three-minute break and important that the boards of the companies selling begin at 11.10 am.
Examination of Witness
Witness: Ana Bot n, Chief Executive, Santander UK, gave evidence.
Q703 Chair: Let’s begin. Thank you very much for so this has meant that, unfortunately, we have not coming to give evidence before us this morning and done the best job for all of them. So we’re working welcome to your new job. First, would you say a bit on the underlying. We’re also working—it’s a big about Project Merlin, the project led by John Varley, priority for us—to improve the complaints handling, for the banks collectively to engage in the bonus issue and there’s also evidence that we are beginning to do and also lending to SMEs, and where Santander stands that much better. on that? a Bot : Sure. Good morning, I’m very happy to Q706 Chair: So it’s, “We haven’t done well enough, be here. We are in discussions, so discussions remain ongoing. We at Santander very much support the but we are going to do better”? overall, I would say, economy-wide objectives of a Bot : It’s a top priority for the bank and for me Merlin in terms of growing lending to the economy to improve service quality and also to improve the and supporting SMEs and communities. As a matter complaints handling, so, for example, one of the of fact, we have been growing our lending in the last issues that we have done this year is that we’ve few years, and last year around 27% to SMEs, so employed 1000 people in our branches and call we’re very supportive of all these objectives. Our centres to improve customer service. We’re aiming to intention right now is to participate specifically also have all of our complaints—today, it’s 80%—fixed in in the lending commitments. As I said, we’re already 8 hours. So there are many issues that are ongoing. growing our lending to SMEs. That is basically where We are improving, and of course our objective is to we stand. have all our customers treated in the best possible way. Q704 Chair: So the reports that you had withdrawn from Project Merlin are mistaken? Q707 Chair: And what about the record on SME a Bot : As I mentioned, we intend to be in Merlin, lending? How has Santander been doing there and but in our own way in certain of the areas that Merlin what steps are you taking to improve that? is working on, so that is the reason, maybe, why these a Bot : On SME lending in Santander, there is a reports have come out so. ranking on eBay and we come out best in the UK, so we are the bank that has the best record in terms of Q705 Chair: Turning to your retail customer base, SME lending. There is a number that are not happy what explains Santander’s persistent poor still, and, as I said, it’s the best track record. SME performance in consumer satisfaction surveys? a Bot : The issue of service quality is a very lending is the most difficult business for any bank, so important one for Santander, and we have had issues it’s going to be one of our priorities to become not in the past few months. As soon as these issues came only a larger player, but also a better player. out, we apologised and started to take action. We are Understanding the customer, being their partner, really beginning to improve. There’s a lot of work to be going through with them in all the sectors of the done, and we’re working basically on two levels. One cycle—sometimes it’s not easy for them, so we have is in fixing the underlying issues—improving to make sure we understand them so we can be with processes and getting queues down in the branches them in the worst times—are absolutely some of our and so on. We have 25 million customers. During priorities. We’ve added 150 new relationship 2010, we integrated 5 million customers from A&L, managers this year in SME lending. Ev 110 Treasury Committee: Evidence
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Q708 Chair: Why is it that other banks cannot get a Bot : It has been a long crisis. It’s a lot of money to their SME clients? Why are they customers, and many economies like the UK and complaining to us so vigorously? others are deleveraging. Deleveraging means there’s a Bot : As I said, lending to SMEs is probably the less capacity and less capacity obviously is companies hardest thing a bank has to do because we’re attending that are either retrenching or, some of them, hundreds of thousands, even millions, of small disappearing, so it’s both an issue of demand and entrepreneurs. We need to get the person who is supply. dealing with that entrepreneur understanding the business, and this is not easy. Entrepreneurs usually Q712 John Mann: I seem to recall your predecessor are very successful, hardworking and very coming in front of this Committee in 200 and giving experienced in what they do, so understanding their the distinct impression that there was a superior business is the key for us to be able to be with them Spanish model of banking as opposed to the Anglo- not only on the lending side, but on the products and Saxon model. The Spanish economy seems to have giving them the services for export. Given the global collapsed compared to other European economies, so economy today, very small companies are selling all what has gone wrong? over the world. So the whole range of products—the a Bot : I wouldn’t say there’s a superior banking way we deliver that to the SME—is quite complex model or inferior. At the end, I think we need to look and something most banks have an issue with at what customers get and the products they have. It’s sometimes. The other issue today is liquidity. Given very important that they have the choice of products, the situation in the market, liquidity is also an issue so you need to be in a market that offers competitive in growing lending at a faster rate, as a system. pricing and good products, then customers can move around and change. In that respect, I believe that the Q709 Chair: I just want a little clarity on why it is UK and Spain come out as quite competitive and good these customers are complaining to us about other markets, both for retail and SMEs. In terms of the banks so vigorously—indeed, they probably complain question on Spain, Spain has had 15 years of very a bit about your bank, but less so than others—and high growth in many cases. I’m not sure of the exact how we’re going to address this apparent shortage of figure, but it is one and a half to two percentage points reasonably priced lending to SMEs as we try and higher than the rest of Europe. Spain is now in a secure the recovery. period of adjustment. The adjustment is happening on a Bot : Again, on the retail side, Santander has the current account. It’s gone from 11% to 5% in 18 25 million customers. Most of them are retail months. The savings rate is going up. Again, as other customers today. In SMEs we have a small market economies, Spain needs to be leveraged, so the share—3%—but we’ve tripled our business since economy is contracting, the savings rate is going up. 2007, going from £1 billion to £3 billion in lending, The Government is making many of the necessary but still being able to deliver that quality of service is reforms so that the country can get growing again. In much harder when you have to personalise the service. the banking sector, it’s a bad three years with one very You need specialist relationship managers. You make small institution having to be intervened on. What is sure that those relationship managers can offer the full happening now? A very important step was taken in range of products that the customer needs. Sometimes July, when a law for savings banks was changed so they’re quite sophisticated, even though they might that private capital could go into the savings banks. be small—trade finance, for example, or international The worry now in the market is not the Spanish banks, confirming. All these products are not easy sometimes which are among the strongest in the world, including to understand, but, as I mentioned, there’s another Santander, but the savings banks. Savings banks now issue, which is the structure of the market—the cycle will go into a process of recapitalisation and attracting we are in right now—which means that liquidity costs private capital, and this will be very important also for all of us have increased substantially, and this is for the future growth of the economy. something that we have to pass on in some way or another to the customer. There is less demand at these Q713 John Mann: In the United Kingdom, how higher prices. The other issue is confidence. many branch closures do you plan for this year? Customers need to be confident that the economy is a Bot : None. We are planning to open. We growing to invest, so it’s both a supply and a have— demand issue. Q714 John Mann: So there will be no closures? Q710 Chair: These huge rates of interest being a Bot : No. There will be no net closures. We demanded by a number of banks for SME loans might reposition some branches, but then, net, we are cannot fully be explained by the liquidity question, opening branches and that is the important issue. We can they? have not closed branches in the last three integrations. a Bot : By that, and also it’s a higher risk Going forward, we might reposition some branches, business, so at the end, you have to take into account but, net, we plan to add to our branch network. the risk return and, depending on the segment, this is Branches and the personal contact are key aspects of the way the— our banking model—being close to the customers. So we have 1,300 branches, or a bit more than that, and Q711 Chair: The banks have become very nervous we’ll end the year with over 1,700 branches, with about this recovery? RBS branches. Treasury Committee: Evidence Ev 111
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Q715 John Mann: Final question. Your bank has of lack of competition. One indicator of that is lack been somewhat under the radar in the discussion on of switching. What steps would you like to see put in bank bonuses, so how much do you pay in bonuses? place—either by yourselves or by Government For the last year, what was the highest bonus that through a new regulatory regime—to give you the anyone from the bank was paid and will that be the opportunity to compete with the big four? How to same or more this year? improve competition, from your perspective? a Bot : Just to give you an indication of where a Bot : I would like to reiterate that we have our bonuses will stand relative to the UK, in the bonus doubled our number of current accounts organically stats, we paid 1%, so that is the proportion of the total in three years, so we have been very successful and bonus pool in the UK system, whereas we have over we are introducing competition to the current 10%, and in some cases 13%, of the retail market. The account market. highest bonus has been the CEO bonus. Q721 Mr uf ey: How have you done that? I think Q716 John Mann: How much is that? it’s laudable. How have you done it? a Bot : I was not involved in that; it was my a Bot : We have done it, very importantly, predecessor. through new products and innovation. We have launched very attractive products like the zero current Q717 John Mann: But you must have a good idea account, which has attracted 176,000 customers. how much it is, or was? That’s zero fees if you go into overdraft. It’s been very a Bot : I’m happy to tell you my bonus last year successful with our customers. We have the best buy in Spain, running Banesto, was €1.7 million. also for in-credit current accounts with 5% interest. The key here is to be able to have competitive Q718 John Mann: And that is what you would institutions—and competitive means efficient anticipate this year? institutions—that can also manage risk appropriately, a Bot : The bonus will depend on performance in of course. That’s very important for a bank, and that the UK and in the UK market, and on what CEOs is the best way to introduce more competition into the currently get paid for running a business. In our case, market. So it’s in our interest to have more it’s related to performance and significant portions are information and more transparency for the customer— deferred, and deferred in shares, and we believe it’s for example, in current account statements, which is very important that our bonuses in general are aligned something that was not done before and is now to the interests of the bank and our shareholders. being done. Chair: We have had a good canter round bonuses in For the end of this year, we have all that information recent weeks. David Ruffley. once a year for our customers, but they can access through different ways—in the branches or on the Q719 Mr uf ey: Thank you, Chairman, and good internet—the different rates and different products that morning. Helen Weir from Lloyds gave evidence to we offer, with the cost and the interest paid in the case this Committee to the effect that the current account of credit. The other issue is the direct debit market is a very price competitive market right now. institutions—how that gets done. Again, that’s an area Do you agree with that? where I believe there has been significant a Bot : Currently, Santander has around 7 million improvement in the last year. So, ease of switch, current accounts and we see ourselves as a challenger making sure the customers are aware of what he or bank. We would like to continue growing in general she is paying and receiving. Our studies show that in the UK market and we have been able to attract 1 there is a perception that customers see this as an million new current accounts in 200 and another 1 issue; it’s a hassle to change and it’s not that much million in 2010. We do believe it’s a market where the case for the majority of customers, so I think transparency and the ease of switch could be consumer education is also important. improved, and we would welcome, and we are working ourselves, on ways to do that. I say it’s Q722 Mr uf ey: Looking at your big four important to put that into context of the overall competitors, would competition be enhanced or stay financial services market. In that case, it’s an the same if investment banking was split off in those extremely competitive market overall for different four banks from retail, and are you arguing for that? reasons and probably the current account market is a Bot : We believe that the universal banking the one that has less competition. Again, even though model is important for the economy and to support switching has been made easier in the last year in the customers big and small. The way that that business industry, and we, in particular, are working to improve is managed internally and how capital is allocated is, that, it’s important that customers have clear we believe, more important in terms of competition information on what they’re paying and what they’re and stability of the banking system. We believe a very receiving for the current accounts, and it’s very strict separation is probably not what would make the important that they can change and switch as easily system safer or more competitive, and those are the as possible. key issues when one analyses what is the banking model we want—here and in the rest of the world— Q720 Mr uf ey: I understand that, but the things that we should bear in mind. Many times, those two you have talked about—greater transparency and the objectives are not exactly aligned. It is a complex rest of it—have, to a large extent, been true for many issue, rather than just saying that by separating pure years in British banking, yet we still have this problem retail commercial banking from universal banks we’re Ev 112 Treasury Committee: Evidence
18 January 2011 Ana Botín going to have a better or more competitive system. By effect if there is a change in interest rate. The variable better, I mean safe and sound and competitive. obviously will change if rates move up.
Q723 Mr uf ey: You’re saying you’re not arguing Q729 Michael allon: But how will it change? Will for that. they have to pay the full increase of any increase in a Bot : We’re not, no. Santander is 85% retail and the policy rate? commercial banking, but we do have a small portion a Bot : If they stayed with that mortgage they of our business that is managing our own balance would, because this is a fixed spread, so the spread is sheet and helping our customers to manage their risk. fixed in the variable rate and, depending on the base, When we speak about SMEs or large corporates, we it moves up or down. If you go for a fixed-rate offer them interest rate or foreign exchange services, product, you would have a fixed rate mortgage, for example, and in very strict separation that obviously not affected by interest rate movements. probably would not fit into the model. We think that The interesting thing in this market, which at least to that model is valid and has proven during the crisis me is a surprise, is the very big turnover, so the that some of the most stable and successful banks average mortgage is four to five years. Typically, in were universal banks and large banks. Spain, for example, it’s 12 years, so there’s a very big David uf ey: Okay, thank you. turnaround of the whole mortgage market, plus there’s another interesting thing, which maybe just from Q724 Michael allon: How much mortgage lending looking at the banking—pure banks—is not evident, did Santander do in the UK last year? which is the big amount, over 50%, of the mortgages a Bot : Our total mortgage book is around £160 originated by IFAs, the Independent Financial billion or £170 billion, and of that, we turned over— Advisers. our new business—around £ 0 billion, but I’d like to get back to you on the exact number. In terms of Q730 Michael allon: Do you think there is any market share, the number is 18% of all the new action that regulators here could take to make it easier mortgages in the UK. That is one in five mortgages for first-time buyers—to make it easier for you to lend done by Santander. to them? a Bot : Again, what’s important is to have a competitive market, so I think different banks at Q725 Michael allon: How much do you expect to different times will have different strategies. Again, do this year? competition is the best way to get first-time buyers to a Bot : The market has been softer, so in terms have access to a home. It’s important that some of the of overall size and how many mortgages, probably regulations that are in place ensure that the market is about the same or maybe a bit more. We are still not going against competition. Even though it’s not aiming to gain market share. Our current market share exactly about first-time buyers, the mortgage market is a bit below 1 %, so we would aim to do more than review, for example, in terms of income verification, our share and grow. could also—if it is approved, as is being discussed— hinder competition by introducing obligations. We are Q726 Michael allon: To increase by share or by now allowed a fast-track method of approval for volume? mortgages that allows us to rely on the Independent a Bot : Our projection right now is for the market Financial Adviser’s income verification. If we had to to be relatively stable in mortgages, or maybe grow a do that ourselves, it would hamper the approvals and, little bit, so we will grow our mortgages and grow therefore, the market, so that is a general comment on market share, but the exact growth is difficult, how we could be more inclusive in allowing depending on what the market is going to be doing. everybody and every single different type of customer in the UK to have access to an attractive and Q727 Michael allon: One of the consumer groups competitive product. has told us that for those looking to buy for the first time, conditions have worsened significantly. Q731 Michael allon: But you wouldn’t want to go a Bot : We have some very attractive first-time back to the days of self-certification, would you? buyers’ products—I’d be happy to send the details to a Bot : What’s important is that we are allowed you—but we do have an agreement with another to go, as we have been now, through the Independent institution to offer that product, so we have been Financial Advisers for verification of income. This is active in the first-time buyers’ market. clearly an advantage. What we would not like, as has been discussed—it’s another important issue in that Q728 Michael allon: Given how far the policy rate ongoing process—is banks that have primary current set by the Monetary Policy Committee is now accounts with that customer being allowed to do that, detached from the actual rate that borrowers are being but banks that don’t not being able to do it. Again, charged, will your home owners have to match any that is one of the issues in that regulation that would increases that now transpire from the MPC? Will they affect us as a challenger. have to pay more than that increase or less? Michael allon: Thank you. a Bot : It depends on the product they have. We have a fixed rate product; we also have a variable rate Q732 Andrea Leadsom: Ms Bot n, I wanted to talk product, so it will depend. Fixed rate obviously for to you about SMEs a bit further, but first, will you the first two years usually is fixed, so there will be no comment on a remark made by the Chief Executive Treasury Committee: Evidence Ev 113
18 January 2011 Ana Botín of Virgin Money, who was just here, where she was a Bot : Yes. We believe it has a lot of merit. We suggesting that one way to create some sort of safer do not believe it has to be applied to everybody, but banking system would be to have banks keep separate we believe that “too big to fail” has to be capital for their retail operations and their investment complemented by other measures. Interconnection— operations. Will you comment on that from or governance or subsidisation—is an issue that would Santander’s point of view? limit the amount of capital you would need to apply a Bot : In terms of crisis prevention, it’s clear to large systemic banks. We have done a lot of work that how we approach regulation is important, and the on that and we are very happy to share it. We are governance model and the structure of the universal sharing it with the regulators in different countries, banks in the case you’re mentioning—that is, having including here. investment and commercial banking within the same Andrea Leadsom: Is there a report on that, group. On the Santander model—this is just one Chairman? model; we’re not saying that it is for everyone—I believe, and we believe, that diversity of models is Q736 Chair: Are you giving evidence to the Vickers important for the system, and for choice and for Commission on that—on the issue of subsidisation? customers, but in that specific model of universal a Bot : Yes. I was there last week. I don’t recall banking and how to allocate capital, our model is very that we were going to share it, but we can do that. much a model of subsidiary, so we believe in We’re very happy to do it. separation between the different entities. Santander UK is absolutely stand-alone from Santander Spain or Q737 Andrea Leadsom: May we request a report on Santander Brazil or the other companies that we have specifically that point? in the group. Within each of these companies, it’s a Chair: If you have something you’d like to send us, very strict separation between that small portion that we’d be grateful to see it. have of market risk—treasury management for ourselves and our customers. We allocate different Q738 Andrea Leadsom: Thank you. Can I ask one amounts of capital to the business, but we don’t final question on that? Have you found that it has believe there has to be necessarily a very strict affected your credit rating—the fact that you have separation. Our model, we believe, has a lot of merit these independent subsidiaries standing alone in in terms of crisis prevention and resolution for the different countries? Do you find that it limits your system, and is very much based upon the principle of ability to access the capital markets in those separate subsidiaries for countries. countries? a Bot : No, on the contrary. We access through Q733 Andrea Leadsom: Just to be clear, you are different names, and now it’s mostly Santander. allocating capital to each subsidiary, so the UK Banesto, the bank I used to run, is the only exception, subsidiary has a separate pool of capital from the but it allows us to access markets, I think with greater Brazilian subsidiary, for example. ease and offering more choice to investors. a Bot : Yes. They stand alone and they issue in Andrea Leadsom: Thank you. Coming on briefly, if the markets, and there are no cross-subsidies or I may, to SMEs? relationships more than the services in terms of Chair: It will be a brief last rejoinder. technology and all that, but not in terms of capital or funding. Q739 Andrea Leadsom: Very brief, then. The Future of Banking Commission said that since the financial Q734 Andrea Leadsom: For example, if your crisis, difficulties faced by SMEs have manifested Brazilian subsidiary were to get into financial themselves through higher costs, problems in getting difficulty, would there be some cross-subsidisation credit extended and sudden and unfair changes to from the rest of the group? terms of contracts such as the withdrawal of overdraft a Bot : No. In fact, Santander did have an issue facilities. Would you say that Santander’s rapid 10 or 12 years ago in Argentina. We followed that growth in SME share is down to that dissatisfaction principle, so a subsidiary had issued that in the of customers? market, and of course had been paying a higher spread a Bot : SME lending is one of the hardest things than the Santander group would have done, so for a bank to do and to do well, and I think there’s a investors were very much aware that this was a stand- lot of opportunity for us to do much better in that. alone subsidiary and we followed that through, so we That would be one of my priorities in growing the have done that in the past. UK business. We want to have a more balanced mix between SMEs and medium-sized companies and Q735 Andrea Leadsom: I am sorry for going retail to deliver 80% retail individuals, but definitely, slightly off the tack of what we said we were going yes. I believe there’s a move by SMEs to have several to discuss, but I think this is a very interesting point. banking transactions, not just one. I think this is very When Bob Diamond was here last week, he was good not only for the system—for us as providers— advocating that subsidisation would not work and to but for the small companies. Just relying on one support his thesis he gave, in my opinion, an incorrect provider is probably not advisable. Having too many example—Barings’ failure. Would you say that probably is also not possible, because you have to subsidisation would be an effective means of limiting manage all these relationships, but having at least two this argument about “too big to fail”? is a very good trend, and from our research in the UK, Ev 114 Treasury Committee: Evidence
18 January 2011 Ana Botín that seems to be happening and we are clearly and, something I feel particularly strongly about, this benefitting. sudden manifestation of unfair changes to terms and We incorporated 1,500 new customers. It’s not a huge contracts, such as withdrawal of overdraft facilities. number in SMEs, but remember we’re coming from Two questions on that particular point. The first is, do zero almost, three or four years ago. So we’re very you recognise that in the existing marketplace in the happy in terms of the response to our product, and UK? Secondly, has that been to your benefit? Are you I know this is difficult to quantify—it’s actually not seeing dissatisfied customers moving across to you as quantifiable—but we are trying to invest in our a result of it? relationship managers and, as I was saying before, a Bot : Even though it’s hard to explain, we trying to have them understand the business of the believe we offer a different kind of SME service, and entrepreneur and of the small company. That is not that, we believe, is the reason that customers are easy, but it’s where we’ve made the biggest joining us. As to the industry—this is not specific to investment and it has been one of our priorities. the UK; it’s throughout the world—I’ve been 30 years in banking and I’ve had the opportunity to work in Q740 Mark Garnier: May I develop the point about the US and Spain, but also in other countries. SME relationship banking? One of the problems that I have lending is hard and this is an issue that we all grapple seen in the past, and certainly anecdotally from with—how to improve that. constituents of mine, is that the relationship manager Here in the UK, we now are part of the BBA taskforce of the big four banks has always been pretty bad. on SME lending and a lot of things are happening What are you doing that is different from them? there. There are 17 different measures, like mentors, a Bot : I know that this is not a very easy-to- for example—putting people who have had measure answer, but the culture of SME business is experience in banking mentoring SMEs. So yes, we something that takes many years to build. We have are getting some dissatisfied customers joining us. We that culture. Santander, as a group, has been known are starting from a small base and we intend to grow for 150-plus years, and that has been one of our core that. For me, it’s going to be one of the priorities strengths. We have traditionally been a leader in SME trying to see how we can do that better. We are going lending and that’s a culture— to work not only as a business; we’re going to do programmes. I’m going back to the Merlin Group. Q741 Mark Garnier: In Spain is that? That’s one of the objectives, and in that one we’re a Bot : Yes, in Spain, but at the end, a lot of the going to go with our own strategy. I did that at practices are similar. This is a totally different market Banesto myself with my team, and we believe we can and you’re absolutely right that we need to understand add through the universities programme that it. The reason that we’re hoping to be a bigger player Santander already has in place here, working with in that area is because we have the chance now to entrepreneurs, working with partners to help SME incorporate RBS branches, so we’ll get to a market growth, not only on the lending side, but also helping share that allows us to compete more effectively. their business. So we’ll be working on that. There are different cultures coming from RBS and from A&L, but, on top of that, we’re putting in our Q744 Mark Garnier: You are a big bank. One of the own, and we have developed our own culture already other problems that people have is that an SME will over the last three or four years, and it’s a combination go to its local bank manager and they will have a of having the best local talent, having clear what it is conversation about a credit term, buy some new plant that we want to offer, based on all our experience, and or machinery, or invest in something. The local adapting it, yes. manager could be very willing, very helpful and do all the usual platitudes to keep it happy, but by the Q742 Mark Garnier: Again, anecdotally this is, I time it’s been back up to the credit committee in some have heard that RBS is particularly bad. Are you not distant city and then come back down, it has either worried that by buying the RBS branches you are taken rather a long time, so opportunities may have buying bad practices into your otherwise okay bank? been missed, or alternatively, it just comes back with, a Bot : We have incorporated a lot of people “The computer says no.” Are you going to try and ourselves and trained them over the last few years. As address that problem or are you going to have to live I said, it takes time to develop that, but we are quite with it because of the size of your bank? happy with the results we’re getting so far. We’re not a Bot : I don’t think size is an excuse. I think size complacent. We know it’s a difficult business, so that’s makes it harder when you’re very big, but we’re not a big focus—when we incorporate these managers, at that point yet in the UK. You’re right: at some we’re already working with them and we have had point, having systems might mean having automated different sessions. Also, I will be meeting with them systems that are faster, but more rigid. In our model, shortly, so we’re trying to work on that as of today, we have risk people, because our risk function is even though they will not come on board for a year totally separate, so they would be working with the or even more. So yes, we need to work on that, but relationship managers. We need to work on a way we believe we have the model and the process to do it. forward. I’m not familiar yet exactly with how it is done here, but we will have to analyse and make sure Q743 Mark Garnier: Coming back to a point that that that works well together. Andrea made, a lot of SMEs complain about problems—this is since the banking crisis—through Q745 Mark Garnier: My final question, if I may, higher costs, problems with getting credit extended Chairman? Are you concerned by the stranglehold that Treasury Committee: Evidence Ev 115
18 January 2011 Ana Botín
Barclays, RBS, Lloyds and HSBC have in the SME Santander, as a group, and Santander UK, has a big market? I think they have about 0% of it. Do you proportion of its balance sheet in prime, residential think that this high level of concentration has led to mortgages. We have half the arrears of the system here really bad outcomes for SME customers? in the UK, so if the quality of our balance sheet is a Bot : The outcomes for SME customers I’m not better, the business we have is more recurrent, and that familiar with, so I don’t know the exact numbers. that’s why, importantly, we do well in all modes of I’ve only been here for a month, but I presume it’s the cycle. We should not be asked to have as much not much different from other places. I am familiar capital as a bank that is riskier. We believe those with the structure of the SMEs in this country and issues are important and should be taken into account they’re much smaller. You have a lot that are much in our non-systemic institutions. smaller at the base, and this is much harder to serve for any institution, because they’re even more difficult Q747 Stewart Hosie: I understand that, but what I to understand in terms of numbers and harder to reach, am trying to understand is whether you believe that so probably the outcomes have not been that good, in the banks that are backed by the Government—in one part because of that. way or another, whether through direct We’re very much a challenger in the SME market and recapitalisation or access to special liquidity—have an we very much believe that the RBS transaction allows advantage over the institutions that are not seen as too us to be a real challenger because we will be able to big to fail? be present in all of the country and our objective is to a Bot : If you look at the CDS spreads in the reach 70 business centres for SMEs. We’ll be hiring market, it depends on the countries. It’s not new RMs this year again and opening new business necessarily a direct correlation. There are banks that centres, as well as integrating RBS. So, independently have been intervened and have the Government as a of RBS, we’ll be opening a few more business shareholder, or have had support, that have better centres—I think it’s 10 or 15, so we do expect to be spreads than others, and others don’t, so it’s not an a strong player over the next two or three years. exact correlation. However, there will be more banks Mark Garnier: I certainly hope so. I think the SME in that category that have a lower perception of risk. market would welcome a fresh approach to this. It’s difficult to measure perceptions and the only way Thank you very much. that I know of is the CDS, so looking at that number— at that CDS spread for different banks in Europe or Q746 Stewart Hosie: Can I say before I ask my the US—some banks that have Government questions that I have seen your relationship managers shareholding or support have a perception of higher at work in a business in my constituency, agreeing to risk than others, because a bank like Santander has lend money to that business, which others would not, not had that as a group and we still have CDS’s that and that allowed a good, solid business investment to are better than Government. go ahead that otherwise would not have? I thank you for that and say that the more of that you can do in Q748 Stewart Hosie: Okay. Has the Santander Scotland, the better. However, if I can go back to the operation in the UK benefitted from any of the questions we have, it is believed that there is an implicit subsidy the Government provided? Does implicit taxpayer subsidy to banks, which are too big Santander access the special liquidity scheme, for to fail. The Government will stand behind them; they example? have recapitalised them. They have access to the a Bot : When the crisis occurred, all banks in the special liquidity scheme. There is paid-for commercial UK were asked to participate in the special liquidity inter-bank lending as well. Do you think that gives scheme—not in the CGS, but yes, in the SLS. those banks, which are too big to fail, a competitive advantage—because the Government stand behind Q749 Stewart Hosie: If that was withdrawn, would them in that way? it have an impact on the cost of money to the banks? a Bot : I believe, and we believe, that no bank a Bot : The issue in the UK is the funding gap as should be too big to fail, so we should have a a system and all extra liquidity that is given to the mechanism that allows banks to fail. Having said this, system will have an impact on the system’s total we should have a system that prevents them as much lending capacity, so it’s not just us. We have a big as possible from failing. If that happens, we mitigate base of retail deposits. We are mostly retail the risk and we reduce the impact on the taxpayer and commercial deposit funded, but I think the issue that’s on the economy. Going back to the systemic issue, important is, as a system, if you take away liquidity, once you have depositors involved, you have there will be less money to be lent out to companies. regulation and, therefore, you need to monitor that, That’s quite clear, so it would have an impact on the and most countries have a minimum guarantee deposit system as a whole. scheme, which clearly makes everybody, big or small, able to compete on that level of the market. Once you Q750 Stewart Hosie: Right, and on Santander get to the higher level and you become systemic, yes, specifically? it’s probably an issue and, therefore, what we are a Bot : On everyone who has participated— advocating is that capital should be allocated not just including us, yes. because you’re big, but depending on the types of business you do. Q751 Steward Hosie: In terms of competition, I On the systemic issue, we should not only have size, wasn’t meaning to go down that road, but the banks but have the kind of business you have. For example, that are deemed to be too big to fail have this implicit Ev 116 Treasury Committee: Evidence
18 January 2011 Ana Botín support from Government. What incentive is there for we need to focus on. The other thing is we should a customer—a retail customer—to leave a large bank focus on working on the issues that we think will with that implicit support and move to a new entrant really improve switching and ease of transfer. Again, in the market? I don’t have the numbers and it might be interesting a Bot : I think that retail customers, except in to look at some analysis, but we’d have to change so moments of crisis, are motivated to change for a much inside the banks and in the system that, variety of factors, and not only the soundness of the probably, the time and effort would be better spent in bank, which is very important. Retail depositors are other areas. guaranteed across the board, up to a very high amount, so the issue of solvency usually is not affecting, Q754 Mr Love: You’ve mentioned transparency except in a crisis and when there’s a period when several times and backed that up with a couple of the things change. That is one of the issues we have to products that you are offering, which you think will ask the financial system to decide, both here and in bring in new customers and lead them to switch. other countries. How do we want to manage crises? Another approach would be a common transparency How do we want to work to prevent crises? Do we code that all banks—all major institutions—would have systemic banks having more capital? How do we have to follow so that the customer could compare the allocate that? The purpose is to try to make the system offers that each was making. Does that have some safe and sound, and also competitive. Those are the merit from Santander’s point of view? two key issues that we have to ensure, but I do not a Bot : Yes. For example, we are offering our believe retail customers, in today’s situation, are being savings account customers—I’m not sure if it’s moved by that. savings or investments now, but one, maybe both— different kinds of product. If you’re a customer who Q752 Mr Love: You mentioned earlier you’ve only has product A from Santander, you can see, either been with us only a month—we hope you enjoy your online or in the branch, what other products we have time here in the UK—but that gives you an and what they pay you, or what they charge you. In opportunity to have a fresh perspective. On personal this case, it’s Spain—it’s investments. I think the more current accounts, the level of switching in this country information we can get to the customer, the better for is very low. Have you had time to think about that, customer choice. Because we are a challenger, we why it happens and what can be done about it? welcome this and are trying to work on it. We’ll be a Bot : Yes. The level of switching is low, but we working during this year at different levels to improve today have 7 million current account customers and that information to the customer. we started with, I think, 2 million or 3 million only three years ago. I don’t know the exact number, but Q755 Mr Love: Some of our witnesses have we’ve grown very fast, and 2 million of those in the questioned whether the “free banking when in credit” last two years. What we believe is that over the years system, which is predominant in this country, militates that we’ve been present in the UK—this is what I against transparency and the ability to switch have been explaining—the transparency has improved accounts. What is the Santander view of free banking? greatly and the switching process has been made Is it helpful in Spain? easier. That is something that we will continue to a Bot : The research I have seen so far—maybe work on because we believe this is what is important there is more to be done—makes it seem that is very for the markets to be competitive, and we work on much an ingrained model in the UK banking that. We believe that our strategy and our business consumer. This is something that people value and it model will allow us to offer best-buy products. In seems to work. It could work better and that’s 2010, Santander offered a quarter of all the best-buy something we need to focus on. Again, the issue is products in retail. We will work to continue to be not choice. We have brought out a number of products only efficient, but good in service, as I mentioned of packaged accounts. I believe it’s a very interesting before. This is the key for that switching to happen, product. We did a lot of that in Banesto in Spain, so the issues being the transfer from the direct debit we would have a flat fee account and you would pay companies is done fast, that there is the least manual anything from €5 a month to €15 and would get a intervention from the customer and that things happen different value for that. This is not a very big market in a short time period. Those are the issues we are right now in the UK, but some customers like it and working on. we have brought out different models of it. What’s important is choice. From the evidence and from what Q753 Mr Love: A witness at one of our sessions we have seen so far, the “free if in credit” model in suggested that account portability might an issue. I the UK seems to be quite well established. want to come back to the issue of transparency, which you have mentioned several times in your evidence, Q756 Mr Love: You are right that packaged accounts but would account portability and other technical have taken some of the market away from “free if in issues help to achieve this? Other witnesses have said credit”, but the public seem to be very committed—I it would be too expensive. What is Santander’s view? think perhaps because they don’t fully understand— a Bot : My view is that I don’t have enough and of course the industry is very reluctant to move, evidence and that it’s certainly a matter that can be because whoever does it first will suffer somewhat in looked into and analysed. From the information I have the short term. If we agree—it seems to be emerging received, it seems like it would be a very expensive from our inquiry that there are major concerns about thing to do and, therefore, maybe that’s not the thing “free if in credit” banking in terms of competition for Treasury Committee: Evidence Ev 117
18 January 2011 Ana Botín customers—how we do not undermine it, but at least Q757 Mr Love: One final question. If competition is raise the issue of choice and the fact that people to work, there has to be transparency in the should look carefully at whether they are getting good marketplace. You mentioned packaged products, yet value from “free if in credit”? the level of transparency in some of those is not as a Bot : As you have mentioned, I am very much great as we would hope. On “free if in credit” a newcomer and I believe that the financial system in banking, there is very little understanding out there the UK has a lot of checks and balances. There is a among the public and very little transparency about lot of media exposure. There’s a lot of regulation that what the checks and balances are in costs. How far do is monitoring whether we are doing things right or we need to go with transparency to make competition not, so I think we have a lot of things in place and more of a reality in this marketplace? maybe having more is not really going to help. I a Bot : I think you can never go too far in believe that, even in current accounts, there is transparency, and I think it’s a gradual process. When competition and Santander has proven that because 1 you have 25million customers and thousands of million current accounts per year for two years is a products, it takes time, but I think the direction in big number and we intend to continue growing. which the industry, and certainly ourselves, is going— I believe we just need to make sure that that we’d like to be leading that movement—is competition continues, so there are one or two encouraging and the right one. We very much incumbent players that have large market shares and welcome that. We are a challenger and we want to we need to continue on a dynamic way to monitor. I grow market share. We are lending more. We are don’t think we need to have new measures or new doing more mortgages and are growing SME lending, regulation. Given the changes in liquidity, capital and so any transparency increment for us is welcome and restructuring, there have been many things happening I think it’s very good for the market. and I think we want banks lending again more and Chair: Thank you very much for coming to give focusing on growth, and having new requirements in evidence to us today. We have found it extremely terms of anything would hamper that. Frankly and valuable, and the Santander experience is certainly honestly, I believe there are a lot of checks and quite different and in many ways refreshing for UK balances, a lot of competition and media exposure. At customers. We will take away a good deal of what you least as a newcomer, my best advice would be that we have said, which will inform our report. Thanks again. should probably make sure that that works. a Bot : Thank you very much. Ev 118 Treasury Committee: Evidence
Thursday 20 January 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Jesse Norman Mark Garnier Mr David Ruffley Andrea Leadsom John Thurso Mr Andrew Love Mr Chuka Umunna ______
Examination of Witnesses
Witnesses: John in leton, Chief Executive, Office of Fair Trading, and Clive Maxwell, Executive Director, Office of Fair Trading, gave evidence.
Q758 Chair: Good morning. Thank you very much I should probably say that the OFT doesn’t regulate for coming to give evidence to us this morning. You the banking sector. Our job is to enforce consumer will have seen we have already collected a large body and competition law. We do that selectively where we of evidence on this subject, and you’re particularly see breaches of it and where we think the issue will well placed to help us with our inquiry. raise broader precedential issues. The way the The first question, given all that evidence, is to ask consumer and competition law works is: businesses you which side of the line you come on the views themselves are accountable for complying with the that have been expressed to us. A very large body of law and for making the market work; we intervene evidence has been put to us that competition is when we think they’re falling shy of what is required inadequate in retail banking, and there is a rather by law for them to do that, and we have really pushed smaller body of evidence that everything is pretty our instruments as hard as we can in many of these much all right and is very competitive indeed. Where areas. do you stand on that? One of the central points that I want to get across oh i l to : I think probably on the side of today is that I do think the CPMA needs to take thinking that the market could be more competitive. seriously some of the issues around consumer We have done a lot of work across a range of financial switching and consumer inertia in the market going markets, but personal current accounts and small forward, and also have a top-line duty to promote business lending in particular, which share some competition in the setting of its rulings, which the FSA currently doesn’t have. common features within the market, could be more competitive. Unlike some other markets, the primary focus of our attention has been on consumer switching Q760 Chair: So you have done your best and it’s and consumer inertia as one of the biggest barriers to now up to the regulators to do better, and in that competition, but we’ve also looked at barriers to entry respect— and we’ve also looked at market structures. I’ll let oh i l to : That doesn’t mean we will stop you dig into some of those issues in more detail as taking an interest in this market, but put it this way: we would like some help. you prefer. Q761 Chair: The help, if I could summarise what Q759 Chair: You have been looking at this for a long you have said, should come in two forms: one is we time. Why hasn’t the OFT been able to sort it out? need action on the concentration in the market and the oh i l to : We have applied every single tool other is that we need something to deal with inertia, we have in this market in one way or another. A which may involve more action on transparency. Is number of mergers have come before the OFT and the that correct? Competition Commission in the last decade. No large oh i l to : Yes. We have come quite a long way merger has been approved by the competition system on inertia. The banks have become more transparent in the last decade. The original Lloyds-Abbey deal in the pricing of personal current accounts over the was not—and, of course, we expressed our view on last two years, even since the Supreme Court decision. the Lloyds-HBOS merger at the time. On competition We got the banks to agree to changes in how they enforcement, for example, we did a case last year; present the information to customers. RBS has agreed to pay a fine of £28.5 million on a competition infringement. So we have used Q762 Chair: Do you think that is enough, or do we competition enforcement in the sector. We have have to go further, and in what respect do we need to brought the bank test case, which went up to the go further? Supreme Court. We were surprised—as many other oh i l to : We think it needs to go further. people were—that we lost at the Supreme Court. We When people talk about transparency it’s important have to accept the Supreme Court’s interpretation of that we’re clear about what we mean, because there is the law, but that also robbed us of an important a tendency—it can be well intentioned—simply to instrument that we thought we had to deal with this flood consumers with information and say then, market. And of course we also regulate the credit “Everything is transparent.” So, in some senses market. maximum transparency—giving consumers lots and Treasury Committee: Evidence Ev 119
20 January 2011 John Fingleton and Clive Maxwell lots of information—is not necessarily any better than Q766 Chair: In a nutshell, what do you want to giving them no information. You’re catching a happen there? waterfall with a teacup; it’s not very helpful. So, it’s oh i l to : On concentration and structure of the giving consumers the information that is relevant to market, I think first we will await—as everybody else them. will—with interest the Independent Banking For example, when we did the market study in Commission’s views on the retail banking market. banking, and that came out two and a half years ago, Having said that, we think that the CPMA should have we discovered that the bulk of the revenues on current a top-line duty to promote competition; in other accounts came from two sources: foregone interest on words, in setting its rules, in thinking about how it the one hand and the overdraft charges on the other. regulates the industry, it should promote competition They were probably two of the areas the consumer in what it does. had the least information on which to make an assessment of what they were paying their existing Q767 Chair: It should be an objective of the body? bank, or to compare prices between banks. It is very oh i l to : It should be an objective. At the difficult for consumers to choose between competing moment it is not a top-line objective set for the FSA; suppliers if they can’t see the prices of the aspects it is a secondary objective of the FSA, but we think it where the most revenue is earned. should be a top-line objective for the CPMA. I think that is consistent with the intention of the Government Q763 Chair: To get to the price, what do we need that the CPMA should be a consumer and market- to know? facing regulator. oh i l to : For foregone interest, which of That is a different issue from concurrent competition course is a different issue in the current interest rate enforcement powers. We don’t think that there should climate, and of a different magnitude, one of the be concurrent competition enforcement powers for the things we have got the banks to agree is to publish an CPMA. That is used where there is a monopoly annual statement setting out the average balance over supplier and the regulator has to regulate access of, for the year, which I think is a good step, because if you example, energy companies or telephone companies to don’t have your average balance, it’s very difficult to some essential facility, and where competition law have a quantity to apply the interest rate to. issues may also come up, the regulator may be best placed to deal with both simultaneously. We don’t Q764 Chair: Okay, but is that enough? have that type of situation in banking, and we feel oh i l to : One could go further with that. We perfectly competent to apply general competition law have gone as far as— in that sector, but we do think that, in the setting of Chair: I am trying to try to pin you down on what the rules, the top-line duty should be to promote the measures are that you think the regulator now has competition. to pick up. oh i l to : Foregone interest would be one Q768 Chair: What is your response to the view that aspect of it—being clear about if one bank is offering we need to address the increase in concentration that a higher rate of interest than another bank. Given your has taken place as a consequence of the emergency transaction pattern, how could you compare those two action to bail out the banks, and does this have a prices? There are a number of ways you could go bearing on the way the Government should divest about that, but that would be one. On overdraft itself of those holdings? charges, I think our focus has been slightly more on oh i l to : There are two ways to look at this: the choice and control that the customer has, and one is to say if we sort out the inertia and get trying to push the banks towards giving consumers consumer switching working better, we look at the information so that they can make informed choices. outcome of the divestments that have already Having the money taken out of your bank account happened as a result of the state aid control, and we without necessarily being aware that it’s happening is make sure there are no unnecessary regulatory barriers part of the problem there. You were going to— to entry in the market. Then the question is: given Cli Ma ll: Yes. I was simply going to add that I those market dynamics, is that going to be sufficient think sometimes thinking about how this sort of data to create a dynamic market structure, in which large can be used by third parties to help inform consumers market shares that are held by banks only because is another way of looking at it. So, for example, they are large, not because they are more efficient, get having information about your average account eroded away over time, and in which consumers balance might be quite similar, if you’re thinking switch to new entrants? That is one view of the world. about changing utility supplier, to knowing how much Another view of the world is that you need to have gas you used in a particular year or something like quite deep restructuring; you need more banks, and so that. It’s the sort of information that might help people on. What I would say about that is: if you don’t tackle use things like comparison websites and the like. the inertia issue and the switching issue, having 10 banks where consumers can’t switch doesn’t Q765 Chair: Did I understand you correctly to say obviously mean it will be more competitive than that there are two legs to what you want the CPMA having five banks where consumers can switch and or the regulators to do: one is the issue we have just where you don’t have ease of entry. been discussing and the other is the issue of concentration and the structure of the market? Q769 Chair: So we need both, but what is your view oh i l to : Yes. on the 10-bank point? Ev 120 Treasury Committee: Evidence
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oh i l to : I think that it could be very costly to oh i l to : It is looking at the entire retail restructure the banking sector before we try the route banking market. I have no doubt, because we hear it— of dealing with the consumer switching and barriers and I’m sure you hear it as well—that there are to entry first, so I think that that could be a very regional differences in the competitive effects, and it costly option. is very obvious, from our decision in Lloyds-HBOS, that the Scottish market was more affected by the Q770 Chair: So you have no view on how the Lloyds-HBOS decision than the UK as a whole. Government should divest itself of its holdings? For example, do you think, as has been put to us by Q773 Jesse Norman: Mr Fingleton, in competitive witnesses, that there should be a public interest test to markets there are certain things we naturally look out secure competition? for: multiple players, low charges, high levels of oh i l to : I think when the Government sells customer satisfaction, profits competed away between its assets in this sector it should consider the trade-off the players. How would you compare the banking between how it increases competition and maximising sector with other competitive areas of the UK revenue. So, for example, selling an existing economy? I am happy for either of you— shareholding in a bank to one of the existing oh i l to : I’ll start off. If Clive wants to jump competing banks would probably look beyond the in, he is very capable of doing so. It is clearly much pale. As to whether it should separately divest assets, less competitive than a lot of the sectors we look at. In certainly we would be arguing that competition should huge sectors of the economy—retailing, distribution, be top of the Government’s mind in that, because the airline transport, and so on—we see high levels of cost to the economy, long term, would be very high. competition, innovation, costs coming down and no However— real difficulty in firms earning a profit for their shareholders and managing to pass on low prices to Q771 Chair: Sorry, that competition should trump customers, being very innovative in the process and revenue? Is that what you said? driving up productivity growth in the economy. That oh i l to : Yes, I would argue that generally as picture does not characterise the banking sector. It is a proposition. If I think about, for example, the concentrated. We see many concentrated markets privatisation of the airports as a single monopoly, that where there is very good performance in terms of would be very high-cost, long term, for the economy, competition. Concentration is not itself the source of and so I think that the costs of lost competition when the problem. It’s a question of how the dynamics of you privatise a monopoly are very high. So, as a the market work. general principle, I think that Governments can get There are clearly barriers to entry in banking. We did that wrong, and there is ample evidence that the UK, a report in the autumn on barriers to entry in banking. although it did very well on privatisation in leading Clive can say a little bit more about it. But, for internationally, one of the lessons was: we privatised example, one of the things that comes out very clearly a lot of monopolies and then had to do various is that the branch network is quite a big barrier to restructurings afterwards. Restructuring at the time entry. We also got the FSA to agree to look at some of its rules on licensing new banks—of course, they you privatise is probably the best thing to do and that hadn’t had a lot of applications for new banks for a promotes competition. while, but there have been a number recently—on What we have here is a different situation. We have making sure that there is nothing in the FSA rulebook two big differences. The Government doesn’t own all that is unnecessarily preventing entry into the market. the banks outright and is not privatising a monopoly, So market entry is more difficult than in other and therefore the issue is more subtle. So I think that markets, and the branch network is a critical thing the difficulty is not whether the Government should there, but that’s not different from certain other retail- prioritise competition in that regard but whether those type markets. divestments would really make a big difference, But I think the big issue is the inertia, and the inability relative to the cost of doing them. That answer might of customers to see what they pay, and to make price be different in Scotland from in the rest of the UK, comparisons. We have done a lot on the switching for example. So it’s a difficult equation. I think the process. The switching process bit has become easier, Independent Banking Commission is certainly and I can say a little bit more about that as well, but considering that question. We have talked to them switching is more difficult here. This market is never about that as well, and I said—as I’m saying to you— going to be as easy to switch as when you’re booking that it’s an evidence-based question, and we’ll your holiday with a flight, because you can switch continue to be involved in it. But it’s not obvious to flight operator, but it should not be as difficult to me that I can say, here and now, “There should be switch as it is made to be. Historically, too much of divestments; that would be a good thing,” because the risk has been borne by the customer in the there would be costs and benefits, and they need to be switching process, and we’ve been very much trying carefully considered. to push the banks so that banks bear the risk in the switching process, so we create the right incentives. Q772 Chair: Just to be clear, the Vickers Do you want to say a bit more about the switches? Commission is looking specifically at the regional Cli Ma ll: Yes. I want to start by saying that distribution of banking retail competition in the retail banking itself encompasses a variety of products context of the divestment commitment that the and subsectors. So we see the current account market Government has made. and the small business market as the ones that are Treasury Committee: Evidence Ev 121
20 January 2011 John Fingleton and Clive Maxwell most concentrated and suffer from the highest levels oh i l to : No, we haven’t. Clearly we’re of inertia. By contrast, the mortgage market has rather aware—as I think everybody is—that in both the high levels of switching, even if at the moment it is mortgage market and the SME lending market, relatively concentrated. For other types of credit— because of the contraction of credit, there has been a unsecured credit and credit cards—there is a much sharp reduction in supply in that market and that has wider range of suppliers, and much lower levels of all the appearances of less competition. If you’re out inertia out there. So you have different patterns within there as a business or as a mortgage customer trying the retail banking spectrum there. to get a switch, or get a different deal in the market, When we looked at barriers to entry, we looked at supply is much tighter. That may be a temporary them across those different bits of the marketplace and phenomenon. I don’t think it’s a feature of a sort of those different subsectors. We looked at the regulatory long-term competition problem if it’s a cost shock to requirements to which John has referred and found the market. But we haven’t been tracking, for that, of course, regulation does present a barrier to example, the impact on personal current accounts of entry to new firms. That is inescapable if you think the Lloyds-HBOS decision. that to do these activities you need to be licensed in some way and authorised in some way. I think the Q778 Jesse Norman: Just turning to the wholesale FSA has made some improvements but time will tell market, which we haven’t talked about much in other whether some of those entry requirements can be done testimony, have you looked at, or are you planning to even better. look at, wholesale market banking charges—for The most significant issues that we found, especially example, the cost of raising equity capital in the UK in the personal current account market, were around markets, which on some estimates has doubled over consumer inertia, to which John has referred; it was the last 15 years? worries about switching and things historically. Cli Ma ll: We have a market study under way at Jesse Norman: We’ve had lots of testimony on that, the moment looking at the equity underwriting yes. market, which is due to report in the next couple of Cli Ma ll: The other issue that came through in weeks. some cases was the need to be able to grow a business Jesse Norman: Okay, that’s very interesting. Thank quickly, for example to be able to recoup IT spend, you very much. which is a large fixed-sum cost. Chair: Andrea wanted to chip in.
Q774 Jesse Norman: Okay, but the point that Mr Q779 Andrea Leadsom: Thank you. Yes, very Fingleton made, which is that the banking industry is specifically, it is on this question that regulation characterised by low levels of innovation and poor perhaps trumps competition. This is a very highly passing on of profits to customers, low productivity regulated market that isn’t regulated by you, yet your growth, high inertia, high barriers to entry—is that remit is to look at issues of competition, whereas in your picture as well? the past—and probably into the future—the FSA’s Cli Ma ll: Yes. remit has only been to have regard to it, and there has not been any specific focus on competition. So, my Q775 Jesse Norman: That is helpful. Thank you. question is this: do you think that there is a structural Can I ask about whether competition can ever problem with enforcing competition in the banking function effectively if you have banks that are too big sector that needs to be addressed through the to fail? Why don’t you kick off with that, Mr regulatory changes that are coming up, which would Maxwell? There is no need for a long answer; just a give the regulator a more proactive focus on “yes” or “no” would be quicker. ensuring competition? Cli Ma ll: I think it makes competition much oh i l to : I think this goes to the heart of the more difficult. If you look at competition, the impact relationship between consumer policy and of competition is felt first within a firm, and it forces competition policy, because a lot of traditional its management to think differently; second, you have competition policy is acting against cartels, breaking rivalry between the firms that exist in the marketplace; up monopolies, and so forth, and then in many of and, third, you have a potential for bigger dynamic those markets the consumer switching drives the change from new entrants coming into the market competitive process going forward. The problem here with disruptive technologies. I think if you have an is quite a different one. It is the lack of the ability of absence of exit from a market it makes the second and the consumer to switch that stops competition from third types of competition much less likely to occur. working. So we have taken the view that it is a consumer policy—a consumer-side intervention— Q776 Jesse Norman: Have you noticed a change in used to drive and stimulate competition. So, in actual the competition levels as a result of the consolidation fact, the biggest part of what I’m saying the CPMA recently? should be doing is it should be getting the demand oh i l to : We haven’t, because we don’t side of the market working well in order to get the regulate the market. We haven’t gone and looked at supply side to work well. measuring competition in the market since the Lloyds- Going back to Mr Norman’s question, you get this HBOS change. virtuous circle: if consumers can switch, the companies that have the best deal in the market win Q777 Jesse Norman: You didn’t track it when you the demand, and that incentivises productivity growth were looking, for example, at your report last year? and efficiency, which furthers rewards consumers who Ev 122 Treasury Committee: Evidence
20 January 2011 John Fingleton and Clive Maxwell do the switching. The problem here is that you have banks are being rather laggard in following these to ask yourself the question: where in that chain is the initiatives? big block happening? In our view, the big block is Cli Ma ll: In nearly all of those areas we’ve happening because the consumers are really unable talked about now, those have been voluntary to switch. agreements reached with banks, so we have no Chair: A very quick rejoinder from Andrea. sanctions directly around those.
Q780 Andrea Leadsom: I can absolutely concur Q783 Mr uf ey: Would you like sanctions? with you in terms of retail banking, but in terms of oh i l to : Even if we bring a consumer case, banking overall, on this whole issue of “too big to there are no fines at the moment under consumer law. fail”, not enough competition, wholesale markets, and There is a pilot piece of legislation coming in later so on, is there the need for the new regulatory this year giving us civil sanctions for breaches of environment to have a proactive regard for consumer law, and we very much welcome that. So competition? we will have those sanctions for a breach of consumer oh i l to : Yes. law, but the Supreme Court has said that the way in which the banks priced and structured their products Q781 Mr uf ey: Good morning, Mr Fingleton. For was not in breach of consumer law. So, as Clive said, completeness, could you summarise the initiatives that anything we have done has been basically by trying the OFT have undertaken to increase transparency and to persuade the banks that this is the right thing to do, also let us know how far the banks have responded to rather than having any legal power or sanction. those initiatives—what the state of play is on implementation by the banks? Q784 Mr uf ey: It will be a civil sanction, in Cli Ma ll: Yes. I think I can cover it under three other words? headings: transparency, switching and control. Firstly, oh i l to : Yes, but that requires there to be a around transparency, the banks have committed to breach of the law, and we don’t necessarily have that being clearer about the charges that they’re applying nexus here. to individual customers, and to setting them out much more clearly on their statements. That is already Q785 Mr uf ey: My final question is for you, Mr starting to happen. They’ve committed to state Fingleton. Sir Don Cruickshank has said this: “Would people’s average balances, for the reasons that we set we allow Google to manage the internet? No, never. out earlier. That is happening in some cases already; So why do we allow banks acting in concert almost it is beginning in other cases over the course of the absolute control over the money transmission systems, next year or so. over which all financial transactions take place?” The second area is switching, where we’ve seen When we asked him to flesh out his thoughts on this, significant improvements in the switching process he said: “give the CPMA both the competition being driven by Bacs, which is the central organiser objective up front, and also give it powers to license of the payment system around this. The number of money transmission systems—a licensing regime, in complaints around switching has fallen from other words. It would be a class licence. It wouldn’t something like 30%, 32%, I think, of customers down need to be specific to the different systems, and in the to less than 10% of customers who have switched legislation I would give the CPMA objectives on current accounts. We’ve seen some improvements using their powers under that licence, and they would there. have sanctions, a bit like Ofcom has.” I wondered On the control side, we have been keen to make sure what you thought of that advice that Sir Don that, through greater transparency, not only do Cruickshank gave to this Committee, because I find it customers understand what the charges are but they quite attractive. feel more in control of the circumstances where those Cli Ma ll: I think there are some interesting charges are levied. A number of banks have things there. The importance of the payment system introduced accounts that allow customers to turn on is a key issue here. To operate as a bank you need to or off their unauthorised overdraft facility. The banks have some sort of access to that. Banks can either do are working with us to put in place some common that directly, or through other banks—agent banks. arrangements for how they describe those sorts of Our barriers to entry work didn’t find that lack of facilities to customers and the arrangements around access was in itself a big inhibitory problem for those, and also to make sure that we have people wanting to set up banks. They found they arrangements for dealing with customers who find could find those sort of secondary relationships— themselves in financial difficulty as a result of those agency relationships—except in a very few cases sorts of overdraft charges. That is going to be included where they said they had some issues about pricing in some lending guidance that I think the OFT will be and things like that, but it really did not come through putting out in March this year. as a major problem. The other recent development has So we’re seeing a series of things going on. I have to been the development of the Payment Services say each of those steps has required an awful lot of Directive, which is a piece of European law that has engagement and work, and it takes place in very been— small, incremental stages. Q786 Chair: Sorry to interrupt. Just on that first Q782 Mr uf ey: Could you remind us of the point, is there something you can send us on that sanctions that you have at your disposal where some particular point? Treasury Committee: Evidence Ev 123
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Cli Ma ll: Yes, of course, very happy to do so. I arguments made by the parties. We encourage people would just add another more recent development there to make efficiency arguments; we don’t want to be a that has happened over the last couple of years, which body that ignores that. is the introduction of the Payment Services Directive There’s a separate part to your question, I’m inferring, and its implementation in the UK through the relevant about minimum efficient scale. I have seen no regulations. It has given the OFT a particular role in evidence that suggests that you need a 33% or a 30% looking at entry conditions for people wanting to market share to achieve minimum scale. There may come into some of those payments markets. The be evidence suggesting that below 5% or 10% of the payments industry, and the banking sector, cannot set market, it may be difficult to have the sort of scale to conditions that are disproportionate for people to deal with the IT investment we’ve seen. But if you go come and join up to their networks. Those sorts of back a few years you will remember that HBOS itself things could be looked at by the OFT, and they’re was a challenger bank in the market; it didn’t have a also considered by the Payments Council. So there are 25% market share, and it was doing rather well at some other mechanisms there, but the centrality of the competing with the other banks. So none of the payments system to banking is very important. evidence I’ve seen suggests that the minimum efficient scale is at 25% or 30% of the market. There Q787 Mr uf ey: Just a final question: are you might be some efficiencies about being able to spread going to be making any representations to the your IT investment over such a wide market share, Chancellor in relation to this? but it’s not clear that it’s of such a magnitude or that oh i l to : We will engage with the Treasury as they would be passed on to the consumers. negotiations go through. We will say things that are exactly the same as those we have been saying in this Q789 Mr munna: Just going back to the first part Committee. In terms of Don Cruickshank’s view that of my question, then, I presume you would therefore the CPMA should have a competition objective, I agree with what Vernon Hill of Metro Bank said to completely agree with that, and I think that could also us. He said the larger a retail bank is, once they get cover the rules on the payment system. So some of past a certain point, the poorer they serve the what we do there could be taken on by the CPMA. consumer. Would you agree with that? oh i l to : No. It is a very sweeping assertion, Q788 Mr munna: Can I just follow up on the and I know some other markets where there are very market concentration and competition issue that you large firms that serve the customer extremely well. have been questioned about earlier? You said What I would say is that in many other markets a very generally in answering that there is a trade-off to be large firm can become complacent and lose its market struck between competition and revenue, and that share over time. So you see two different approaches: generally competition should trump revenue. I think you see firms who are very good at constantly it’s fair to say, on the evidence we took last week from innovating, being responsive to the consumer, and Bob Diamond of Barclays, and also very much in my keeping their leading market position, and in other view the evidence we took from Eric Daniels of markets we see companies where their leading market Lloyds, we listened with some incredulity to their position gets eroded over time. claims that with the increased consolidation there wasn’t a reduction in competition. One of the Q790 Mr munna: Do you think our five big boys arguments that was cited by them, in favour of have become complacent because of their size? consolidation in the larger banks, was that the oh i l to : “Become” is the verb I would focus economies of scale would ultimately benefit in on. I’m not sure that this has ever been a market consumers, in terms of lower prices. Do you agree that has been incredibly customer-focused in that with them? sense of thinking what do we need to do— oh i l to : I am sceptical, and I’ll explain why. Mr munna: Hence all the fines we’ve been seeing When we consider a merger, like Lloyds-HBOS, it over the last few years. would be normal for the parties in a merger like that oh i l to : Yes. Clearly there are pockets of the to argue there are some efficiencies or economies-of- market where you see very high levels of competition. scale arguments. Because the banks sort of knew the A few years ago, you saw very intense competition to answer to the question, they didn’t really engage with win mortgage business; certain types of saving us on efficiencies, so they didn’t put forward the products might be driven by a very high level of evidence on efficiencies. So, first of all, we didn’t see rivalry. The banks do compete with each other, in the the evidence on efficiencies. In terms of how we look sense that the free-if-in-credit banking market is itself at that evidence generally in a merger situation, if the a sign of a certain type of competition, but it is market is not particularly competitive, or is not likely channelled in ways that are maybe not particularly to be competitive after the merger, we would be very what the consumer wants. sceptical that the incentives are there to exploit those efficiencies; that is number one. Number two, even if Q791 Mr munna: I’m glad you brought up Lloyds- they are there to exploit the efficiencies, the incentives HBOS, because I was going to ask you a few won’t be there to pass them on to the customer. So, questions about that. You obviously had some generally speaking, I think we have a sceptical concerns about that merger at the time that it went approach to efficiencies in mergers. Having said that, through. My impression very much at the time was we have allowed through a number of mergers in the that there was a general consensus towards it, because last few years where there were good efficiency people thought it was something that should be done Ev 124 Treasury Committee: Evidence
20 January 2011 John Fingleton and Clive Maxwell in the interests of financial stability for the system as oh i l to : Yes. But I do think it is an important a whole. Do the concerns that you had then still question where you’ve had a merger that has gone remain valid now? Do you think they still remain through. I will unpack that. I think there are two valid now? considerations there: one is the impact in the banking oh i l to : There is no reason to think that the market; the other is the signal it sends more broadly— issues we identified then don’t remain valid but for the incentive it creates for others to lobby for political the divestments that have come about, or will have protection from anti-competitive mergers. I think that come about, as a result of the application of the State people feel that getting an anti-competitive merger Aid rules by the European Commission; that is point through by political clearance can create incentives one. Point two is that once a merger has gone through for lobbying and rent-seeking, long term, and I think and been consummated, if the answer to the question, if people feel that is not a lifelong guarantee for a “Would the merger have been a bad idea in the first business, that it’s an important consideration as well. place?” is a clear “yes”, it doesn’t obviously mean that So that is another factor to be weighed in the balance. undoing the merger later is the right thing to do, So it’s not just the impact within the banking market because there could be very big costs associated with but the broader signal it sends about merger policy. doing that. But I’m not opining on what I think should be done; I am saying that it is an important question and in some sense it shouldn’t go unanswered. Q792 Mr munna: Is there any evidence that it has been detrimental to competition since that merger took place? Q795 Mr munna: I would have been quite oh i l to : We haven’t tracked that. If we do an astounded if you had pre-empted the findings of the Independent Banking Commission in that regard. ex post analysis of what has happened in a merger, The other thing that Lord Myners mentioned in the typically we would wait three to five years to see how piece that he wrote was what should be done with the market has settled down. This market is anything Northern Rock. This week, UKFI issued invitations to but settled down. We would have great difficulty in tender to corporate finance advisers to advise on separating out contraction of supply issues, strategic options for privatising Northern Rock. One divestment issues and other issues, and in working out of the things that Lord Myners has argued, for which what the marginal impact of the Lloyds-HBOS merger I have great sympathy, is re-mutualising Northern is on competition. At the time, we were pretty damn Rock, again in the interests of competition and convinced this merger was going to reduce increasing diversity in the financial services sector. competition. We have a balance of probabilities test; Where do you sit on that issue? we have to take a cautious approach. The Competition oh i l to : On the question of what type of Commission has the ability to clear mergers in a business model would be best, I probably don’t have different way than we do. The tests are slightly a strong view. Lord Myners will have a different different for the Competition Commission, if it had perspective on this, having been a Minister in the gone there. But as to our assessment then, nothing that Treasury. I’ve seen in the market since has made me think that Mr munna: Of course, but I’m asking what you some of the concerns we had would not become think about that. problems in the market over time. oh i l to : I don’t have a strong view. I think I would say that— Q793 Mr munna: We have taken evidence from Lord Myners, and he wrote a piece in the in n i Q796 Mr munna: Do you think it would help ieson 13 December last year, which was well with competition? reported, in which he argued that proper consideration oh i l to : I think what would help competition should be given to splitting up one or both of Lloyds is for Northern Rock, or the privatisation of Northern Banking Group and RBS in the interests of increasing Rock, to not add to existing concentration in the competition. Do you agree with him—yes or no? market. That would be my strongest point. oh i l to : I agree that consideration should be given to it, but I don’t know what the right answer to Q797 Mr munna: Do you think the privatisation that question is. That is a very difficult question. The of Northern Rock would add to concentration in the Independent Banking Commission will, I think, be the market? first port of call on that, and we would then look at oh i l to : I think if it was sold to the wrong what the Independent Banking Commission has said. person, it could increase concentration in the market, It is not clear what instruments the Government has and that could be a concern, but I wouldn’t want to to implement something like that. The Government opine on that formally because there are can’t easily undo mergers. The competition regime circumstances under which that issue might come can look at those issues. We can refer the market to before us formally for review. the Competition Commission, for example. Mr munna: uite. Thank you very much.
Q794 Mr munna: That is quite significant: you Q798 Michael allon: Going back to the Lloyds- think consideration should be given to splitting them HBOS merger, do you think the Government was up in the interests of competition, which isn’t the wrong to overrule your advice? same, of course, as saying that we should actually do oh i l to : I think at the time, in September that. 2008, when the original decision was made, the Treasury Committee: Evidence Ev 125
20 January 2011 John Fingleton and Clive Maxwell decision was perhaps understandable. I think in market dynamics are very slow. We do ex post October, when the systemic issue had been dealt with evaluation of mergers, and it is at least three years, by the recapitalisation of the banks, the assessment of if not five years, before you see what has happened. whether the Lloyds-HBOS takeover then made sense Separating that out and identifying the marginal effect became a different one. I think the problem was that of the Lloyds-HBOS merger from other things would, at that stage, it had become quite a big juggernaut that I think, be very challenging. uite apart from that, I was too difficult to stop. think it would be inappropriate simply to go after the merged bank now because you didn’t like a decision Q799 Michael allon: Do you think they were that was made. That might appear vindictive. I do wrong to ignore your advice and let it go through think we should look at the banking market as a whole without insisting on some divestment, which the and ask what is wrong with the banking market as a European Commission later did insist on? whole, and come at it from that point of view. I think oh i l to : Obviously, we would have preferred that would be the fair way to deal with it. The efficient if they had used the reference to the Competition way to do it is to do that when everything else has Commission and gone down that path at that stage, settled down, and then you can look properly at where yes. you have got to.
Q800 Michael allon: So that was a mistake? Q804 Michael allon: That is helpful. It has been oh i l to : Yes, I think so. proposed that an alternative to breaking it up is to introduce a cap limiting its market share in certain Q801 Michael allon: Why does it take you three to products. How do you weigh the comparative costs of five years, as I think you said earlier to Mr Umunna, restructuring against the benefits of competition? to look again at the competitive position of such a oh i l to : I think a cap on market share would large group? Is this not something you monitor be a rather crude instrument to try and achieve that. annually? We’re trying to encourage dynamic competition in the oh i l to : First of all, the Lloyds-HBOS market. If Lloyds manages to win customers over by merger is fully legal and it is not our job to go and better offerings, I wouldn’t want to prevent the try to override what Parliament and Government have consumers benefiting from that. decided to do. So, one can express a view on it, but we work within the existing law. The Lloyds-HBOS Q805 Michael allon: You spoke earlier about the merger is a fully legal merger; I don’t want any doubt costs of having to break up a bank, and so on, which about that. What we would want to do before we also get passed through to the consumers. How do intervene in the market is establish that there is a case you weigh the balance of those two arguments? Even for intervention. I think there is quite a lot happening though a cap might be crude, it might be cheaper. in the market at the moment, when you take the work oh i l to : A cap could create quite a big we’re doing on switching, the divestments that are incentive not to be very efficient. I would weigh the happening, and the Independent Commission on cost of that incentive for the bank not to be efficient— Banking; I think it would be foolish of us to try and engage in further, duplicative activity. So, for so they would lumber along not feeling they had much example, we are doing the equity underwriting work, incentive to do good—against the costs of the which is not duplicative, and we have done the divestments. The problem with divestments is that it barriers to entry work, which is intended to is always going to be what it is that you cut out, complement and provide a better evidence base for because simply divesting small bits of the business the work of the Independent Banking Commission. may not be enough of a leg-up for entrant banks. I While all of that is going on, we wouldn’t propose to think that is part of the cost and the challenge there. open any significant examination of the market. After the Independent Banking Commission has reported, Q806 Michael allon: Just one final question, if I after the Government has responded to that report, we may. On new entry, we haven’t really had a second will want to look at that and then take a view on tier of banks. It all seems incredibly slow. Apart from whether any further action is required. the switching you have referred to, are there other changes that could make the whole thing more Q802 Michael allon: So simply the existence of competitive and just make it faster for new banks to those two other inquiries means you won’t revisit your enter? original concerns? oh i l to : I would say that even in other, highly oh i l to : When companies merge—and going competitive, markets we see, the entry process and the back to the earlier question about the efficiencies—it process by which firms grow is slow. If you think takes quite a bit of time for things to bed down, and about airline liberalisation, the first liberalisation we would not be able to measure the effect of the measures happened in ’87 at a European level, and merger. We did a prospective analysis. We tried to they happened from ’87 through to ’ 7. The low-cost anticipate what the effects of the merger would be. airlines business model really only took off in the last decade as a serious phenomenon; even in that market, Q803 Michael allon: Sure, but it’s two years ago with very high levels of switching and very high now. levels of customer transparency, the incumbents oh i l to : But the full effect of the merger will retained market share for quite a long time. But what not have been felt yet. On the implementation of that, we have seen there is that the incumbents brought Ev 126 Treasury Committee: Evidence
20 January 2011 John Fingleton and Clive Maxwell down their prices and became much more efficient Q808 Mr Love: Are those the latest figures you have over time. from your 2008 study? On the process of entry, going back to the point Clive oh i l to : Yes. We have not updated those made about the within-firm and between-firm effects, figures, no. what you really want the competitive process to do is not to wipe out the incumbents but to force them to Q809 Mr Love: Let me ask you a slightly different be more efficient. Very often, a market entrant—a question. Free-in-credit banking: who gains and who challenger—with 5% to 10% of the market can have loses from the free-in-credit banking model, and do a dramatically big effect on the others, simply because you believe that cross-subsidy exists in that model? of the threat that they are going to grow. If the oh i l to : There is truly a cross-subsidy, incumbent banks respond to that, the process will look because people who don’t pay anything over the year slower, but you get a lot of the delivery of the effect for their current account clearly have cost something on the ground. to the supplier. Therefore, there is logically a cross- I think what we saw with the market study, and what subsidy. The people who benefit in that model are the we probably regretted about Lloyds-HBOS, was that people who have average balances that don’t go into HBOS was a challenger bank. It did things slightly overdraft and who manage their accounts very well. differently; it had a different strategy; it was a little People with average balances of less than the £1,000 more disruptive in the market. Competition authorities a year are far more likely to go into overdraft. As that like challenger entrants. We like entrants who come number comes down, you get numbers that go into in and try to do things a bit differently and try to upset overdraft, say, six times a year. If you go into the existing business model, because they cause more overdraft six times a year, the chances are you are potential for change in the market, and we like to see paying way above the average cost of a bank account. change in the market. So I think at the moment we’re So there is an important distributional aspect of this. at quite a sensitive period in trying to work out which Some of the people at the lower end of the income of the new entrants’ business models might succeed, distribution are cross-subsiding people perhaps in the and what we see in the market is there is a diversity middle. Perhaps some people at the higher end of the of different business models being used in the market. distribution with high average balances, on the That diversity is quite healthy. At the moment we foregone interest, are also cross-subsiding some of the would foster that—anything we can do to help it. The people in the middle. reason why we did the piece on barriers to entry In terms of customers whom the market serves well— before Christmas, and so on, was to make sure that the this is a phenomenon we see in the credit market as regulatory system and other things weren’t interfering well—those on lower incomes face less competition with it. for their business. If you have a poor credit record, Cli Ma ll: I have just one small thing to add to generally speaking, you’re going to find it more that, to do with thinking about where new banks come difficult to switch; you are not going to have people from. They can be set up from nowhere, or they can competing for your service. Possibly those in be other types of businesses that choose to get into Scotland, as a result of the merger, also face less banking. So I think thinking about the different parts competition for their business. So there are pockets of of the retail banking market is quite important. We consumers, either geographically or in terms of would certainly be concerned if, for example, some of average balances in their account, who may face less the regulatory hurdles to getting into some of those competition in the market, and there may be other markets that are very closely related to retail banking, customers who might find quite a lot of competition like some of the types of corporate lending, were in the market if they go out and search around. raised. If the entry barriers to those were raised, it might make it more difficult for firms to take the first Q810 Mr Love: Let me ask you: we suspect step up, and then to be able to get into the more core consumers out there think free-in-credit sounds great, retail banking markets later. but there is a complete lack of transparency. How important is it to improve transparency so that the Q807 Mr Love: I want to ask you some questions consumer understands better? And how about this about current accounts. We have found it incredibly cross-subsidy element that you have talked about—is difficult to get clear answers from some of our that something you’re concerned about? witnesses so far. Are current accounts profitable for oh i l to : The cross-subsidy is not in itself banks on a stand-alone basis? something that would concern us. If you think about oh i l to : The banks don’t attribute their cost airline pricing, people who book late cross-subsidise by product line. people who book early, and that happens in quite a Mr Love: We found that out. competitive market. So we don’t necessarily think that oh i l to : Consequently, it is not possible for cross-subsidies are inconsistent with the competitive us to make that assessment. I should say, when we did market situation. I think what concerns us is the the market study, what we did do was outline where inability of people to know what they pay for their the revenues came from, and what we found was that bank account and, as a result of that, the inability to I think 70% or 80% of the revenue from the current make any meaningful comparison between them. account market came from foregone interest and from There are clearly very big distributional consequences default charges. What we were not able to do, and we from changing that model, because if you move away don’t have investigative powers in our market studies, from free-if-in-credit banking there will be winners was to— and losers. In any process like that, the losers usually Treasury Committee: Evidence Ev 127
20 January 2011 John Fingleton and Clive Maxwell cry a lot harder than the winners cheer; it’s much more Q813 Mr Love: We have asked quite a lot of visible to them. In this case, I suspect that would be witnesses from the banking industry about the free-in- particularly true. credit banking model, and whether or not that is a So we have very much adopted the approach of trying barrier to competition. There has been quite a move in to make sure that where the banks make their recent years towards packaged accounts, but generally money—on the foregone interest and on the overdraft speaking, the free-in-credit model has survived and charges—that that is far more transparent than it has thrived. Is it a barrier to competition and how would been. Clive has outlined the measures we have done you foresee an alternative model emerging? in that regard. We could go further. We have gone oh i l to : It is part of the barrier to switching probably as far as we can go. We’re doing what we do at the moment, because it is part of the transparency. now with voluntary persuasion by the banks. I think it For a long time I have said that very often it’s not does require tougher powers to get that bedded in free; people are paying. So in some sense there is an properly. element of it not being what it says on the tin. I think that is not helpful for competition or for switching. I wouldn’t favour saying that you should regulate to Q811 Mr Love: That is leading me up to the very have fixed fees for banking. That would seem to be obvious question. You mentioned the Supreme Court heavy-handed. Instead, I think it’s paring away at decision, and the disappointment that you weren’t able hidden charges, so that you are forcing the banks to to look at the fairness aspect of this. If these put more and more of it up front. What might emerge conditions were amended to allow you to do that, in the market then is a situation where there are more what powers do you think that would then give you products with up-front fees. You might still have some to deal with some of these issues? free-if-in-credit banking, but cross-subsidised in a oh i l to : I think the way we would prefer to more transparent way that enables better switching go with that is to make this specific for this sector, between consumers. That type of diversity in the because some of the issues we see here are very consumer offering might be better than trying to different from the issues we see in other sectors. So impose a standardised approach. I think what it dealing with it through the specific regulation and the requires is that you really pare away at the CPMA might be a better way of dealing with it than untransparent hidden charges that are in the system. trying to change all consumer law. I think the risk of As long as they are there, and they are allowed to changing all consumer law to address the Supreme cross-subsidise the up-front fees, you are always Court decision would be that it would create a lot of going to have that problem. uncertainty for other businesses and other sectors of the economy about where intervention might occur. Q814 Mr Love: Finally, let me ask you, Having said that, we will publish a market study in philosophically in a sense, will that be enough? Will February on consumer law and our approach to transparency—exposure, if I can put it as crudely as consumer contracts generally—issues like small print that—be enough to get the banks to change the model, and so on. That is very much with a view to us or do you need some rather heavy-handed regulation bringing other cases that clarify the law in this area, that you are reluctant to go down the road of? and trying to get back to some of the issues that came oh i l to : We’ve never tried it, but we see that up in the Supreme Court case. it works in other markets, so I think it is worth trying. I wouldn’t give up on the fairness law to be able to I think Adair Turner, when he was here, may have deal with similar issues in other cases. I think it is used the term “nudging the market in the right really important that we don’t just look at one case direction”, and I think what we need is a CPMA that and think, “Well, that’s it: the law is useless.” I think has the regulatory power to nudge the market faster it is always important to bring other cases. This case and harder than we’ve been able to do, but to continue had a number of very unusual features, and we would that, what I would call, “nudging approach,” so that like to bring other cases back before the Court of you do let the dynamic in the market lead it forward. Appeal and the House of Lords in due course, having Regulators would not be well placed to control the IT thought through what they have said in this case and investments and the systems that banks develop, and framing it correctly. So I think our view is that, to anticipate all the possible ways in which banks may broadly speaking, current consumer law is fit for try to get around regulation, game the system, and so purpose. We don’t think that should be upset, but we on. I think if you can work with the grain of the industry, work with competitive incentives and try to think that in the banking sector there are very specific get them to work better, that’s a better way to go. So issues that the CPMA should deal with. I’m not advocating heavy-handed regulation—that the CPMA should regulate every price in the market and, Q812 Mr Love: But you wouldn’t want to ban cross- in some sense, try to impose a market solution—but subsidy in any shape or form through fairness in giving it a competition objective, and making sure provisions? it has the tools to nudge the transparency issues in the oh i l to : No. We are very much driven by right direction, that it is really forcing the market to trying to get the market to sort this out and trying to sort this issue out. If we go down the road of thinking encourage the banks to be the ones who lead in that the regulator sets prices in the market, we would process. It will be more efficient if it happens in that probably have a very inefficient sector, and it might way. be worse than it is now. Ev 128 Treasury Committee: Evidence
20 January 2011 John Fingleton and Clive Maxwell
Q815 Andrea Leadsom: You said earlier that you do done at a sector-specific level by the regulator, as believe the CPMA should have a competition Ofcom does in number portability, for example. If one objective, a specific one. How would that work in compares number portability with telephones and conjunction with the proposed merger of the OFT and number portability with bank accounts, there is an the Competition Commission? Do you think that they important difference. It is critically important with would work together? How could you see that telephone numbers that everybody else knows your working to improve competition in the banking telephone number. Therefore, changing your sector? telephone number is very costly: you have to change oh i l to : I don’t think the merger of the your business cards; you have to tell everybody; you Competition Commission and the OFT would have risk losing contact with people you haven’t seen for a any impact on giving the competition objective to the while, and so on, when you change your telephone FSA. At the moment, the way the system works is number. With your bank account, you can function that we have a duty to look at the rules the FSA sets your bank account without everybody you know and give the FSA an opinion on competition. We’ve knowing your bank account number, so the benefits done that a lot, for example, with clearing houses, of that and the costs associated with switching are stock exchanges and so on, and it has given us a good slightly different. evidence base on the issues in the industry. It would If the switching process makes sure that those people affect that relationship, and some of that would then who need to know your bank account number be done internally by the CPMA. It would not take change—that is, those people who have standing away from us the ability still to offer an opinion on a orders and other relationships with you—then I think voluntary basis if we thought there was a problem. We it deals with a large part of the issue. So the benefits retain that ability in any sector that we look at. of having number portability here are probably lower Normally, we do that by working closely with the than with telephone numbers. On the other side, the regulators. We do this in communications, energy, cost of number portability needs to be brought into water, transport, and so on; we work with the regulator the equation. So I think there is a careful cost-benefit informally on a lot of these issues, and they come to analysis of whether it is worth the systems costs that us for advice and we give them advice, as we do with would be there. I don’t know the answer to that Government Ministers who are thinking about question. My intuitive hunch would be that it could regulating things. So I think that the merger of the be very costly and not worth while doing it in the OFT and the Competition Commission is not short term. But if you said, “From 2020 or from 2025 specifically relevant to that question. It just raises a that is what we expect”, you might give the banks the broader question. time to make sure that the upgrades to IT systems that If I could mention payment protection insurance as an happen over the next 10 years move in that direction; example, payment protection insurance is an issue that so you set it as a longer term objective. That would was dealt with by the OFT, the Financial Services be a much less costly way of achieving it. So I think Authority and the Competition Commission, and there with some of these things, we have become very is certainly an argument that the competition part of aware that well-intentioned, industry-wide moves, that, which the OFT and the Competition Commission when everybody has different IT systems, can be very dealt with, could have been dealt with faster and better costly to implement in the short term. and with greater consistency for everybody if there So, certainly intuitively—and again I’m caveating had been two organisations rather than three this; it is my own personal intuitive stance—I am organisations. That is not to say that the co-operation attracted to it as a long-term vision for the market. between the three organisations was not handled well, There are some other things there that I think one but it is always more difficult to manage a relationship should think about in that regard, but in the next year among three bodies than among two bodies. As we or two it wouldn’t be my top priority. and the Competition Commission apply broadly the same competition tool in that case, that type of benefit Q817 Andrea Leadsom: Can I just push back on that could arise from a merger. a bit? We had Jayne-Anne Gadhia, Chief Executive of Virgin Money, here this week. She was very much Q816 Andrea Leadsom: Moving specifically to the saying that in her experience—obviously, they are a question of switching, you will be aware of the business trying to win account customers—one of the various conversations we have had here on the idea of biggest objections is this whole concern that account portability. Sir Don Cruickshank was consumers have that “If I change my bank, then my particularly in favour of consumers being able—but direct debits will be lost; my TV bill won’t be paid,” obviously not compelled—to move their bank account or whatever it is. Indeed that does prove to be the with them, to dramatically change overnight the case, and there is a period—some of the chief prospects for switching between banks. The first executives of the big four said it is between two and question is: would you support that as an idea? The six weeks—to transfer all of that information. second question is: if there were such a move to do So while I take your point about telephone numbers— that, who would you see enforcing that? Is that you want people to know it, whereas for bank something that the OFT would give direction on or is accounts, you don’t—on the other hand, if you have a that something that, in the future, you would see the complicated life, as people do these days, there is that CPMA giving direction on? concern that things won’t get transferred in a timely oh i l to : In answer to your second question fashion. Surely that is a big contributor to the reason first, it would be very much something that would be why people don’t switch banks and that in itself has Treasury Committee: Evidence Ev 129
20 January 2011 John Fingleton and Clive Maxwell huge implications for bank customer service, their place and funding arrangements in place. Needless to willingness to improve and to be innovative, and so say, in some cases the providers of that funding will on. Certainly, Jayne-Anne Gadhia felt that it was a only sign up to the necessary documentation when key to improving competition in the retail sector. they know that the licensing has reached a particular oh i l to : If, when things go wrong in the point in the process. That is the sort of thing the FSA switching process, the banks are liable—there is a has been looking at—how to create milestones certain irony in the fact that if I don’t manage my through the process to give people a better personal or current account balance well, the bank can understanding of where they are, so they can be impose a very large charge on me, but if the bank talking to their backers and to other businesses about doesn’t manage my switching process, I can’t impose where things have got to, and to give them a key a very large charge on the bank—and if you said that member of staff who will follow that process through. when things went wrong, the bank had to compensate The thing I find very difficult to know, where firms the customer for things going wrong, that might be a have not been given a licence, is whether that is far more effective way of dealing with the switching because they have decided to withdraw because of the issue. As Clive has said, the complaints about quality of the licensing process, which is the FSA’s switching have come down from over 30%, I think, responsibility, or whether it is because they didn’t like to about 10%. the sorts of conditions that the FSA were requiring of Cli Ma ll: 32% in 2007 down to 8% in 2010. them, and they couldn’t meet those requirements. That is the perception of it. oh i l to : The perception of it is not to be Q819 Mark Garnier: Yes, which is a very good ignored. I agree with you. I don’t think I disagree with point, and there is the so-called Catch 22 problem, the vision you have for the consumer perception that which is where, as you say, you have to have evidence things should go well. I am arguing that, on the cost of funding in place, and this is a big leap of faith into side, it could be very costly to implement it quickly. the unknown, to a certain extent, by the investor. But I think longer term it is very compelling. Cli Ma ll: It is.
Q818 Mark Garnier: In your report—and I am Q820 Mark Garnier: Of course, the other problem looking specifically at the FSA, at the regulatory is the IT systems, which seem to be bespoke. Do you process here—you said that a small number of think that is a big problem? Of course, you have to respondents indicated that the uncertainty, length of have your IT systems in place in order to test them to time and cost of the application process had proved get your licence. insurmountable, and decided not to apply for a Cli Ma ll: Yes. The IT raises some similar sorts banking licence. This was something that I picked up of issues that have required significant types of and have been sticking needles into to try and extract investment. That investment is very typically sunk, so more information about it. Certainly, when we not only is it a lump of funding, but if the business interviewed Hector Sants and Adair Turner about it, doesn’t take off, very often you will have to write off he came back and said, “No, no, this is not the case; those costs. So people are very wary about making it only takes six to nine months.” those financial commitments to IT. Being able to I followed the same line of questioning up with people prove the stability and solidity of the IT systems is like Virgin Money and Vernon Hill at Metro Bank, one of the important steps that people have to show and their experience has been very much that the FSA to the FSA, so again that is an important part on that is very good and the whole process has been very critical path of becoming a bank. easy, although Vernon Hill did say it took 18 months to get their banking licence, which obviously is Q821 Mark Garnier: And the fact that there aren’t different from what Hector Sants has said. But I am any off-the-shelf systems is also a problem? particularly interested to find out more about those Cli Ma ll: No, that is true. I think increasingly people who have had problems because, of course, we there are more things that look like off-the-shelf don’t get the people who have failed to get a banking products. I think the people we spoke to tended to say, licence in front of us. I’m just wondering if you could yes, you buy the off-the-shelf system, but then in fact expand on that and say what the problems are that you you need to spend quite a lot of money making it have seen for people who have failed to get a banking specific to your business. So there are a range of licence, or been put off getting a banking licence? options there. It is quite possible that different ways Cli Ma ll: Yes. When we talked to people about of thinking about computer systems and being able to their experiences in doing this, one message we got rent some of that computing power, or buy it through was that, in fact, things probably had incrementally as the size of your businesses changes, improved over the recent months. As John said, the will offer different sorts of business models to people FSA has had a period where they had very few wanting to get into banking in the future. I think some banking licence applications, and they have changed of those sorts of developments are starting to happen. some of their systems and the way in which they deal with things. The message we were getting from Q822 Mark Garnier: Are you talking to the FSA businesses was that it is very often the uncertainty that about how they can improve their regulatory process? they find most difficult; that there is a certain If so, what sort of recommendations are you making? circularity—the chicken and egg situation here. For Cli Ma ll: What we said in that particular report example, something that a firm will need to be able to is: we talked very closely with the FSA about their demonstrate to the FSA is that they have finance in experience over recent years, and we listened to the Ev 130 Treasury Committee: Evidence
20 January 2011 John Fingleton and Clive Maxwell improvements that they said they had put in place. Q826 Michael allon: How do they do that if we’re Those improvements seem to us to be in the right moving to more of a judgment-based regulatory direction, as to what they should be doing. I think time environment? How can they bring about change? will tell whether they go far enough, in terms of being oh i l to : I think by addressing the able to provide the certainty to people as they are transparency and switching issue, and the CPMA will going through the process. have regulatory powers to do that. I should mention as well that our credit powers will move to the CPMA. Q823 Mark Garnier: Finally, on Basel III, again, The Government is consulting on that at the moment, you need quite a lot of capital, and increasingly more but that is the expectation of the outcome of that capital under Basel III. This sort of fundraising thing process—that credit regulation will be done by the is obviously a key barrier to entry, particularly when CPMA as well. That will also give the CPMA the you are trying to build a business from scratch, ab power to regulate the credit side of the market, as well initio, as new businesses would be doing. Do you as the deposit side. I would say that if the CPMA has think there is any way that we can tackle this problem, an objective to promote competition, and has the and do you think there should be slightly different ability to deal with the switching issues, the new capital requirements at the earlier stages, while a entrants in the market are much more likely to be business gets going? challengers in some sense, because they will be Cli Ma ll: You clearly want banks to hold a bringing some fresh, new ideas or some approach that certain amount of capital. I think the expectations of they have from existing markets they are in, bringing those levels need to be higher than they have been that into the market and having a different approach previously. We are also seeing, though, ideas about to customer service. the fact that capital requirements should reflect some of the different sorts of risks that different institutions Q827 Michael allon: They will need a competition pose. For example, it may be that larger, more policy division, won’t they? As well as an objective, systemically important firms will have to hold they will need people to do the kind of analysis— proportionately more capital, not less capital. So you oh i l to : They will need that skill within the might see a differentiation on the basis of size across organisation. I wouldn’t go so far as to work out how different types of banks. That might have the same they should structure it internally, but they will need— sorts of effects in the real world as what you are suggesting. I think we will have to wait and see how Q828 Michael allon: They will need some of your that happens. people, to be blunt about it. I think customer trust and confidence in an institution, oh i l to : They will need to analyse the especially a new one, is very important. As part of our competitive effects of rules that they make. I don’t survey results, we asked customers about switching, necessarily think that means a vast number of people. interest and things. That is clearly an important It is as much about attitude and approach to the type consideration for them. I suspect that feeling that a of questions you ask. new bank was less well-regulated, had less capital and Cli Ma ll: Can I give a particular example, at a lower funding requirements might make them more very micro-level, of the sorts of difference it might worried about that sort of bank than they ought to be. make? There are questions such as whether to put interest rates on the statements for savings products. Q824 Mark Garnier: Do you think Basel III is an You can look at that from a narrow consumer advantage, or a disadvantage or disincentive, to people protection point of view, in the sense of saying, “Now, coming into the market? On the one hand, you have the consumer needs the right information. You need the greater capital requirements, but on the other hand to protect them, look after them and make sure they you have a safer system, so therefore you may feel have that information,” or you can look at it from a more inclined to come into it. competition perspective as well, and you can say, Cli Ma ll: I don’t think we would be able to “Well, in thinking about the benefits that putting those take a view. It is a big set of changes to the capital interest rates on the statements”—for example, cash requirements across the economy. A lot of the ISAs are a market we have looked at—“not only do implementation issues are still being worked through. you get those benefits of consumer protection but, by I think the sort of flexibility I talked about may well having that information, you will help drive end up being quite important. competition in the market through the market.” So it Chair: A quick question from Michael Fallon. is about the way in which the body could think about regulation. Q825 Michael allon: I just want to come back to Mr Fingleton on this concept of challenger banks. Q829 John hurso: Can I apologise to the witnesses How can we be reassured that the new regulator will for being absent for much of what has been said? I understand the need to look at business models in was unavoidably in the Chamber. Can I ask a very that sense? quick question regarding consumer credit, which is oh i l to : I think that the new regulator will due to go to the CPMA? Are there any dangers you want to be able to tell a story about competition in foresee in that, or any particular things that need to be this market a few years out—to say that the regulator looked out for? has made a difference. I think it is going to be very oh i l to : As with any change like this, there important for the CPMA to be seen to have brought are going to be risks that need to be managed. At the about change in this market. moment, we enforce consumer law and consumer Treasury Committee: Evidence Ev 131
20 January 2011 John Fingleton and Clive Maxwell credit law in tandem. So there is a risk associated with put to us as a concern. People are reluctant to switch separating those out. There is also a risk in that the because they think it might increase the risk of fraud. majority of the businesses that we regulate are small Rather than explore that now, I wonder whether you businesses. I think 0% of the licence-holders are sole could come back to us with what information you traders. They are generally people involved in some have been able to glean on it. At various times we type of retail or other service business where, because have tried to obtain a bit of information orally from of the cost, it makes sense to break it down into witnesses. We haven’t done very well on it, but it has payments, and they need a credit licence to do that. certainly been raised with me outside formal sessions. We have just under 100,000 licensees in the consumer Today you are announcing, are you not, your credit regime, so you’re putting a lot of the retail conclusions on the case for anti-competitive practices sector under a financial regulation when really it is in RBS? You mentioned it earlier in your evidence. Is retail, and not financial, regulation. there anything you want to say on that before we It has never been easy, because, of course, then we conclude? end up with the large institutions as well on the credit oh i l to : No. I think it is a formality of a side. But it doesn’t make sense to have the large decision that is already properly known. There is no institutions just in the CPMA and the small ones in particular news in that. It is just the writing-up of the ours, so we think it is just important to manage the decision whereby RBS agreed to pay a fine of £28.6 risk. One of the things I think could happen is that we million last year in respect of a breach of competition might expect the fees to rise. We are, I think—touch law. We are very pleased that we dealt with that case wood—not the highest-cost regulator in the world. expeditiously, and that resulted in everyone being sent Even the industry itself sometimes says to us we an important deterrence message, a compliance should raise more fees and do more activity. We message, not just in the banking sector but across the stepped up our activity a lot in that market in the last economies. two years, really trying to clean up the market. But I think one can expect that the fees would rise a lot. So Q832 Chair: And that suggests that there are some there is an issue about the impact of that on sole anti-competitive practices around. traders and small businesses who hold credit licences, oh i l to : We have done a huge amount of and that needs to be thought through. I don’t think the work on compliance, and one of the things we have intention is to rush the move, and I think there is seen in a number of cases is that one of the things plenty of time to think through those risks. companies need to worry about is when individual employees move from one business to another; you Q830 John hurso: One of the reasons I ask—it is really need to focus on compliance then, because very a small example—was the work you did last year on often what we see is that the companies don’t want to the debt management industry. You have a large chunk have this type of investigation and a fine. What we’re of it that has no fees to the consumer because it is trying to do is to help them understand how to avoid paid for by the people that they deal with, which I it. That is the best answer we can get, in terms of think is largely regarded as a pretty effective way of the economy. doing it. But there is a growth industry of people who So we are seeing some risk factors, and there is charge the consumer a fee, where quite a number, as always a risk factor when employees move from one you have highlighted in your September report, give bank to another operation. But I think you come a very poor service. Is there a concern that those kinds together to meet common standards in the industry. of important bits of work might fall through the We have produced some compliance guidance for cracks? business last year, in the light of this and other cases, oh i l to : No. I think we would expect that all highlighting a risk-based approach where—and in the of that work would continue regardless of the switch. banking sector you have a lot of this—people do need We gave warnings to 12 firms in September. We are legitimately to come together from competing going to follow that up, and we would expect that businesses to discuss shared standards, but where they follow-up to continue seamlessly through. We’ve also need to be absolutely crystal clear about where the red taken a lot of action on home credit in the last year, lines are that they must not cross. So where we see which we’ve seen as a particular issue, and we’ve those red lines crossed, I think we will take a strong done a lot to try and create minimum standards in the view on enforcement, because we need to make sure sector and done a lot on guidance in the sector as well. that banks take their compliance responsibly in that So I would expect all of that to continue through. area, as with other firms in the economy. Chair: Thank you very much for coming to give Q831 Chair: Thank you very much for coming to evidence. It has been extremely clear—outstanding; give evidence. There is one issue that you haven’t very direct answers, and very valuable for us in the covered, with respect to barriers to entry on the conduct of this inquiry. Thank you both. switching side, and that is fraud, which has often been Ev 132 Treasury Committee: Evidence
Tuesday 1 February 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Stuart Hosie John Thurso Andrea Leadsom Mr Chuka Umunna John Mann ______
Examination of Witnesses
Witnesses: Dou las lint, Group Chairman, HSBC Holdings plc, and Joe Garner, Deputy Chief Executive UK, HSBC Bank plc, gave evidence.
Q833 Chair: Thank you very much for coming to ou las li t: I certainly think it is worth looking at see us this morning, Mr Flint and Mr Garner. Can I the investment horizon. I also think, again a personal begin by asking you a question which flows from the view, a great deal of careful thought has gone into evidence you put to the Vickers Commission; you looking at the structure of compensation in the fingered the institutional investors as the villains of financial industry and deferral and so on but that has the piece, or certainly one of them, in your evidence touched less the investment intermediary industry and to the Commission, don’t you? Why is that? I wonder whether that is an area where, again, some ou las li t: I think the point we were making at alignment with the companies in which they are that time was that during the very heady days of the investing might be worthy of reflection. mid-2000s there was a great deal of pressure coming from shareholders who were looking for enhanced Q836 Chair: Okay, worthy of reflection but this is an returns and were pointing to business models that old story, this misalignment of shareholder interest have, with hindsight, been shown to be flawed and in and the boards that are running the firms they invest particular very leveraged business models and saying, in; what are the concrete proposals to sort this out that “You guys are inefficient. You have a lazy balance you are putting to Vickers or have you not formulated sheet. There are people out there that are doing much any? What duty do you think one should consider better than you are”, and there was tremendous imposing on institutional investors to behave pressure during 2006 2007. differently that might assist with the reduction of I remember research notes being written saying we systemic risk? had 20 billion too much capital and that was a major ou las li t: If it was easy to point to a single thing subject of meetings that we had; being challenged all I guess it would have been done, but I do believe some the time as to why we couldn’t be more efficient. review of the incentivisation—in the broader sense of incentivisation—over the short, medium and long There was an element of pressure coming from that term would be worthy of review. which many did not resist and we took some pressure for a period for resisting. Q837 Chair: Would be prepared to set out some suggestions of that type to us? Q834 Chair: Okay, and how are we going to get the ou las li t: Sure. institutional investors to analyse things more Chair: If I may say so your reply is still pretty shrewdly? general, to say the least, but it is a fairly big issue that ou las li t: A personal view—I think there is you raised in your submission to Vickers. some misalignment in their own objectives. They tend ou las li t: I will give it some more careful to get monitored in their own industry on relatively thought and I will drop you a letter. short term performance—quarterly performance, even one or two year performance—when in fact the Q838 Chair: Do you have examples, other than the business cycle into which we are investing is much Icelandic banks, as examples of aggressive pricing? longer than that so it has been a conundrum for a long Excess competition would seem to be the implication period of time as to whether the cycle over which they of what you were saying in your submission, causing get monitored and the statistics through which funds problems rather than reducing them. are attracted into their particular institutions are ou las li t: Let me make the general point and aligned with the investment cycles of the companies then Joe, who runs our retail business in the UK, can in which they invest. probably give more specifics. I think the point that we were making was that some of the things that are there Q835 Chair: I have not read all the evidence you to protect the system, like deposit insurance, can have have put into Vickers yet, which is several inches the unintended consequences of allowing people to thick, but I made a start; you published it late last compete aggressively for deposits and people can week. I have not seen any concrete suggestions though place deposits with institutions that apparently offer a to address this and I wonder whether you did have higher rate without having to consider whether in fact some concrete proposals. the business model that would drive the ability to offer Treasury Committee: Evidence Ev 133
1 February 2011 Douglas Flint and Joe Garner higher rates, is aggressive, i.e. because they’re lending driven by more competition between products, to leveraged property developers or to higher risk between the banks, however many there are? consumers and they can still attract depositors because ou las li t: I think it would be both institutional the depositor is underpinned by the Deposit and product. I think it is very difficult in our industry Protection Scheme. to invent a product that gives you any real lead over Indeed we saw that very vividly in the United States, your competition because it is instantly replicable, as the banks that failed were failing, they began to certainly if it is a product directed at the mass market. gain significant market share in deposits because they And therefore I think competition tends to be were paying up for deposits and the market was giving increasingly about service—perception of service and them deposits below the deposit insurance threshold brand—but Joe is much closer to it than I am. in America because effectively it was Government oarr:Can I just make a point on concentration risk. because I think there seems to be a perception at times oarr:Another example would be the mortgage that there are three or four major players; there are at market through 2006 and 2007 where there was quite least six major players in the UK market and national extreme price-led competition at rates which we fully supported. In most of the categories in which we thought at the time were uneconomic. compete HSBC is the sixth largest. I think there are more major groups than people often think and while Q839 Chair: Did you say so publicly? we look around the world and we can see markets oarr:We didn’t say so; it wasn’t something where there are a greater number of players, they often that— then tend to be regionalised. If you have a greater number of players, but there is only one in your Q840 Chair: Did you say so to the regulator? locality, it still has not improved choice. I think there oarr:We didn’t say so to the regulator but— are some aspects, when we look across the world, that make us think the UK is a pretty competitive market. Q841 Chair: Do you think you should have done? oarr:I am not sure if it is our role to—maybe Q845 Stuart Hosie: Just on that point of regions and we should have done, maybe we should have done. nations, obviously in Scotland RBS and Lloyds What did happen is we lost some market share in the Banking Group could be considered a virtual duopoly. mortgage market through that period. HSBC have a Scottish Chief Executive and that is ou las li t: We explicitly said we had lost market good; the Clydesdale bank continue to exist and all share because we felt the pricing in the marketplace the rest of it, but in Scotland the competition is far at that time was uneconomic; we did say that publicly. less, concentration is much higher. Do you see a I think Mike Geoghegan said that at a Merrill Lynch particular issue in a country like Scotland, or indeed conference at the height of the boom, he said, “We are some of the English regions, where there is less cutting back; we don’t think that the pricing is competition than the six that you talk about? economic.” oarr:Yes, although speaking of Scotland specifically, despite the strong presence of competition Q842 Chair: In markets where some players have there, we see it as an opportunity. We have been models that are fundamentally unsound, when they go opening branches in Scotland at quite a rate and we bust the sound players mop up. Here you have done plan to continue that over the next couple of years. better but you have not had the ability to mop up on Even though there is a strong traditional competition quite such a scale as you would have done in an all we still see opportunity there. conventional market because of Government support to the defective institutions; does that annoy you? Q846 Stuart Hosie: That is interesting. In a sense, ou las li t: Not really, no, because I think longer although you are not new, you are a newish entrant in term it is more important that the institutions that were terms of a High Street profile; do you think new beneficiaries of Government support survive because entrants generally will find it straightforward or will I think it is important that there is a broad based they find it difficult to penetrate markets wherever competition and therefore I think long term it is they are because of customer inertia? important that there is a broader base of competition oarr:I think it depends on how they approach in the UK. I think if it were to go on forever with the it. We, in the UK, operate through HSBC but also institutions receiving Government support, continuing John Lewis, Marks and Spencer Money and First to receive Government support, that would be Direct and what we think we learned from our irritating. But in the particular circumstances, no, I experience with First Direct—which of course was a think it was the right action. new entrant that we grew from zero to today around a million customers—is that if you do genuinely deliver Q843 Stuart Hosie: You said that there needs to be fantastic customer service, customers will switch to broad based competition and that would mirror pretty you. much what Lord Turner and Hector Sants said that a Stuart Hosie: Thank you. less concentrated retail market would benefit consumers; I take it you would agree with that? Q847 John hurso: Mr Flint, can I follow up on the ou las li t: Yes. comments you were making to the Chairman—I well remember the criticism you got for being too Q844 Stuart Hosie: Do you think that competition pedestrian back in 2006—I was interested by your will be driven by new entrants to the sector or will be comment that you just thought some of the business Ev 134 Treasury Committee: Evidence
1 February 2011 Douglas Flint and Joe Garner was simply not economic which means you thought it customer used; all of those things you would have to was too risky. At that time everybody loved Northern factor in to make an individual calculation. I don’t Rock, which they thought was the absolute ultimate think that either it is really practical to do or very model to invest in; was your corporate governance useful. better or were you just lucky? ou las li t: We would obviously prefer the former. Q851 John hurso: Banking must be one of the very I think part of the DNA of HSBC goes back to its few services or industries where you have not a clue foundation. We were, for much of our history, bigger what the cost of your product is. than Hong Kong and therefore our financial model has oarr:I wouldn’t say we haven’t a clue and always been based on raising deposits and lending; so although I was saying it is very difficult to attribute the model of Northern Rock, which was a the product costs; if you take, as we do, a more securitisation vehicle warehousing mortgages and holistic view of the customer relationship it gets a then funding via the wholesale market, was simply not little bit easier because customers typically have more a model that was particularly in our history. I know than just a current account relationship—particularly that we did some element of that, particularly in the with HSBC and First Direct—and so we are able to United States; it was a very small part of the look at the relationship at the more aggregate level aggregate business. and while it will always be an approximation to some So our business model was different and we stuck to degree, it is more useful. that business model, largely speaking, for the whole 1 5 years of our history and we have tended to avoid Q852 John hurso: You look at the cost per faddish elements of the financial markets. I am not relationship. saying we have always been successful but we have oarr:We try to look at the customer as an tended to avoid particular structures that don’t fit with individual and look at not the cost but the value of that that model. Yes, I think we are very disciplined by relationship to both the customer and indeed to us. what we do and what we don’t do. Q853 John hurso: I tell you what I struggle with— Q848 John hurso: If you had to quickly say, “Here and it is at the heart of working out whether or not we is one lesson the others could learn from corporate have competitive personal banking in this country— governance, risk management, whatever” what would is that I cannot find a banker who provides personal you say that you could have taught them, what is the banking, who will tell me what it costs. I cannot find lesson we should learn from your survival? a banker who does not want to wrap it up in a bunch ou las li t: I would absolutely come to one thing of relationships but I can never get a straight answer time and time again; it is funding. We run a funding as to whether that has particularly been costed and I model that means that our loans are about 80% of our cannot believe—what is vaunted as the UK’s biggest deposits and that is probably a bit lower than we industry and most successful and largest single would like it to be but there is not a great deal of contributor to Treasury does not know what anything credit demand at the moment. But funding our long costs; as a sort of simple old small businessman this term assets with core deposits has been at the heart of just does not quite fit. our strength. It is also at the heart of the comments oarr:To help with that, two comments: first of that were made historically about a lazy balance sheet, all you can always do an average so we can always but I think it is a fundamental strength of banking. take what is the total cost of running a bank and divide it by the number of customers which gives you a Q849 John hurso: Okay, thank you. Mr Garner, number. However, that is an average and won’t be can I ask you about personal accounts and the costs; representative of the large number of customers. Each of your customers how many end up paying for of us is unique in the way that we use our banking. current account services and what proportion are free? Everyone here has a different pattern in terms of how oarr:It is a very difficult question because I you use ATMs—whether you use our ATMs or would see the current account as the way the customer someone else’s ATMs—which means that it is really chooses to have their money available for immediate an individual thing. You can have either an aggregate access; it is akin to keeping money in a wallet and, as or it is very hard to get down to the individual. One such, I would say that it is genuinely free to thing I would say; we operate in a lot of markets and customers. It is true that the vast majority pay so we do see other pricing models and there is an additionally no or very low overdraft charges and assumption I think that if everyone paid a flat monthly there is a small minority who do pay more in overdraft fee that it is somehow fairer. That is not necessarily charges and those are the ones that need particular the case because again, people use banks very care and attention. differently so you are still going to find some people are paying more and some people are paying less than Q850 John hurso: Do you know what it costs to the true cost to the bank. provide a current account? oarr:It is, I would say, pretty much impossible Q854 John hurso: The trouble I have is that I do to isolate the cost of providing a current account to an not know that. Now it so happens that is how I pay individual customer. The reason for that is that you my bank charges. I pay a quarterly fee to my provider would have to make an assumption over how much of and I know that is what I pay but the majority of your branch network, your ATM network, your people in this country have free in-credit banking but purchasing system, your internet usage, et cetera each they have no idea whether that is a good deal, a bad Treasury Committee: Evidence Ev 135
1 February 2011 Douglas Flint and Joe Garner deal, whatever. That is what we cannot get at. This ou las li t: I think it is fairly concentrated. Joe? seems to be the blancmange that we cannot get our oarr:A bit like the answer on the personal hands around, is what actually anybody is getting. side; there are a significant number of major players oarr:We do show very, very clearly charges but yes, we can look around the world and find more related to anyone’s account; not just on statements on atomised competition. the internet but also I think we are the only bank that will tell you at an ATM if an overdraft charge will be Q862 Michael allon: Let us talk just about the UK incurred from that withdrawal. However, we do also for the moment; the Big Four banks, in your view, offer a £15 a month current account with no charges have what share of the SME market? whatsoever and it is impossible to incur charges on oarr:I wouldn’t like to quote a specific that. Our customers have the choice and if, like you, number because I don’t have it in my mind; I don’t they are looking for certainty over what it costs them want to get it wrong. any one of our customers can opt to pay £15 a month; Michael allon: Well, approximately; is it 70%, is it clear, simple and straightforward. 80%, is it 0%? oarr:I would estimate it is in that range, Q855 John hurso: Do you have many who take 70% range. you up on that? Is that something that people use? oarr:We only introduced it towards the end of Q863 Michael allon: 70%, is that over- last year. It has not taken off to a great degree, concentration? however, we are now writing individually to oarr:I don’t think that concentration is the customers for whom we think that is an appropriate measure of competitiveness, there are markets where product—we are writing to 20,000 of them this month you have only two competitors but they function in fact—to encourage them to move across to it. extremely well and give value to customers. The OFT John hurso: Thank you. had a good look at SME banking a few years ago and put some remedies in place which have now passed Q856 Chair: When you show these charges do you and the judgement has been that things are show the interest forgone? functioning. oarr:We don’t show interest forgone because our view is that a current account is for daily Q864 Michael allon: But if small businesses are purchases and we have savings accounts for those telling their accountants that they are being badly who want to accrue interest on their savings. treated, are we not entitled to look at the degree of concentration and wonder whether the Big Four have Q857 Chair: Still it is a cost to the customer, isn’t it? not got too much of a stranglehold? oarr:No more than the cost of keeping money oarr:Of course. I think like many things, in a wallet, I would say. however, in banking that is a general comment that is being made there about banks in general and there are Q858 Chair: But it is a cost to the customer. Had we differences in the way that banks conduct themselves. not better get some transparency on interest forgone? ou las li t: I wonder if this is a question of timing, We are being told by a lot of people we should. if I may, to—I don’t know, was this study 200 or oarr:I would still argue that the best way we 2010? can give value to our customers is if they are looking Michael allon: It was the last nine to 12 months; for interest on their money, to put it in a savings this is the report that was published in January, so account where, because it is a savings account, we can 2010 is the answer. offer a better rate of interest. We don’t make any ou las li t: Okay. There was a report at the end bones about the current account; we don’t pay interest of 2010 from the Department of Business Innovation on current accounts, it is our position so we are trying and Skills that recorded that SMEs were able to get to be clear about it. finance—the vast majority—from the first port of call and those who couldn’t from the first port of call got Q859 Michael allon: Mr Flint, the Institute of it from the second, and that the cost of finance had Chartered Accountants in their January report on not gone up between 200 and 2010. I think in 2008 access to SME finance said, I quote, “Whatever trust 200 , it is fair to say, the cost of banking did rise existed between banks and SMEs in 200 has mainly relative to history but I think history would show, with dissipated due to the ways SMEs have been treated by hindsight, that risk had been mispriced. My perception banks in the last nine to 12 months.” Are they correct? or our experience would be that customers are happier ou las li t: I don’t recognise that as an experience today than they were 12 or 18 months ago. that the vast majority of our customers would subscribe to, no. No, I don’t recognise it. Q865 Michael allon: Okay, but what is the HSBC position at the moment; are you trying to do more Q860 Michael allon: Why would the chartered SME lending or less? accountants say that? oarr:Yes, and a couple of things to evidence ou las li t: They obviously spoke to a segment of that, towards the end of our January sale we are customers for whom that was their experience. promoting two years’ free banking to SMEs, we are offering a 10% discounted loan to SMEs and we are Q861 Michael allon: How concentrated do you about to launch a new promotion to SMEs as well; we think the SME market now is in the UK? absolutely have the appetite. Ev 136 Treasury Committee: Evidence
1 February 2011 Douglas Flint and Joe Garner
Q866 Michael allon: Are you increasing the kind going on, and I presume that you are involved with of conditions you impose, compared to say four or that, what are the prospects of a deal in that regard? five years ago, in terms of the security and demand? ou las li t: I am very hopeful there are very oarr:No, we haven’t made any material strong prospects. My own perception is that we are changes in recent times, in fact the opposite; we are very, very close, that both sides see the advantages in introducing some incentives to encourage SMEs to concluding an agreement to mutual advantage and I borrow from us. believe that we are very, very close to that position. I very much hope that it concludes. Q867 Michael allon: Right, so it is now easier for small businesses to access finance from HSBC? Q873 Mr munna: Brilliant, that is encouraging. oarr:We haven’t changed our lending criteria; Can I just ask you about the Independent Commission I wouldn’t like to give you that impression. Our on banking and some of the comments that have been lending criteria have been consistent; what, if made by Sir John Vickers; in his speech at the London anything, we are doing potentially is trying to market Business School a few days ago he said that he did a bit more strongly so that small businesses know that not think it was credible for governments to argue that we have the appetite to lend to them. they would not intervene to save retail banking—retail Michael allon: Thank you. banking services of any particular group—do you agree with that? Q868 Chair: I have to tell you that your suggestion ou las li t: I think if the circumstances were that things are functioning in SME lending will be met severe enough I think it would be very difficult for a with incredulity by some of our constituents trying to government to stand and see ordinary depositors lose run small businesses. money. Yes, I think governments would intervene and oarr:If they are HSBC customers I would I think that has been the experience all the way around encourage them to contact us because it is true that the world. we are trying to lend to SMEs where we see the appropriate opportunity to do so. Q874 Mr munna: What do you think will be the impact on your group in the event that, say, a form Q869 Mr munna: I just want to pick up on this of separation were pursued in this country where, for lending point; the Bank of England has estimated that example, you were required to separate out your retail the value of the subsidy to your sector was about £100 banking activities into a separate subsidiary, ring- billion in 200 and you are the sixth largest financial fenced? services group, I think, in the world. Given your ou las li t: That is an incredibly good question importance to the sector can you just tell us, do you and one which the Independent Commission has asked often meet and talk about these issues with the us to do some work on, in terms of how you would do the definition; how feasible would it be in terms of Chancellor of the Exchequer and the Business legality and practicality; what would be the Secretary? Perhaps I will aim that one at Mr Flint. consequences in terms of service delivery and cost; ou las li t: That has not been a matter of what would be the unintended consequences in terms discussion, no. of disruption to the economy and the financing of the Mr munna: No. So you do not often meet with the economy while the separation was taking place. I Business Secretary or the Chancellor of the think it is an extraordinarily challenging concept and Exchequer; one would have expected— it will take a considerable amount of work, even just ou las li t: I have been in my role for two months to sort of articulate. There was something in our now and I have met them once, and that is what, eight response to the Commission not to make that weeks, but I would expect to meet them regularly but separation because effectively you would be that was not the subject matter we talked about on unbundling a single institution, opening up risks that that occasion. were today offset, disaggregating flows that work to the benefit of both sides of the business. Q870 Mr munna: Can you tell us, we are People talk about resolution regimes and how difficult obviously in the middle of the current bonus round— it would be to resolve a major institution by making a and it is going to wind up in the next month or so— separation, so effectively you are resolving two have any representations been made to you by either institutions rather than one. It is an enormous task. the Chancellor or the Business Secretary asking It would be a huge, huge exercise and it would be whether you will exercise restraint in relation to the particularly complicated for us and indeed for any payment of bonuses? Representations have been large international bank, in the sense that the UK piece made? of the wholesale bank is not only integrated with the ou las li t: Yes, yes, representations— legal entity that is the bank in the UK but with the wholesale activities globally. Q871 Mr munna: Also can I ask the same question in relation to lending to SMEs; is that something Q875 Mr munna: Okay. If you were to, say, look Government has spoken to you about before too? at this issue maybe a bit more conceptually and less ou las li t: Yes. Yes. focused on what the likely hassles are going to be for you in separating out the two, and there has been an Q872 Mr munna: There has been a lot of argument that without separation there is always going speculation about Project Merlin and the negotiations to be this inevitable taxpayer subsidy and that if you Treasury Committee: Evidence Ev 137
1 February 2011 Douglas Flint and Joe Garner went for separation—and there has been a suggestion being taken by international banks in Singapore at the of this in relation to your group—that that might lead moment that might have gone somewhere else. to banks shopping around for jurisdictions when a separation is not required and there is, therefore, in Q878 Mark Garnier: I want to carry on with this effect, a state that is happy the underwrite the point, because it is incredibly important how sticky, if activities in that country of a bank. John Kay, in the you like, London is as a financial centre. There is lots FT, said that in that situation such banks would be the of speculation in the press about you relocating corporate equivalent of the benefit scrounger posing somewhere else in the world, and the obvious one as an asylum seeker and are likely to receive the would be Hong Kong, and you are after all the Hong welcome that such migrants receive as individuals if Kong and Shanghai Banking Corporation, and you they sought to, for example, relocate; he is right, have a 130, 150-year history out there. It was from 1 isn’t he? ueen’s Road Central that Willie Purves took on the ou las li t: I think that is a particularly unhelpful world and won, and you are there where you are. colourful description. I think it would be very, very What on earth is keeping you here? Why aren’t you difficult to shop around the world for a jurisdiction to going back to Hong Kong or, indeed, anywhere else? take you where you were explicitly trying to find a ou las li t: We came to London in 1 2 because regime that was more benign than the one you were we acquired Midland Bank. We acquired Midland coming from. I just don’t think that would be possible Bank partly for a diversification, as because up until to do. that point we were a very substantial, very successful I think it is fair to say and London has for ever—and regional bank. We acquired Midland Bank to become certainly over the last 20 years—set its stall out by a global bank. Midland Bank had been one of the being the most attractive, or seeking to be the most great banks of the world, and that brought us to attractive, place for wholesale market activities. London, which was then, and grew into being an even Today, it dominates the foreign exchange world, the more, important international financial centre. So to interest rate world, the equity capital market flows, it grow our business as an international bank was not is second to New York in terms of servicing of hedge going to be possible from a regional base, and there funds, largely because of the financial system and were technical reasons too why the regional base was infrastructure. So London has set itself up as being a more difficult from which to do international capital place where you get sort of the cluster effect of market activities. We centred those activities in institutions who service those important segments of London, because London was the international the global economy seeking to come together. If financial centre, and it has grown over those 20-odd regulation or public policy were to dictate that that years—nearly 20 years—into a much more successful international activity—we are not talking about retail international financial centre, gaining the market share banking in the UK—but that cluster of international lead in interest rate derivatives, foreign exchange and activities were going to be done somewhere else, and a whole bunch of other things, and that is why we New York obviously already does them, because a came. So the location of our principal activities is particular jurisdiction no longer wanted to participate driven by the cluster effect of where others do it and in that level, then the cluster effect would mean that where the market is with the greatest liquidity. That over time, activities would migrate. I don’t think it has been London. would be a question of moving institutions. The activities would migrate to places where those clusters Q879 Mark Garnier: One of the issues though in were welcome. 1 2 was you had five years ahead of you then before the hand-back of Hong Kong to the Chinese, and Q876 Chair: You are well placed to tell us whether people like Jardine Matheson were going off and Asia is picking up business it would normally be moving their domicile to Bermuda in order to get growing in the two Anglo-Saxon markets. Are we around any potential threat, and there were lots and losing out? lots of people who were moving, getting dual listings. ou las li t: I think, over time, Asia is going to I think you have a dual listing: a primary listing in grow in importance, just because of the scale of its Hong Kong and a secondary listing in London, if I economy and as they get more sophisticated, and as remember rightly. they build their retirement savings business for the ou las li t: Dual primary. demographics of the region. So Asia will grow anyway. There is at the moment evidence of quite Q880 Mark Garnier: Dual primary, okay. We have noticeable—not huge, but noticeable—growth in now moved on 20 years. We now have a 1 -year Singapore and in Hong Kong, particularly probably history of what the Chinese are doing in Hong Kong. Singapore. There is no doubt about it, the centre of gravity of the Chair: Business that we should have had? global economy is moving towards the Far East and ou las li t: I don’t think anyone has the right to Asia. That is where the opportunity is going to go. anything. Any economist will tell you that an economy coming Chair: Business that we would have had? from a low level with a big growth potential will ou las li t: Business that we would have had, yes. continue to grow very well, which has Asia all over it. You have a very sort of sophisticated regulatory Q877 Chair: Yes. On what sort of scale? regime in Europe and in the Western world, which is ou las li t: Modest at the moment. There are, to quite—or can be quite—constrictive, whereas in the my knowledge, three 200,000 square foot buildings Far East, you have a less restrictive regulatory regime, Ev 138 Treasury Committee: Evidence
1 February 2011 Douglas Flint and Joe Garner you have the history of how the Chinese operate, you looking at this, and you obviously want to send the have a 15.5% tax rate, which is always going to be right mood music to them as well, I think—that you more competitive, and you have the global economy have no plans at all to move to the Far East and that gravitated towards that. I ask the question again: why you will continue to have your headquarters here in on earth aren’t you going to the Far East? London for the foreseeable future? By foreseeable, I ou las li t: It is no secret. We formally go through mean a significant amount of time, not just six the discipline, the governance, of looking every three months. years, if you were coming down from Mars with our ou las li t: I can categorically say that we will business configuration, where would you seek to place continue to do what we have always done, which is the international headquarters of that group? London every three years look at where we believe the best has historically, and continues to have, advantages place to be is. On the current analysis, that continues based on not just time zone, but just the history of the to be the UK, and we said publicly we want to remain tax networks that the UK has that are more expansive here, we want to work with the UK authorities to than any other part of the world, political stability, rule ensure that London continues to be— of law and the cluster effect, that in fact the markets in which we operate, the most important thing we seek is liquidity, and liquidity is most evident still in Q884 Mark Garnier: When was your last three- London and New York. Over time, there is no doubt year assessment? that as Asia becomes stronger and the currencies in ou las li t: We’re doing one this year. the region become more international, they will play Mark Garnier: You are doing one this year? a larger role, but today we believe, on the analyses ou las li t: This year, 2011. that we do as to where you would locate, Europe— and the UK within Europe—remains very Q885 Mark Garnier: This year you could make a competitive. decision to move out of London or not? ou las li t: There is nothing special about 2011. Q881 Mark Garnier: But why do you have to be Mark Garnier: No, but I am just looking at your headquartered here? You can still have a very three-year cycle. There is something, you have a successful business. Let us go back and look at history Banking Commission going on; you have a new again: Hong Kong and Shanghai Banking Corporation financial regulation Bill coming through. This is a big, bought James Capel to have a quasi-investment bank big year, actually, you know? that developed in London. You do not have to be in ou las li t: It is a big year in a whole bunch of London to be able to take advantage of the cluster ways, and what I would say is that ultimately any effect here. decision we make will not be based upon regulatory ou las li t: No, you don’t, but there are other arbitrage or anything else. It will be based upon the aspects in terms of the organisation of the economics of where it is best to do our business. international group where the UK’s history in terms of its tax treaties and therefore the free flow of capital Q886 Mark Garnier: So tax, legal system? and so on and so forth into and out of the UK makes ou las li t: All of that, but you are right, if there it an international headquarters town, which is what it were to be business model constraints placed upon us, has designed itself to be, in a way that virtually no that would have to be factored into the consideration, other city in the world, no other country in the world that there are other aspects in relation to the cost of has quite the unique competitive edge that London being in London, the fact that the bank levy that is has. being imposed is on a global balance sheet, not just a UK balance sheet, there is a tax on being Q882 Mark Garnier: So why does Stuart Gulliver headquartered here. We are finding institutional want to have his chief executive office in Hong Kong, or is that just false speculation? investors routinely now in meetings asking us to ou las li t: No, Stuart’s moving to Hong Kong for explain the cost of being in the UK, and the benefits. his office because the growth in our business will be Now, we don’t have that calculation yet, because it is in Asia, and it is really important that his principal all very, very new. So there are going to be more office is in Hong Kong so that he can drive the growth inputs into the decision going forward, but we are into the region that is growing the fastest. There is no certainly not starting—and you are kind of leading question—being in the flow of the conversation me, trying to say we are trying to leave. We are not around people who are living in the region, investing trying to leave. in the region and looking for opportunity in the region Mark Garnier: No, I am not. is considerably better than sitting in London trying to ou las li t: But we will look at it entirely see what the mood music is about China, about Hong dispassionately from an economic perspective and our Kong, in the region. You can’t get the vibe of the shareholders in fact will do exactly the same, and it is region you are most interested for growth in by sitting they who will be coming to us and saying, “Explain in London. to us what the cost of your current business model is, your geographic structure, your headquarters. You Q883 Mark Garnier: This is causing a great deal of know, what are the economic consequences of the way confusion to the world in general, as to where you you are structured? Is there a different way of doing want to be. Will you categorically say now—bearing it, and if there was a different way of doing it, are the in mind that the Chinese authorities may well be benefits superior to the cost of getting you there?” Treasury Committee: Evidence Ev 139
1 February 2011 Douglas Flint and Joe Garner
Q887 Mark Garnier: If you were to leave this John Mann: So if your— country, because we will know by the end of this year ou las li t:—our focus is on the economic exactly what you are going to do, because you have progress within China. guaranteed that this year you will make the decision John Mann:—customers in China want to have a say with all these big, big things going on— about the banking system in China, how would they ou las li t: Routinely, yes. express that view? Mark Garnier: Sure, but it is this year, as opposed ou las li t: If our customers in China have a view to last year or next year. We are at point zero of this of the banking system, they choose to bring their three-year cycle. Will you make it very well known business to us or not. That is the way they express how you came to your conclusion? their opinion. ou las li t: Absolutely, absolutely. Chair: I am sure you will. Q891 John Mann: No, but if they want to have a view on the system, they have to join the Chinese Q888 John Mann: Mr Flint, I want to start by asking Community Party. Do you regard that as an about your philosophy. Does banking exist to support appropriate form of government for those people? democracy, or does democracy exist to support ou las li t: I am sorry, I don’t have a view. I don’t banking? have a comment. ou las li t: In my view, banking exists to support economic progress through facilitating economic Q892 John Mann: You do not have a view. It is just endeavour and giving a secure home for the product that you said your role is to play a proper role in of that endeavour, and providing capital so that people society. Over the centuries, have any of the underlying can pursue personal and business objectives. So ethics or moral principles of banking changed? banking serves society. ou las li t: I don’t believe so, no.
Q889 John Mann: Are there any values that are Q893 John Mann: Where does the word “bank” more important to your board than making money? come from? ou las li t: Absolutely. Absolutely, yes. ou las li t: You’ve got me. John Mann: What are they? John Mann: Well, you are the banker, not me, but ou las li t: Playing a proper role in society. I the word “bank” comes from “bench” because all think we started this meeting by saying that there were transactions were carried out on a low bench so periods in the mid-2000s where we, as a board, were everyone could see them. So on transparency, is there being heavily criticised by elements—elements, and any information in terms of the pay of your senior not the entirety of—the shareholder community, executives that is requested by this Committee that saying that we were not taking an aggressive enough you would not be prepared to provide? view of our balance sheet and we could make more ou las li t: Well, you haven’t made a request. We money. We stood aside from that, because we believe already gave more information than any other bank that there is an optimal financial structure to enable us based in the UK, because our Hong Kong listing to have sustainable value. You know, we have a requires us to show, in addition to the board pay, the market capitalisation of around 200 billion, £120 pay of the five highest-paid executives in the group, billion. 65% of the dividends that we pay are in this and we set that out—and have done forever—in our country, and therefore roughly, as a proxy, 65% of annual report and accounts. So we already give more our shares are owned by people in this country. They information than any other bank. I am totally relaxed passionately care about our success, and our success about transparency. is more than just our profitability in a single year, it is our long-term sustainable value creation and the Q894 John Mann: So if we want to know how many dividends that come from that. of your employees earn over 1 million, we can find that out? Q890 John Mann: So in terms of playing a proper ou las li t: We would be very happy to provide role in society, you then would support moves and that information, assuming we were not alone, i.e. if urgent moves towards democracy in China? this was something that was going—we would not ou las li t: I am not sure how that has a relevance resist an industry disclosure of that information, no. to banking. John Mann: Well, you are a big player, you want to Q895 John Mann: You would not resist it as an play a proper role in society. individual bank either? ou las li t: Absolutely, and our business— ou las li t: I think we wouldn’t like to be on our John Mann: You operate in China— own, simply because it would give undue attention to ou las li t: We do, and— us, but if you ask me do I have an objection in John Mann:—and China is not a democracy. So in principle to transparency, absolutely not. terms of democracy in China, would you support, as a bank, moves to democracy in China? Q896 John Mann: Would there be any problems for ou las li t: I think that is outside of my ability to you as a bank in doing that? comment. We have 100 branches in China. We have ou las li t: I think there are potentially unintended opened rural branches so that we can bring banking consequences that would come from greater services to the most remote parts of China and transparency internally, in the sense that I think it therefore— could have the unintended consequences of putting Ev 140 Treasury Committee: Evidence
1 February 2011 Douglas Flint and Joe Garner pressure on pay rising, because a bunch of people Q903 Chair: On the transparency issue, you will would see where they fell in the pecking order and have seen Eric Daniels’ letter to us, and my letter to they might be somewhat disappointed that they were the Chief Executive of the FSA. Do you think that the at a lower rung than they thought they were. So I think approach taken in that letter will pose any difficulties the risk is with much more granular disclosure of pay for HSBC or do you feel able to give it a fair wind? is that people begin to get information that they didn’t ou las li t: I personally don’t have any difficulty. otherwise have to negotiate their relative value. They If that was a proposal put forward, we wouldn’t don’t have that at the moment. That is the one resist it. downside I can see. Chair: You will co-operate with the FSA in helping them put it together? Q897 John Mann: You have reportedly doubled the ou las li t: Yes. fixed salaries for your investment bankers. Is that the case, and how many people does that cover? Q904 Jesse Norman: You have said almost in terms ou las li t: I don’t believe it was across the board that you see the bank as motivated by certain moral that we doubled. There were some, I guess, but it values or certain ethical positions, and of course in wasn’t—the move to more fixed pay was in response this country historically banks have been set up by to regulatory concerns around the leverage of dissenters and Presbyterians and non-conformists for incentive compensation, as to whether it leads to exactly that kind of reason, to express a moral position excessive risk-taking. Therefore the industry has gone as well as a commercial one. Is that your view? through a process of not changing total compensation, ou las li t: Sorry, I missed the bit in the middle but changing the leverage to the base as a— of your question. Jesse Norman: That the bank is infused with a certain Q898 John Mann: So how much more are you kind of moral— paying out then in fixed salaries for your investment ou las li t: Absolutely. bankers, roughly? Jesse Norman:—position and values. ou las li t: I can tell you. 150 million was ou las li t: Yes. moved from the bonus pool, or what would have gone into incentive compensation, to fixed compensation. Q905 Jesse Norman: Why then are you planning to take a decision about where you locate purely on Q899 John Mann: How many people did that cover? economic grounds? Why not think of the character of ou las li t: I don’t have that figure. the institution and the values that it has always stood John Mann: But we could have that figure? for, its relationship to British history and take it on those grounds as well? ou las li t: Yes. ou las li t: I don’t think there is any possibility of our moral or ethical character changing depending Q900 John Mann: Why should your investment on where we locate, and indeed, we wouldn’t bankers be paid so much more? relocate—I find this difficult, because we don’t have ou las li t: They are not being paid any more. an intention to relocate, but were we to relocate, it The structure of the pay is changing. Their total would not be to any part of the world where the compensation is not changing as a result of this. The character of the organisation would in any way be ratio of fixed to variable is changing. impacted. So that would be one of the considerations. We would not go anywhere where there was a risk to Q901 John Mann: I think people can see what is the character of the organisation and, you know, I going on. You are trying to manoeuvre around the should say out of 1 5 years of history, we have been systems that are there. in the UK for 18. ou las li t: No, we are responding to concerns that excessive leverage in variable pay could lead to Q906 Jesse Norman: In thinking about Merlin, does unintended consequences of people taking excessive Project Merlin cover not merely asset lending or risk. I don’t necessarily agree with that, but that was lending and compensation, but also transparency? the conclusion of a number of reports into how to ou las li t: It does, yes. better align shareholder and societal interests with the compensation structures and we have adjusted Q907 Jesse Norman: Can we expect positive moves accordingly. in the direction that the Committee has indicated on that issue? Q902 John Mann: A final question: if the pressure ou las li t: Obviously the discussions in Merlin for democracy in certain countries around the world didn’t have the benefit of the letter you have just spreads to China this year, how will you deal with that written, but part of the dialogue with Government has unintended consequence? been about transparency and there are proposals to go ou las li t: We deal with all these situations as further than we go today, and as I said, we already go they arise. We have a substantial number of branches further than our peers in the UK because of the Hong in Egypt and one of the things I will do when I leave Kong listing requirements. here is get another update as to what is happening to our many thousand people in Egypt. So, you know, Q908 Jesse Norman: That would fit with the ethos, there are a number of situations that we have to deal the values of the institution? with and we respond to economics, not politics. ou las li t: Yes. Treasury Committee: Evidence Ev 141
1 February 2011 Douglas Flint and Joe Garner
Q909 Jesse Norman: Have you looked at the ou las li t: No. But the point of the transfer is to possibility of paying staff in CoCos or in subordinated reduce the leverage, which is what it has done, but debt or other things that would align their incentives also we should remember that the bonus pot is there to more with the interests of the asset base as a whole? incentivise people for delivering against the objectives ou las li t: For the last couple of years, the vast they have been set at the beginning of the year, which majority of our more senior and highly-paid people are much more broad than a profit. Nobody’s paid a have been paid in equity, which is obviously the most percentage of their profit, and therefore it is to achieve responsive form of instrument to the future prospects the alignment that shareholders have asked us over a of the institution. So CoCos are higher up the capital long period of time to deliver. So what we are trying structure, as is subordinated debt, than equity. We pay to do is— staff in equity and I suspect that is what we will Mr munna: I understand where— continue to do for a large part of their remuneration. ou las li t:—manage the structure of the Jesse Norman: Thank you very much. compensation, so that it means that we don’t end up paying a large amount of fixed pay in periods where Q910 Mr Mudie: It is just a question in response to the performance is weaker and individual behaviours something you said to the Chairman and something aren’t what we wish, so there is this balance all the you have just said to Mr Norman, which is this: you time. were very forthcoming and positive in terms of transparency and information to the Chairman, which Q913 Mr munna: I understand that balance, but I is welcome. One gets the impression that Merlin is am just saying to you that this 150 million transfer, struggling to reach agreement, and if Merlin reached in the context of your overall bonus pool of 2 billion, agreement that is just to cover over the fact that they is not that much, and so you have not changed a great could not really do a deal in a positive way, but they deal, have you? cobbled something together, would you feel bound to ou las li t: On that basis, no, but I am not sure accept the transparency arrangements agreed in we tried to. What we were trying to do was get the Merlin and the statement you made to the Chairman appropriate mix that we think works for the business. would be, “Sorry, but I have to be part of this agreement”? Q914 Chair: Would you be prepared to tell us what ou las li t: I think we would take our own view. proportion of the bonus pool is going in payments I mean, we already, as I said, do more than UK banks, over 1 million? so we are already further forward. We have only had ou las li t: I am happy to tell you. the benefit of seeing the Chairman’s letter this Chair: When it does, when it does. morning, so we will take that on its own merits, ou las li t: I don’t know the figure off the—the independent of Merlin. Remuneration Committee doesn’t sit until the end of this week or next week, so— Q911 Mr munna: I just wanted to follow up on the Chair: Yes, I am very grateful for that. Thank you response you just gave in relation to the composition very much for coming to give evidence and being so of remuneration and how you are moving towards frank with us. It has been helpful. You have agreed to fixed salary, as opposed to high bonus payments, and give us some further information and we look forward you said that 150 million had been moved from the to receiving that, and also to your further participation bonus pot to the fixed salary component. How big is in Merlin, not least looking at the transparency issues the bonus pot, roughly, in billions? that we have been raising this morning. We will now ou las li t: We haven’t determined what it is take a five-minute break before we take our next going to be this year, but it is around two. witnesses. Thank you very much.
Q912 Mr munna: Billion? So transferring 150 million from your bonus pot to your fixed salary component is not that much, is it? Ev 142 Treasury Committee: Evidence
1 February 2011 Neville Richardson and Rod Bulmer
Examination of Witnesses
Witnesses: Neville ichardson, Chief Executive, The Co-operative Financial Services and od Bulmer, Managing Director, Retail, The Co-operative Financial Services, gave evidence.
Q915 Chair: Thank you very much for coming to pressure on the plcs to deliver, and so there would be give evidence to us this morning. We have a number less competition and less diversity. of relatively crisp questions, and it would be helpful if we have some crisp replies. Unless something you Q918 Chair: You may have heard the previous say that we feel needs quite a long follow up, I do not evidence session, in which we discovered HSBC does think it needs to be a long session, and we have not know what each individual customer is costing another one following, as you know. Could you first them. Do you know what each individual customer is of all tell us your assessment of the impact that recent costing you? consolidation within the sector has had on the retail ill ichar so : Yes. Perhaps if I can ask Rod, market and retail competition? who is my Managing Director of Retail, to say a word ill ichar so : You mean consolidation in the on that. plc sector or across the entire financial services o Bulm r: Yes, so each individual current account sector? customer we believe costs us £85 per year. While that Chair: Let’s concentrate on the area in which you is a specific figure, it is an average. As you will have the greatest expertise. understand, different people use different services, but ill ichar so : Okay. I think in the mutual I think it is appropriate we give you the figure, which sector, the history of the sector has been very much is £85. Clearly, though, the marginal cost is not £85 one of consolidation and I think that has given the and we think that is very important, because growing strength that we have across the sector today. The Co- our share will allow us to grow much more operative Group, which is the one that I speak for, competitively, because the networks lodge their fixed mainly, has been the result of many— costs, the ATM infrastructure, the very high Chair: Could you speak up? I am sorry, I am only investment in IT. But last year, about £85. just hearing you. ill ichar so : Yes. The Co-operative Group, Q919 Chair: It seems we have travelled a longer way which is the part that I speak for, is as strong as it is there than we did an hour ago. today because of those many mergers that have taken place. Having said that, there is strength in the local Q920 Mr munna: I was going to say exactly the part of the mutual movement, and long may it same thing. Can I just go back to this issue of continue. consolidation, because you said that in your sector, if you are looking at the mutual sector, it has given you strength, but I have to say, paradoxically, this Q916 Chair: The overall competition coming from Committee has listened with some incredulity to in other players: less, greater, the same that it was? fact HSBC, I suppose, Lloyds and RBS, all have come ill ichar so : I think when we look at here and argued that increasing consolidation across competition, we look at it across financial services, so the financial sector as a whole has not adversely if I just say a word or two about the size of our impacted on competition. I am just not totally sure organisation, we have about 1.25 million current from—I understand you were kind of asking, when account customers and about 8 million customers in you were talking about the mutual sector or the total, so I don’t look on competition as being within financial services sector per se. Let’s start looking the mutual sectors, I look on competition being across across the board. How can increasing consolidation the whole sector, and effectively what the mutual not have adversely impacted on competition? That is sector does is bring significant diversity and challenge something that I think we are all struggling with at to the plc sector. the moment. ill ichar so : There is a point at which the Q917 Chair: When Eric Daniels said that consolidation starts to take significantly away from competition was, “Enormously competitive in the competition. retail sector” did that ring a chord, did that strike a chord, ring a note? Q921 Mr munna: Have we reached it? ill ichar so : It is competitive. It is a ill ichar so : I think we are probably close to competitive market, but I think what the mutuals and reaching it, but if I give you an example, we are at the Co-operative bring in particular is a challenge to present replacing our core IT systems. We are the first the traditional model, and I think when you look at UK clearing bank to do that. None of the plcs have the service awards, we just recently came out as top done that, so many of the systems were written in the bank, top high street bank in the JD Power survey. 1 70s, 1 80s and 1 0s and are therefore inflexible Under that survey, when you look at the pricing of and difficult to work with from a customer point of products, so if you look at the products that appear in view. We are spending £0.5 billion on replacing our the top quartile, whether it’s mortgages or savings or core IT systems. If we were a much smaller current accounts, invariably you find mutuals and organisation—so the two predecessor organisations ourselves in those highest echelons. If we were not that formed what is now Co-operative Financial around, then I believe that there would be far less Services, which was Co-op Bank and Britannia Treasury Committee: Evidence Ev 143
1 February 2011 Neville Richardson and Rod Bulmer
Building Society—neither in isolation could have Compensation Scheme, where we are a prudent afforded to spend that £0.5 billion. organisation. The deposits that we take in from customers are greater than the loans that we lend out Q922 Mr munna: You mentioned the benefits of to customers, so we are around about 105% funded the customer satisfaction levels; you referred to the from customer deposits. That makes us a lower-risk Which? survey and the costs. What are the other organisation. Conversely, and quite bizarrely, that then benefits that you see for having a more diverse retail means that in compensating for the Icelandic failures market? What in particular do mutuals like yourselves and so on, we have to pay more towards the bring to that? compensation scheme because it is based on retail ill ichar so : If I can talk about the deposits, and that just seems wrong to us. background to our organisation. The Co-operative Group is very much a membership-led organisation. Q925 Mr munna: Can I just go back to the capital In fact, our main board is made up entirely of elected issue? My understanding is that those of you in the members. The members are customers, so our mutual sector are going to struggle somewhat with the customers— Basel III capital requirements. Is that right, and how Mr munna: A bit more democratic, if you like? are you addressing that with Government? ill ichar so : Yes. Our customers are ill ichar so : It is not a case of struggling with democratically elected effectively straight to the main it. It is a case of making sure that we have new board, so that means that views that are taken are instruments available to us that we can raise further taken straight from the customer. Now, when we capital from. So we are a well-capitalised assess our performance, we assess across the balanced organisation. What is happening in the market is a scorecard, and our balanced scorecard is one that does perception that the capital should be higher because take in financial measures, but it also takes into of the problems of the past, when many of the plcs, account customer measures, employee measures and who were under-capitalised, had a problem. We have social goals. Social goals, to our organisation— always maintained high levels of capital, but as both because we are very much a values-driven market perceptions of the requirement of capital and organisation—are of critical importance to the way in regulatory requirements increase, we want to have which we do business. continued access to new forms of capital, and so as I said, we want to work with Government and with Q923 Mr munna: What are those social goals? regulators to work out what are the best solutions for What do you mean by that? the mutual sector. ill ichar so : We have a whole spread of social goals, whether it is the way in which we invest in Q926 Mr munna: Do you think that one way— local communities, or whether it is the type of lending this is my last question—in which we could promote that we do. We have a whole load of values-driven mutuals would be to remutualise Northern Rock? That objectives, so for instance, in my part of the business, is obviously a topic that is rising up the agenda very in the financial services part, they were a significant fast at the moment. Would you like to see Northern lender into renewable energy, and that is something Rock be mutualised? that my board believes is the right thing to do. We are ill ichar so : I think in terms of bringing also significantly investing back into local another mutual into the sector, another competitive communities, so many of our local Co-operative mutual into the sector, that would be a good idea, but stores have local representatives, who will receive there are issues that would have to be dealt with, such donations and will use monies for local benefit. as the capital. Mr munna: The capital. Q924 Mr munna: The Government, in the ill ichar so : The Government is providing Coalition Agreement, has said that it will promote that capital at present, and I think in terms of diversity, mutuals and organisations like yourself. Do you think that would be a good move. it is doing enough in that respect or do you think there Mr munna: Thank you. is scope for it to do more? ill ichar so : I think there is scope for it to do Q927 Chair: Just to be clear, have you written to Sir more, and if I can give two examples of that— John Vickers with your points about the compensation Mr munna: Please. scheme and Basel III? ill ichar so :—and the examples I would give ill ichar so : We have, and in fact I am giving would be in the areas of capital, and there is evidence on Friday of this week, so I will do that significant attention paid to levels of capital of in person. financial services organisations, more so than ever. We have on occasions, as mutuals, been looked on as the Q928 Chair: Okay, and that is already in the public end of the train of thought and we want to be there at domain, although we have not yet had a chance to the start of the train of thought, so quite often read it. Thank you. legislation is being discussed by the regulators with the plcs in mind, and then as an afterthought, the Q929 Mr Mudie: A good friend of mine, Robin mutuals. Now, if we want to have a diverse financial Smith from Leeds, has been bending my ear about this services sector, then we need to be right at the table capital instrument. I had the impression it was under at the time that thinking is going on about capital. way in terms that adversely affected the mutuals. Can The second example would be the Financial Services you be specific about it, because at the beginning it Ev 144 Treasury Committee: Evidence
1 February 2011 Neville Richardson and Rod Bulmer was almost as though you were feeling you were not working its businesses together for the benefit of all at the table and you were the last they thought about? of its members and customers. It has operated in too Certainly Nationwide have included it in their siloed a way. I think the examples you give of the evidence. Is there something happening now that it is funeral business, the food business and the bank crucial it is put on the table and drawn to the business not working well together are very valid and Ministers’ attention? appropriate. We believe over recent years we are ill ichar so : I think the answer to that is that starting to make progress, and indeed over the last in the initial stages, it did feel like we were left on one three to four months we have announced a new group side. It now is feeling like we are being represented at structure with a single group chief executive to the table, but it feels like it has been an effort to get exactly deliver on those promises to customers under there. So, yes, I think that the appropriate discussions a banner of Project Unity. Our plan is to achieve 20 are now taking place, but the point I was raising was million members by 2020 with a real co-operative in order to give an example of situations where I think community approach in each and every community in we were being thought of after the event as opposed the UK. I think that the challenge is very valid. We to at the same time as the plcs. hopefully have plans to address it—
Q930 Mr Mudie: When you say that discussions are Q936 John Mann: I have loads of Co-op stores in taking place, who is party to them? Which parties are my area, over 20,000 members, but you are not there to these discussions and where are they? Is it getting any of them into your bank. Europe or here? o Bulm r: Yes. ill ichar so : Both. Q937 John Mann: At the current time, if this is not Q931 Mr Mudie: Are they going sufficiently well your opportunity, with the unpopularity of bankers, that we should not be concerned? when will it ever be? So, isn’t it the case that your ill ichar so : I think the answer that I’d have business model is so weak that you are not capable of to give to that is they are in progress. So, at present, moving into that space? progress is being made. ill ichar so : I think actually our business model has been demonstrated incredibly well over the Q932 Mr Mudie: We are having the Minister here past three years to be a very strong model. At the time tomorrow. Is it something we should press the that the plcs were failing, the fact that we take a Minister on or draw to his attention? values-based approach to life, the fact that we look ill ichar so : I think you should draw to his medium term and are not chased by the short-term attention the advantage that diversity in the overall vagaries of this quarter’s profit has meant that we are market, the diversity given by mutuals gives to the a strong organisation there for the future. market, and therefore encourage him very strongly to Now, to address your point specifically, then what we continue to support moves for new capital. believe that we need to do is we do need to grow as an organisation, but growth is not a target that is Q933 Mr Mudie: Do you think before tomorrow you uppermost in our minds. Providing service to our could just do a note on it and pass it to the staff so customers is uppermost in our mind. What we are we can be quite specific with the Minister and so that doing is we are now experimenting with a number of we do not lose the opportunity? branches within food stores, which will enable us to ill ichar so : I would be delighted, yes. expand in areas of the country where we are not well Mr Mudie: Thank you. represented at present. We believe that provides a big opportunity. We as a group have 5,000 stores across Q934 John Mann: How many employees have you the UK. We only have 350 bank branches, and we got, under all definitions of payment, getting over £1 think we have a significant potential to grow and million a year? provide financial services into areas like your ill ichar so : We have zero employees over £1 constituency in the future. million, although I am the highest paid employee and if on a very good year we achieve our targets and our Q938 John Mann: I was going to say, because you bonuses, then I could be over £1 million, but it is can get money out in my local Co-op but you can’t highly unlikely anybody else would be. put money in, and that is why nobody joins. Is there any other financial institution that has the names and Q935 John Mann: I have over 20,000 members of addresses of 20,000 members that does not ever mail the Co-op in my constituency. I have had a Co-op Visa them out and then go after them as potential customers card for 30 years. My grandma only ever shopped at for the bank? If your competitors had this, they would the Co-op in her entire life, for 2 years, and was be all over areas like mine investing in order to get buried by them, the Leeds Industrial Co-operative those people in and they would get a good section of Society. You have never bothered asking me or my them. I do not understand why you are not doing it. constituents to join your bank, so what is wrong with ill ichar so : I think you are pushing very you? much on an open door. It is exactly what we are doing ill ichar so : I will ask my Managing Director at present. The strength of the brand of the Co- of our retail business to answer your question. operative Group has grown immensely over the past o Bulm r: I think the Co-operative as a broader few years and in particular the Co-op Bank side of group has not been as good as it should have been in things following its merger with Britannia is a much Treasury Committee: Evidence Ev 145
1 February 2011 Neville Richardson and Rod Bulmer bigger and stronger organisation. The investment in Q944 John hurso: Roughly, business-wise mix? the— ill ichar so : In terms of our so-called balance sheet, around about a quarter of our balance sheet is Q939 John Mann: Yes, but people do not want corporate and business lending. Over the past three or brands, they want branches. four years, we have very much stayed open for ill ichar so : Absolutely, but people want to business to SMEs and to corporate business in feel confident they are going to get a good service and general. good products, and that is what they get from us. Now we need to expand into more locations for that Q945 John hurso: One of my colleagues I think is competitive alternative to the plcs. going to ask you about that. Can I ask you about the three-quarters, the individual? You get consistently Q940 John Mann: So we can look forward to you some of the highest scores from your customers, and doing a full review of my area on whether or not it is I mean markedly higher than the Big Four, Five, Six commercially viable for you to move in when others or whatever they are. How much of that is down to are exiting it to try and get some of these 20,000 as your status as a mutual and how much is down to the customers? style you choose to use for management? o Bulm r: Absolutely. Apologies, John, I do not o Bulm r: We think the mutual model gives us a know your specific area. I would comment, though, good head start but, to be blunt, I think simply a good on Horbury. This is a location in Yorkshire. We had head start, and actually we are a business that is 1,500 Co-operative members write to us and say, “No centred around clear values. As Neville said before, other banks in town. We are prepared to switch our we run our business across the balanced scorecard. account to you if you open a branch”. We are in the Indeed, I am incentivised not on profit or explicitly the profit make, I am incentivised across the whole process of opening a branch in our Horbury food store scorecard, which includes how well we perform and we genuinely believe—and I am glad you do as financially, profit, liquidity and capital, how we well—that with the Co-operative in renaissance we perform in our customer advocacy against our peer have a huge opportunity to expand our banking group, how we employ employee satisfaction and how business as part of that broader business and, in well we manage our risk. Each of those components particular, expand our network from the 350 to contributes to my bonus, and every one of our 12,000 above 500. employees are orientated around that same scorecard. John Mann: Well, if it is good enough for Mr Balls’s I genuinely believe that the mutual model, the area, it is good enough for mine so— member-orientated model, gives us a real point of Chair: I did not expect to find John bidding for the focus, but actually it is the way we run the business job of head of marketing, but— around the values and the way we measure and remunerate the business that makes the difference. Q941 John hurso: uick technical question: is If you would tolerate just a return to the earlier there any difference between the building society question, the point on competition to me is the mutual model and the co-operative bank mutual model following. If there is such dissatisfaction with the and, if so, quickly, what is it? banks, why would only 7% of people switch per year? ill ichar so : uite largely it is the legislation That really is the point of competition. There is a fear that set them up. The principles behind them are very and a lack of transparency that means despite the similar, but the legislation that set them up is different. dissatisfaction that exists people are not inclined to That is the principal difference. take that journey. So it might be a tough market, but is it competitive from the eyes of the consumer? I Q942 John hurso: Is there anything in that think the answer to that simply is no, it is not. legislation and the differences between the two that you would draw our attention to as a barrier to going Q946 John hurso: If we go back not that long ago, forward? You have talked about tier 1 capital; you my first house, 80%-plus of the mortgage market was have talked about the relationship. Is there anything in mutual hands. Today, what is it, 18%, if that? else in the legislation besides that you should draw— Something like that. ill ichar so : I think a real move forward two o Bulm r: Yes. or three years ago was the Butterfill Act that brought through the ability of different forms of mutuals to Q947 John hurso: That is a massive change in the merge with each other. It was under that Act that the market. Then, banks were just not interested in Britannia Building Society was able to merge with the mortgages. That was beneath them; that was Co-operative Group. So I do not think there are something that was done by other people. Today, they specific restrictions within the legislation that I would are falling over themselves to grab it. We have clearly draw your attention to, no. had a massive change. How preferable is it to think of some reversal in that and how important is it that Q943 John hurso: To what extent does the Co- we should be seeking to achieve it? operative Bank work in commercial lending as ill ichar so : I think the answer is not one that opposed to personal lending? would change via legislation. It would change by the ill ichar so : We are very much a corporate actions of the mutuals. There was a stage the mutuals lender as well as a personal lender. We have a very went through, which was quite a defensive stage, the successful— carpetbagger stage. The demutualisations that did Ev 146 Treasury Committee: Evidence
1 February 2011 Neville Richardson and Rod Bulmer happen have subsequently proved to be disastrous, if ill ichar so : We are a small player, but you look at what has happened to those demutualised minorities can be effective. organisations. But I think we have to stand on our own two feet and prove to people that we are better. Q956 Michael allon: But you are a big player in When you think about it, we are owned by our the council account business? customers. We do not have to pay out to external ill ichar so : I think a lot of that reflects the shareholders. We have an absolute requirement in my values that people see in us as an organisation. They eyes to be commercial as a business, to be efficient as see the service that we provide and they see the a business for those customers, and it is up to us to consistency of values that we demonstrate. keep demonstrating that it is better being part of a mutual than a plc that is only really interested in Q957 Michael allon: Why don’t small businesses making profit for external shareholders. But we have see that? to do that. ill ichar so : If I could do, I would grow by more than we currently are doing, but we have been Q948 Michael allon: What share of the local constantly an organisation that has been prudent in the authority account market do you have? approach that we have taken and I expect to be taking ill ichar so : It is around about 30% to 0%. larger shares at times in the future.
Q949 Michael allon: 30% to 0%? Q958 Michael allon: What are the barriers between ill ichar so : Yes, in terms of banking with us. you getting that right up, from 2% up to a more respectable figure? Q950 Michael allon: You have only 2% of the ill ichar so : I think there are two. I think the SME market? first one is the market in general, because to lend ill ichar so : Slightly more than that, but it is money out to SMEs we have to take money in. Over around about that size. recent times, the wholesale markets have become very expensive, so to borrow money is becoming expensive Q951 Michael allon: Why is that? You have been as banks are having to repay the SLS and the other trading rather comfortably off all these council government schemes. So, to lend out to them we have accounts and not getting your jacket off with the to borrow in. SMEs. I think the second is regulation, where the regulators ill ichar so : Well, no, in fact, as far as the are increasingly asking organisations such as local authorities are concerned, they tend to be ourselves and across the financial services sector to banking with us more than us lending to them. I think hold more capital and more liquidity. The more capital we have— that you hold, the more liquidity that you hold, the less you can lend out. Q952 Michael allon: Do you make money out of that? Q959 Michael allon: Is that happening at the ill ichar so : We make some money, but you moment or is this something you fear will become asked how many as opposed to the balances that are a requirement? being held. But if we look at the SME market, that ill ichar so : It is happening at the moment. tends to be people wanting to borrow from us and that is where we have continued to be active over the Q960 Michael allon: Which requirement is this that course of the last three years, in fact increasing our— is specifically restricting you? Is this the FSA requirement or is this Basel III? Q953 Michael allon: But if you have only got 2% ill ichar so : It is the FSA. you have not been very active, yet you have been sitting on a third of the local authority business and Q961 Michael allon: That is on small business coasting. lending or is it on mortgage lending? ill ichar so : Well, the local authorities on the ill ichar so : No, across the piece. So across whole are not wanting to borrow from us and so— small businesses, across all firms, the requirement to hold more capital and more liquidity is more intense Q954 Michael allon: No, but you are making now than it has been for a considerable time. money out of them. You are servicing their accounts. ill ichar so : Yes, we are comparing two Q962 Michael allon: Does it damage you different markets. One is the people investing with us particularly vis- -vis your competitors? and the other is the people who want to borrow from ill ichar so : No, I do not believe that it does. us. The local authorities on the whole do not want to I believe it is a fairer approach. It is a sector-wide take significant borrowings from us. Now, the separate question as opposed to a specific one to us. question is would I like to grow our SME and corporate banking side. Yes, I would, and that is why Q963 Michael allon: Do you believe the OFT is we have been active and open, in fact grown our SME right that there are significant barriers to entry for new and business banking by over 0% over the last three competitors in the SME market? years. That is a real statement of intent to grow. ill ichar so : I think in the SME market probably not. I think if people want to set up—the Q955 Michael allon: But it is only 2%. It is tiny. difficulty actually is of entering as a bank as a whole, Treasury Committee: Evidence Ev 147
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I think. I think it is quite difficult to get into the Q967 Mark Garnier: Just out of interest, what market. We are demonstrating our wish to grow as an happens if somebody makes a payment that was going organisation and it is probably becoming easier as to result in them going overdrawn? Do you charge time progresses. But I just mentioned earlier the them like normal banks or are you much more gentle amount of money we are investing in new systems about it? and as a small new entrant it is very hard to do that. o Bulm r: No, we do not charge and we do not allow those payments to go through. We have a very Q964 Mark Garnier: Can I just turn to those in our small “pencel” limit and what that is is to avoid society who are slightly more financially excluded and people who are going to go pence over the limit being just I think frame my next line of questioning? Would embarrassed or uncomfortable, but we do not allow you just briefly outline the difference between a basic anything beyond that “pencel” limit. So it is bank account and a normal PCA just so we can— impossible beyond that “pencel” limit to go o Bulm r: Yes. So, largely and in simple terms, a overdrawn. basic bank account from Co-operative, you do not have the ability to have an overdraft facility. We do Q968 Mark Garnier: There are a lot of accusations, offer a full Visa debit card, we offer full branch certainly from the New Economics Foundation, that access, but you do not have the ability to go this Committee is not looking into this type of market overdrawn. With a personal current account you do enough and that the general banking debate is not have the ability to have a formal overdraft looking into competition for this section of the market. arrangement. It is largely the difference in how we run Do you think that is a fair criticism? it. We have about 300,000 Cashminder—as we call— ill ichar so : Yes, I do. In fact, some evidence basic bank accounts in our population.1 We have that we have from that is two or three years ago we 1.25 million current accounts. started to open basic bank accounts for prisoners coming out of prison. There was a study carried out Q965 Mark Garnier: That is quite a significant by Liverpool John Moores University after a couple of number. That is a quarter, basically. years and that showed there was a significantly lower o Bulm r: We think there is about 30,000 to 35,000 re-offending rate from those prisoners who had taken basic bank accounts opened per month. We open up the basic bank account because they had come 5,000, so we think we open about 1 % of the market back into financial inclusion and back into more and we have stock share in aggregate of 2% and a % mainstream activity. share of flows on primary current accounts, to give you a sense of the market. Q969 Mark Garnier: What do you think about competition among the basic bank account market? Q966 Mark Garnier: I think I am slightly lost a bit Do you think there is sufficient competition? Do you on that. How many people do you think in the country think we need to increase it or is it irrelevant? need basic bank accounts? I remember hearing a ill ichar so : My own view is that others figure from the Post Office that their equivalent was should be encouraged to supply basic bank accounts. something in the region of million. Does that sound We supply significantly higher than our market share. about right to you? We think it is the right thing to do, going back to o Bulm r: Yes, I think my broad answer would be social goals. everyone should have a bank account, should have the ability to access a banking relationship. I think it is a Q970 Mark Garnier: What is your market share, cornerstone of how people should operate and sorry? orientate. If you then looked at the appropriateness of ill ichar so : It is about 1 %. the types of accounts, I think I would probably concur o Bulm r: 1%. 3 million to million would be appropriate on a ill ichar so : So significantly higher than our basic banking. stock share of overall accounts. We think that the plcs should be strongly encouraged to provide basic bank 1 te itness: The Co-operative Bank offers a basic bank account, Cashminder. Features include: an option to pay bills accounts. One of the opportunities that will throw by direct debit (which can yield bill reductions); the ability itself up is when the part-nationalised banks sell off a to have pay, pensions and benefits paid directly into the number of their branches. There could be a condition account; and access to money via a VISA debit card. Cashminder customers can make deposits and withdrawals attached that requires them to open a certain number in Co-operative Bank branches and also at the Post Office. of basic bank accounts. Customers also have access to over 6 ,000 LINK cash machines, most of which are completely free—please note that some cash machines may make a charge for Q971 Mark Garnier: So none of the Big Four or withdrawing. Like most basic bank accounts, a cheque book Five are offering them at the moment? is not provided. The account is open to any adult, including ill ichar so : They provide them but do not undischarged bankrupts, with the exception of those with encourage them. convictions for fraud. Cashminder customers are not able to arrange a formal overdraft. Where a customer has a direct debit or set-up a payment when there are not funds in the Q972 Mark Garnier: Why do you think they do not account, there is an unpaid item charge of £1 .50. There are encourage them? also charges for special items such as replacement statements. The Cashminder account does not have a buffer ill ichar so : Because there is very, very little or 'pencel' facility. money to be made in a basic bank account service. Ev 148 Treasury Committee: Evidence
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Q973 Mark Garnier: There are an awful lot of these Q977 Jesse Norman: But your view is, is it not, that banks are coming in to see us and talking about their a diversity not merely of institution but of ethos is a moral fibre and how good they are for communities, positive value in the system, that it should be and yet they are denying huge numbers of people. You something that Government should be aiming to said up to million people who need these types of increase and improve? things. That is a shocking indictment on these big ill ichar so : Absolutely. I believe the culture banks. of an organisation is absolutely central to the decisions ill ichar so : I would encourage you to ask that are subsequently made. So organisations that are them why they do not provide the basic bank taking on more risk have a culture that is aimed accounts. We do. We think it is the right thing to do, towards risk. and yet we have a significantly high market share because we encourage people to have those accounts. Q978 Jesse Norman: Thank you. It is very striking We think it is the right thing to do and clearly if they that there is a wide degree of cross-party support now do not make much money they are not encouraged by for the co-operative sector and for mutuals, and I have the plc competitors. written a lot on this topic. What three things do you think Government could do to promote co-operatives and mutuals in the financial sector? Q974 Mark Garnier: To a certain extent, do you ill ichar so : I think I have already said one think—because, of course, it comes back to this whole of them, which is very much about when legislation question about the cost of having a current account, is being looked at, then look at co-operatives and but presumably somebody who is socially excluded is mutuals at the same time and with the same not going to necessarily want to go off and take out enthusiasm. So, no matter what the legislation then, loans or savings plans. Do you think a lot of it is to do not look first at plcs and then at co-operatives. do with this cross-selling element? ill ichar so : Yes. We make very, very little Q979 Jesse Norman: Do you think the Treasury has, money out of these basic accounts. In terms of as it were, been co-operative blind or mutual blind organisations that are predominantly aiming towards when it has been thinking about framing financial profit maximisation and return on capital, these legislation? accounts show very little interest to them. ill ichar so : I think blind is probably a stage too far, but certainly in need of a little bit more vision Q975 Mark Garnier: So, in fact, looking back to the I think is probably the answer. I think otherwise there New Economics Foundation’s comments that we are is a general enthusiasm, and your colleague here not as a Committee looking at this stuff, it is actually raised it earlier, to move towards co-operatives in the a very fair comment and perhaps if you had come in market at present. I think the Government could do first it would have been one of the questions we more to speak about it. When the Government speaks should have been asking? about big society, then we are an organisation that has ill ichar so : Yes. many of those attributes in place at present. So, our o Bulm r: I think it is very fair. links with local community—and I can give an Mark Garnier: Perhaps we ought to write to them. example in a very tiny scale of a local hydroelectric scheme close to one of our branches, which is benefiting the local community in New Mills, Q976 Jesse Norman: Mr Richardson, you have Derbyshire, at this point of time. Now, that is the big spoken about the demutualisation process and it is society approach and I think it could be clear that very striking to independent observers that the actually a co-operative could be at the centre of that. financial sector has been transformed by the corporatisation of a wide range of existing institutions, Q980 Jesse Norman: So better legislation, more including mutuals but also including brokerage firms advocacy; is there anything else, specific initiatives, and other forms of financial institution. How do you removal of impediments? What kinds of things in think we can improve the diversity in the banking those areas do you think? sector? It is almost as though we have taken a view ill ichar so : I am not sure of anything else. that the portfolio effect works even if you have a Rod? number of institutions that all think the same thing o Bulm r: I would push very strongly for the and behave in the same way, so how are we going to transparency agenda. I think you have to ask: is the improve that? current banking sector transparent to customers and, ill ichar so : I think I said earlier that we are if not, is that the reason why customers are showing very much a values-driven organisation. We are just a apathy to act? My belief is it lacks sufficient different type of organisation. So the question then, I transparency and any support to increase transparency think, gets back in terms of current accounts—which to make people aware and, therefore, make them have is the staple product, I suppose, of retail banking—to the ability for informed choice would be hugely how can we encourage more people to switch to our beneficial to us. accounts rather than to other types of organisation. That has to happen over a period of time and it has to Q981 Jesse Norman: That would include be encouraged. As Rod said earlier, the number of transparency on, for example, compensation people who switch bank accounts is actually very low arrangements within the Co-op itself? at present. o Bulm r: Yes, absolutely. Treasury Committee: Evidence Ev 149
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Jesse Norman: Thank you very much. would like to add please do put it to us in writing, but we are grateful for this evidence. We will take a two- Q982 Chair: Thank you very much for coming to minute break and go straight on to the next session as see us this morning. We found that extremely valuable soon as the witnesses are in their seats. and you fulfilled what we requested, which was crisp o Bulm r: Thank you. and detailed replies. If there is anything further you ill ichar so : Thank you.
Examination of Witnesses
Witnesses: Graham Beale, Chief Executive, Nationwide, and Chris hodes, Executive Director, Group Product and Marketing, Nationwide, gave evidence.
Q983 Chair: We are going to begin. Thank you very Q985 Chair: Brands have just taken a bit of a knock, much for coming before us in what is almost this haven’t they? afternoon, still this morning. Thank you very much raham B al : Brands have taken a huge knock, but for the evidence that you have put to us. In that, you at the moment there is limited choice in the UK and, say, “In the short to medium term, greater competition therefore, it is probably the best of a bad job in terms in banking is more likely to come from existing of the choice that does exist. participants than from new entrants”. Why, then, are Tesco, Virgin, Metro and others looking to enter this Q986 Chair: Inadequate choice? market? raham B al : Possibly. In terms of the specifics at raham B al : The reason we said that is because the individual level of moving, can I ask Chris in the cost of establishing a full-blown banking service terms of the perceptions of switching? is very, very large. It requires an investment in Chris ho s: I think there is— infrastructure; it requires an investment in expertise; you need to have the necessary financial resource in Q987 Chair: Sorry, just before we go into that, when terms of capital and liquidity; you need access to you said “possibly”, either there is enough choice or there is not? distribution and you also need a brand. When you put raham B al : I think there is a lot of choice in the all of those components together, they are all UK but it is very heavily polarised between—you necessary to have a full impact so that you are have effectively the banking model, and you have the something more than a niche player. I think the only four or five larger players, and then you have the entities that I can see in the UK that could actually mutual model. Really, within the mutual sector, there attempt to satisfy all of those conditions are actually are only two institutions that offer the full array of the supermarkets, and that is why I think of the most personal financial products, which is Nationwide and likely entrants it would be the likes of Tesco that could the Co-operative. achieve that. But they have been looking at this for a long, long time and I think even for an organisation Q988 Chair: Sorry to interrupt, Mr Rhodes. with the resource of Tesco, they are still on the edge Chris ho s: That is okay. I think, talking about the of deciding whether they are to make a full-blown personal current account market, I think there are two entry into banking in the UK or not. What you do perceived and in some respects actual barriers to see are lots of entrants offering the simpler products, customers changing their accounts. I think the first is general insurance, loans, cards, et cetera, where you the switching process because there is a concern that will find that the market is much more fragmented your direct debits are going to get messed up and because they are much easier products to offer, but, effectively you will incur charges and that will not be particularly if you intend to offer a personal current an easy process. I think the second one, though, is the account, mortgage products, investment products, they charging structure and the way it operates, not require very substantial investment and that is, I necessarily in that it is not transparent, because I think believe, a significant hurdle for new entrants into the if you look at each individual component of the charge marketplace. you can work out what you will pay if a cheque is not paid. But it is the overall impact in terms of the total Q984 Chair: What about the barriers at the point of cost because customers actually believe that a current account, with the exception of the interest forgone on consumer perception to switching, we have just heard any balance, is free. The reality is for 80% of the in previous evidence, which we have heard so much population that is correct. Your forgone interest cost about, and also the lack of transparency on price? is a very few pounds. So for 80% of the population raham B al : I think there are a number of issues the personal current account is free. But for those who there, and I will ask Chris to respond to one of them. have unauthorised overdrafts, who have cheques or I think in the first instance, though, the brand and the direct debits that are not paid, then it is a significant strength of your franchise is hugely important because cost. banking revolves around trust. If you do not have a So, to create what I would call pull demand in a brand that is credible in the marketplace, I think market where 80% believe it is free is incredibly consumers will think twice before they would difficult. Because I am saying, “Come to Nationwide contemplate moving their financial affairs. because you have your free account”, so we have to Ev 150 Treasury Committee: Evidence
1 February 2011 Graham Beale and Chris Rhodes add on a whole range of other incentives, which alone, and I reiterate as 80% of the population never makes it very expensive to recruit new personal pay the other charges and most believe they never current account customers. Then your earnings only will, you cannot create competition in that way. You occur at the back end of the process when customers have to have other incentives to encourage you to start to incur the overdraft structures that we know so switch accounts. much about. So, unless you have a back book of current account customers, day one you have no Q998 Mark Garnier: Can we talk about your mutual income. status? How do your customers benefit from the fact that you are a mutual as opposed to a plc? Q989 Chair: The front-end loading of— raham B al : The philosophy that sits behind being Chris ho s: Of the investment costs of mutual is to give back long-term good value on a establishing. From a marketing earnings point of consistent basis. I would define value as being the view— offering of the quality of service, the quality of the products, strong access, a competitive price. We do Q990 Chair: To attract the new customers? not hold out to be the cheapest in town but we like on Chris ho s: I think is a very significant barrier. a consistent basis to give that good value through pricing. That is the relationship, and it is very much Q991 Chair: That is made possible because once about relationship banking. We try to give value back people are there there is inertia and you will make in a focused way to the members that create it by money out of them by just— having exclusive offers for our long-term members. Chris ho s: And 80% never pay a charge. They So, again, we are giving value back. The overall have a few pounds worth of lost interest. So there is model, and I would contrast this with the banking no real push to push them out of an institution because model, is that we are a commercial entity and it is 80% are paying very little. necessary for us to make a profit to meet our capital prudential requirements and so on. But we seek to Q992 Chair: Can’t we require financial institutions optimise the level of profit in the business so that we to publish interest forgone on current accounts? make just enough to meet our prudential requirements. Chris ho s: You can. If you take the average— We do not seek to maximise profit, which is more akin to the banking model. Q993 Chair: Wouldn’t that increase competition? Chris ho s: No. Let’s be clear, the average in credit Q999 Mark Garnier: It is very interesting that when balance in— you read that list out, you were looking at service, product, access and then price. You see that as being Q994 Chair: The OFT are wrong on that? very important, do you, that you are actually Chris ho s: Let me give you a few facts and then delivering a very good quality of service before— you can, I think, reach your own conclusion. The raham B al : It is the collective in terms of all of average in credit balance in a UK current account is the things that we offer. The market is very price about £1,500. So if you put base rate as an anchor rate driven and has been excessively price driven over the to do a calculation, you get £7.50 a year. last few years, so it is always difficult for us, where you see market distortions, to be able to match on Q995 Chair: That is a very unusual low rate. What price. In those situations, we tend to retract from the about doing it at the average over the last 10 years? marketplace until we feel that it is a price that is fair Chris ho s: If you put your best instant access rate that you could get from a high street provider, about to our membership. £30 a year. That is your forgone interest cost. That is I will give you an example. In the previous financial not a lot in terms of convincing you to move your year, and we are a March year-end so to the year account even if you put an in credit interest—even if March 2010, the UK market was dominated by a very you disclosed that number, worked out the price, it is aggressive fight for retail deposits. This in part was not a significant driver to cause you to switch your driven by certain institutions that were repositioning current account. I will let you judge, but that would their balance sheet to try to reduce their dependency be my view. Whereas the charges are more significant on wholesale funding. The pricing for retail deposits but most people believe they will never pay them, and went way beyond the economic parameters that meant 80% in reality never do. that if we were to compete we would make a financial loss. That is not in the interests of our membership, Q996 Chair: What people need is an aggregate of all so we stood back from the marketplace and we had these numbers, isn’t it, so they can see annually what an outflow in excess of £8 billion from our balance it is costing them to run their account? sheet. So that was a rather extreme example and, Chris ho s: They do. therefore, when we find that the market is not operating in a normal fashion we will stand back, Q997 Chair: Then they could go to another bank and which is I think again one of the virtues of a mutual say, “Will you do this more cheaply”? model in that because we are not driven by short-term Chris ho s: But for 80% of the customers, it would profit desires, we can take a much longer medium- be £30 of in credit interest rate and, as you have heard, term view. We try to be very fair with our members, it costs the Co-op £8 ; it costs us £6 to run an but we cannot be uneconomic and it is not in account. So it does not work on in credit interest anybody’s interest if Nationwide was to make a Treasury Committee: Evidence Ev 151
1 February 2011 Graham Beale and Chris Rhodes
financial loss. So we have had to take some rather this, is the importance of capital for the mutual sector. extreme decisions in the last two or three years. We have been working very hard with the FSA for many, many months now to debate the definition and Q1000 Mark Garnier: You do talk a lot about time the creation of a capital instrument for the mutual horizons in terms of medium term and long term and sector because I think it is very important that we can this sort of stuff, and you are obviously very clear proactively manage our balance sheet. The FSA about that. You refer to obviously short-term profits started with a definition of capital that was entirely as being on the better side of it. Can you give us some driven by the plc model, and I think that would have more examples about how this long-termism compromised the mutual status by having equity manifests itself in the way you run yourself? shareholders sitting on the mutual balance sheet. So raham B al : I come back to our philosophy in we have resisted that and I think it is important that terms of the members that we have is to try to the Government again ensure that the mutual sector establish true relationship banking. So, our desire is does have access to a capital instrument that does not not to prospect for lots and lots of new members. Our compromise the mutual business model. desire is to establish a relationship with individual members so that they have their personal current Q1002 Mark Garnier: How do you find the FSA? account with us, that they take a mortgage, they do a raham B al : I would echo what Neville said in that personal loan, their insurance, et cetera. That is very the FSA have been very focused on issues within the much an investment in the long term with our plc sector and, therefore, their attention to the mutual members and trying to establish that relationship and sector and I think their— serving the members. As I said a moment ago, we try to give value back to the members that have the Q1003 Mark Garnier: So not very helpful is what broadest relationships with Nationwide through price you are saying? rebates, through special offers, through access to raham B al : I think their understanding has been savings products that are specific for loyal members, limited at times. I do not think they have fully et cetera. recognised that there are quite distinct business models with different characteristics and certainly Q1001 Mark Garnier: The Government is looking different risk profiles. I think they have been very at proposals to promote the mutual sector. What narrowly focused on the problems within the plc realistically do you think the Government can actually sector and I think as a result we have found ourselves do to do that? after the event trying to deal with probably unforeseen raham B al : I think that there are a number of consequences but nevertheless having to, if you like, things that the Government can do. I think the first rectify positions that the FSA have created. thing is that the Coalition statement about fostering diversity and promoting mutuality, at the moment I Q1004 Mark Garnier: Are they willing to learn? have not seen any substance that sits behind that as a Are they paying attention to what you are saying? comment, is the first point I would make. raham B al : Yes, they have. I would say in the last What we have been asking for, and we have given few months there has been a distinct change in evidence to the Independent Commission on Banking, attitude, certainly in terms of dealing with the point is first of all I would hope that the Government would about capital. I would say that we do now have a resist any attempts to narrow the mutual business meeting of minds, although it was very disappointing model to restrict what we can and cannot do beyond when we had the comments in this Committee just a the current constraints. I am very comfortable with the few weeks ago about deliberalising the building parameters in which we operate at the moment, but I society model, which I think would be a very think you took evidence from Lord Turner a couple of retrograde step. weeks ago where he was talking about deliberalising Chair: We are very grateful, actually, for those frank building societies. That would have very severe remarks about the FSA. We do find that a number of consequences for our business model in narrowing it witnesses come before us very reluctant to say and making us unable to compete with the banks. So anything critical in public and then pour forth I think the first thing is that I want a level playing privately but in a form that is very difficult to take up field with the banks. I am not looking for any with the FSA afterwards. So, thank you for those additional powers in terms of what we can do as a remarks. business, but I do not want any constraints either. That is the first thing. Q1005 Mr Mudie: You could understand it, Chair, The second thing is that the emerging regulation over when Hector said the financial world would fear him the last couple of years, and I think Neville made this in the end, so when you introduce fear into it point, has been very much orientated around the plc The business of capital instruments you have model. I think it overlooks the fact that the building mentioned again. When I questioned Neville about it society model is different. It is typically a much lower he seemed to feel it was—I am not putting words in risk model than the equivalent banking model and, his mouth—under control. Is that your impression or therefore, my second request would be that any is it heading in the right direction? regulation is in some way risk based so it recognises raham B al : Yes, it is. I can expand— the fact that building societies that are co-operative Mr Mudie: Do we need to do anything—sorry? are much lower risk entities than the mutual sector. raham B al : Well, the debate within the UK I think The third request, and again George Mudie referenced now we have got to a point where there is a common Ev 152 Treasury Committee: Evidence
1 February 2011 Graham Beale and Chris Rhodes understanding of what is required and I think we have up should be looked at. Now, last thing, testing your definitions that do not compromise our model that courage with the FSA again, I am horrified by the satisfy what the FSA are looking for. Ultimately, the mortgage market review. I think the FSA have lost definition of capital will be determined in Europe and their balance. To guard against, “You were weak and the Capital Requirements Directive will be the you are still weak”, they have swung the other way, directive that contains the absolute definitions. I am and it seems to me they could damage the building content that in the UK the FSA have briefed HMT industry, they could damage the mortgage industry, and we have seen the HMT material in terms of their they could damage young kids getting a start with a positioning on this, and it is very supportive. But new house because of all the regulations. Are they clearly we now need to go through the European micromanaging it, and is it not your job and the process. Our lobbying in Europe suggests that actually borrower’s job to work out risk and the terms of the Europe is probably more pro-mutual than we mortgage? experience in the UK, so my expectation is that it raham B al : Yes, to the second point of your will go through, but we are several months away from question. It is our job to manage the risk and— debate in Europe, before we can confirm the point. Chair: What about the first bit? raham B al : In terms of the first bit, I don’t think Q1006 Mr Mudie: So we want to keep an eye on it. the FSA did a full economic assessment in terms of I want to raise another thing that you raise in passing, understanding the implications of the mortgage but the Co-op raised more fully, was the compensation market review, in terms of what it would do to the scheme and the effect on the mutuals. Can you just ability of borrowers in the UK to borrow from either tell us the difficulties this is causing in mutuals? banks or building societies. So I don’t think they fully raham B al : Yes, it is huge as a cost burden. The understood that and I think when they eventually did, failure of Bradford and Bingley and the Icelandic they found that there were an awful lot of unintended banks will cost Nationwide, in the full term, we think consequences, which is why it has now gone into between £250 million and £330 million, i.e. between consultation again with a view to trying to get a quarter and a third of a billion pounds. It is the something which is more pragmatic in its application, cost to Nationwide, to Nationwide’s members, for the that will achieve some of the extra safeguards that the failure of those institutions. That is because the FSA want to achieve, but without undermining the compensation scheme is driven by the proportion of market to the extent that the original draft did. While retail liabilities—i.e. savings deposits—that you have I have expressed some forthright views on the FSA, I on your balance sheet. Of course in the mutual sector, think they are also right in wishing to eradicate a and Nationwide in particular, we hold very large repeat of the state of the mortgage market prior to the quantities of retail deposits. So it seems wrong that crisis, where the lack of constraint around lenders like failures in much riskier models—take the Bradford Northern Rock, where they were lending at 125% and Bingley model—are paid for by the much less loan-to-value, where they were lending against risky organisations such as the mutual sector. I have incredibly high loan-to-income multiples, et cetera, been arguing for a long time, and there was an early went clearly beyond the realms of reasonable and day motion that we had over 170 MPs signing up, to responsible lending. I think it is right that we do not have some modification of the compensation rules. It have an environment where that could repeat itself. has not gone anywhere, it seems to have just stalled in the long grass. We are not saying we should not Q1008 Mr Mudie: I totally agree with that, but I make a contribution, I think we absolutely should, but think that the scheme is far from that, the scheme again it should be proportionate to the risk that we seems almost personal and would rob the building have as a financial institution. It is very clear that societies of any discretion in terms of individual mutuals, by virtue of the nature limits contained customers. It is one thing building a mortgage book within the Building Societies Act, the business up of doubtful loans but another taking a chance on a restrictions in terms of what we can and can’t do; we young couple who you can see clearly are in work but can’t trade for example, we could not have investment cannot get that deposit. Are you satisfied with the banks even if we wanted them, it is not permitted. RDR? That should be recognised in terms of the regulation raham B al : Do you want to answer that one, and the cost of things like the compensation scheme. Chris? The bank levy is another example where the impact Chris ho s: Obviously, we saw some news last on the mutual sector is disproportionate relative to our week about one institution pulling out from the risk, and disproportionate relative to the cost to the provision of financial advice. I think Nationwide banks. remains absolutely committed to the provision of Mr Mudie: You got a lot off your chest there. financial advice and indeed, we will both widen our raham B al : I have been frustrated for many, many product range and grow the number of advisors, and months, Mr Mudie. I think lots of what is in the RDR is very positive: increasing the skill level of advisors is very good Q1007 Mr Mudie: No, I think that is very useful. It news; I think the removal of commission, in the sense seems to me that when the Government was setting it of agreeing explicit charges with consumers, is good up, we in this Committee put on record something news. But let us be clear, it will change the economics about the review, and I do not know what time frame for a number of providers of advice out there and it was, but it seems to me that they have had a good therefore could ultimately restrict the availability of period of working and things that have been thrown that advice, and the institution that withdrew last week Treasury Committee: Evidence Ev 153
1 February 2011 Graham Beale and Chris Rhodes made the comment with respect to their return on is a substantial loan and they will require a personal capital. Now, as a mutual, we have a different set of commitment from the borrower as part of that bargain. values, we have a different requirement from an overall profitability and return point of view, therefore Q1013 Mr munna: Mr Beale, listening to your it is viable, in the new world, for us to provide advice evidence, one slightly gets the sense that you are a and we will do so. little bit—how can I put it—unhappy with what has turned out to pass over the last couple of years, in Q1009 Mr Mudie: A last question, going back to that in many senses your sector have been angels of mortgages. At the moment, there seems to be real prudence. I get the sense from you that you do not difficulty in some people getting a mortgage. Is this think that has been sufficiently recognised by because the industry is trying to second guess where Government. On the other hand we have these villains the FSA are going with the mortgage review, or is it of the piece, we have had several of these large simply market conditions? banking groups in front of us who—there has been raham B al : I would say that there has been a shift £1.2 trillion worth of support put into the sector from in attitude to risk, if you were to compare the which they have benefited and probably would not be mortgage market today with four years ago. Four operating without. The Government raises a bank years ago about 0% of the total mortgage market was levy, they complain about that. We all want to see based around buy-to-let and self-certified mortgages, greater transparency, they complain about that. Do very high loan-to-value. I think quite rightly, in my you think they have been treated with kid gloves? opinion, a lot of those extreme forms of lending have raham B al : I don’t think that is for me to disappeared from the marketplace, and anybody today comment. Everybody can draw their own conclusions. who does not have a sufficient deposit or has a What I would say is that in terms of understanding seriously impaired credit history, is going to struggle the mutual sector and in particular its contribution to find a mortgage, and I think that is a response to over the last three or four years, which has been one risk. If you have good credit credential and you have of stability and endurance through the conditions— a deposit, I think there is plenty of choice in terms of and I am not saying there weren’t issues within the finding provision of mortgage within the UK. sector but they were predominantly dealt with by the sector and the only institution requiring taxpayer Q1010 Chair: George is asking a slightly different support was the Dunfermline Building Society. question, which is not, have the FSA restricted Compared with the banks, that was a tiny, tiny amount imprudent lending, but is uncertainty about their of support. So I think the mutual sector has behaved review of that market itself having a depressing effect incredibly well throughout the financial crisis. I think on lending? it has demonstrated the resilience of the model, and I raham B al : I don’t think so. do not think that has been reflected either in some of the attitudes coming from the regulators or indeed the Q1011 Mr Mudie: Do you genuinely think that the Government, who have made the sounds of wanting widespread imposition of large deposits is something to promote mutuality but have not put any substance you can sustain without doing tremendous damage behind that declaration. socially as well as to the building industry? raham B al : I think the size of the deposit is— Q1014 Mr munna: In terms of putting substance there are some lenders, including Nationwide, for our behind declarations of promoting mutuals and existing customers we will accept as little as 5%. It diversity, do you think one way of doing that would is the market norm to be typically seeking anything be by remutualising Northern Rock? between 10% to 15% as a minimum to get access to raham B al : I think there is an opportunity to do a mortgage. I do not think that is unreasonable. I think that and the Government has a choice. You can turn it is quite reasonable to— Northern Rock back into a mutual, and you would then have all of the positive attributes of a mutual Q1012 Mr Mudie: On an average house of entity: consumer focus; retail orientated; low risk, and £100,000, that is two young kids saving up £10,000. so on. So that is the plus. I think the cost of doing that But how long does it take two young kids on the sort is that the return of taxpayers’ money will—I think it of wages youngsters have at that time of their career would be returned, but over a much more extended to save up £10,000? To me, it is horrifying. window than the other options, which would either be raham B al : I accept it is a lot of money, but an IPO or a trade sale. So I think there is a very clear equally, you are taking on a very substantial financial choice there. commitment. I think part of the responsibility of a borrower in taking up that commitment is that there is Q1015 Mr munna: But you certainly see there some equity that goes into the transaction and that being a return? they are very clear that they can afford to service the raham B al : I think there would be a return, but it debt. Good underwriting revolves around would be over a much, much longer period. I think affordability, because it is not in anybody’s interest to that is the choice, in terms of, do you want to have a put either an individual or a couple into a position socially useful animal—to quote somebody else—or where they have undertaken a loan that they then can’t do you want to have an early payback of taxpayers’ service. I think we have to recognise that it is a very money? That has to be a political decision, at the end serious undertaking when you take out a mortgage. It of the day. Ev 154 Treasury Committee: Evidence
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Q1016 Mr munna: Would you argue that, when capital instrument available to mutuals so you were making that decision, obviously, Government in some not looking to having equity infecting your model. senses would have to take a more medium to long- What would the best capital instrument be? term view of the benefit of remutualisation? raham B al : The capital instrument that has been raham B al : I think they actually would have to, defined so far is called a permanent loss-absorbing yes. deferred share—you asked me. Broadly, it is an instrument that allows investors to invest in building Q1017 Mr munna: Would you say that their societies, and the coupon, the dividend that is paid on attitude to that would perhaps be indicative of whether that investment, would be capped. So rather than they are going to take a medium to long-term view of being open-ended, which is what you have with an the overhaul of the sector in general? equity investment, where your dividends can grow to raham B al : I think it would be a very substantive whatever level, this has a ceiling. But in all other gesture if they were to remutualise Northern Rock. respects, it absorbs losses, the capital is at risk, it is permanent, and those were the key features that the Q1018 Mr munna: Given your experience of the FSA were looking for. So we had all the debate sector, what would be the most effective way of around whether we could have something with a remutualising the Rock, in your view? capped distribution. They now recognise that, one, raham B al : There are two ways. It could be that does not compromise our model, and therefore remutualised directly, which I think would be quite that is a plus. And, secondly, it prevents an over- complicated to achieve, or it could be merged with an distribution of reserves from the mutual sector. On existing mutual entity. There are a number of players that basis, we have now reconciled our respective who are large enough, including Nationwide, to be views, and I think we have a definition that everybody able to take that sort of transaction on. is comfortable with.
Q1019 Mr munna: But do you think that would Q1021 Stewart Hosie: Just a question to follow up be helpful, though, because in some senses—I am not George Mudie in terms of mortgages, notwithstanding sure if you were here earlier in our exchanges with loan-to-value ratio, notwithstanding deposit levels, is the Co-op—increasing consolidation is not necessarily the truth not that mortgage availability is driven— always the most desirable thing, and one could there is a direct correlation between that and savings perhaps understand why the Nationwide would like to deposits? Given savings deposits, or the savings ratio gobble up Northern Rock, but do you think there rather, is due to fall every year for the next five years, would be a benefit in greater diversity in your mutual is that not an underlying concern in your ability to sector if either Northern Rock were remutualised provide mortgages? stand-alone, or maybe one of the smaller participants raham B al : I think it is an issue, but both the in the mutual market were to merge with it? structural size of the mortgage market and the retail raham B al : I think in terms of the consolidation savings market are both falling quite significantly, within the sector and whether Northern Rock should and, if anything, the size of the mortgage market is be a stand-alone or merge with a smaller player, it is going to shrink more than the size of the savings an interesting point. I believe that you need a number market. So in terms of access to longer term liquidity, of very large mutuals in order to have the right level we see the issue as one of: if we raise retail deposits, of scale, the right power of distribution, the right how can we apply it in a way that generates a yield spread of product to be able to compete with the banks from that, rather than the converse, which is, will effectively. There are really only two mutuals at the there be a shortage of liquidity for the mortgage moment that fall into that category, which are market? We do not see that, we see it the other way Nationwide and the Co-operative, your third one is around. possibly the Yorkshire Building Society, but they do not offer personal current account banking. Therefore, Q1022 Stewart Hosie: That is helpful, thank you. to a degree, I think consolidation is a benefit within Just to go back to what the Chairman was speaking the sector, because we are more likely to create about at the beginning. In terms of competition, in mutuals with sufficient scale that they can take the terms of switching, there is a lot of talk about banks head-on. That is not to say—and I think this is transparency, particularly price transparency. The OFT where we need to be very clear here—that there is not said much has been done but there is more to do. I a place for the very small mutual sector, where you take it that is where you are, broadly, at the moment? have a mutual that is dominant in their geographic Chris ho s: Yes, the switching process, as I said, I area, it serves the local community, it is a very simple think is a barrier to customers switching their current model serving not broad requirements from the local accounts. To some extent there is a limited amount the population, and I think there is a place for that as well. banks can do, because this process works by, So the mutual sector operates, if you like, at the two effectively, the bank that the account is coming from ends of the spectrum, offering very local service, but giving you the direct debit details for the customer, also the ability to offer a national service as well. I then you going off to the utility companies and others, think the Northern Rock would fall within that to get those direct debits transferred. There is not the national category. process to tie those people down to service levels and make them perform in the same way that the banks Q1020 Mr munna: Thank you. Can I just ask one perform between each other. So I think there is more final question? You talked about there needing to be a that can be done in the switching process. I think the Treasury Committee: Evidence Ev 155
1 February 2011 Graham Beale and Chris Rhodes whole charging structure is a much bigger debate Chris ho s: In principle, it sounds great, but the because, as I said, 80% pay very little, we can debate cost of changing the account numbers right across 65 the right level of in-credit interest. The bulk of charges million UK current accounts to achieve a portable are only paid by 20% of the population. That is the number is massive, and I am not sure it would be challenge to creating a competitive market. I think that economically viable to do that. I really don’t. The cost is what the OFT are referring to. of getting everyone to align would be absolutely huge and it would take many, many years. Q1023 Stewart Hosie: So in terms of that then, what changes would you want to see for that 20%, in terms Q1028 Stewart Hosie: Could you give us a figure, of current accounts, current account pricing an estimate, of the billions we are talking about to transparency? What would you like to see presented deliver that? or provided, so that there was clear transparency? Chris ho s: We are bringing in a new current Chris ho s: I think on that we are largely there, so account system and it has a few hundred million it is simplification of the charges, so you know what pound price tag on it, and that is without changing the you will pay in individual circumstances, and, within payment systems. the overall disclosure of the information you get when you buy an account, the cost of certain scenarios. Q1029 Stewart Hosie: So the likelihood of this Because I think what customers don’t believe is that single portable account is? they will ever fall into a position where they will incur Chris ho s: My personal view is it will never these charges. Therefore, they do need to understand happen. what it might cost them if they were to do certain things. Q1030 Jesse Norman: Can I just ask about the discussion you had earlier with my colleague about Q1024 Stewart Hosie: Yes. You are saying, “We are the remutualisation of Northern Rock, something almost there”, but you have also warned against the which I am extremely sympathetic towards? How, potential for information overload. specifically, would it take place? Say you went down Chris ho s: Correct. the direct route, would you be then going to the Stewart Hosie: The spurious information that may or account holders of that institution and asking them to may not be useful but might even add to the inertia put up capital to buy out the Government’s stake? because it is too complicated. In terms of that, what How would that work? would you like to see removed then, from the raham B al : I think this is the difficulty, and I information which might be provided? think the likelihood of being able to deal with it on Chris ho s: I am not sure there is anything you can that basis is low. remove. Ultimately, you would not start from here. You would start from the perspective of, this is an Q1031 Jesse Norman: Because they simply would expensive service to provide, it is a valuable service, not have enough capital or interest to take the initial run on the right basis, and you should ultimately pay risk? for what you consume. But that is not the market we raham B al : If you just think of the broad mutual have in the UK and the competition therefore model, there is no cost to entry. If you want to become responds to the market reality in the UK. a member of Nationwide, provided you take out the right product, which is either a savings account or a Q1025 Stewart Hosie: So by and large then, in mortgage loan, that then conveys membership rights. terms of information upon which people will make a I think the way it would happen is that the— choice either to open an account or to switch an account, notwithstanding the complexities of Q1032 Jesse Norman: Sorry, just on that. So the switching, you think we are almost there? way it would be mutualised by the direct route would Chris ho s: Except the 20% who pay never—there simply be to give the shares to the account holders at is a lot of research that basically says you leave your Northern Rock? current account provider because either you have had raham B al : Correct. poor service or you have been charged. There is no evidence in the research that we do that suggests that Q1033 Jesse Norman: Which would be a transfer the customers then look at the charging structures of of, presumably, £5 billion, £10 billion? A substantial the new provider and see whether they are any amount of money. different to the one they have just left. So they will raham B al : Possibly. You are asking quite a find themselves in the same circumstances with the difficult structural question here. I think basically, if new provider that they had with— you put the structures to one side, the only way that I can see it happening is that over many, many years, Q1026 Stewart Hosie: So the reasons for changing as the Northern Rock generates profits, that profit is are many and varied, but when they change, they may used to effectively extinguish the taxpayers’ liability. not look at— So there would be a very long earn-out. I think you Chris ho s: Correct. At the reason that caused would be talking a long, long period of time for this, them to leave in the first place. 10, 20 years to get the right level of profits going through the Northern Rock so you have an earn-out Q1027 Stewart Hosie: But in terms of the ease of and a long drawn payment of the taxpayers’ funds. transfer, you would back a single portable account? Which is why, while it may be socially attractive, Ev 156 Treasury Committee: Evidence
1 February 2011 Graham Beale and Chris Rhodes from a financial perspective I think it is very amount of contribution should be risk-based so that complicated. the higher-risk entities pay a greater proportion of any failure than the lower-risk entities. I think that is the Q1034 Jesse Norman: Presumably, this would be a risk-based approach to regulation that I have been whacking piece of debt sitting in the Northern Rock trying to promote as an argument for a long time now. balance sheet which would then impose its own strains on the capital structure and so on? Q1040 Jesse Norman: One of the things that was raham B al : Correct. so striking about the Northern Rock in particular was that the regulators saw that it was leveraging itself up Q1035 Jesse Norman: So what would happen on and taking market share, but did not seem to do very the other route then? Say, not necessarily Nationwide much. The non-executive directors were missing, but you or the Co-op, someone were, as it were, presumed dead. The industry did not seem to be invited to get involved, what would the structure be taking any great interest in watching this person there? hoovering up market share. Why wasn’t there any raham B al : The same sort of principle, where you more, as it were, internal whistle-blowing and have to have a long-term earn-out because nobody is regulation from within, if you like, or pressure for in a position to effectively replace the capital that is regulation from within? currently in there by virtue of the taxpayers’ raham B al : I think it was just a feature of that investment in the Northern Rock. time in the economic cycle. The Northern Rock was the darling of the stock exchange, it could do no Q1036 Jesse Norman: The difference would be that, wrong for many, many years. So there was a huge as it were, you would have the initial capital to be amount of momentum and support for that business able to withstand the many billions of pound loan hit model. I sat through a number of presentations to that would sit there through that instrument? institutional investors, who provide some of our raham B al : Yes. wholesale funding, and I could always guarantee getting the question, “Why are you not taking a Q1037 Jesse Norman: That is helpful, thank you. greater proportion of the market share, why are you You have talked about transparency. Could you just not following the Northern Rock model?” We never tell the Committee how many employees you have went to the high levels of 100% loan-to-value lending earning over £1 million in compensation? or any of the other extremes, things that they did, raham B al : Two. because we just saw it as being wrong. I go back to my earlier point that there are times, if we are not Q1038 Jesse Norman: Two, thank you. When we comfortable in terms of market conditions and how it were thinking about the Bradford and Bingley—I took relates to our business model, we pull back from the the point you made, very interestingly, about that— marketplace, and that is what we did. why was there not, or maybe there was and could you help us with this, as it were, a bit of an uproar within Q1041 Jesse Norman: My final question. One of the industry beforehand, that the structural the things that is coming through so strongly to this compensation system that had been created, inquiry is the importance of culture in these different essentially, discriminated against big, solid players institutions. Within a bank, particularly a large bank, and in favour of wild, risk-taking players? what are the kinds of cultural moves that could be raham B al : I don’t think anybody could foresee made to restore a sense of sobriety in the balance and the sort of consequences that occurred when the crisis a good ethos, more of a traditional ethos, to our started to impact players like Bradford and Bingley banks? and the Icelandic banks. You have to remember that raham B al : I think you are asking me as a chief the Bradford and Bingley transaction was done over a executive of a building society to tell the banks how weekend, so on the Friday it was up and running and to run their business. by the Monday it had gone through the resolution process and was in the hands of Santander and a Q1042 Jesse Norman: I am asking you if there are liability for the taxpayer. So it was very difficult to any lessons from your experience which would respond to what was a very, very fast-moving event. I transfer over. It is a very live issue, I can assure you. think the anomaly within the compensation scheme raham B al : I can relate to what we do in and the disproportionate impact on the mutual sector, Nationwide. We never lose sight of the fact that we it has always been there, was a structural defect, but put our members first because our members are our had never been applied in anger and therefore was not customers and they are our owners, and that is a very apparent or was not contemplated prior to the crisis. simple relationship. We reward relationships, we try to maintain our brand so that there is trust in Q1039 Jesse Norman: Would it have been better, as Nationwide, we focus very much on the delivery of it were, to have run this scheme across the whole of good service and the quality of our product, and that the retail banking and mutual sector, on the grounds combination of events is hugely important to us. We that they, as it were, equally drew on the taxpayer have an internal acronym called PRIDE which funding? captures all of those features, and I would be very raham B al : Anybody who is a retail deposit-taker disappointed—if you were to talk to anybody who in the UK has got a liability to the compensation works for Nationwide, be it somebody who works in scheme. The point that I continue to make is that the the post room, to somebody who works in a branch in Treasury Committee: Evidence Ev 157
1 February 2011 Graham Beale and Chris Rhodes
Aberdeen, to somebody who works in the head office, as the darlings of the market, and we have had and you asked them about the values of Nationwide evidence from HSBC and numerous others that the and they will be able to articulate most of those points. institutional investors have been part of the problem. They may not use the same language as me, but it If you have concrete proposals on how they can be goes all the way through the organisation. That is more heavily engaged in activities as shareholders hugely important and our focal point is around the which can improve the quality of monitoring of membership and giving value back to our members. I systemic risk, we are very interested. think the banks have a more complicated set of raham B al : Okay. Well, I do not have institutional arrangements because they have the customers on the shareholders because we do not have any equity stock. one hand and they have their shareholders on the We will give it some thought and if we can come up other, and their interests do not always align. That, I with anything that is useful, we will certainly let you think, is some of the issue that they have. have that. Chair: Thank you very much for giving such clear Q1043 Jesse Norman: You have been very frank evidence here this morning. It has been extremely about the shortcomings of the FSA in regard to your valuable for our inquiry, and I think you have one or model. Would you consider writing to us if you have two points off your chest you have been eager to have any further thoughts on how these kinds of lessons in the public domain. Thank you. and ideas could be transferred across? raham B al : Yes, yes.
Q1044 Chair: A moment ago you were having a go at the institutional investors who saw Northern Rock Ev 158 Treasury Committee: Evidence
Wednesday 2 February 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Jesse Norman Andrea Leadsom Mr David Ruffley Mr Andrew Love John Thurso Mr George Mudie Mr Chuka Umunna ______
Examination of Witness
Witness: Mark Ho an MP, Financial Secretary to the Treasury, gave evidence. Alison Cottrell, Director, Financial Services, was in attendance.
Q1045 Chair: Thank you very much for coming to major shareholders would engage with PLCs prior to see us this afternoon. You will have seen that we have their appointment of a chief executive. collected quite a lot of evidence on this subject and related subjects, and your evidence will also be very Q1051 Chair: What message was sent prior to the important for our inquiry. As you know, we saw decision being taken from the Treasury to UKFI? UKFI. Is the governance of UKFI being conducted at Mark o a : I think they knew that we were aware arm’s length from the Government? of the terms, and that was as far as it went. Mark o a : In what respect? Q1052 Chair: That was the message—“Thank you Q1046 Chair: I am reading from the letter of for making us aware”? engagement for the creation of UKFI: “The Mark o a : Yes. governance of UKFI will be consistent with the Chair: No other message. So when I asked UKFI, Government’s intention to manage its investments on “I’m trying to get at whether the Chancellor was a commercial and arm’s length basis and not intervene sending a message via Treasury officials to UKFI in day-to-day management decisions”. about this pay settlement” and the reply was, “Yes, Mark o a : Yes, that is how the arrangement there were messages”, the message was just, “Thank worked under the previous Government and works you for making sure the piece of paper was under this Government. delivered”? Mark o a : I believe so, yes. Q1047 Chair: When UKFI came to see us, they told us that the Treasury had been heavily involved in Q1053 Chair: When he said that the Chancellor was setting the terms of Mr Horta-Osorio’s pay and bonus. involved in consultations about pay, he was really Is that consistent with arm’s length management? describing a consultation about ensuring that a Mark o a : We were aware of the terms of message arrived? reference and the Chancellor is aware of the terms, Mark o a : I think we were aware of the package but in terms of ministerial involvement that is as far that was being offered to Antonio Horta-Osorio, and as it goes, and I understand there was some discussion that was appropriate. with officials. Q1054 Chair: If I may say so, your replies don’t Q1048 Chair: Are we talking here about a look very consistent with those from Mr Budenberg, discussion with officials or are we talking about either in tone or substance, and it strikes me that there engagement in the setting of the terms of pay and might have been some compromising of the arm’s bonuses of the new chief executive’s package? length nature of UKFI’s management. Mark o a : Of course the pay and bonuses of the Mark o a : I don’t feel, from my engagement with new chief executive is the responsibility of the board UKFI, that that was the case. of Lloyds, as with other groups. Q1055 Chair: I think it will be a matter of Q1049 Chair: I am not asking who was responsible considerable concern if we discover that there has for it; I am asking who was involved in the setting of been a compromise of the arm’s length arrangements. those terms. Were you aware of the terms yourself Mark o a : I think the arm’s length arrangements before they were agreed? are very important because I think that the Mark o a : We were aware of the terms. independence of Lloyds Bank and the interaction between Lloyds Bank and UKFI should be at arm’s Q1050 Chair: Were you personally aware of them? length and I think that is one of the ways in which Mark o a : Aware of them before they were UKFI aims to protect and maintain taxpayer value in agreed? Yes, we were aware of those terms before that institution. they were agreed, but UKFI, acting as the Government’s representative as a shareholder, clearly Q1056 Chair: We also took evidence on possible engaged with Lloyds Bank in the same way as other divestments. To what extent is there a conflict between Treasury Committee: Evidence Ev 159
2 February 2011 Mark Hoban MP increasing competition and getting the highest Q1062 Chair: As I’m sure you have seen from the possible price for the bank shares? evidence, obtaining and maintaining full competition Mark o a : It is an interesting point and one that— in the banking sector is of considerable importance to we are yet to embark on that process. UKFI, as you this Committee, and it will be helpful if some thought are aware, advertised recently for advisers to assist on can be given to this question since we may find the disposal of Northern Rock, so we haven’t seen all ourselves in a position where divestments are taking the options yet. But we recognise the way in which place shortly. we can use our stakes in banks to help facilitate a Mark o a : I hope we are in that position, and it is change in the market structure in the UK, and I think certainly something that the Chancellor and I take that we will wait and see what offers come forward very seriously and see as being very important in for Northern Rock, but clearly where an offer could trying to learn the lessons from the financial crisis. result in a significant enhancement of competition in the UK banking market, that would be of great interest Q1063 Andrea Leadsom: Mark, I would like to just to us. press a bit more about the issue of competition. Do you think that the Government has a role to play in Q1057 Chair: What is the priority for you: getting competition policy vis- -vis banking? to a more competitive banking sector or getting the Mark o a : I think there is a broad role for highest price? Government to play in this and different players Mark o a : I think there is a balance to be struck within this have a different remit. So, obviously the between the two. OFT and the Competition Commission have some formal responsibilities; the FSA currently is structured Q1058 Chair: So we are going to sacrifice some so that they have regard to objectives for competition cash in order to get some competition? in the way in which they supervise the sector. There are measures that I am keen to see, which I Mark o a : Yeah, I think we will wait and see. think will help promote competition, and one of the things that I think we need to do is to empower Q1059 Chair: Was that a yes, by the way? consumers to ensure that they can make some good Mark o a : No, I think we will wait and see what choices about which products to buy and be able to the options are, because we may find that a new compare products. I think it is a role that the Treasury entrant is prepared to pay more to acquire the platform can help play. We are very supportive of the work that that Northern Rock offers than perhaps an established CFEB are doing. incumbent. I am not clear in my own mind yet what To push it a little bit further, we also published a the trade-off will be, if there is a trade-off. I am consultation document recently on simplified looking forward to seeing where UKFI get to in this products, which again I think is another way of process. improving competition by enabling people to compare and shop around for something that is like for like. So Q1060 Chair: A moment ago I thought you said I think Government does have a role to play in this. there was a trade-off and that we needed to strike a balance. Now in your evidence you just said you are Q1064 Andrea Leadsom: We have recently taken not clear whether there is a trade-off. evidence from the OFT, and John Fingleton said he Mark o a : There may be a trade-off, but until we believes that the proposed new CPMA should have see the offers I think it is rather difficult to know a specific competition objective, whereas in previous where to strike the balance. But I am keen to see more evidence you felt that a secondary objective—a sort competition in the banking market—that is part of the of “have regards to”—was adequate. Do you still Government’s policy—and clearly this could be a way think that that is the case and why do you disagree of delivering that. What I am not clear about at the with John Fingleton? moment is whether we can expect someone who is a Mark o a : I think competition has an important challenger to pay more or less than someone who is role to play in financial markets and I think the an incumbent. regulator has a role to play in that. I think the discussion was about the sort of hierarchy of Q1061 Chair: When I asked Mr Budenberg how he objectives, and I would rather not be drawn on that, would assess where on that trade-off he should be, as we are going to publish later this month a more what criteria he should use, he said that he hadn’t detailed consultation document on regulatory reforms given much thought to that but that he was going to that will address this. put something down on paper and let us have a look. Perhaps I can just say as part of that, we are Are you going to engage in that process with him or announcing today that Martin Wheatley, currently the is this going to be at arm’s length? Chairman of the Securities and Futures Commission Mark o a : It is not a process I have discussed with in Hong Kong, is going to become the chief executive Robin since he gave evidence to you last week, and I designate of the CPMA and join the FSA in think we need to think very carefully about the extent September this year. One of things that he and I have to which we confine UKFI’s mandate on this issue, talked about is the importance of good outcomes for but I think it would be helpful for us all to see what consumers and I think competition will play a role in he thinks the trade-offs may be through the sale that. I think that is an issue that Martin will be very process—if there are any trade-offs. familiar with from his work in Hong Kong. Ev 160 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP
Q1065 Andrea Leadsom: Would you say that you about switching, it is about the transparency of have a concern that regulation has always in the past charges, about the ease of comparability—some of the trumped competition—perhaps issues around principles that underpin the consultation document we regulation have meant that the need for banks to have published on simplified products. I think that regard to proper competition, this issue of too big to competition is probably the best way of getting the fail, barriers to entry for new players? Has regulation right outcomes, but you do need a good regulatory played too big a part? framework within which that can operate. Mark o a : I think there is a tension that we see in financial services between the safety and soundness of Q1070 Michael allon: We have heard in evidence the banking system, the prudential supervision, and some pretty poor consumer outcomes in the retail competition. I think we need to get that balance right. banking sector. To what extent do you believe more It is important that regulators play their role in doing effective competition there on its own would help that. solve those? Mark o a : I think that if you look at the retail Q1066 Andrea Leadsom: Do you think the balance financial services sector and around some banking is right now or do you think there is more that needs products you see some very competitive markets. I to be done? think we would argue that the mortgage market in the Mark o a : I think that in the aftermath of the financial crisis is very competitive. There are very financial crisis clearly there has been a refocusing on competitive markets around credit cards and personal prudential supervision. I think we would all accept loans; there are less competitive markets, frankly, that is an important aspect. I think we have now got around personal current accounts. to think about how you move away from that and I think there are areas where we can learn lessons make sure there is a role for competition innovation from financial markets about where competition in financial markets. That is very important, I think, works effectively and use those in areas where to delivering long term economic growth. competition is less effective. I think, for example, some of the work the OFT has done with the banks Q1067 Andrea Leadsom: Would you consider on greater transparency around charging, the annual giving the CPMA a specific primary objective to statement showing how much your charges have been, promote competition? what your average credit balance has been and what Mark o a : I think you will see later this month your average debit balance is, is helpful in promoting what our proposals are on that. an agenda around transparency. But I think there is more that can be done in those areas. Q1068 Andrea Leadsom: Okay. Just one last question. The consumer protection part of that title Q1071 Michael allon: Would that include reducing has been a cause of concern, and I know that the BBA the bank’s influence over the money transmission have also shown some concern about the CPMA, and system? perhaps it should be the MCPA. Is that something that Mark o a : I know that you took evidence from you might be considering as well? Specifically, due to the fact that consumer protection is something we Don Cruickshank, who spoke quite a lot about this— have all had concerns about; being a consumer not just in his 2000 report, but also in his evidence champion is not necessarily flowing in line with its session. The OFT looked at the money transmission role as a markets regulator. system as part of its report into barriers to entry, Mark o a : I think as we set out in our high-level expansion and exit in the UK retail banking market response to the responses received to the original and didn’t see this as a significant barrier to entry. I consultation document, people shouldn’t see the noted that Vernon Hill, when he gave evidence to the CPMA as a consumer advocate. What we are looking Committee, also said it wasn’t for him a major barrier for is good outcomes for consumers and that requires to the success of Metro Bank. getting the balance right between the interests of consumers and the interests of businesses. Q1072 Michael allon: We heard all that, but we want to know what you think. Q1069 Michael allon: Lord Turner in a recent Mark o a : I think that the environment around the speech spoke of a series of waves of major customer regulation of payment systems has changed detriment over the last 20 years. Do you think that significantly since Don Cruickshank’s report in 2000. was, looking back now, a failure of competition or a You have got a Payments Council; that was formed failure of regulation? out of the work the OFT had done. You have got the Mark o a : I think that’s a good question, and I Payment Services Directive, which enables non-bank think that there are ways in which competition could players to enter into payment system work. I think we deliver better outcomes for consumers. I firmly are moving to a much more transparent market. I don’t believe that one of the areas we need to focus much see at the moment there is an issue there, but that is more attention on is improving outcomes, and one largely based on the evidence and experience that way I have always believed that you can improve others have highlighted, particularly in the run-up to outcomes is through enhanced competition. this inquiry. It is about how you create the environment of financial markets that enable consumers to make better- Q1073 Jesse Norman: Sir John Vickers is planning informed choices about the products they buy. That is to publish his final report in September this year. Can Treasury Committee: Evidence Ev 161
2 February 2011 Mark Hoban MP
I just ask what the timetable is for responding to his We have got Basel III—that will be going through proposal? the European Parliament and the European Council Mark o a : We haven’t set a timetable yet to process in the latter half of this year. We have got a respond to his work, but we take Sir John’s work very crisis resolution mechanism being debated at the seriously and set this up to look at some big issues moment in Europe. There are still ongoing debates around the structure of the banking sector. Clearly about the FSB and about global SIFIs. So there is a what he will say will be very important, but we need lot of process around the rules, I think, of regulation time to digest his remedies. I think we also recognise, rather than the structure. It is not within Sir John’s of course, that Sir John’s work will come out around remit to make recommendations on the structure of about the time when there is wider European regulation in the UK. international discussions about SIFIs and resolution mechanisms and things like that. So that will, in part, Q1079 Jesse Norman: Of course, some of the ideas also drive our response to Sir John’s work. that have been sketched and entertained, at least, range from, as it were, breaking up the banks along Q1074 Jesse Norman: What will you do if he comes casino-versus-utility lines, requiring segregated out with a suggestion or a set of suggestions that are capital for the investment of commercial banks, and unacceptable to the Government—you just don’t like separate subsidiarisation. Is work being done within them? the Treasury that can evaluate some of these things in Mark o a : Let’s wait and see what he produces order to give you a view on what you think of his and then review that. I think it is important that Sir recommendations when they do emerge? John is given the freedom to continue his deliberations and the freedom to come up with his own options. Mark o a : We are working on a wide range of There will be plenty of people lobbying Sir John on options, partly as our contribution to some of the the outcome. I don’t think the Government’s role is to global work that is going on at the moment. So, we do that. are not letting the grass grow under our feet.
Q1075 Jesse Norman: But the options available are Q1080 Jesse Norman: Do you have a preference that you could have another consultation, or among those? presumably you could have a further period of Mark o a : I think I would be accused, rightly, by reflection yourself, or, as a Government, you could you of trying to influence the independence of Sir come up with alternative proposals. John Vickers’s work, so I don’t have a preference I Mark o a : I think, Mr Norman, if we were looking would share. for a long grass solution we perhaps would have thought of other ways instead of appointing a high Q1081 Jesse Norman: Or if you do, not one that powered commission under the chairmanship of Sir you can share? John Vickers. Mark o a : I think it is right that Sir John gets on with this work. Q1076 Jesse Norman: Right. But you could conceivably come up with other proposals; that would Q1082 Chair: Just to be clear, did you say that it be an alternative? was not possible that any aspect of Sir John Vickers’s Mark o a : We set this commission up with quite work and recommendations could have an impact on a tight timetable, with very high powered the structure of regulations? commissioners—people who are independently Mark o a : I find it hard to see, given his minded and will expect their work to be taken pronouncements, just where that would impact on seriously and responded to promptly. the structure. Chair: I think that was a— Q1077 Jesse Norman: Do you think there is a Mark o a : I think I was agreeing with my own tension between the timetable you have adopted on statement earlier. the Vickers Commission and the rapid speed of the Chair: You were basically saying yes, which is not process of thinking about regulation that is going on what a good number of others have suggested to us otherwise? in evidence. Mark o a : I think that there are—
Q1078 Jesse Norman: Just to put it in context: say, Q1083 Mr munna: Can you confirm that it is the for example, Sir John recommends something that Cabinet Committee on Banking that will look at the meaningfully changes the kinds of players that are in recommendations of the ICB and presumably come the market. Would you then not have to think again up with proposals for Cabinet? about the kind of regulation you would be submitting Mark o a : Yes. them to? Mark o a : I think there is a range of issues here. Q1084 Mr munna: Who sits on that Cabinet We have set out on a process to reform regulatory Committee? structure, but also within that structure there are a Mark o a : I think the information is in the public whole series of developments that are partly UK domain. I’m assuming that it is but I’m not entirely driven, partly global driven, partly European driven, clear if it is in the public domain or whether it is which will have an impact on the structure of banking. appropriate for me to do that. Ev 162 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP
Q1085 Mr munna: I have looked at the list of Q1088 Mr munna: I would suggest this is a fairly people who are on it, but it is an old list. Can you unique position, and I think that the commission being confirm that Lord Green, the new Minister for Trade set up is a very good thing, but this is quite and Investment, sits on the committee? exceptional and what it comes out with will have a Mark o a : I want to just check that. I don’t have huge effect on the share value of a company that a an up-to-date list of members of the committee, and Minister potentially has an interest in. I’m sorry it is not cited on the protocol of announcing The chair of UKFI appeared in front of us last week these things, but I will write to the Chairman and and that was shortly after Sir John Vickers had given clarify the membership. his speech. We saw that, the first working day after that speech, the share value of the financial institutions Q1086 Mr munna: I ask the question because a dropped by some £2 billion. The chair of UKFI press release, which was put out by the Business confirmed that, obviously, whatever the ICB comes Department, said that he was a member of this out with will have a major impact on the share value. committee, but it didn’t marry up with other things. He said that potentially, for example, there won’t be I was just wondering whether you think it would be separation and you will see a diminution in the value right and proper for Lord Green to sit on that of shares—certainly of some of the publicly owned committee, given his inherent conflict of interest. banks across the sector. Don’t you think this is a very Perhaps if I just explain that. The ICB is obviously important issue? going to make some recommendations, which will Mark o a : I think that Stephen Green’s have a major impact on the share value of the big appointment, and the arrangements around his banks. HSBC is one of those, and as such I would appointment and his financial interests, would have suggest that there is quite a big conflict of interest in been dealt with in accordance with the usual him sitting and helping determine the Government’s procedures, as they are for all Ministers. It is not response to that, given that the Government’s response unusual for Ministers who have a particular interest or can have a major impact on the share price of HSBC. experience in an area to engage in debate. Lord Darzi Mark o a : I am confident that all proper processes was viewed to be a very effective Health Minister; at would have been pursued in relation to the the same time, I think he maintained his practice in appointment of Stephen Green to the Government. the NHS and I don’t think anyone levelled that criticism at him. Q1087 Mr munna: But usually the process is, where you have businessmen joining Government, Q1089 Mr munna: Would you be prepared to their assets or their shares, or whatever they may be, make arrangements for the Cabinet Secretary and the are put in a blind trust and they are managed by Permanent Secretary of the Business Department to somebody else. He, according to the HSBC annual write to us to clarify the situation in relation to Lord report that was published in 200 , has over 1 million Green, and him taking any part in the Cabinet shares, which are due to vest this year, in HSBC. Committee, which decides on the Government’s Obviously, they are going to be majorly impacted response to the Independent Commission on Banking? upon by whatever response the Government comes up Mark o a : I am sure that proper arrangements will with to the ICB recommendations. Even if he didn’t be made. necessarily, maybe he has divested himself of those shares—he worked at that bank for about 2 years, I think. I would suggest that he can’t necessarily come Q1090 Mr munna: But would you be prepared to at this in an unbiased fashion. Would you agree? ask for them to write to us to confirm the Mark o a : First of all, I am not privy to Stephen arrangements? Green’s financial affairs, and I am sure that in his Mark o a : I will raise that with the Cabinet appointment to Government all the proper processes Office, yes. would have been fulfilled. We all come to this debate with views about banking—whether you are a banker, Q1091 Mr munna: Can I, moving on, ask a whether you are a bank account customer, whether question about the actual terms of reference that the you have had a bad deal from a bank. I think one of Government gave to the commission before it the things the previous Government was very reported? The terms of reference say that the successful at was identifying people to join commission will have regard to the Government’s Government who had particular experience. wider goals, financial stability and creating a diverse My own predecessor, Lord Myners, had extensive banking sector. It says, “There will be specific experience of business. I don’t think anyone suggested attention paid to a list of things, including the risks to at the time that it would be inappropriate for him to the fiscal position of the Government”. What exactly use that experience in resolving matters around was meant by that? financial services, when he himself had been a former Mark o a : I think that we have seen in recent fund manager, been a director of the FTSE, the times the way in which taxpayers’ money, for chairman of M&S, and other responsibilities, had example, has been used to support the banking sector, worked for NatWest. So I think that it is an interesting and clearly in moving to a much more stable banking precedent that the previous Government set in sector, it is important to minimise the risk to the fiscal recruiting people with experience to work in areas that position. That is a very good example of some of the they were familiar with. meanings behind that phrase. Treasury Committee: Evidence Ev 163
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Q1092 Mr munna: One thing I suppose I had in something that fell into abeyance prior to the general mind is obviously when the Government realises its election. We are looking at modernising legislation stakes in the publicly owned banks, that is going to around building societies and introducing elements of raise a substantial amount of money. That could, the Bill that Malcolm Wicks promoted in the last whatever the proceeds are, impact on the fiscal Parliament around modernising the framework for co- position of the Government, if there, say, happens to operatives, and that applies to a wide range of be a hole in the finances and things don’t turn out to financial mutuals. be as the Government hopes in relation to growth. Also we are working very closely with the sector as Would that be something that the commission would part of the debate on CRD on an appropriate capital have to take account of? instrument for building societies. That is something Mark o a : The commission can propose its that I know Mr Beale is very keen on and it is recommendations. I think that one wouldn’t expect the something the sector is very keen on. What I hope is commission to be thinking about the value of RBS that if we are able to secure that, the sector will use and Lloyds in context of their recommendations. that opportunity to add a further competitive spurt in the retail financial services sector. Q1093 Mr munna: That is encouraging. On the point about Northern Rock, I think there is a Finally, something else caught my eye in the issues sort of elegant circularity about this, a former building paper that was issued by the commission that seemed society being remutualised after its nationalisation, to me to provide a massive get-out clause from radical and my mind is not closed to that. change. This was paragraph 3.26 of the paper where Mr munna: That is encouraging. it said that, “The commission has to have regard to Mark o a : But I would just point out that the the likely impact of the recommendations on the taxpayer has a £1. billion holding in that and I think competitiveness of the wider UK economy”, and it that the taxpayer would expect some return on its goes on to mention the attractiveness of the UK as a investment. I am not clear how a large Government place in which to conduct business. shareholding will become a mutual, and I am not sure To me, that sounds a bit like a big get-out clause from you are really suggesting I should write off that any kind of radical change because, as has been investment. mentioned by the Chair, there is a tension between the need for competition, the need to protect the taxpayer Q1096 Mr munna: No, perhaps you should—I and also other considerations, and the OFT have would invite you to look at the evidence that was talked about that as well. That clause to me would given to us by, I think, Keith Morgan of UKFI who seem to give a massive get-out clause for the looks after Northern Rock. He said that there was Government if any major radical proposals were put definitely no problem with returning the stake or forward on separation, for example. returning taxpayer money, but it could take some Mark o a : The terms of reference are set out for more time. the benefit of the commission and for them to think Mark o a : It could take some time. I think about their recommendations in that context. It taxpayers have a limited degree of patience, but I did doesn’t frame the Government’s response to those see Keith’s evidence and he reflects an important recommendations. view. But when UKFI goes through the process of selling Northern Rock, clearly if there are good Q1094 Mr munna: So we can’t expect to see the proposals on remutualisation or where there is Government waving the flag of competitiveness and interest— the UK going for a unilateral position on how it Mr munna: They said you will determine that. structures the industry and the rest of it in response? Mark o a : They have to come up with options; Mark o a : No, what I am saying is the terms of we decide. reference are for the commission. Mr munna: You decide, yes. Mark o a : We look forward to seeing whether Q1095 Mr munna: My final question was just to there are any viable options out there. follow up on some evidence we took yesterday from the CEOs of Nationwide and the Co-op Bank. I Q1097 Mr uf ey: Financial Secretary, you will be brought up the issue of the coalition document and the familiar with table 5. of the Bank of England’s last commitment to promote mutuals. The CEO of financial stability review. It has some interesting data Nationwide said that he thought the pledge to promote relating to the argument that big banks are too big to mutuals was, at the moment, lacking in substance by fail, that successive Governments can’t afford to let the Government and that one way you could make big banks fail, and that because they guarantee them that promise—or make good on that promise, I the subsidy in 200 , according to the Bank of suppose—was by seriously considering the England, was about £100 billion a year and in 2008 remutualisation of Northern Rock, which is something about £50 billion a year. I am very much in favour of. Does the Government Those are Bank of England estimates. Do you think, have a view on that at the moment and, if it doesn’t, in the light of that, that the “too big to fail” regime is it open to that as an option? that this Government and previous Governments have Mark o a : Just to deal with the first point that operated enhances competition, decreases competition Mr Beale raised yesterday. We have taken steps to or doesn’t have any effect on competition at all? strengthen the mutual sector. We are pushing forward Mark o a : I think there is an argument about the the Legislative Reform Order on Credit Unions, extent to which it undermines competition in the sense Ev 164 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP of whether there is an uneven playing field that that could you just trot through the top five possible implicit support enables them to operate to the solutions to the problem I have outlined? detriment of other players in the market. I think there Mark o a : You can have global capital surcharges is legitimate argument there. on SIFIs, which is one way of doing it; you could go I think one of the challenges that emerges from the through subsidiarisation; you could have a split financial crisis, and Northern Rock is a very good between retail and wholesale banking; or you could example of this, is that it was very difficult for there to decide to do what Paul Volcker suggested, which was be an orderly exit from the market of a failed financial split off proprietary trading, which is a variation on institution. A lot of work is going on at the moment the theme of Glass-Steagall. I think I have got to four to look at ways in which there can be a more orderly at that point. wind-down of a failed financial institution. There is Mr uf ey: That will do; four out of five isn’t bad. quite a big international debate about this. We supported in the previous Parliament the requirement Q1101 Chair: Living wills. to have living wills, recovery and resolution plans. Mark o a : Living wills. I am not sure that living They are all measures that are aimed at seeing how wills are necessarily a response to Mr Ruffley’s you can wind down a failing institution. In fact question, but they are an important tool to be used. yesterday in a Standing Committee we debated rules that would facilitate the orderly winding down of an Q1102 Mr uf ey: I asked that for one reason. We investment bank or investment firm. So there are a are not going to press you on which is the favourite series of steps in place to try to tackle this. there, but I am just wondering. Whichever of those There are other ways in which we are intervening to options or combination of those options the ensure financial stability: higher capital requirements Government comes up with after this very welcome through Basel III, increased liquidity requirements and very laudable investigation and work, what levers, and a more intensive supervision approach. So I what ability to enforce any of those options or mixes recognise the problem. I suppose in a way the work of options, does the Government have? of Sir John Vickers will help assess some of the wider Mark o a : There is a range of options. So, for consequences of “too big to fail”. example, one of the debates that we will have perhaps later in this year at a European level is about capital Q1098 Mr uf ey: You said in your answer that surcharges for global SIFIs, for example, so there will there was a legitimate argument, there wasn’t a level be legislative option through CRD . There will be playing field. Can I just clarify: do you think that that routes like that that will create legislative options. the “too big to fail” regime, as it currently exists— Some of them could be through a legal change. So I forget about the reforms that are in prospect— think a range of implementation measures—and it will damages competition or doesn’t have any effect on be split, I suspect, between ourselves and the regulator depending on the nature of those rules. competition in the British banking market? I don’t We haven’t looked at how you would implement these want you to go off on to international arenas. We are at this stage. In a way it’s a question that hasn’t arisen talking about competition domestically in British yet because we are awaiting Sir John’s banking. recommendations. He might propose that there isn’t a Mark o a : If I look across the banking sector, route or this is the best legislative or regulatory route there are different levels of competition in different to achieve a particular outcome. sectors, and I am not sure that the level of competition in some sectors is related to the debate about “too big Q1103 Mr uf ey: Subsidiarisation. Would that be to fail”; sometimes it is about the functioning of something the banks would have to agree to, or could markets in particular segments. As I said earlier on, that be forced through by regulatory or legislative there has been a lot of competition in personal loans, change? mortgages, credit cards, but less competition in Mark o a : It is not something I have looked at in personal current accounts. I don’t think that lack of any detail, so I don’t want to give an outcome, but I competition in personal current accounts is linked to am sure there are a range of routes where this could “too big to fail”. be used.
Q1099 Mr uf ey: So you would be happy with Q1104 Mr uf ey: I ask that because there is public any new set of arrangements that allowed a British disquiet, I think, about banking generally. There is this bank to fail? huge implicit subsidy, as the Bank of England has Mark o a : I think there is a challenge about how calculated, given by the British taxpayer to the big we minimise the impact of a potential failure on the British banks. It is £100 billion a year in 200 and taxpayer, and that is why there are moves to increase £50 billion in 2008—Bank of England estimates, not the amount of capital. I think the way in which the some para-Marxist outfit making all this up. goal of Basel III was articulated was that banks should I think the British taxpayer would want any reform of hold sufficient capital to absorb losses of a scale the banking system to be delivered with despatch and experienced in the past financial crisis. effectively, and I am just trying to understand whether any of the menu of options that you have outlined Q1100 Mr uf ey: Without attributing any today—and we are all familiar with them—are all preference on your part or the Government’s part to things that could be imposed by a Government on the possible solutions for the “too big to fail” problem, behalf of, frankly, the British people who do want Treasury Committee: Evidence Ev 165
2 February 2011 Mark Hoban MP change in this area, and to what extent the banks impossible for us to get any of the big banks to tell would have to come willingly and agree. Is that us what it costs just to have a bank account. If the something you are concerned about? transparency that you want, and I agree with, was Mark o a : Clearly, we need to find workable there, that would exist. Surely that is something that solutions to some of these issues, and we have also it should be a matter for at least the authorities, if not got to think about the practical implications. I think the Government, to be concerned about and helping the other point I would make is that we need to to drive. balance off the costs and benefits of these measures Mark o a : Yes, indeed. We have seen the OFT do as well and clearly think not only about the cost to some very good work on ISAs to improve the taxpayer potentially of implicit guarantees or what transparency there. They have worked with the banks economic benefits or otherwise would emerge from to have greater transparency on bank charges and these reforms. I think there are a range of factors we making sure people are much more aware of the cost need to bear in mind in responding to Sir John’s of their accounts. As we have touched on in this recommendations. Committee, I think last time I gave evidence, things like the Retail Distribution Review highlights the cost Q1105 John hurso: Can I just come back to three of advice in a much clearer way than perhaps had things you said in answer to Andrea Leadsom? One been the case before. So I think we are making was that competition, as far as CPMA is concerned, progress on the transparency debate. But I agree that will be a “have regard to” matter, which of course we all know is parliamentary shorthand for a polite nod. there is more work we wish to do on this. The second thing was you said that you want to empower consumers, which is a nice way of saying Q1107 John hurso: Let me tell you why that, to “buyer beware”. The third thing was that we’re me, is important. The one area we never talk about putting a Hong Kong banker in charge. Isn’t it game, are the unbanked. This Committee did some very set and match to the big banks? good work on that in the last Parliament and also on Mark o a : What I said to Ms Leadsom was that the financially excluded. If we don’t know what a you would have to wait until we produce the next basic bank account in the normal market, if I can put consultation document later this month to see our it like that, costs, and we don’t know how the banks further thinking on competition. So I don’t want to view the basic bank account, as opposed to the prejudge that. standard one, how can we assist people who are In terms of empowering consumers, I think it goes unbanked, and therefore financially excluded, into the beyond caveat emptor. I think that we need to be able system? How can we look at their legitimate to help consumers make better choices, and I think consumer needs? that there is a symmetry of knowledge between the Mark o a : I think that is a good point, and consumer and the provider of financial services something that concerns me is the number of people products, something that often we don’t do. It is who are unbanked. I think there are some very something we don’t do very often. The person who complex reasons why people don’t have bank perhaps is selling them or marketing to us knows more accounts. Some very good work was done by the about how these products function than we do. Financial Inclusion Taskforce that reported in, I think, So I think we need to redress that balance, and that is December last year that suggested that many of those why I am a very keen supporter of financial literacy, people who didn’t have bank accounts at the moment improving financial capability. That is why I think it had had bank accounts, but had chosen for one reason is important there is much greater transparency around or another not to have bank accounts. For a lot of charges, and this is why I very much welcome the people, bank accounts don’t go with the grain of how work that the OFT did about ISAs and making sure they want to run their lives; they are very concerned that people who held ISAs knew all the interest rates about the unexpected charges if they go overdrawn, they were being paid on ISAs. for example, and want to have more control over their I think transparency helps empower consumers and finances. I think why people don’t have bank accounts being able to shop around. I think if you look at one is a very complex area. of the most competitive markets in retail financial services, motor insurance, it is a very good example I think one of the things we have seen over the course of how competition can work to the benefit of the of the last few years is a significant reduction in the consumer. Once you know what the product is you number of people who don’t have accounts. But I can compare from brand to brand, you can compare agree that one of the challenges is to know how much prices and compare service, and the consumer can you are paying for what it is. I was reminded earlier make an informed choice. So I think empowering the that when you are shopping around there are two consumer goes way beyond caveat emptor. It is giving costs: one is a search cost and one is a cost of them the tools to do the job properly. switching. I think in bank accounts the perceived cost of switching is quite high, but the search cost is quite Q1106 John hurso: You can also, using your high too. You have got to spend a lot of time trying analogy, create a great market in little furry animals. to work out the difference between the many different If you take free-in-credit banking, which we have accounts that providers have. It is a very curious asked a lot of questions about, it is interesting that market; we have very few providers of personal John Varley was recently quoted as believing it is a current accounts, but they offer a lot of current structure that has outlived its time. It has been accounts. Ev 166 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP
Q1108 John hurso: What I would ask of case for keeping this on, however temporarily, until Government is not to always think in terms of the your new arrangements are— informed, articulate, numerate consumer but be aware Mark o a : It is something we are looking at; I can there are people who don’t trust banks who need to assure you of that. be thought of, and that if the competition authorities are not having a little bit more than “having regard Q1111 Mr Mudie: Lovely. You saw the briefing to”, that sector will always get left behind. So from yesterday, the mutuals. I promised to ask you a something needs to be done to bring them front and couple of questions and they have supplied the centre in the equation. questions. We will get them over very quickly, Mark o a : I think you make a very good point. because I want to deal with just another matter. Would When I started off in this role in opposition, I was the Minister agree that measures that promote a level talking to someone who was an expert in financial playing field for all financial service providers, inclusion and they made the point to me that one of regardless of ownership structure, could prove the problems was that middle class people design helpful? That is the first question. products for those who are less well-off and we should Mark o a : Yes. It is a very straightforward engage much more often with those who either use question. When you’re thinking about mutuality, and those services or don’t use those services, to design I am keen to see a diversity of business models and products that actually meet their needs. I think there ownership models, but at the end of the day what is a lot of thought going into different ways of meeting matters to me is does it deliver better outcomes for their needs. eMoney is a growing example of that the consumer? I think the argument put to me by where Tesco pays temporary staff using eMoney cards mutuals is that the fact that they don’t have to satisfy and that gives people a lot of control over how they shareholders means they can offer a better deal for use their money. consumers. That is what I want to see from the mutual One of the great fears is you are going to be stuck sector—that spur to competition and better consumer with an unexpected charge if your direct debit or outcomes. standing order bounces. People want more control and we need to think about how we deliver that for that Q1112 Mr Mudie: The way to give them the group of the population and to understand why it is opportunity to give even more competition to the they are unbanked and what we can do to tackle that. Barclays of this world is the second thing. To be fair Chair: That is very encouraging, what you have been to them, they were speaking highly of the efforts of saying. George Mudie. the Government, because a few months ago they were seriously worried in terms of the capital instrument. They are simply saying that will you renew your Q1109 Mr Mudie: It would be encouraging. Just on efforts, particularly at EU level, to allow access to that last question, though, I would believe in your and external core capital—I am reading this because I the Government’s concern for less well-off people if could certainly never do this on my own—through you were not ending the Financial Inclusion Fund in an instrument, which specifically includes a cap on March. I don’t know if you know about it, but 500 dividend to third parties, so that the core essence of debt case workers will be unemployed at the end of mutuality can be maintained. That is the key one, isn’t March. In Leeds, we have 11 additional ones in the it? You are doing well now; are you going to citizens advice bureaux who have handled 2,500 cases continue? in the last year—serious bad debt problems, people Mark o a : I can tell you my officials know my sick, disabled, relationship breakdown and illness. interest in resolving this satisfactorily, and I do raise How can you expect us to accept you are worried it regularly. But I would say this. We want to see about the less well-off and the financially excluded if financial institutions holding more loss absorbing you are prepared to do that at short notice? Are you capital to ensure the taxpayer doesn’t have to foot the going to blame the last Government for the mess? bill for future failures, and that applies as much to Mark o a : The programme was due to wind up at mutuals as to any other financial institution. the end of March, that was the plan that we inherited, and it is an area we are looking at. We are very Q1113 Mr Mudie: No, but at the moment they are conscious of the need to provide increased levels of largely depending on profits from their incomings and advice. That is one of the reasons why we proposed a that restricts them, and therefore they cannot provide national money guidance service that CFEB are going the competition to the Barclays of this world that we to be operating, which is funded by the industry would like them to. This would do it. through a levy. I think that we need to ensure that Mark o a : I agree, Mr Mudie, I think that is there is better advice available and I am very mindful absolutely right, but I think we do need to make sure of the impact on debt advisers. That is something we that they too hold loss absorbing capital—capital that are looking at very carefully. can absorb risk if their business is unsuccessful. Taxpayers expect the same protection arising from Q1110 Mr Mudie: You will also be aware, Mark, of building societies as they would from banks. I think the good work done by the Citizens Advice Bureau; we should be neutral on ownership, and that works it is a sound organisation. Until you have a scheme both ways. ready to slot in—this is two months away, these 500 people are going to be taken away, stranding Q1114 Mr Mudie: There is a third one. As you have thousands and thousands of people—is there not a spoken about that, they raised a very, very, very Treasury Committee: Evidence Ev 167
2 February 2011 Mark Hoban MP important matter about how the money for the FSA after and the answer is, “Well, we expect them to run compensation scheme is raised and it is harmful to the on commercial and at arm’s length from mutuals. It was agreed when we set this up—we set Government”. Can I just ask you about this, because up this hurriedly—that it would be reviewed. I heard this is what the ordinary person in the street cannot in the last 2 hours the FSA are too busy with other understand? With all that is hitting the ordinary person things to review it, but this compensation scheme in the street, they look at Mr Diamond sitting where affects smaller companies and the mutuals, you are and he says on his bonuses and lending and particularly mutuals, in a different and harmful way. the lot, “Nothing to do with Government. It is a matter They would like it reviewed. Will you agree to at least for my shareholders and you should stay out and so look at that and understand there is some concern? should the regulator”. That is what he said to us. Mark o a : I am well aware of the concerns, and it Here we have two banks at least in which you are the started to flow from the point at which the FSCS was major shareholder. How do you explain to the used as a resolution tool during the financial crisis. A ordinary man in the street that you are prepared not to lot of the funding of transfers and balances was give—you have a right to give, as the main financed effectively through the FSCS and a levy on shareholder, an expression of opinion about their FSCS members who are deposit takers. conduct in key matters such as salaries, lending and There are significant concerns raised by different transparency. Diamond said, “I would expect my subsectors within the FSCS about the funding shareholders”—he doesn’t pay any attention to them, mechanism. People say we shouldn’t be paying for the but, “I expect that to come from my shareholders”. problems of other sectors, but a point comes when Here we are the shareholders and we say, “Oh, we potentially it is your sector that is facing the loss and can’t do it”. Tell the ordinary person in the street who you may well be grateful for the support of others. I is losing his job or his house because of the behaviour think this is a very difficult balance, but I understand of these banks and their continuing arrogance that, the concerns. I have had letters from building societies despite you owning them, you won’t lift a finger to about this, investment managers, IFAs, insurance say, “I think you should behave in a different way”. intermediaries. All are uncomfortable that somebody Mark o a : You raised a point; let me just finish needs to pick up the cost of failure. It is important, I off the point you raised earlier on about the FSA and think, for consumer confidence that the cost of this the fees. I think one of the important areas is that failure is picked up somewhere if someone goes member firms feel they get value for money from the insolvent. Someone needs to pay the bill. FSA, and I think one of the under-used provisions of the existing— Q1115 Mr Mudie: To finish that off, do you think it is going to review in the near future? Mark o a : My understanding was that the FSA Q1119 Mr Mudie: This is the FSA that let the was reviewing the funding and I haven’t heard that country down by light regulation. Bloody hell. they— Mark o a : You said it. Mr Mudie: Wouldn’t have paid them in buttons. Q1116 Mr Mudie: Did you see the FSA’s increasing Mark o a : I think one of the under-used elements yearly charges announced yesterday? Are these fees— of the Financial Services and Markets Act was the I think it is £50 million—agreed with Ministers? I requirement to get the NAO to look at value for have always got the impression the FSA have a blank money in the FSA, and that is something that has been cheque because it’s not coming from Government, it pointed out to me. It is something I am very concerned is coming from the practitioners, so they feel they can about to ensure we don’t repeat the same mistakes in charge anything they like. This recent increase the future around good value. announced yesterday, was it cleared with Ministers? On the broader point, I think it is important that banks Mark o a : No, it was not cleared with Ministers. do rebuild confidence with the people in this country, taxpayers who have directly bailed them out— Q1117 Mr Mudie: That is shocking, isn’t it? whether it is RBS or Lloyds, or whether it is more Mark o a : Setting the levy is a matter for the FSA. generally through the financial support that has been Mr Mudie: Oh, no, no, no. offered. I think the best way for them to do that is to Mark o a : But they do consult, Mr Mudie, with take a more responsible attitude around remuneration, registered firms. I can’t comment about this year’s fee particularly for senior management, and also around settlement, but I know last year, in between the lending. Those are a couple of the principles that consultation paper and the final decision, amendments underpin Project Merlin that are being discussed at were made to reflect some of the concerns expressed, the moment. particularly by smaller regulators. I think the other thing I would say, though, is that the easiest way for us to destroy shareholder and taxpayer Q1118 Mr Mudie: Can I just indicate my value in RBS and Lloyds is for Government to feel it disagreement in terms of it being nothing to do with can micromanage individual decisions that they make Government? They do treat it as a blank cheque and about who they should lend to, whether it is business the effect of that, especially on smaller firms, is very, in my constituency or yours. I think that there needs very dangerous. to be a proper degree of engagement. I think there is The general principle takes me to the last matter, a proper degree of engagement between UKFI as a which is when the Chairman was speaking to you shareholder and the— earlier about this business of the banks that UKFI look Mr Mudie: No, but okay. Ev 168 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP
Mark o a : One thing that struck me when I was of what they were intending to pay the new chief reading the evidence that UKFI gave to you last week executive. was that Robin had spent two days in a call centre Mark o a : What I am talking about is— listening to complaints made by customers. I don’t Chair: That is what you said before. think there are very many shareholders who get that Mark o a : No, I agree. engaged in a business and hold them to account in that way. I think there is a good level of engagement there. Q1123 Chair: You want them to express restraint, but you didn’t express an opinion when you had an Q1120 Mr Mudie: Last week, we saw UKFI and we opportunity to do so. raised the question of Lloyds and Lloyds said to us, Mark o a : We are dealing with that at the moment “Commercial, commercial. Nothing to do with the across all the banks as part of Project Merlin. Government—commercial”. We were acting in the commercial interests of the British public as their Q1124 Mr munna: We listened to the evidence shareholders. The Chairman pointed out that there is from the UKFI and their engagement with Project a commercial argument on the investment side where Merlin, and I have to say half the members of the people are making huge profits for the bank and their Committee almost fell off our chairs when UKFI told performance deserves reward if you wish, even us that they really hadn’t played any direct part at all though we may say it’s excessive, but you can’t say in the Project Merlin negotiations. I found that quite that about a retail bank. Within a week, the Chairman extraordinary. Will you not instruct them to play a was rewarded with Lloyds coughing up on greater role in the Project Merlin negotiations, given transparency, what we asked. The commercial that they are managing our shareholdings in some of argument had been blown out of the water by the the biggest banks to whom Project Merlin is highly Chairman. relevant? When you say “commercial shareholder value”, there Mark o a : There is ongoing engagement between is more to life than that. In fact, that is what caused Government and the bank chief executives on Project the problem, wasn’t it? HSBC said exactly that to us. Merlin, and I think that is the right level at which to “Why did you survive and the others went down, and have that discussion. had all this trouble?” “Because we were prepared to listen to our shareholders and even ignore them in Q1125 Mr munna: Why do we bother having terms of—” Why aren’t you as a major shareholder— UKFI if they are not going to play any part in some— by not saying anything, you are telling the British Project Merlin, one of the major parts of it is public that you are saying things but you won’t do transparency, one of the major parts of it is anything to stop this bad practice. remuneration, one of the major parts of it is lending, Mark o a : I think it is right that UKFI engages and yet the organisation that manages our with Lloyds and RBS, and again also with Northern shareholdings in some of the banks to whom all those Rock where there is a slightly different relationship, issues apply, is just standing back and saying, “Oh, to discuss strategy and to monitor how they perform we’ll leave it to the Government and the executives”. What is the point of this organisation if it is not going against that strategy. I think that is the right thing for to play a role in Project Merlin in particular? them to do and I would expect them to have that Mark o a : UKFI has a very clear mandate about active level of engagement. This shouldn’t be seen as its role. Its role is to act as the shareholder some passive investment. representative of the taxpayer in managing our interests in those institutions, and its role is to Q1121 Mr Mudie: So you accept that there is a maximise taxpayer value and concentration around number of people—under 10—in Lloyds, a retail competition and financial stability. I think it is a very bank, earning more than the chief executive, and he is clear remit it has and exercises across the course of getting between £2 million and £3 million? In a retail the year. I think this is a separate exercise to that. bank that you own, you are prepared to pay people in a retail bank £2 million to £3 million—up to nine of Q1126 Mr munna: Given the remit you have just them? It is not acceptable. It might be acceptable in given, surely the remit requires input in Project an investment bank, you could argue it, but you can’t Merlin. I mean, I don’t understand. argue it in a retail bank. Mark o a : I do think the shareholders of Barclays Mark o a : With Lloyds, it doesn’t offer the full would expect us to engage with them when it comes range of services that an RBS or a Barclays or an to Project Merlin. I think it is a very different— HSBC does, but it does recruit in a pool of talent. They do need to find the right people to do these jobs, Q1127 Mr munna: No, but I am talking about and I think they have got to pay the right rate for that. UKFI. But I do think that the banks should show restraint Mark o a : I think it is a very different process. when it comes to bonuses, and I think that is an important feature of the discussions that are going on Q1128 Chair: It does look a bit odd that the at the moment. Chancellor is not involving himself at all, so it appears—not even as far as expressing an opinion on Q1122 Chair: Although you feel they should the remuneration package for the new chief executive exercise restraint, the Treasury and the Chancellor did of Lloyds, while UKFI is not involved at all in Project not express an opinion after UKFI had informed them Merlin. It does strike me as unusual. Treasury Committee: Evidence Ev 169
2 February 2011 Mark Hoban MP
Mark o a : I think it just recognises different consumer protection, we can talk about financial responsibilities. stability; I am not sure how that is consistent necessarily with having a specific duty around Q1129 Chair: On an earlier point that George Mudie diversity. I would not want consumer outcomes or raised—that we need to find ways of getting value for financial stability compromised by pressure on the money from the levy for the FSA and the successor delivery of diversity, and I am not sure our institution, the CPMA—would you be prepared to go constituents would either. away and have a hard think with officials about further ways of achieving that, beyond engagement with the Q1135 Mr Love: Let me raise two of the concerns NAO? This was an issue that exercised a number of that exist that relate to this issue, one mentioned by us hugely at the time of the Financial Services and Mr Mudie a few moments ago. Don’t you find it rather Markets Bill, and is still unfinished business in many surprising that low-risk organisations should find of our views. themselves paying more into a deposit protection Mark o a : I think it is an important point, and it scheme than high-risk organisations? That is the net is something we need to think about very carefully. It effect of what has happened to the building societies. is a topic that I— Mark o a : I don’t particularly want to get into a debate about the categorisation by risk but, of course, Q1130 Chair: When drafting the Bill, a new Bill? Mr Love, you will remember too the great Mark o a : It is a topic—I don’t think it’s consolidation that has gone on in the mutual sector, something we can leave until the new regulatory around building societies during the crisis. One of the regime is in place. I do raise issues around value for interventions the previous Government had to make money with the Chairman— was around the Dunfermline Building Society. So I am just very wary of making some statements about Q1131 Chair: We are going to have a new Bill, the level of risk associated with particular institutions. aren’t we? We are not going to try and do this with a There are other institutions that didn’t generate any succession of dog-eared amendments? financial loss, who are also picking up a higher bill as Mark o a : We will have a proper legislative a consequence of the financial crisis and paying levies process to set up the new body. into the FSCS. The levy is based on deposit-taking level and deposits that you take, and consumers get a Q1132 Chair: Was that a yes or a no? certain degree of protection as a consequence of that. Mark o a : We will have proper legislative I am just very wary about this. It is very easy to say, process; there will be a new Bill. “My sector shouldn’t get hit now for the levy because it’s somebody else’s problem”. The time may come Q1133 Chair: There will be a new Bill? when it is members of that sector who have to pick Mark o a : I mean, unless you have got any up all the bill and they would be grateful for some of interesting ways about how we might amend FISMA the cross-subsidisation that is on offer through the by an SI, but I don’t think we can. FSCS. Chair: We are going to write it again. I think it is a very seductive argument and I Mark o a : There will be a new Bill to set up the understand exactly the pressures that building new regulatory regime. It has always been our case societies are under on this, but they are not alone in that that is the case, that that will be the process. There facing this issue. Someone somewhere has to pick up is nothing new. the bill for compensation when an institution becomes Chair: We are not going to try and— insolvent, and it shouldn’t necessarily be the taxpayer. Mark o a : I think, Mr Chairman, we have always been very clear. Q1136 Mr Love: I accept entirely that there were Chair: Just as long as we are really clear on it. some building societies that did things that perhaps Mark o a : We have been very clear since June last were unwise in retrospect. The question I am raising year that there will be a new Bill to set up these is why was it not critical to the decisions that the FSA bodies. took that their established view of risk should not be the way in which they decided how much the deposit- Q1134 Mr Love: I want to come back to the taking institution had to pay towards compensation. comments raised earlier in relation to the Mark o a : The compensation scheme is on a flat- Government’s proposals to promote the mutual sector. rate basis. There is a debate about whether you should Specifically in relation to the new Bill, if there is to move to a prepaid scheme and whether that levy be a new Financial Services and Markets Bill, will should be risk weighted, but the scheme we have at you give the new regulator an objective to promote the moment is ex post funding, and that is on a flat diversity in financial services, as a way of addressing rate. some of the concerns that I will come on to? Mark o a : I think that we had this conversation Q1137 Mr Love: Let me just say that there are the last time I gave evidence to the Committee, and concerns expressed in relation to that. Let me go on we will be touching on it in the report. I will go back to mention mutual insurers. I’m not sure if you are to what I said earlier on. My priority is better aware of the debate around the closure of with-profit outcomes for consumers, so in a way I am blind to or funds and the likely disappearance of the mutual neutral about the method of ownership, but I recognise aspect of those insurers. Doesn’t that raise a concern we need to support mutuals. I think we can talk about with you that perhaps the regulator isn’t recognising Ev 170 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP the essential difference between the mutual sector and Q1142 Mr Love: There is considerable concern out the rest of the financial services sector? there in the small business sector. We had it reflected Mark o a : I am aware of that debate. It has been in the submission by your own institute, the chartered quite a long running debate between mutual insurers accountants, saying that the trust that had previously and the FSA. There is an issue about where the capital existed between small businesses and the banks has comes from to support mutual insurers. Historically, almost entirely dissipated. Are you concerned about they relied on money that built up in with-profit funds that? to provide that capital. If you look at an insurer like Mark o a : Absolutely. I think it is a big issue. I the Prudential and Aviva where that fund belongs to think it is not just between banks and business; I think with-profits policyholders, it has been a process of it is banks and the wider community. I think that we reattribution and looking at that fund where some need to look at ways of restoring that. I think one of money has gone to with-profits holders. the ways of doing that is a much greater degree of I think it is a very complex issue that I have raised transparency, and that is why we shouldn’t look at with the FSA. I have had a conversation with the chief Project Merlin in isolation. executive about this, and I am concerned about how The BBA, under the leadership of John Varley, had a we are going to find capital for mutual insurers. It taskforce, which reported last year, which set out does beg the question of whether we have a new some measures in which we can improve the mutual insurer. Where does the capital come from to transparency of the relationship between banks and start off a greenfield operation for mutual insurers? I their customers, particularly around business lending. think, again, that it is another one of these areas where For example, they committed to a quarterly survey to we have to think very carefully about how we find look at the attitude of customers to banks around capital for financial mutuals. I think it is a very business lending, the availability of finance and also important issue to try to resolve. regional lending data as well. I think that will help. Once trust breaks down, the best way to try and Q1138 Mr Love: I take that point and there are resolve it is greater transparency, and I think those different views about the basis on which you can raise surveys will help. Clearly, the banks are committed to capital as a mutual organisation and whether that will the Business Growth Fund, which will help provide prejudice the very mutuality that you are trying to equity investment to businesses, a modern day 3I. I protect. What I wanted to do was to raise two very think it is a very important contribution to achieving prominent concerns that exist, and ask the question— a much greater diversity of sources of finance. and I think you have tried to answer it as best you But the banks do need to do work and I think the can—about whether there should be some distinct commitments in the BBA taskforce will help them recognition within the regulator of the special improve that transparency. They are welcome and attributes of a mutual being different from that of the should be seen alongside, I think, lending rest of the sector. We will come back to this, I can commitments that are made as a consequence of absolutely assure you. Project Merlin. Let me go on. You are the Minister responsible for bank lending. We talked earlier about whether others Q1143 Mr Love: Are you optimistic that Project should be involved in the Merlin process. Are you Merlin will deliver the objectives of the Government? involved in the Merlin process as the Minster with Mark o a : We will wait and see what the that responsibility? Chancellor reports. Mark o a : There is engagement between the Government and the banks on this at various levels. Q1144 Mr Love: The SME financial sector is dominated by four banks; I am sure you are very well Q1139 Mr Love: Even though you are responsible aware it is 80% or so of the marketplace. Does that for bank lending and the Government is very concern you at all? Do you think that that doesn’t prominent in its concerns that the level of lending promote competition and therefore the willingness of continues to go down, you are not taking any direct banks to lend to small businesses? involvement in that whatever? Mark o a : Certainly, I think more players in the Mark o a : I didn’t say that. I said there is market will help, as long as people perceive that they discussion at various levels in Government about are getting a good deal and are able to switch. I think Project Merlin, both at ministerial and official level. there is a lot of concern, and Don Cruickshank’s original report was about lending to businesses. It is Q1140 Mr Love: There is a report in the in n i important, I think, to see more competition in the iestoday saying that the Government is looking for marketplace. I think it is also important that we see a 10% increase in bank lending to small businesses. greater flexibility and sources of finance for SMEs, Do you recognise that? that they become—there is more access to equity or Mark o a : I am always intrigued by articles I read direct access to debt markets for SMEs in a way there in the in n i i es and their origin. I am not going isn’t at the moment. I do think we need to see that to comment on it. The Chancellor will make a diversity in sources of funding. statement in due course. You took evidence from the new chief executive of Santander UK. I think they are working very hard to Q1141 Mr Love: The Chancellor will make a grow their SME lending sector and have quite statement in due course? ambitious plans. I think it is good to see new entrants Mark o a : Yes. coming into the market like that who can offer Treasury Committee: Evidence Ev 171
2 February 2011 Mark Hoban MP capacity. Of course, one of the things we have seen after the taxpayer’s interest but we are not doing recently is there were a number of new entrants anything for the taxpayer” because every time we around during the heady days of the boom who have asked them whether they were challenging on now rather withdrawn from the field hurt and that has remuneration, whether they were taking advantage of restricted the supply of lending, but new entrants the share price to sell a bit, the answer always came would be great. We need to see businesses being able back, “No”. We did ask, “Well, what did you do?” to shop around, but we need to see new sources of “Well, we focused on corporate governance.” Having finance out there as well to create a much more been in corporate governance for 10 years, that is sustainable model of finance for business. It shouldn’t precisely those things. That is what you do in just all be about debt. corporate governance. Just very specifically, I would be interested in your Q1145 Mr Love: One final question. You mentioned thoughts on one fact, which is that since the taxpayer about raising equity and other sources. Of course, that is in at an average price of 7 pence per share in is very prominent in the newspapers today that they Lloyds, why didn’t UKFI sell any shares last are looking for additional sources from other banks to September when the share price hit 80 pence? Their try and boost that ability. However, you would response was, “Well, it was only going to be a recognise that, even if you are successful in achieving temporary price rise and we didn’t want people who that, that will still be a fairly marginal contribution to bought them to then lose money subsequently”. But I the overall financing of the small and medium-sized thought in my naivety that that was the point of businesses. markets. You sell high and bad luck if the person who Are you concerned that we need to do more in terms bought it loses money on it. It did seem bizarre to me of the structure of the banking industry to widen that presumably we are paying sensible sums of participation in the marketplace to fund small money to these people so what are they doing for us? businesses? What do you think we could do in the Mark o a : I saw the exchange about— longer term—not the immediate priority, but in the longer term—that would help to make small business Q1148 Andrea Leadsom: Were you surprised? Did banking more competitive? you laugh? Mark o a : I would like to see more challenger Mark o a : No, I didn’t because we own I think it banks. I would like to see more new entrants into the is % of Lloyds Bank and to sell down that stake is banking sector to offer better deals and different going to be a significant challenge. products to SMEs. I know you took evidence from the FSA on the authorisation process and I think they Q1149 Andrea Leadsom: But you can’t do it in a have done some work to make that smoother. lump. I do think that we need to look across a broader Mark o a : No, I agree and I think you need to do horizon about the ways of getting more finance into it in a measured way. I do wonder whether someone SMEs. I know that the European Commission who bought at 80 pence would be prepared to buy published a consultation paper on their review of the again if they had lost money. I just think that they— MiFID, the Markets in Financial Instruments Directive. uite a big chunk of that is around SME Q1150 Chair: Was the Treasury approached by financing and how we can attract more equity into UKFI to consider a sale at that time? their businesses using exchanges. I think that is quite Mark o a : No, but I think one of the— an important development too, but we do need to see a broader range of finance. That means more players Q1151 Chair: Sorry, was that a yes or a no? in the lending market, but also, crucially, it means Mark o a : No. businesses not just being reliant on debt and looking Chair: So UKFI did not even bring forward a for equity from business angels, VCs, direct access to proposal? capital markets. I think there is a big challenge there. Andrea Leadsom: Yes, because the share price could have gone to £2 from 80p. Q1146 Mr Love: Very quickly, there is some debate going on about whether the advantages of debt in Q1152 Chair: Sorry, I just want to be clear. Did terms of the taxation of companies in this country UKFI bring forward a proposal to the Treasury at the should be dealt with by trying to make an instrument time when a sale was possible and profit, at any time? available to equity that would similarly reduce the tax Mark o a : Not at that time, no. burden on companies. Is that something the Government is currently looking at? Without giving Q1153 Chair: Have they at any time since then? away the secrets of the Budget, is it something that Mark o a : Not certainly since I have been a you are currently looking at? Minister. But they are aimed, Mr Tyrie, at trying to— Mark o a : I think there are a large number of it is a long-term plan; it is a big challenge to sell a people who have put forward proposals to shift or to stake of that size. I think that it is important in terms rebalance incentives around debt and equity. of looking at maximising shareholder taxpayer value in the long term to get that process right. Q1147 Andrea Leadsom: I just wanted to come back very quickly to the UKFI situation. When they Q1154 Andrea Leadsom: Yes, but if you ask came in it was rather astonishing because, as Chuka anyone in the equity markets, they would say you sell Umunna said, they did suggest that, “We are looking bits here and there when you get the opportunity. You Ev 172 Treasury Committee: Evidence
2 February 2011 Mark Hoban MP might have a programme sale in mind but at the same Mark o a : In terms of disposals by RBS that were time you would seize opportunities in the market, and mandated as part of the State Aid regime, of course it seems that UKFI have been in place now for a they have started to take place, and Santander have couple of years and have not done that. They don’t acquired a number of branches from—expressed in seem to have a strategy to do that. legal and technical terms, they are committed to Mark o a : I think it is right to recognise that there buying a package of branches from RBS. The is a degree of uncertainty around Lloyds as a European Union placed the same requirement on consequence of the Independent Commission on Lloyds Bank. I think the intention is to sell 600 Banking. I just think that it is important to get the branches in the case of— structure and process right. It is, as you know from your experience, a challenge to sell a stake of this size Q1158 John hurso: My particular question is— and it has to be done as a very considered process. I Mark o a : I think the deadline is later next year am not sure that opportunistic sales of relatively small for the sale of those Lloyds Bank branches. We proportions are the right way to do that, but it is a haven’t set out plans yet on whether we are going to matter—that is why we employ UKFI to advise us on be a shareholder at that point. But I would say this. these things. The requirements of the State Aid divestment say that Lloyds can only sell those branches to businesses with Q1155 Chair: Minister, you will have heard quite a a less important share of the personal current account bit of interest this afternoon about the divestments and market, which is less than 1 %. So that divestment the relationship between those and competition and should, I think, help either bulk up someone that is an concern for the consumer. You do not have to give a existing player or create the opportunity for a new definitive answer, but would you be prepared to entrant into the market. consider, as has been put to us, a public interest test incorporating competition considerations for the Q1159 John hurso: The Chairman’s question divestment of Lloyds and Northern Rock? I am asking about the Government’s attitude to competition and so you if you would be prepared to consider it. forth could be very different depending on what it is Mark o a : Well, I think we have been very clear selling—whether it is selling something with those that we are prepared to use the sale of our stakes in still in it and the divestment yet to come or with the the banks that we own to facilitate competition. I think divestment having already taken place. we have been very clear about that as Government Mark o a : I think clearly there is an impact on the policy. share price of those divestments and the extent to which the market price will factor in whether those Q1156 Chair: But would you be prepared to disposals have taken place or not. But the EU State introduce a public interest test? Aid rules are very clear, as they are applied to Lloyds Mark o a : I think we are acting in the public Bank, about who can buy those branches. I think it interest in the way in which we realise our holdings will be a helpful boost to competition. Interestingly, I in this and we have said consistently that competition think you had the chief executive of the Co-op in is an important aspect. We have had this discussion yesterday. I think the 600-branch network that Lloyds about the disposal of Northern Rock and that trade- will sell is a larger branch network than the Co-op has off, if there is a trade-off, between price and currently, so this is potentially quite a transformative competition. I think that is evidence of our move. commitment to this process. Q1160 John hurso: That is precisely my point. Q1157 John hurso: A very quick question. It is of What I was asking was whether the Government are course right that UKFI act basically as an institutional going to be proactively engaged in the transformation shareholder. It is also right that the Government have or a reactive shareholder in the— a clear policy. One of the questions regarding both Mark o a : I think the board of Lloyds Bank will RBS and Lloyds Banking Group is that the European be responsible for that sale process, but they know authorities require parts of them to be divested. Has they need to meet the State Aid divestment rules. the Government thought about whether it should be Chair: Thank you very much for coming to give still the biggest shareholder in one and certainly the evidence today, Minister. It is an issue of huge public largest shareholder in the other during that process, so interest, as of course you are very well aware. We will that they can have an influence on it, or would they be taking careful account of what you have said today like to leave that process entirely to the market and as we draft our report. maybe even divest themselves of the stake ahead of Mark o a : Thank you. that process? Treasury Committee: Evidence Ev 173
Written evidence
Written evidence su mitted y Consumer ocus Consumer Focus is the statutory organisation campaigning for a fair deal for consumers in England, Wales, Scotland, and, for postal services, Northern Ireland. We are the voice of the consumer and work to secure a fair deal on their behalf. We welcome the opportunity to provide evidence to the committee.
Executive Summary Global and domestic financial policy and the impacts of the recession have resulted in the market constricting. Prevailing bank models, and the dominance of the major combined institutions, have increased moral hazard, prevented new entry and restricted choice. In looking at competition and choice in the banking sector we ask the Treasury Committee to consider the following as crucial to reform: — Encoura ement of new models (not just new entrants) and consumer oriented innovation, including retail only models, that both provide real choice and safety for consumers. — Promotin a fair and competitive market place, one that ensures that consumers can have confidence in and exert choice to influence the sector through increasing transparency, providing early intervention in relation to unsafe or unsustainable products, safeguarding consumer interests and ensuring accessible and appropriate redress. — Guaranteein the provision of essential services where it is clear that the market will not provide and tackling problems of social exclusion by addressing the needs of the vulnerable and disadvantaged. — Enhancin the social usefulness of the market by supporting a savings culture, reducing risk, and securing sustainability of financial services in a broad sense—economically, environmentally and socially.
1. ssess t e i t t e n n i isis n etiti n n i e in t et i n es e ets 1.1 In a sector that thrives on virtual products, confidence can make or break a market. Addressing people’s low expectation of the sector is crucial,1 particularly to promote the savings and banked environment necessary to replenish capital stocks and give customers confidence in exercising choice. For low income consumers a lack of trust is the primary impediment to being banked. The majority of customers without a bank account are in this position because they’ve had bank accounts previously and had a bad experience; or they simply don’t trust the banks with their money.2 1.2 The market has become more concentrated, with bank failures, mergers, and state support for some major players resulting in less choice for consumers and more barriers to entry. The failure of companies like Icesave will add to the concerns about whether a new entrant can be trusted, particularly in times of crisis. There may also be a reluctance to move to new or small providers because consumers know the Government will bail out the big banks. More work needs to be done to determine how this may impact customer choices and what assurances need to be provided in relation to new entrants. 1.3 However, it is clear that some providers have benefited from consumers’ lack of trust with the main providers, with the increased popularity of co-operative models and the increasing success of peer to peer platforms such as opa. Competition and consumer choice in this area needs to be facilitated by removing barriers to these new models and extending the appropriate assurances and guarantees.
2. ssess t e i t i es e ns i ti n n n s n t s 2.1 The consolidation that has resulted from both global and UK financial services policy has led to a lack of diversity of models. Our recent research shows that a significant proportion of people are reluctant to switch banks because they feel there is little difference between them.3 2.2 Combined banking models standardise operations across their branch networks in pursuit of a “single customer view”. This can make it too costly or difficult for banks to service “hard to reach” parts of the market or assess and respond to the needs of local communities and enterprises. Prices for basic services (credit, overdraft charges) have gone up while rewards for savings have gone down. Services are increasingly being withdrawn from the less profitable markets or segments while the proportion of the population rendered vulnerable by the financial crisis has increased. 2.3 Low income consumers and those who are unbanked cite the failure of the sector to cater for them, the lack of options that would provide them with a functional service that allowed them to manage their finances, 1 Antony Elliot, in n i e i es , in Consumer Focus, et in in in n i e i es, June 2010, 38. 2 HM Treasury, Financial Inclusion Taskforce, Policis, e isin n in n si n: t e ie e ents n en es May 2010 3 3 % of consumers who have not switched provider believe banks are not sufficiently differentiated reinforcing OFT’s evidence that consumers perceive offerings as essentially very similar. e s n ent nts in t e 2008, 1. Ev 174 Treasury Committee: Evidence
and the prevailing model of hidden charges, as impediments to banking and choice. Without the encouragement of different models banking will become an exclusive service for the well-off.5
3. a ine the e a ie s t ent inhi itin inc ease c etiti n inc in e ati n 3.1 The impediments to competition identified in the Cruickshank report6 have not gone away, and in fact may be more significant as a result of the recession, and therefore need revisiting and updating.
Regulation 3.2 New entrants have a significant role in changing business models and delivering value for money. We suggest consideration of more stratified regulatory approaches for different models or activity. The EU requirements for Deposit Guarantees, which permits exclusions for certain categories of authorised firms such as Credit Unions, Friendly Societies and independent intermediaries, go some way towards recognising this— as does the regulatory regime for Credit Unions more generally. 3.3 The existence of separate regulatory processes for credit and deposit taking activities adds to the cost of the application process and the subsequent regulatory burden for those wanting to carry out both activities. The current authorisation process for deposit taking activities is complex and lengthy and the requirements designed to avoid risk may also act as a deterrent to new entrants. Market evidence, reputational and consumer protection issues are not given the same emphasis they receive in consumer credit licensing. More attention to these areas across the board may deliver a better balance of offerings. 3. Where there have been new entrants they have tended to adopt old models, given the cost and complexity of creating branch networks and infrastructure from scratch. It seems far easier to get authorisation if you buy off the rack rather than tailor to needs, hence the takeover of existing shells or mergers rather than stand alone applications.7 Assessments seem to favour those who take over existing networks or old systems as being better equipped. This is in effect stifles innovation and new approaches and creates the further challenge of absorbing and integrating existing branches and updating information technology systems.
Payment systems 3.5 New technology should offer great opportunities for new business models, small operators and more efficient and convenient payments methods. Firms’ investment plans for information technology are broadly flat for the next 12 months, while the balance for those planning to spend more on marketing in the coming year has risen to 53%, the highest in 10 years.8 The Faster Payments Service (FPS) is the first new payments service to be introduced in the UK for 20 years, but despite three years of operation it still does not do what it says on the label. The reason often cited for lack of innovation is the slowness of systems to respond and the difficulties of unifying and upgrading these, particularly post merger and acquisition. 3.6 The Cruickshank Review identified profound competition problems and inefficiencies in the market for payment services.10 Issues such as slow clearing cycles for cheques and automated payments, high charges for cash withdrawals and interchange fees levied by monopoly providers still prevail despite some improvements leveraged by the Payments Council. 3.7 The Payments Council is dominated by the major financial institutions and needs to do more to lead the future development of services. Historically, innovations have disproportionately arisen from small companies, however small stakeholders expressed a measure of dissatisfaction with the access and support they received from the Payments Council when proposing innovations.11 More pro-active work in supporting innovation and overseeing adoption, and a more inclusive membership structure to enable entry to payment providers that are not financial institutions, is needed to remove barriers to innovation and market entry. 3.8 New payment methods, and in particular payment methods that may actually benefit consumers, must be fostered within the system rather than developing outside it. For example, there is support for the widespread introduction of contactless and prepaid cards which are easy to use and accessible. Prepaid cards in particular offer a number of opportunities to financially excluded consumers, particularly those without a bank account or those who are reluctant to use a standard current or basic bank account to its full potential. Being able to transfer a set amount of money onto a prepaid card can potentially help them to manage their budgeting needs while at the same time allowing them to use ATMs, buy goods on-line or over the phone or use the cash-back facility in shops. There are no credit checks and no fees for going overdrawn. Consumer Focus, n the a ins ciet s st ne a e e e an an in e c si n, March 2010 and t nit n c s i in a te nati e an in s ti ns -inc e c ns e s at the st ce, January 2010. 5 inancia e ices , ethin in nancia se ices, Consumer Focus, June 2010. 6 C etiti n in an in e t t the Chance the che e , Don Cruickshank, March 2000 7 For example, Virgin bought Church House trust and Walton and Co is negotiating for Hampshire trust. 8 CBI PwC Financial Services Survey, 28 June 2010. http: www.chapsco.co.uk faster_payments 10 C etiti n in an in e t t the Chance the che e , Don Cruickshank, March 2000 11 OFT1071, e ie the e ati ns the a ents C nci , March 200 , 25. Treasury Committee: Evidence Ev 175
3. The Payments Council has been monitoring the market and has agreed to review this again by the end of 2011. Mobile payments are also being monitored. It is likely to mean that these methods will develop without consistent standards and consumer protections or will be left without support in a market that has been slow to adopt them. These systems are likely to offer less costly alternatives for small or new entrants. 3.10 There is a lack of offerings to attract customers or to distinguish financial institutions. Customers want to be able to manage their payments and so it is important that there is more certainty about clearing times and a firm commitment to a consistent service in relation to electronic transactions, as well as a range of payment options that are customer-controlled. Customer-controlled payments are a feature of the payment systems of other countries and our research has indicated that these options are key for consumers.12
Clearing fees 3.11 Highly concentrated markets, particularly for credit card acquiring, may enable incumbent banks to restrict new entry and charge high card fees.13 Fees set, essentially by the two main providers Visa and Mastercard, are well in excess of the cost of processing the transactions, and contribute to rising prices and restrictions on access to these systems.1 Large financial institutions are in a much better position to negotiate these charges whereas small organisations would not have this leverage. 3.12 Interchange fees are also an issue for ATM access and may discourage new entrants and provide impediments to alternative providers or providers of services to low income consumers. Interchange fees are likely to be an issue in DWP’s willingness to offer LINK ATM access to Post Office Current Account users. Interchange fees may also be a barrier to the remaining banks offering Post Office counter access, and therefore to improving provision in areas poorly served by banks at present (eg rural and urban deprived areas).
. a ine hethe c etiti n is inhi ite i c ties ace c st e s in accessin in ati n a t cts .1 Most financial products, by their nature, may not be conducive to market pressure as they are purchased infrequently and their impact is often long term. The complexity and sheer volume of offerings, charging structures, and the difficulty in comparing products create further impediments to demand-side drivers. The OFT studies in relation to the current account market show that there is a lack of readily available information on the various charges involved and this is exacerbated by use of different terminology and different ways of presenting rates and charges.15 .2 In the area of product regulation, the Mortgage Market Review Discussion Paper proposals16 and the policy paper on Distribution of Retail investments17 will help build consumer confidence that products and services are safe and fit for purpose in terms of affordability and risk. Intervention of this nature is needed at least in the short term to ensure transparency of information, some standardisation of products, and to restore balance to markets. Where there are choices they should be clear, transparent an safe. .3 Consumers generally would welcome a set of basic and safe products that met their needs.18 Basic bank accounts (BBAs) are important as a potential entry level product and for those on low incomes. Their appeal might be more universal, and less stigmatised, if some of the shortcomings were addressed. These include practised and perceptual barriers to opening accounts, the gap between essential account features and the functionality some BBAs offer (or don’t offer) and the perceived and actual risks associated with operating such an account.1 These products should be readily available, not collecting dust because of lack of sales incentives, and they should not be treated as second-class products.
5. e the e n ent an c etiti n a th ities st ate t inc ease c etiti n in an in inc in the i e ih that ne ent ants i s ccess ente the a et Public policy initiatives and essential service provision 5.1 A true safety net and real choice for those not currently being served is unlikely to be provided by the market alone. In other utilities, and in the internet market, it has been recognised that in delivering these essential services and ensuring that competition is functioning Government must play a role. Similarly the Government intervention in the banking crisis indicates the crucial role that banking plays in both economy and society and the legitimate role of Government when the market is not working. 12 Consumer Focus, t nit n c s i in te nati e an in ti ns inc e c ns e s at the st ce, January 2010, and ee in the ates innin , August 2010, 35. 13 European Commission, Report on the Retail Banking Inquiry, Commission Staff Working Document, SEC (2007) 106, http: ec europa eu competition sectors nancial services in uiries sec 2007 106 pdf 1 Recent figures from the British Retail Consortium estimate that the average credit card transaction costs retailers 3 p, compared with 8.5p for a debit card transaction and 2.1p for cash. This is in addition to the rental of the mobile card terminal, which can be about £500 a year and interchange fees levied by the customer’s bank and the retailer’s bank. http: it ly cmi L 15 Office of Fair Trading, e s na C ent acc nts in the , 2008, 0. 16 FSA, DP0 3, tae a eteie, October 200 17 FSA, PS 10 6, ist i ti n etai in est ents: e i e in the ee ac t C an na es, March 2010 18 Consumer Focus, t nit n c s, i in a te nati e an in s ti ns -inc e c ns e s at the st ce, January 2010 1 Ibid. Ev 176 Treasury Committee: Evidence
5.2 The Conservative and Liberal Democrat manifestos and the Coalition programme have emphasised the push towards sustainable and green banking alongside greater community engagement and the promotion of social entrepreneurship. We are yet to see the “detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry”,20 but this is unlikely to be achieved, particularly in the current environment, without specific incentives. Consideration needs to be given to taxes or tax incentives such as the Netherlands Green Funds Scheme. 5.3 Initiatives such as extending the services and functionality of the Post Office bank provides an option for addressing some of the defects in the market and for promoting universality and improved accessibility to banking products. Our research among low income consumers has shown that they want a custom account that is simple, convenient and offers control over their money, an account that is offered by a trusted provider. There was strong support for the Post Office Bank delivering this service, being seen as a community based and trusted institution.21 We call on the Government to view the Post Office as part of its strategy for retail banking. This model will require Government support. It should not, however, be the only model with a customer focus.
Encouraging switching or relying on the market to fix it doesn’t work 5. In relation to personal current accounts the OFT are seeking to rely on “significant changes in the market that will help lead to a better outcome for consumers”.22 There is no evidence of either significant changes or better outcomes to date. Indeed, since the decision by the OFT not to further pursue its action on charges, unauthorised charges have been creeping up again and authorised overdraft charges have increased significantly to ensure profit margins are retained. There has been no rush to introduce new charging models. 5.5 The consumer currently has limited choice in financial services and has intrinsically been reluctant to exercise that choice because of a loyalty to institutions once considered stable and providing an essential (not an optional or desirable) service. Our recent research shows that switching among consumers of financial services remains consistently low as compared to switching in other areas. Switching rates for current accounts in the UK has lagged at around 7% for the last 10 years, whereas utilities such as energy and phones show switching rates well in excess of this, starting at 26%. Those who are not interested in switching believe that there is little value to be gained because there is little difference in what is on offer and the switching costs, such as the potential for error and impact on credit rating, are too high.23 It appears that the market itself is not consumer driven and unlikely to change unless motivated by external stimuli that are more compelling.
Divestment rules, are they enough? 5.6 The public interest is a vital factor in the consideration of divestment options. The return on our investment is not just about selling to the highest bidder. 5.7 The German government has been able to agree more stringent conditions for state aid with their Landsbanken. Running through all of the Landsbanken restructuring plans is the need to reduce their capital market activities and proprietary trading, while returning to their local roots and core banking business. These are the areas where the UK’s divestment conditions could be improved. 5.8 Divestment conditions should take account of the public interest and aim to: — Promote competition and sustainability. — Prefer community based and controlled institutions. — Provide for sectors of the market not being served. — Focus on the provision of retail services and particularly simple and transparent products and charging models. 5. Public monitoring, audit and review of the divestment process to ensure conditions are being met needs to be ensured.
6. C nsi e the e ati nshi et een c etiti n an nancia sta i it 6.1 There is not necessarily discordance between competition and financial stability. Consumers are now looking for stability and sustainability (in a social, environmental and economic sense) in their banking but choices are limited.2 6.2 Financial stability also involves encouraging the unbanked to be banked, encouraging savings in an environment of lack of trust, and providing essential and affordable banking services to those market segments that are not serviced by current models. 20 The Coalition: a e e n ent, May 2010. 21 Consumer Focus, t nit n c s i in te nati e an in ti ns inc e c ns e s at the st ce, January 2010. 22 Office of Fair Trading, e s na C ent cc nts in the na an e e a ts, March 2010 23 Consumer Focus, Upcoming research report 2 See, EIRIS, What’s needed to mainstream green and ethical finance? November 200 and Neville Richardson, How can the consumer gain a voice in reform of financial services? in Rethinking Financial Services, Consumer Focus, June 2010, 5. Treasury Committee: Evidence Ev 177
6.3 The failings of the market and competition are associated with high risk and short term gains in the eyes of consumers. Long term, sustainable models are not widely available and need some help in overcoming the significant hurdles of regulation, market power and trust on entering the market and developing their business.
7. C nsi e the i act ee- an in n e ecti e c etiti n 7.1 Under the prevailing model of so called free banking, charges are hidden and punitive and present barriers to comparison. A consumer will not make decisions and cannot make comparisons on the basis that they are likely to encounter financial difficulties. Penalty charging is not a fair business model and is difficult for a consumer to predict or manage. 7.2 Penalty charging is also a barrier to consumers entering the market. One of the concerns among low income consumers is that the cost of having a bank account can lead to greater financial insecurity due to revolving credit and penalty charges. Respondents to our research on consumers without accounts cited lack of transparency in account based transactions as undermining budgetary control and planning.25 Our recent research into pay day lending has indicated that many consumers chose pay day lending because they found the fee structure easier to understand, even though rates are very high and it may cost them more.26 7.3 The cross-subsidy model supports existing institutions and combined models, as they have the established business from which to divert resources and a wide model which allows for this to happen. The big institutions have deep enough pockets to offer products and services on terms which may not necessarily reflect cost (at least in the short term) or be a product of competitive measures. Existing players use introductory offers to lure in customers with the confidence that profits can be made once that offer ends because they can bet it is unlikely a customer will switch.27 ete e 2
Written evidence su mitted y Barclays Introduction 1. Barclays welcomes this inquiry as an important further contribution to the debate on the future shape of the banking industry. 2. The Committee’s inquiry coincides with a number of investigations into the banking sector including the Office of Fair Trading’s review into barriers to entry, expansion and exit in retail banking and the Independent Banking Commission’s inquiry into banking reform, financial stability and competition. 3. Barclays supports measures to promote stable and competitive financial markets. . Banks play an essential role in society by taking deposits, providing money transmission and credit services, and enabling “maturity transformation” to take place which helps households and business absorb financial risks and uncertainties. In performing this role, banks need to manage their business in ways which facilitate appropriate risk-taking by households and business, which do not pose unacceptable risks to financial stability, which help maintain market and consumer confidence, and which also support effective competition in the market. The interaction between these policy goals needs to be acknowledged and balanced by policymakers. Your review will be important in exploring these inherent policy tensions and helping ensure that an appropriate balance is struck.
Recent Changes in the Banking Market 5. The market has experienced significant change over the last few years. There has been consolidation (eg Santander’s acquisition of Bradford & Bingley and Alliance & Leicester, Lloyds TSB’s acquisition of HBOS and mergers and acquisitions in the mutual sector) and foreign players have exited the UK market (eg the Icelandic and Irish banks). Some pre-crisis business models have proved unsustainable (usually because of excessive reliance on wholesale funding). Despite these changes, the landscape remains competitive and dynamic with the emergence (even during the crisis and its aftermath) of new competitors, products and customer propositions. 6. New entrants into the retail banking sector have used a variety of methods to enter the market. These range from those who are developing full retail banking operations to compete across a range of products (including current accounts, mortgages and savings), such as Santander and Tesco Bank; to those who compete strongly on a monoline basis on one or more specific product areas, such as ING Direct. We are also seeing new retail market entrants such as Metro Bank and Virgin and increasing activity from emerging country banks such as India’s ICICI. 7. That said, the scope for product providers to generate commercial returns from a wider range of offerings in the current macroeconomic environment is limited. In its 2010 Financial Risk Outlook, the FSA cited the 25 Consumer Focus, n t e ins iet s st ne e e e n n in e si n, March 2010, 26 Consumer Focus, ee in t e tes innin , August 2010 27 ISA Super complaint, http: www.consumerfocus.org.uk campaigns super-complaint-cash-isas Ev 178 Treasury Committee: Evidence
example of the Building Societies sector where it believes low net margins and a difficult macroeconomic environment will continue to challenge profitability in the immediate future, and where competition for retail funding is likely to remain high, and may intensify further.
Impact of Regulatory Reform 8. Barclays agrees with the need to reform and strengthen banking regulation and supports the G20 reform agenda. The extent of change already delivered by Governments, central banks, supervisors and the industry has been significant. But there is still more to do. . Since the crisis began, Barclays Core Tier 1 capital ratio has more than doubled from .7% to 10%, and our liquidity buffer has increased from £1 billion to £160 billion. Barclays leverage ratio has fallen from 33x to 20x. It is clear that capital and liquidity ratios have moved to a permanently higher level as a result of market and regulatory developments; and that lower leverage (relative to pre-crisis levels) will be regarded as a key measure of stability going forward. 10. Regulatory barriers both on entry, and on a continuing basis, are already relatively high (eg capital adequacy requirements, systems and controls, conduct of business rules, etc) and are likely to become higher when prudential reforms to strengthen stability are fully implemented. Whilst these reforms have attracted broad support, they will make it more difficult for banks to achieve target returns on capital that are acceptable to shareholders and, other things being equal, will make entry into the banking market less attractive. 11. Given the global nature of banking, it is vital that a level playing field is maintained to avoid regulatory arbitrage and competitive distortions. The British banking industry will best serve British households and business (and thereby contribute to the UK economy) if it is able to compete on equal terms. Prudential reforms need to be implemented to broadly equivalent standards and timescales in different jurisdictions. This is important both within Europe (eg harmonised implementation of Basel 3 and CRD , including the approach to discretionary measures) and also between the EU and the rest of the world, notably the US. It is also important that prudential requirements do not introduce competitive distortions between types of financial institution (the risk here is pushing risk currently being taken by regulated financial institutions into unregulated territory).
Stability in a Competitive World
12. Barclays believes that diversity by business model, type and size of banks is a source of resilience to the financial system and of advantage to customers and clients. A broadly based industry increases the capacity of the overall system to absorb risk. An industry made up of small, narrow banks is less resilient (witness the Ca as and an es an en communities in Spain and Germany) and poses more risk to financial stability than a mix of banks of different sizes and with different business models. 13. We see a number of specific benefits in the business model we follow. Our range of service and product capabilities allows us to respond strongly to the needs of customers. Our experience over time suggests that broadly based banks are more resilient to shocks and unexpected changes in market conditions. Barclays universal banking model has demonstrated its ability to be a risk diversifier during the current crisis (aggregate pre-tax profits generated by Barclays since the crisis began in Summer 2007 up to and including first half 2010 amount to some £25 billion). 1 . In addition, firms that have a large deposit-holding business (in proportion to their overall size) are likely to find it easier to meet capital and liquidity requirements under a wider range of stressed circumstances than other firms. During the credit crunch, those institutions with a narrow funding model (particularly those relying on securitised and wholesale markets to fund assets) suffered immediate impact from the closure of the wholesale markets, which had devastating consequences on their liquidity and capital position. 15. It is important to the sound working of competitive markets that large complex banks can recover, be rescued, or allowed to fail in an orderly way without recourse to taxpayer funds. Barclays fully supports the development of recovery and resolution plans, and is fully engaged with the ongoing work by the authorities to develop better coordinated and more effective crisis management regimes for cross border banks.
Competition and Customers
16. Competition for market share of different banking products delivers choice for consumers and has made the UK banking market one of the most innovative and customer centric in the world. An appropriate framework for regulation and competition should support a market in which customers can shop around for a range of banking products and secure them on terms that benchmark appropriately with international standards. Research has shown two things: that a customer in the UK is likely to hold a range of financial services products sourced from different providers (much higher concentration of suppliers is observable in most other markets); and that for those who hold a credit balance on their current account, the cost of a basket of retail products in the United Kingdom is considerably lower than the equivalent in most developed markets. Treasury Committee: Evidence Ev 179
17. Low levels of current account switching are perceived, by some, as evidence of a lack of competition. However, actual switching data only present part of the picture as the European Commission recently found.28 In reality many UK customers multi bank; the average UK customer holds two current accounts. Barclays was pleased to participate in the recent OFT market study on switching bank accounts which addressed how the switching experience for customers could be improved. For switching to be hassle-free, it is important that direct debit originators also play their part and amend their records as appropriate. 18. Simplicity, transparency and reliable customer service are key to empowering customers and enabling them to shop around and choose the product that is right for them. Barclays works closely with consumer groups, regulators and competition authorities to develop products which meet both our customers’ needs, and the requirements of our regulators. For example, our basic bank account (designed to help those outside the banking system gain access to it) was developed in conjunction with consumer representatives and is viewed as one of the best in the market. We have nearly one million such accounts. In 2008 we introduced new current account products with a Personal Reserve in response to customer needs for certainty, simplicity and transparency. In 2010, the OFT’s report on current accounts2 set out its ideal model for a current account service, which Barclays Personal Reserve meets in almost every respect. 1 . Comparative information can be important in helping consumers make informed choices, but we think it should be developed in the right way to ensure that it is additive and not misleading. The OFT has successfully worked with banks and consumer groups to improve transparency, and over the next 12 18 months banks, including Barclays, will:30 — introduce an annual summary of the cost of their account for each customer, which will help them to identify more clearly the value they are getting in a similar way to annual car or house insurance renewal quotes; and — provide average credit and debit balances, which will help consumers to estimate the potential benefits of switching bank. 20. Banks have already produced and published illustrative scenarios showing unarranged overdraft charges, giving consumers an idea of the costs for different patterns of use. 21. The UK is unique in operating a “free if in credit” current account business model (eg no charges for ATM withdrawals, online and telephone banking, direct debits, standing orders, mobile banking and most routine transactions). The model is popular with many consumers and attempts by some banks to move to alternative business models have failed to attract support from consumers or representative organisations. We recognise the commercial difficulties facing any market participant seeking to move from such a business model. 22. The provision of banking services to SMEs has also been the focus of a number of inquiries.31,32 Barclays and the other main UK banks gave pricing and behavioural undertakings to the Competition Commission in 2002, which were reviewed by the OFT in 2005. Behavioural undertakings and price change reporting to OFT remain in place. However, the Competition Commission and OFT considered the market to be sufficiently competitive to remove the pricing undertakings in October 2006. 23. As with retail banking, the SME market has continued to evolve with online banking providing an important new channel since the last competition review. Barclays and other providers now provide the option of online accounts at cheaper cost to SMEs. Here, too, new entrants have changed the market through the introduction of innovative products and services. For example: PayPal has become a popular online payments services provider, used frequently by online businesses; Ford offers asset finance on some of its vehicles; the Bank of China has entered the market for buy to let mortgages; Weatherby’s provides full service money transmission SME banking with no branch network; and Travelex, Hi-F and F -Moneycorp provide foreign exchange services. 2 . The wholesale market was heavily affected by the withdrawal of foreign lenders at the height of the financial crisis. However, Barclays has continued to lend actively to creditworthy corporate clients and businesses in all segments throughout the last three years. 25. Our investment banking activities play a vital role in enabling us to deliver a full relationship banking service to clients, helping businesses to raise capital, bringing companies to the market for the first time, advising on risk management strategies, and so on. The breadth and depth of Barclays offering to clients has developed in response to the changes in client need. Barclays Capital provides large corporate, government and institutional clients with advisory, financing and risk management services. The presence in wholesale markets of large, sophisticated counterparties and competitors ensures vigorous contention for business, a 28 http: ec.europa.eu competition sectors financial_services inquiries retail.html 2 http: www.oft.gov.uk shared_oft personal-current-accounts oft1216.pdf 30 http: www.oft.gov.uk news-and-updates press 200 122 0 31 http: www.competition-commission.org.uk inquiries subjects banks.htm 32 One difficulty which has been encountered, is to arrive at a definition of SME banking. The UK competition authorities use turnover of up to £25m to define an SME, however, Barclays does not have an “SME division” as such, but segments customer groups broadly on the basis of where the mass market, covered by UK Retail Banking, ends and bespoke services, covered by Barclays Corporate banking, begins. Ev 180 Treasury Committee: Evidence
diversity of product offerings, and constant service improvements. In common with many of its clients and competitors, Barclays Capital operates on a global basis. 26. Innovation is an integral part of our business strategy. For example, Barclays Capital acted as joint bookrunner, underwriter and adviser to Resolution plc on its recent rights issue. The rights issue is partly financing Resolution’s acquisition of certain of A A SA’s UK risk and pension insurance businesses for a total consideration of £2.75 billion. Barclays Capital helped put in place an innovative fee structure, aligning risk and economic reward, which delivered a strong message of support, lowered overall costs, and provided a greater allocation of fees to shareholders. 27. Since the start of 200 , Barclays Capital has been involved in more than USD 260 billion of equity underwriting and played a role in over USD 2,000 billion of debt underwriting for public and private sector clients.33 This is essential, real economy work.
Conclusion 28. Despite the changes in recent years, the banking market remains competitive and dynamic with the emergence of new competitors and new products and services for customers. 2 . Whilst we welcome the focus on strengthening the regulatory regime in the UK, the EU and internationally, we look forward to the final determination of the optimal reform package. This will help give clarity and certainty to customers and investors and allow us to focus on our core purpose: fuelling sustainable economic growth in ways that deliver appropriate returns to shareholders. ete e 2
Written evidence su mitted y Vir in Money 1.0 Executive Summary 1.1 Retail banking does not seem very competitive. It is dominated by five large banks with broadly similar products, prices and customer service. As a strongly pro-competition new entrant, we would like to see greater competition, and we believe that competition in retail banking would benefit from more providers and from greater diversity of providers. But smaller providers and new entrants will make little difference to overall competition in retail banking if entry is difficult, and if those which do enter simply compete with each other for such switching business as is available in a “two tier” market of large incumbents and smaller providers. 1.2 Our view is that smaller providers and new entrants will only be able to compete effectively with the larger incumbents if actions are taken to reduce or eliminate some significant barriers which are discussed in this paper. Our conclusions, from consideration of these barriers, support our specific recommendations at the end of this submission.
2.0 Background and Introduction 2.1 Virgin Money was established in 1 5. It now has over two and a half million customers, and currently offers a range of financial products across lending (including credit cards), savings (including tracker funds) and protection (including motor insurance). 2.2 Virgin Money’s experience is that initial entry to financial services through the provision of a limited product proposition is not particularly difficult. We have maximised income opportunities by concentrating on “transactional” products such as credit cards and motor insurance, where customers are willing to switch between providers, and have minimised costs by outsourcing product “manufacturing” activities to established providers, and by limiting access to direct channels—mainly the internet. 2.3 Despite Virgin Money’s success so far, we recognise that this business model has some limitations. Because of its limited product range and the absence of branches, it does not appeal to all customer segments. In considering how to expand our business to the benefit of a wider range of customers, and become a credible alternative to large incumbent banks, we believe that it is important for us to become a full-service bank, offering “relationship” as well as “transactional” banking products. As a first step towards establishing full- service banking capabilities, to support our business expansion, we acquired a small bank, Church House Trust, in January. 2. Our business plan to become a full-service bank sounds simple. We aim to add a range of “relationship” banking products—deposits, mortgages and personal current accounts (PCAs), and, if possible, banking services for small business (SMEs). To meet customer needs and expectations, we plan to open a limited national branch network. And, to maintain our “Virgin” reputation for product innovation and good customer service, we intend to establish some in-house “manufacturing” capabilities. 2.5 In planning this business expansion, we are encouraged by the demand for Virgin to offer a credible alternative to the large incumbents. uantitative research from February 2010 shows that consumer 33 Source: Dealogic Treasury Committee: Evidence Ev 181
consideration for Virgin as a banking provider has grown to reach the same levels as the incumbent big four high street banks (NatWest, Lloyds TSB, HSBC and Barclays). However, despite consumer consideration on a par with the incumbents, we observe that a number of barriers make the implementation of our plan more difficult than it sounds—or, we think, than it would be in many other industries. We discuss a number of such barriers in the next section of this submission.
3.0 Barriers to Entry and Expansion aetstcte Barrier 3.1 It is difficult for new entrants to compete with the large incumbent banks in retail banking because of the large banks’ dominant market shares in most banking products, particularly in the key relationship banking products, PCAs and SMEs.
Commentary 3.2 The UK market in retail banking is highly concentrated. Four large domestic banks (Lloyds, RBS, Barclays and HSBC) and the UK subsidiaries of the large Spanish bank Santander, together account for almost 0% of PCAs and over 0% of SMEs. Lloyds Banking Group (formed by the merger of Lloyds TSB and HBOS) alone accounts for 30% of PCAs and over 20% of SMEs. 3.3 In such a concentrated market, these five banks enjoy competitive advantages from substantial economies of scale in their operational and marketing costs, and from their extensive branch networks. 3. Twenty years ago, there were many more providers of personal banking services and a much greater variety of providers. In addition to the “Big Four” (Barclays, NatWest, Lloyds and HSBC), customers could choose as alternatives the two Scottish banks (RBS and Bank of Scotland), the unique TSB, the converted bank Abbey National and the about-to-convert Halifax, and a number of building societies with national distribution including Nationwide, Cheltenham & Gloucester, Woolwich, Northern Rock, Alliance & Leicester and Bradford & Bingley. Many of these providers were retail-only, and they competed effectively with the “Big Four” by offering a different product focus or service proposition, reflecting the priorities of their stakeholders. Now, in the UK, there is no credible alternative to the large banks for full-service banking, except to some extent Nationwide and the UK subsidiaries of NAB.
Conclusion 3.5 The UK banking market has evolved to the point where there is a limited oligopoly of incumbent banks that have very little differentiation. As we will discuss in the following sections (3.6 to 3.1 ), their control of the PCA and SME markets makes it very difficult for a new entrant to compete effectively and grow successfully in this market.
e s na C ent cc nts C s Barrier 3.6 In personal banking, PCAs are key “relationship” products, enabling banks to establish long-term relationships with their customers, to gather information about them and to offer them other suitable products. However, PCA switching rates are low, and it would take some time for a new entrant to achieve scale in PCAs—during which time incumbent banks could respond to threats from new entrants.
Commentary 3.7 We believe that “free” banking contributes to the low rates of switching in PCAs: — The widespread availability of “free” banking means that all banks seem the same to consumers, and there is no obvious financial incentive for customers to switch their current accounts. — Even if customers are considering switching between current account providers, “free” banking means that it is not easy to assess likely charges, and it is not possible to compare the levels of service offered by different banks, except by hearsay. “Free” banking makes it very difficult for new entrants to the PCA market: — New entrants are not able to compete by offering lower prices (than zero) or by innovating with simpler, lower-cost products. 3.8 Of course, “free” banking is not free. Free banking for good customers is subsidised by “insufficient funds” charges, which are generally paid by customers who are less affluent or less well-informed. We believe that it would be fairer for all customers to impose or at least encourage a more rational pricing structure, with lower insufficient funds charges and with some appropriate fees for PCA services. As well as being fairer, this more rational pricing structure would make it easier for customers to compare their likely charges, and would enable new entrants to compete on price and through innovation. Ev 182 Treasury Committee: Evidence
Conclusion 3. We recommend that the TSC should acknowledge the need to bring fairness and transparency to current account bank charges.
a sinesses s Barrier 3.10 It is desirable that a new entrant to retail banking should be able to offer SME as well as personal banking services, to serve the needs of communities, including many small businesses where personal and business activities are inter-related, as well as to generate additional income to justify the necessary investment in people, infrastructure and branches. However, organic entry to SME banking is very difficult.
Commentary 3.11 To enter SME banking, a new entrant would have to offer current accounts and other SME banking products, recruit experienced customer-facing and credit personnel, and invest in appropriate infrastructure— and would probably have to open branches, since many SMEs visit branches frequently for advice and to make payments. Credit management is also challenging for a new entrant, without historic customer information. 3.12 Even if these could all somehow be resolved, there would remain the difficulty of demonstrating a reputation for good service in SME banking. SME banking is different from many other businesses in that both the customer and the bank expect a long term relationship in which the unquantifiable aspect of service is as important as the quantifiable aspect of price. A reputation for delivering the required quality of service can only be achieved through being in the business. So, in a perverse sense, an SME bank “has to be in the business to enter the business”. 3.13 A new entrant without a reputation would find it hard to compete on price alone, because switching rates of existing SMEs are very low, and new SMEs are offered free banking for an initial period—and so, given the absence of a price advantage from new entrants, new SMEs (and their financial advisors) are likely to “play safe” with established incumbents.
Conclusion 3.1 Given the barriers to organic entry and expansion, including the necessary up-front investment in people, products, infrastructure and branches, the absence of a reputation in SME banking and the time it would take to achieve scale, it is clearly difficult for a new entrant to become a significant challenger to the large incumbents within a reasonable period by this route.
th a ne ent ant th h ac isiti n Barrier 3.15 An alternative route, to accelerate entry and expansion for a new entrant, would be the acquisition of a suitable banking business. However, in practice, entry by acquisition is difficult—possibly even more difficult than organic entry.
Commentary 3.16 Although theoretically attractive, it is not easy to enter retail banking through the acquisition of a suitable banking business: — In the UK, no small banks with suitable characteristics exist. — It is clearly not possible for a new entrant to buy a large incumbent bank. — Acquisition of another new entrant would add scale in “transactional” products such as credit cards and insurance, but would not address the strategic objective for a new entrant of entering the market for PCAs and SMEs, and establishing branches. — Acquisition of a building society would add capabilities in mortgages and deposits, and branches, but the acquisition of a mutual building society is a prolonged process and is vulnerable to interloper risk. Other than Nationwide, building societies have only limited regional networks. 3.17 It is extremely unlikely that incumbent banks would wish to sell any of their core retail banking assets. If such banking assets do become available, as a result of financial difficulties experienced by incumbents, it is still very difficult for new entrants to take advantage of such opportunities: — The first of the EC-mandated disposals, the sale of the RBS assets (in which Virgin Money expressed strong interest, and for which it received indications of material financial support) to Santander, shows that a new entrant can be beaten by an incumbent which is able to deliver cost- saving synergies and funding benefits by integrating the acquisition with its existing business, while meeting the market share threshold set by the EC (regardless of other competition issues). Treasury Committee: Evidence Ev 183
Conclusions 3.18 Growth through acquisition is challenging for a new entrant—and this makes the disposals being made of RBS, Lloyds Banking Group and Northern Rock assets critically important if further competition is to be introduced into UK banking. 3.1 These disposals should be subject to the normal OFT Competition Commission review on their likely impact on competition in the UK, but in addition should also benefit from a public interest test where the long- term economic implications of proposals made to acquire the assets are understood. Such a public interest test should consider, for example, the retention of jobs and the commitment to lending made by a potential acquirer. 3.20 This will ensure that the RBS, Lloyds Banking Group and Northern Rock disposals are not judged just on the short-term economic value they deliver to shareholders, but also on the long-term value they create for society, including stimulating greater competition. 3.21 In addition, the disposals of RBS, Lloyds Banking Group and Northern Rock assets should be structured such that there is a level playing field for banking incumbents and new entrants (for example, by enforcing the provision of cost cover for due diligence for all parties). 3.22 In particular, we believe a public interest test should be applied to the RBS asset disposal before the transaction is completed and the assets sold to Santander.
e ati n Barrier 3.23 Basel II regulations place new entrants at a financial disadvantage relative to the large incumbents, despite the fact that retail-only new entrants such as Virgin Money are essentially low-risk, while the large incumbent banks have high-risk activities in investment banking, including complex products and proprietary trading.
Commentary 3.2 Pillar I of Basel II prescribes how banks must calculate capital for credit, market and operational risks. New entrants, without a sufficient track record, must use a standard approach. Large incumbent banks are allowed to use their own statistical models to estimate their capital requirements, which have generally been lower than would be required by the standard method, despite the limitations of the models in extreme situations. 3.25 In addition to the Pillar I requirements of Basel II, the local regulator requires additional capital to be held under Pillar II for other risks, and for stress tests. Although the local regulators’ requirements for individual banks are not disclosed, it is believed that new entrants may be subjected to more onerous requirements, compounding the Pillar I imbalance. 3.26 The disadvantage of requiring proportionately more capital is not particularly onerous at entry, when the amounts of capital are relatively small. However, as a new business expands and requires more capital, the cost disadvantage from having to carry proportionately more capital could become a significant barrier.
Conclusion 3.27 A level playing field in capital requirements between incumbents and new entrants would reduce this barrier to new entry and expansion, and would encourage greater competition. Given the riskiness of the business models of large banks, and the limitations of their risk models, our conclusion is that a level playing field should be achieved by requiring large banks to hold at least as much capital (proportionally) as new entrants—and perhaps more at some times in the economic cycle.
e n ent initiati es Barrier 3.28 It seems unlikely that a more competitive market in retail banking will emerge unless the authorities are willing to impose more pro-competition measures than have so far been indicated.
Commentary 3.2 Policy initiatives over recent years have been disappointing for new entrants. The Cruickshank Review quantified “excess profits”, but did not suggest structural changes or actions to improve competition. The Supreme Court failed to support the OFT ruling that current account insufficient funds charges should be reduced, preventing the possibility that banks might start to charge for some current account services, to offset their reduction in income—a move which, we believe, would have encouraged greater competition and more switching in PCAs. The acquisition of HBOS by Lloyds TSB was allowed. Ev 184 Treasury Committee: Evidence
3.30 Although only two of the five large banks (RBS and Lloyds) received state aid, all banks benefited from actions taken to protect the banking system, and now they all benefit from being perceived as “too big to fail”: — There is no incentive for customers to move deposits from a state-aided bank, or from a bank that is “too big to fail”. — In an environment where bank lending is restricted, banks have greater power than their borrowers to determine the availability and pricing of loans. — The large banks, whether overtly supported or not, are all benefiting from funding rates lower than they would otherwise be—and lower than new entrants.
3.31 These factors make it difficult for new entrants to benefit significantly from the financial and reputational difficulties suffered by many large banks in the financial crisis. In other industries, where large providers are not protected, strong challengers can gain at the expense of weakened incumbents.
3.32 Banking initiatives have tended to concentrate on one aspect of banking at a time, without considering the possible unintended consequences on other aspects. In particular, the need to create a more competitive framework has been subordinated to financial stability issues. We therefore welcome the current initiative by the OFT and the TSC to look at competition in retail banking, and the establishment of an Independent Commission to consider at the same time financial stability, possible reforms and competition.
3.33 However, it is disappointing that, while the sale of Government-owned shares in RBS and Lloyds have been deferred until after the Independent Commission has reported, and will be sold with a view to encouraging greater competition, the disposal of RBS’s retail banking assets, which could have been a key component in the creation of a more diverse and competitive retail banking market, has been allowed to proceed.
Conclusion
3.3 In view of the continuing benefit that all large banks are gaining from their “too big to fail” status, we believe that the Government will have to introduce some significant legislative or regulatory reforms such as those recommended below, to redress the detriment to competition caused by the “too big to fail” status of large banks and by the prioritisation of financial stability above competition, and to deliver the cross-party pre- election consensus of the need for a more competitive and diverse retail banking market.
.0 Recommendations
.1 tt e s
Consider splitting large retail banks into smaller units as well as to splitting large banks between retail banking and investment banking
.2 ent nts
Acknowledge that the ending of the apparently unfair cross-subsidy in current accounts caused by unauthorised overdraft charging would be fairer for all customers, and would enable competition in the PCA market to be more easily created.
.3 etin
Remove any regulation which, however well-intended, is unfairly onerous for new entrants to retail banking and could therefore discourage new entrants.
. e ent nts
Consider what legislative or regulatory reforms are required to encourage the creation of new building societies, banks, credit unions and community banks, as the Conservatives promised before the election.
.5 isiti ns
In relation to retail banking assets being sold now or in the future, take a wider view of public interests (including in particular the expected impact on competition) than has been the case during previous banking consolidation. ete e Treasury Committee: Evidence Ev 185
Written evidence su mitted y Nationwide Buildin Society Nationwide Building Society welcomes the opportunity to respond to the Committee’s inquiry into competition and choice in the banking sector. We are the UK’s third largest mortgage lender and savings provider, with around £1 0 billion in assets. As the UK’s largest building society we are different from many of our competitors. Unlike banks that are run for shareholder benefit and to maximise profit, we are owned by and run for the benefit of our 15 million members.
Executive Summary — The banking sector has changed considerably, with widespread consolidation over recent years leading to the mortgage, savings and current accounts markets being dominated by the largest high street banks. — In the short to medium term, greater competition in banking is more likely to come from existing participants than from new entrants since the UK is effectively a mature, low-growth market. Competition also materialises from “challenger” brands operating successfully amongst the high street banks. — Government proposals to “foster diversity, promote mutuals and create a more competitive banking industry” are welcome but no further details have been communicated to date. — Building societies offer much needed diversity, with their long-term focus providing a much- needed counter-balance to the short-term pressures of the banks. The mutual business model— based on lower risk, trust, a focus on customer service, price stability and member engagement— offers consumers a genuine alternative. — However, the current regulatory approach threatens to reduce mutuals’ competitiveness with banks. Regulation must recognise the needs of the mutual model, particularly with regard to capital requirements. At present, societies are without a wholesale Core Tier 1 capital instrument that is consistent with mutual principles, satisfies the demands of regulators and meets the needs of investors, leading to potential negative impacts on competition. — The Government should also be mindful of the cumulative burden of existing and new regulation across the financial sector. It must seek to achieve the right balance of stability, competition and ensuring appropriate returns can be made to encourage market entry and expansion. — Together with regulatory requirements, significant barriers to entry and expansion exist in the form of brand strength, branch networks, low margins and customer inertia. — When considering greater transparency of information on financial products, a balance must be struck to avoid information overload, potentially increasing consumer inertia and apathy. — Foreign-based operators remain strong competitors in the savings market but are unlikely to re- enter the mortgage market in the medium term.
I. Wi es ea c ns i ati n has e t the t a e sa in s an c ent acc nts a ets ein inate the a est hi h st eet an s 1. Focusing on the impact on retail markets only, there has been widespread consolidation amongst banks and mutuals which has led to an increase in concentration in key retail markets. Market share for the top five players in the mortgage market increased from 55% to 68% between 2007 and 200 ; 7% to 62% in savings; and 7 % to 8 % in personal current accounts. Although part of this can be attributed to volume performance, the vast majority of the change is due to consolidation (Appendix 1). 2. Lloyds Banking Group, Santander, Nationwide, Barclays, RBS and HSBC made up the six largest UK retail businesses in 200 , accounting for 81% of the total UK retail assets of the largest 15 market participants. In 2007, the top eight firms, which included Northern Rock and HBOS, comprised 81% of the top 15 banks mutuals (Appendix 2). The mortgage, savings and current account markets are now dominated by the largest high street institutions (Appendix 3). 3. The number of “post crisis” entrants into Personal Financial Services (PFS) markets has been limited, despite media noise. Entrants include Tesco (who were operating before the crisis but were and are focused on segments of PFS markets), Metrobank (which has recently opened its first two branches) and a few overseas organisations. The impact of these entrants on PFS markets is limited due to the current size of their operations and scope of activity. The new entrants are likely to have greater impact on PFS markets when they have generated the financial and organisational infrastructure to distribute products on a wider scale, in addition to far greater brand awareness by consumers.
II. n the sh t t e i te eate c etiti n in an in is e i e t c e e istin a tici ants than ne ent ants . A healthy degree of competition is vital for financial stability and the UK has a wide variety of PFS providers. However, the pre-2007 evidence suggests that there is a limit to the number of competitors that can be active in a stable market while making acceptable returns for their owners. As we have seen, large retail banks are heavily entrenched in the market and simply increasing the number of new entrants will not deliver Ev 186 Treasury Committee: Evidence
genuine competition. Supporting the “challenger” brands already operating successfully amongst the high street banks is necessary to achieving this goal. 5. Any new entrant will be faced by all the problems of lack of scale and the range of entry barriers outlined below. New banks will need to take market share of an existing player, since the UK is effectively a mature, low-growth market. This would require a USP, such as service or more likely price, both of which will inevitably impact on marginal and average costs of acquisition and administration of business. The fact that it took two years for a new bank to recently open a branch is a further illustration of the challenge. 6. Existing banks and societies will be attempting to retain their best, most profitable customers and are likely to be able to offer better deals to them than a new entrant could manage. If that is the case, a new entrant seeking growth will have to accept lower net worth customers, with the potential for self-selection as only those customers in the main who cannot access services elsewhere will choose new entrants. This may lead to mispriced risk (as discovered by new entrants into sub-prime mortgage lending recently) and or the acquisition of customers who will regularly move from provider to provider in search of the highest short-term rate. 7. The problem illustrated by the financial crisis was one of firms seeking vast balance sheet growth in an attempt to remain competitive, funded by unstable retail and wholesale deposits. This misalignment between risk and reward had a substantial impact on financial stability. Having said this, of course, increasing competition in markets like current accounts will not destabilise the economy. More should be done to encourage greater competition here, particularly around the mechanics and consumer perceptions of account switching, if all providers are on a level playing field. 8. The Government’s strategy to increase competition in banking is, however, currently difficult to interpret, partly because the only aspect of this so far articulated is the potential sale of Northern Rock and the disposal of Government stakes in LBG and RBS. . Competition may be improved by creating a level playing field for banks and mutuals. This includes the withdrawal of state-backed deposit guarantees for LBG and RBS and placing restrictions on these banks, Northern Rock and NS&I in terms of the rates that they offer on certain mainstream products and their market share of these products. Furthermore, Santander has been allowed to expand and it has become an even more significant force. A consequence has been the removal of many “challenger” brands and less choice for customers. The Government should work with the industry to facilitate viable new entrants, support “challenger” brands and examine seriously the possibility of returning Northern Rock to mutual status, which would involve repayment to the taxpayer over a long timeframe.
III. i in s cieties i e ch-nee e i e sit 10. The Government also intends to bring forward proposals to “foster diversity, promote mutuals and create a more competitive banking industry”, but there needs to be an urgent debate on its expectations for mutuals, particularly on creating greater competition. 11. A range of different business models in any industry is important because it offers different ways of combining economic, social and political priorities, thereby maximising their potential benefit. The more diversified a financial system in terms of ownership, governance structures and portfolio make-up, the better able it is to weather strains created by the normal business cycle. The long-term focus of building societies provides a useful and necessary counter-balance to the short-term pressures of the banks. 12. Whilst they need to exhibit the same efficiencies as banks to maintain the mutual pricing difference, their foundations of reciprocity and common ownership allow building societies to prioritise long-term returns ahead of short-term private gain, offering consumers a genuine choice of a different approach to business. The financial crisis has served to reaffirm a number of fundamental strengths of the mutual model: — nherently less risky with a lon -term approach—societies generally have a lower risk appetite than banks because they seek to serve members’ needs rather than short-run profitability and most members are depositors who tend to be risk averse. This strategy is reinforced by a more restrictive legislative framework and greater difficulty in raising new capital outside of retained earnings, both of which have meant a more limited use of wholesale funding. This has been translated into responsible lending with lower credit losses and arrears than many other lenders. — rust—the focus on relationship banking has maintained the bond of trust between members and societies. The importance of this must not be underestimated in what has been a troubled period. By offering personal interaction and immediacy of transaction through branch networks situated close to members, societies are able to develop personal relationships with members. — Customer service—a different ethos that puts members first, the proximity of branches to members, the strength of relationships and a long-term approach to business are just some of the underlying reasons for the consistently higher member satisfaction levels. — Price sta ility—as societies do not pay dividends to shareholders they are able to convert this potential distribution into a pricing advantage and provide products to members at better, less volatile prices than banks. Treasury Committee: Evidence Ev 187
— Mem er en a ement—as democratic organisations, societies are accountable to all those with a stake in their success, giving users and employees a say in how they are run. 13. A lower risk appetite is one reason why the building society sector has, in general, managed the stressed environment far better than most banks, particularly the converted societies (none of which survived without third-party intervention), which proved vulnerable having moved away from their once conservative business model. Whilst there have been clear problems as a result of unwise lending decisions by some societies, the sector has, in the main, supported itself with a significant degree of consolidation, not least as a result of Nationwide’s support.
IV. he e a e a an e si ni cant a ie s t ent an e ansi n in an in The regulatory response to the financial crisis must recognise the needs of the mutual business model, particularly with regard to its capital requirements 1 . The Government wants to create a more competitive and less risky financial industry, which includes fostering diversity and promoting mutuals. However, regulatory changes have invariably failed to take proper account of the mutual model and this is one reason why the sector has found it difficult to compete with banks. 15. Regulation must be tailored to encourage a diversity of business models. In particular, margin contraction and reductions in profit have made it difficult for some societies to increase levels of organic capital without reducing the benefits provided to members—new regulatory requirements mean that societies are currently without a wholesale capital instrument compatible with the mutual business model. 16. A major concern for the mutual sector is the ability to issue a Core Tier 1 capital instrument that recognises the unique mutual business model, satisfies European and national regulators regarding quality and meets investors’ needs. Successful resolution of this will strengthen the mutual sector and enable it to continue to present a viable, competitive alternative to banks. If not addressed, this factor, taken with the restrictions societies face with regard to non-retail funding and increased competition for retail deposits, means that the sector faces an uncertain future which will have an undesirable effect on competition.
The Government should be mindful of the cumulative burden of existing and new regulation and its impact on market entry and expansion 17. Regulatory requirements in the banking sector are considerable given the nature of the market. In the wake of the financial crisis, the sector is facing significant regulatory reform that will impact on the ability of providers to enter and expand within the market. Whilst Nationwide fully supports the goal of a more stable financial sector, governments and regulators—at domestic, European and international levels—must be mindful of the cumulative burden that their regulatory response has on the sector. 18. In addition to the mutual-specific concerns raised above, the financial sector is currently facing stricter capital and liquidity requirements, a new bank levy, changes to the deposit guarantee scheme, potential restrictions on mortgage lending through the Mortgage Market Review, the Retail Distribution Review, changes to corporate governance and a new regulatory architecture. The cumulative impact must be assessed and recognised to enable the Government to achieve the right balance between stability, competition and the need to ensure appropriate returns are available to encourage market entry and expansion.
In addition to the regulatory burden, there are a range of further significant barriers that limit entry and expansion 1. he development of a stron rand is vital ut is hu ely costly and can only e achieved over an extended period of time Retail banking is characterised by strong brands due to the relatively high risk and complex nature of consumers’ purchase decisions. It is also important to note the clear relationship between brand and trustworthiness, and the significant barrier this presents to new entrants. 20. A ranch network remains necessary to achievin scale, particularly when considering the provision of the full range of personal financial products, not least as a means of cross-selling to existing and new customers. Alternative channels have clearly reduced branch use by some customers and new entrants have demonstrated that success can be achieved without high street presence, although primarily for less complicated, less transactional products such as savings, loans and credit cards. Branch location and convenience continue to be major factors in choosing a current account provider, with face-to-face interaction important in developing strong customer relationships. 21. Low mar ins in a hi hly competitive mature market where existin players are all seekin to attract the est customers create a stron arrier to entry The necessity to offer front book deals to attract customers from other banks is likely to lead to a period of low profitability. This is exacerbated by the absence of a sizeable backbook that can be used to generate ongoing profitability to subsidise front book deals. Profit levels are important as new entrants (and existing participants) will only be attracted if returns are at a suitable level compared to other economies and sectors. 22. Customer inertia is powerful and should continue to e tackled. This is particularly the case in the current account market and may lead to the new entrants having to offer higher incentives to switch, Ev 188 Treasury Committee: Evidence
subsequently reducing profits. In our view, inertia is more to do with customer and established bank attitudes than the range of products on offer. Improving consumer awareness and financial capability remains an important element when addressing this issue and the sector does need to improve the switching process from a customer experience perspective.
V. When c nsi e in eate t ans a enc nancia cts a a ance st e st c t a i in ati n e a tentia inc easin c ns e ine tia 23. The consumer should be the central driver of effective competition in any industry, yet in financial services there is evidence of low levels of consumer empowerment, primarily due to low levels of education and awareness, which has led to high levels of customer inertia. 2 . Transparency of information is important and has been recognised by the financial sector in a number of initiatives over recent years. Many aspects of the Banking Code sought to improve consumer information, including summary boxes. The self-regulatory Banking Code has now migrated to the FSA to become the Lending Code, ensuring that the regulator assists the industry in making improvements where necessary. Credit card charging structures have been simplified and the Government will be bringing forward proposals on unfair bank charges and more effective product comparison tools. 25. However, a balance must be struck between achieving greater transparency and avoiding information overload that could potentially increase, rather than reduce, consumer inertia and apathy, precisely because there is too much information to digest. Comparison websites, for example, can provide a plethora of information about a certain product but in doing so may not improve consumers’ ability to extract pertinent information. 26. Improving consumers’ financial capability remains a key element in achieving this balance. In particular, there is a real need to move the customer away from focusing on a “single price point” (ie the headline rate) and instead focusing on the value of a product over its lifecycle and providing the consumer with the necessary skills to make an adequate comparison of providers and products when faced with a large amount of information. 27. A particular issue that the Committee’s call for evidence raises is free banking. Retail banking is exceptionally costly. As well as servicing branch networks, staff must be trained and qualified, call centres must be manned and head offices staffed to run functions such as finance, audit and risk management. Building societies are focused on optimising profit for the benefit of their members through better rates. In order to do this they need to fund growth through retained earnings and to attract investors to generate inorganic capital— as a result, they need to generate income from banking, whether through up-front charges or a fee structure. 28. Competition is best served by providers offering a range of accounts, some of which will be fee paying and others not, that provide customers with a choice to ensure they have access to products that meet their individual needs. It is therefore necessary for consumers to have choice and awareness of the costs of banking. However, it should be noted that a recent Which? survey3 found that 82% of consumers are always in credit and therefore charges such as those for authorised and unauthorised overdraft charges will not apply.
VI. ei n- ase e at s e ain st n c etit s in the sa in s a et t a e n i e t e-ente the tae a etintheei te 2 . There is a widespread misassumption that foreign-based operators have left the UK. In reality, they are incredibly active in the savings market, including banks such as ING, Punjab National Bank, ICICI and Bank of Ireland. Foreign banks’ presence is likely to remain high in the savings market as banks globally continue to seek retail deposits. 30. Foreign-based operators were active in the mortgage market pre-2007 but their presence is now limited. During this period, some of these foreign lenders mispriced risk and led to a general contraction in mortgage spreads, which was unsustainable given the level of risk, and also contributed to the housing boom. Indeed, investment banks were carrying out this business in order to generate packets of loans that could be passed on in this way, rather than for an intrinsic desire to be active in the mortgage market. This contributed to a drastic overheating in the market and a rapid increase in risk. Re-entry into this market seems unlikely in the medium term, not least because risk is now better understood and the market for securitised loans has collapsed. 31. From the pre-2007 mortgage market and the current savings market, it is clear that foreign-based operators have the ability to both increase competition and distort the market. ete e 2
3 As referenced in: Which? Magazine, “No such thing as free banking”, September 2010. Treasury Committee: Evidence Ev 189
APPEND 1 MARKET SHARE, 2007 AND 200 , OF MORTGAGES, SAVINGS AND CURRENT ACCOUNTS t a es a ances a in s a ances C ent cc nt acc nts 22 2 2 2 2
Top 5 55 68 Top 5 7 62 Top 5 7 8 Rest of market 5 32 Rest of market 53 38 Rest of market 21 16
LBG 8.8 2 .0 LBG 6.5 21.1 LBG 1 30 Santander .6 13. Santander 6.6 11.7 RBS 17 17 Nationwide 10.2 10.8 Nationwide 11.2 11.3 Barclays 15 15 RBS 6.2 7.7 NS&I 7.0 .3 HSBC 1 13 Barclays 5. 7. Barclays 6.0 8.7 Santander 6 HBoS 20.3 a HBoS 16.1 a HBoS 1 a
Northern Rock 7.6 5.1 HSBC 6.0 70 Nationwide 6 7 HSBC 3.7 .5 A&L 3.7 CFS 2 2 A&L 3.7 B&B 3. Post Office 2 2 B&B 3.3 Britannia BS 1.8 c Yorkshire Bank 2 2 Bank of Ireland 2.2 2. CFS 0. 2.2 Clydesdale 1 1 Britannia BS 2.0 c ING 1.0 2.0 CFS 0.3 2.0 NAB (UK) 1.5 1. Yorkshire BS 1.3 1.3 Northern 1.1 1.8 Rock Coventry BS 1.0 1.2 Yorkshire BS 1.3 1.3 NAB (UK) 0. 1.1 Coventry BS 1.0 1.2 Other building 3.0 2.3 Other building 6.3 .2 societies societies a—part of LBG; b—part of Santander; c—part of CFS
APPEND 2 CUMULATIVE ASSET SHARE OF TOP 15 BANKS MUTUALS 100%
80%
60%
40% Cumulative Share
20%
0%
2 4 6 8 10 12 14 Rank Within Top 15 Ev 190 Treasury Committee: Evidence
APPEND 3 THE IMPACT OF CONSOLIDATION Change in Net Mortgage Balances, 200 £40bn
£30bn RBS
£20bn HSBC £10bn Sandtander BARCLAYS £0bn LLOYDS Nationwide Other Societies
-£10bn Other Lenders
-£20bn
-£30bn
Change in Savings Balances, 200 £25bn
£20bn RBS £15bn LLOYDS £10bn BANKING GROUP NS&I £5bn Sandtander Other Societies BARCLAYS £0bn Others NATIONWIDE -£5bn
-£10bn Treasury Committee: Evidence Ev 191
New Current Accounts, 200 6m
5m LLOYDS BANKING 4m GROUP
3m RBS
2m Santander
1m BARCLAYS
HSBC Others 0m Nationwide
Written evidence su mitted y Which
Summary
1. Which? is an independent, not-for-profit consumer organisation with over 700,000 members and is the largest consumer organisation in Europe. Which? is independent of Government and industry, and is funded through the sale of Which? consumer magazines, online services and books.
2. Which? welcomes the Treasury Select Committee focus on competition and banking. We have consistently advocated for significant reform of banking to establish, once and for all, the necessary pre-requisites for effective competition. The financial crisis has seriously harmed the prospects for competition. As a result, the crises has also brought to light fundamental flaws in the underlying public policy and regulatory approaches to banking that the t e n in issi n reported on in May this year.
3. Which? consider that four primary factors prevent and distort competition: — The size and market concentration of banks; — Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents; — No effective regime to enable market exit by failing banks while preserving financial stability; and — Consumer inertia where, perhaps more than in any other industry, consumers have an inbuilt tendency to remain with their existing providers. This in turn reduces the incentives for firms to actively compete against each other.
. These first three factors effectively make the largest incumbent banks immune to market discipline. This leads to inefficiency, weak prospects for meaningful competition and significantly contributes to the underlying causes of the financial crises. The fourth factor, the role of consumers in driving the competitive process, remains as an impediment to competition. Unlike the first three factors that uniformly affect each and every market in which banks supply services, the impact of consumer inertia, however, differs from market to market.
5. The Government has a real opportunity to affect a permanent and one-off step change in the competitiveness of banking services benefiting consumers and the UK economy. Only the Competition Commission has the necessary powers to affect substantial and lasting reform. We hope the Committee will find this submission helpful. Ev 192 Treasury Committee: Evidence
t ct e this es nse
6. The response is structured as follows: — First, we define the types of banking services considered in this response; — Second, we set out the experience of consumers using banking services. This includes the largely anecdotal evidence from individual consumers, including views gathered during the Which? Big Banking Debate, relating to their direct experience of banks. We also set out the results of our own satisfaction surveys of key banking services, based on quantitative surveys of Which? members over recent years; — Third, we summarise the changes to market outcomes including a review of key product performance, bank performance and the impact on market structure, which has lead to a significant concentration of banking services in part due to the response to the financial crises; and — Fourth, we review the impact of regulation on the development of competitive retail banking services, including the effect that government support and state aid has had on competition for banking. We consider the role regulation has to play in promoting competition, and reject the notion of a “trade-off” between competition and financial stability, noting the measures that regulators should take to build consumer confidence in financial services markets.
7. We conclude by noting the harms that arise from not taking banking competition seriously, and suggest two remedies: — Significant structural reform considering the economic market power of banks, and those reforms necessary to address financial stability. This may best addressed through a reference to the Competition Commission, which is the only body with the necessary powers to enforce structural change, but must be considered by the Vickers inquiry; and — Significant reform of public policy and regulation of banks to enable poor performing banks, whether due to poor management or customer dissatisfaction, to fail and thus become subject to market discipline.
Definition of Banking Services for the Purpose of this Response
8. The Committee’s terms of reference for its inquiry are broad, covering both retail and wholesale products. Which? has focussed on retail or personal banking services, with particular emphasis on three economic markets: personal current accounts, deposit savings and mortgages.35 These three products form core banking services that consumers are likely to use on a frequent basis and which may be commonly “cross-sold” by banks. Banks also supply a range of other financial services, including medium-long term savings and investment products, personal loans, credit cards, general insurance, life and pure protection products and access to some specialised services like share-dealing. Each of these products is likely to form a discrete economic market affected by the distortions to competition affecting banks’ core services.
. Which? is concerned that an inquiry into competition should go beyond the various individual economic markets and also give detailed consideration to the institutional and structural nature of banks. Banks, especially the largest, operate similar business models, are regulated via a banking licence and the FSA’s conduct of business rules and have received similar levels (or offers) of aid—on an institutional level—during the financial crises. Banks operate multi-product, vertically integrated firms that intrinsically link essential “utility” aspects of banking, on which we all rely, to wholesale markets and more speculative activity. This has a key bearing on competition and affects the scope and nature of regulatory interventions necessary to promote competition.
10. We have not considered banking services for small and medium sized enterprises (SME). Banking services to SME have often been considered to form part of the same market given the common set of banks that supply retail and SME customers and, in many cases, the similar scale of business. From a supply-side perspective, there appears to be little to differentiate retail customers from SME customers with similar needs (holding, accessing and transferring money).
Customers’ Experience of Banking Services
11. Poor outcomes for consumers have been found in a host of competition enquiries relating to banking: — The OFT’s personal current account (PCA) study found that “the PCA market as a whole is not working well for consumers”.36 35 An economic, or relevant, market defines the products and geographical area that impose competitive constraints on suppliers given the substitutability of those products by virtue of their purpose or use by consumers. It forms the basis for most competition enquiries and, alongside consideration of other factors such as market entry and technology helps determine the strength of a firm’s market power. See the OFT’s a et e niti n, OFT 03. 36 Page 2 e s na c ent acc nts in the , July 2008, OFT. Treasury Committee: Evidence Ev 193
— The Competition Commission, in its investigation of Northern Ireland Banks, found that: banks’ charging structures are unduly complex; too little is done to explain charging structures to customers; and customers are largely indifferent to the product, considering PCAs as “all the same”.37 — The Competition Commission’s investigation of Payment Protection Insurance found rivalry was weak with a significant “point of sale” advantage by incumbent banks and considerable concern over sales practices.38
12. These findings are reflected in the day to day experience of ordinary banking customers. Which? has collected views directly from members of the public and users of banking services that form a picture, albeit anecdotal, of peoples’ experiences of and expectations of banks. We also set out results from Which?’s regular satisfaction surveys of members.
i ence e e s the ic an an c st e s
13. Since October 200 Which? has actively sought the views of ordinary members of the public, bank customers and Which? subscribers to understand how the banking crises has affected them and to hear their demands for change.3 This culminated in the Which? Big Banking Debate on February 2010 attended by over 300 people. 0
1 . Which?’s dialogue with consumers of retail banking services has made two messages clear: — Consumers want change, including structural reform of banks to promote competition and tackle the risks created by banks that society has had to pay for; but. — Consumers feel disempowered, subject to complex products and hard-selling and unable to affect change in the face of “all powerful” banks.
15. Nearly three-quarters of participants of the Which? Big Banking Debate considered banks should be broken up to create more competition, while nearly 50% consider separating investment banking from day to day banking is essential. 1 These views reflect an overall impression that the banking system serves banks not consumers. The banking crisis has brought to light issues that many consumers may not have previously considered: the implications of a potential collapse in the entire banking system brought home just how fragile and disastrous the situation could have been.
16. Despite the strong preference for change, in particular structural reform, customers of banks feel individually powerless to change the banking industry. This powerlessness arises from unilateral and market wide worsening in terms: savings rates have fallen, interest on credit has increased (for example on credit cards where effective interest rates have increased significantly above base rate 2), credit is less easily available and terms of existing products have moved against customers interests (see paragraphs 31 to 38). The most recent financial statements from banks support these observations, confirming that profit margins on products are widening (see paragraphs 3 to 1). 3
17. When seeking help and advice from banks, consumers are faced with hard-sell tactics and a lack of personal service or “localisation” of services: banking today is not tailored to one’s needs. A number of people reported to Which? a noticeable shift away from a more personalised banking service to one driven by sales targets: “Why does my bank only want to talk to me when it wants to sell something?” a tici ant Which i an in e ate “I phoned Santander to ask advice regarding my mortgage. Although most of my questions were answered, I was put through a very hard sell by an employee of the new zero account. I felt pressured into swapping to this account but managed to say no for the third time and it was accepted. I have looked up the details of this account and it is not suitable for me anyway, although he kept saying it was ” www.which.co.uk banking yourstories (2 April 2010)
18. Which? has received many anecdotal examples from consumers that whenever they visit a branch for “day-to-day operations”, they are subjected to sales promotions. Not only have consumers reported disappointment with this approach it can also impose real detriment. Hard-selling is stressful for some 37 Paragraphs 56 60 e s na c ent acc nt an in se ices in the n e an a et n esti ati n 15 May 2007, Competition Commission. 38 a et n esti ati n int a ent tecti n ns ance 5 June 2008, Competition Commission. 3 Which? set up the Britain Needs Better Banks website where consumers could record and share their experiences (www.bnbb.org ) and collected additional stories during the Future of Banking Commission (www.which.co.uk banking ). 0 A summary of the Which? Big Banking Debate is available here: http: www.which.co.uk banking ourevents. 1 Polls were taken during the Big Bank Debate via electronic key pads of key questions. 2 See chart 3.2 en s in en in July 2010, Bank of England. 3 See for example the results of Lloyds Banking Group which holds a market leading position in current accounts, deposit saving accounts and mortgages. Ev 194 Treasury Committee: Evidence
customers, especially if they rely on their bank for impartial advice from expert staff. Sales targets and commission based sales incentives mean consumers lose the benefits of independent and tailored advice, while there is a risk of mis-selling in some cases.
1 . Consumers have reported frustration over the complex terms and charging methods employed by banks, with a sense that individual service comes second to any opportunity to “gouge” customers. Consumers clearly accept that there are inevitably going to be costs associated with any financial product, but they do not feel they are always a true reflection of the actual costs and are disproportionate to what they would expect to pay: “Most ordinary customers borrow from banks for their mortgages. Banks are not transparent on their lending because they load up front end fees in the guise of valuation fees etc. which bear no resemblance whatsoever to reality. They should simply state the interest rate and forget about all other complicated costs”. C ns e hich c an in “In October 2008, I took out payment protection insurance on a loan with Lloyds TSB. I took it out because I was advised that I had to buy the insurance to take out the loan. I asked the bank to cancel the insurance several times but they failed to stop taking my money.” Krystyna, via Which? Customer Services
20. Consumers frequently cite the Lack of transparency in financial services as a particular problem. This includes the terms and conditions, small-print associated with products, the perceived unfair charges levied which often take people by surprise, and lack of information on monthly statements about the current interest rate for their product. There is a perception that charges are “sneaked” into the small-print of products, making it difficult for consumers to get adequate clarity on what they are buying and leaving some feeling as if they are purposely designed to trip you up.
21. Many people value the idea of having face-to-face contact with an old-fashioned-style bank manager who you recognise, and who recognises you. People feel there is a lack of ownership at their bank when it comes to dealing with any issue or complaint, with complaints and redress handled inadequately.
22. Overall, the poor service, hard-sell, complexity of product terms and ineffectiveness at addressing problems, alongside a unilateral worsening of product terms, has all reinforced consumers’ feeling of disempowerment.
C st e satis acti n s e s an c aints
23. Which? has conducted satisfaction surveys of its members for savings, current accounts and mortgage providers in 2008, 200 and 2010. Results for these surveys have shown both significant variation across different banks, with new entrant or internet-only banks performing especially well, and a consistent story with continued poor performance by the largest of the high-street banks.
2 . For current accounts, our surveys have found the main high street banks performing poorly compared to internet banks and many of the smaller or new entrant banks and building societies. Table 1 below summaries these results:
ale1
SATISFACTION RESULTS FOR PERSONAL CURRENT ACCOUNT BRANDS44 an222
Lloyds Banking Group (a) 5 % 55% % (HBoS) 56% RBS (b) 61% 57% 55% HSBC 57% 60% 58% Barclays 53% 55% 53% Santander (c) % 58% 52% eae i e c in antan e 2 an s achie in eate satis acti n es ts First Direct 85% 0% 88% Virgin One 88% Co-operative bank 82% 8 % 86% Smile 88% 1% 85% The 2010 Which? current account survey was conducted in October November 200 and April 2010 and consisted of over 1 ,500 Which? members through an online survey. Treasury Committee: Evidence Ev 195
an222
Nationwide 7 % 7 % 72% First Trust 72% Cahoot 82% 8 % 71% Intelligent Finance 72% 7 % tes: (a) Lloyds TSB, Halifax and Bank of Scotland, except for 2008 when the results exclude HBoS (b) Royal Bank of Scotland, Natwest (c) Santander (Abbey & Bradford and Bingley), Alliance and Leicester, except for 2008 when results are for Abbey brand alone Internet-only brands operated by one of the Big 5 banks The results are the un-weighted average across high-street brands, excluding the results for internet-only banks operated by the Big 5 banks. ce: Which? annual satisfaction surveys 2008, 200 and 2010.
25. The satisfaction performance of the Big 5 banks’ high street brands has consistently been below the best performing banks. This is despite the fact that some of these banks also operate successful stand-alone internet banking businesses such as First Direct (HSBC). It is notable that previous brands, including Intelligent Finance (LBG) and Cahoot (Santander), are now only offering savings products rather than full service personal current accounts to new customers.
26. The main areas of dissatisfaction were the level of interest payments or charges applied to accounts followed by the provision of up to date information on rates and charges. Some of the Big 5 also performed poorly for provision of internet and phone banking services and resolution of problems. Customers of the Big 5 were most satisfied with the accuracy and timelines of statements and availability of branches.
27. Similar results are reflected for savings and mortgages. 5 The average satisfaction score amongst the Big 5 for savings accounts was only 7%, First Direct and Co-operative Bank were the only brands to score 70% or higher. The worst performing bank brands were Santander at 3 % followed by Cheltenham & Gloucester, Bank of Scotland and Halifax (all operated by Lloyds Banking Group). As for current accounts the main areas of dissatisfaction were the level of interest and keeping customer informed on rates and charges. Customer satisfaction in the mortgage market is similar, with the Big 5 scoring an average of 55% satisfaction compared to the best result of 87% (First Direct). The main reported reason for dissatisfaction was lenders failing to pro-actively inform customers when more suitable or better mortgages were available.
28. Despite the Big 5 banks’, at best, average satisfaction ratings they continue to dominate the provision of key retail financial services, emerging as clear winners of the financial crisis. In particular, customer satisfaction scores are especially poor for brands operated by Lloyds Banking Group and Santander. As outlined below, Lloyds is a clear market leader with Santander having rapidly expanded (mostly due to purchases of failed or failing banking institutions throughout 2008 and 200 ). We conclude that a poor quality service for customers is irrelevant to the growth of significant market power, a clear sign that normal competition is failing.
2 . Which?’s findings of average to poor levels of satisfaction are reflected in the consistent, and considerable, growth in complaints to the financial ombudsmen service. 6 For example, over five years FOS has dealt with over a 5 fold increase in personal current account and deposit saving complaints, while mortgage complaints have risen by 1 0%. 7 The FSA has reported similar findings in the number of complaints brought to its attention. 8
Recent Changes to the Competitive Landscape of Retail Banking
30. Consumers have seen a real impact from changes to the competitive landscape, with worsening product terms whilst banks themselves have seen increasing margins. The financial crisis accelerated changes to market structure, which has resulted in an increase in concentration and winnowing of choice from the market. Significant entry barriers and, more importantly, exit barriers remain which seriously fetter the prospects for effective competition. These developments are reviewed below. 5 Which? savings account research was conducted in October November 200 and April 2010 and consisted of over 13,500 Which? members through an online survey. Which? mortgage research was conducted in January and June 2010 and consisted of just over ,500 Which? members through an online survey. 6 See Which? press release “Too many complaints wrongly dismissed” at http: www.which.co.uk about-which press campaign-press-releases personal-finance 200 05 too-many-complaints-wrongly- dismissed-says-which.jsp 7 See the Annual Review 2008 0 , FOS (http: www.financial-ombudsman.org.uk publications ar0 about.html). 8 See Which? press release “Complaints reflect financial firms’ standing amongst consumers, says Which?”, 3 September 200 (http: www.which.co.uk about-which press campaign-press-releases personal-finance 200 0 complaints-reflect-financial- firms-standing-among-consumers-says-which.jsp). Ev 196 Treasury Committee: Evidence
ct e ance 31. Economic conditions have remained difficult since the beginning of the credit crunch and resulting recession. Consumers of banking services have faced considerable uncertainty. Bank of England base rates have remained low since November 2008, reaching their current level of 0.5% in March 200 . Higher than target inflation, which has made real saving rates negative, and banks’ steps to recapitalise, following their near collapse, has lead to worsening product terms across the board. Some consumers, such as those on long term tracker mortgages have seen marginal improvements from pricing changes introduced by banks. However, for most current account customers, those relying on savings to support their income, or those looking to buy a home for the first time or re-mortgage, conditions have worsened significantly. 32. Two key changes have affected personal current accounts. First, the overall level of in-credit interest payments has fallen. Table 2 below illustrates the fall in the credit interest rate offered by a sample of popular current accounts. Those accounts that previously offered higher in-credit interest rates have all fallen, by over 5% in the case of Halifax (now part of the Lloyds Banking Group). Some of the low-interest paying current accounts still offer 0.1 or 0.15%, while others have fallen to zero. ale2 ILLUSTRATIVE CHANGES FOR CURRENT ACCOUNT IN-CREDIT INTEREST PAYMENTS Credit interest rates on a £1 to £1,000 balance an an i in s ciet cc nt na e n- a - a -
i h inte est acc nts Alliance & Leicester Premier Direct Current A c 8.50% 6.00% 5.00% Abbey (Santander) The Abbey Current (Cr Opt) 8.00% 5.50% 5.00% Halifax High Interest Current A c 5.12% 0.00% 0.00% Halifax Ultimate Reward Current A c 5.12% 2.50% 0.00% Lloyds TSB Classic Plus .00% 2.50% 2.50% Barclays Bank Current Account Plus 2. % 0.00% 0.00% HSBC Bank Account Plus 2.50% 3.00% 0.00% inte est acc nts Alliance & Leicester Premier Current A c 0. % 0.50% 0.50% Nationwide BS FlexAccount 0.50% 0.00% 0.00% Royal Bank of Scotland Royalties 0.15% 0.15% 0.15% Abbey (Santander) The Abbey Current (Db Opt) 0.10% 0.10% 0.10% HSBC Bank Account 0.10% 0.00% 0.00% Lloyds TSB Classic 0.10% 0.10% 0.10% NatWest Current Plus 0.10% 0.10% 0.10% First Direct 1st Account 0.00% 0.00% 0.00% ce: Moneyfacts and Defaqto 33. This fall in credit interest rates reflect the overall fall in base rate and inter-bank lending rates. Credit interest is an important revenue source for banks, estimated to represent 50% of the revenue from so called “free” bank accounts.50 This revenue is derived from the difference in interest payments made to customers and the income banks can earn from this stock of funds, in essence the difference in the cost to banks of raising in the region of £ 7 billion daily directly from consumers rather than going to wholesale money markets, bond or shareholders.51 The funding difficulties which banks have experienced will have increased the attractiveness of using the deposits in current accounts, compared to other methods of funding. 3 . Second, the structure of charges has changed. This may lead to better treatment of those with very high unauthorised overdrafts but has tended to be less favourable for authorised overdrafts: the average authorised overdraft rate is 18.86%, higher than any rate for the last 15 years.52 Some banks have introduced more significant changes, examples include: imposing a fixed charge per day of overdraft rather than a percentage interest charge; and making a gratuity payment into a customer’s account if a minimum amount of funds is regularly paid-in. Consumers may find it difficult to judge whether these charging structures suit their needs. 35. For example, in December 200 , the Halifax brand of Lloyds Banking Group introduced an authorised overdraft policy of a minimum £1 per day fee for all of its current accounts.53 Ostensibly this is a simpler, more transparent overdraft policy. However, a consumer would need to have an overdraft of nearly £2,000 in £5 a month reward paid if account is credited with more than £1,000 each month 50 Figure C. , annexe C, e s na c ent acc nts in the a a et st , July 2008, OFT. 51 This is the estimated daily credit balance in current accounts for 16 banks, it excludes savings deposits. See paragraph 2.23 of e s na c ent acc nts in the a a et st , July 2008, OFT. 52 Source: Bank of England. 53 The daily fee is £1 a day for overdrafts less than £2,500; £2 a day for overdrafts of more than £2,500 and £5 a day for unarranged overdrafts Treasury Committee: Evidence Ev 197
order to pay less than the average authorised overdraft rate.5 The OFT’s 2008 market study estimated that, of those accounts in overdraft, no more than 10% of accounts were over £1,000 and no more than 5% over £2,000 in debit.55 This leaves 0 5% of consumers, that regularly use an overdraft, likely to be significantly worse off if paying £1 per day. For example the implied effective annual overdraft rate of £1 per day on a £500 overdraft is 73%.
36. Customers relying on mortgage products have been the most adversely affected by changes in product terms. In particular, those faced with high or very high loan-to-value (LTV) now face a significant challenge attempting to re-mortgage. Many of these consumers have found themselves stranded on high LTV products through no fault of their own: with some mortgage lenders were offering up to 125% LTV, mortgages with 5% LTV were widely available and many expected house prices to stay buoyant. Post-crises, house prices have fallen and are, at best, recovering fitfully. This forces many families into dependency on higher LTV mortgages. Lenders’ own policies for new or re-mortgage lending have tightened, with the FSA requiring higher standards from banks in their assessment of individual credit risk. Banks have also been repairing their balance sheets, lending less and ensuring a higher margin on each product (see below). These changes mean that many ordinary families are now dependent upon their original lender offering reasonable terms with no other lender willing to offer re-mortgage terms without a sizeable deposit.
37. Changes in base rates and the decision of banks on how to re-capitalise has significantly affected the volume of lending and led to a significant growth in margins (the lender’s charge net of the Bank of England base rate). Graph 1 below illustrates the dramatic impact across the mortgage market. Before July 2008 lending volumes (both secured and unsecured) were buoyant, while margins were modest or, in the case of tracker mortgages, negative at some points. Since July 2008, lending volumes have collapsed and margins grown: banks lend less but make more money for each new customer and all existing customers that must now re- mortgage or face very much higher standard variable rates (SVRs).
Graph 1
VOLUME OF LENDING AND MORTGAGE BORROWING COSTS Lending to individuals and cost of borrowing January 2006 - June 2010 (interest rates net of base rate)
14000 4 Monthly change lending (secured)to individuals 12000 3.5 Monthly change 3 lending (unsecured) 10000 to individuals
2.5 Total monthly 8000 change in lending 2 6000 SVR 1.5 £ millions 4000 1
Percentage interest rate 2 Year discount (75% 2000 LTV) 0.5
Tracker 0 0 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 -2000 -0.5 Date
e: Bank of England
38. These market changes have had specific effects on consumers: — First time buyers find it more difficult to obtain any mortgage, with significantly greater deposits now required; — Existing customers with high LTVs (ie over 60%) have significantly less choice of re-mortgage options and must remain with their existing lender paying the current SVR. When these rates rise, in due course, these captive customers will face significant mortgage costs if house prices have not recovered; 5 A daily rate of interest, based on the effective annual rate of 18.86%, requires a credit balance of £1, 35.50. 55 Chart .5, e s n ent nts in t e et st , July 2008, OFT. The OFT estimated that 0% accounts in overdraft were up to £100 in value, and about 32% between £100 £500. Ev 198 Treasury Committee: Evidence
— Some recent products expose consumers to an imbalance of risk, for example with the marketing of some tracker mortgages or with recent increases in SVR. For example, Halifax markets its tracker mortgage with the wording “if you want to be able to take advantage of lower interest rates if they go down, a tracker mortgage could be what you need”. With base rates at 0.5% (their lowest in the history of the Bank of England) the most likely direction of interest rates is upwards. This is particularly troubling where the same bank offers term trackers, for the lifetime of the mortgage, at rates over .5% above base rate. Which? is also concerned with the behaviour of Skipton Building Society which raised its SVR by 1. 5% in March 2010, breaking a promise to customers that its SVR would never be more than 3% above base rate;56 — Treatment of customers in arrears, where consumers in arrears face cumulative and penal charges and banks have taken insufficient action to assist customers before they miss a payment. For example, Abbey (a Santander brand) has increased its monthly charges for mortgage arrears to £ 0 from £35.
an e ance 3 . In contrast to the poor performance for customer satisfaction by banks and, as outlined above, the worsening product terms for their customers, banks themselves have thrived. Margins on key retail products have significantly increased leading to greater profitability for retail banking arms. The Big banks have performed especially well: — The retail-arms of the Big banks remained profitable throughout the financial crises; — Those banks that have been reliant on state support—and without which would have collapsed— have recently announced significant increases in profitability: — Lloyds Banking Group57—Profitability of the retail business in the first half of 2010 was £2, 5 million, compared to £360 million for the same period in 200 . The increase in margins was attributed to “the c ntin e e- icin is an a ec ease in the s ea t ase ate inte est ates a s eant that e t a e c st e s e nt an a e sta in n stan a a ia e ates etai has a s e ce the ti n e e ensi e te e sits hi e aintainin st n e sit th ” UK tax payers own 1% of LBG shares, managed by UKFI. — RBS58—Profitability of the retail business in the first half of 2010 was £ 16 million, compared to £37 million for the same period in 200 . RBS noted Wi enin asset a ins ac ss a cts an an inc easin n e t a e c st e s ch sin t e ain n stan a a ia e ate e e the e i e s ia i it a ins h e e e as a es t e inte est ates a c etiti e a et ace an c s n sa in a ance th UK tax payers own 8 % of RBS, managed by UKFI, with £282 billion of assets publicly insured under the Asset Protection Scheme. 0. Some improvement in the availability of mortgage lending has been reported.5 However, the cost of funding mortgage lending has fallen but lenders are only passing on a fraction of this fall, retaining funds to rebuild their balance sheets. The losses for which these funds are required were almost exclusively incurred by the investment banking and wholesale arms of the largest incumbents, but the ongoing costs are borne by customers of the retail bank.60 As noted by Sir Martin Taylor, former CEO of Barclays, to the te an in C issi n: the in est ent an in acti ities a ni e sa an e e at a ti es a asitic n the etai an a ance sheet 1. Profit performance alone is not sufficient to draw conclusions as to the competitive health of an industry. It is, however, sufficient to raise challenging questions: — Why has the retail banking industry made such significant profits, in such a short period of time, when customer service and product performance is exceptionally weak? In most industries, unhappy customers and poor quality products leads to falling profitability (and market share). — To what extent have the changes in market structure, set out below, played a direct role in increasing profitability? Market power can directly contribute to excessive pricing. — To what extent does the continued state support of banks enable exceptional profit performance? — To what extent are retail customers paying the costs of recklessness or incompetence in the investment banking arms of the largest incumbents? The largest investment banks are vertically integrated, multi-product firms, this may have a significant distortionary impact on retail market competition. 56 Which? has previously presented evidence to the Treasury Committee of specific cases, see Which?’s responses to the Committee’s enquiries into mortgage arrears and access to mortgage finance. 57 2 nte i es ts, Lloyds Banking Group, http: www.lloydsbankinggroup.com investors financial_performance company_results.asp. 58 a an c t an nte i es ts 2 , http: www.investors.rbs.com our_performance resultsandpresentations.cfm. 5 “Mortgage margins at all time high”, 1 August 2010, press release, Moneyfacts. 60 “Banks customers still paying for mistakes by investment bankers”, 1 August 2010, www.guardian.co.uk Treasury Committee: Evidence Ev 199
2. The weakness of competition also affects the incentives of banks to be dynamically efficient: to innovate in ways that improves customers’ experience and productivity. Concentrated markets may often suffer from an “x-inefficiency”, where the cost-base of firms in those markets becomes bloated or excessive. This appears to be found in the banking industry in the form of: — Persistent and high-level bonuses, especially for investment banking which is intrinsically linked to the crises. These bonuses are part of banks’ cost base yet appear to be unconstrained by any market process or innovation to reduce these costs; — Industry inefficiency or incapability to improve services on which customers rely. For example the speed of cheque clearing which agreed improved clearing speeds effective from November 2007 yet concern with was originally raised with efficiency of payment clearing services in the Cruickshank report published in March 2000. The OFT recently investigated the speed of ISA savings transfers, following a complaint by Consumer Focus, and has agreed changes to speed up the system: without this intervention it seems the industry would not have adopted any improvements. 3. There are some indications of innovation, for example the Barclaycard touch and pay service that allows payment for small items with using the chip and pin device.61 However, there has been no detailed investigation of bank efficiency since Cruickshank. Recent changes that increased market concentration, detailed below, threaten to exacerbate x-inefficiencies in the banking industry.
a et c ncent ati n . The financial crisis has seen a step-increase in the concentration of key retail banking services. This has exacerbated a trend that was first noted in the Cruickshank report into UK banking over a decade ago. 5. The main driver of recent changes has been a significant increase in mergers. Since April 2008, there have been 1 mergers. Nine mergers involved mutual building societies. Ten mergers arose because of concerns over capital or losses incurred through the crises. Of these, the largest by far was the merger of Lloyds-TSB and HBoS, which has resulted in a market leader for key retail banking products. This has been an exceptional number of mergers. Between 2003 and early 2008 only four mergers affecting retail or commercial banking had been considered and cleared by the OFT. In addition to mergers, two banks failed: Northern Rock and Bradford & Bingley. ale3 MERGERS AND AC UISITIONS IN UK BANKING (SINCE APRIL 2008) ea inancia nstit ti n e e ith c i e
2008 Santander Alliance & Leicester 2008 Santander (Abbey) Bradford and Bingley (savings and branches) 2008 ING Direct Heritable Kaupthing Singer & Friedlander 2008 Chelsea Building Society Catholic Building Society 2008 Nationwide Building Society Cheshire Building Society 2008 Nationwide Building Society Derbyshire Building Society 2008 Lloyds-TSB HBoS 2008 Yorkshire Building Society Barnsley Building Society 200 Co-operative Financial Services Britannia Building Society 200 Yorkshire Building Society Chelsea Building Society 200 Nationwide Building Society Dunfermline Building Society 200 Skipton Building Society Scarborough Building Society 2010 Barclays Standard Life Bank 2010 Coventry Building Society Stroud and Swindon Building Society ce: Bank of England (2008). “Financial Stability Report”, Issue 2 , pgs 2 25, pub: Bank of England: London. Office of Fair Trading (2010). “Merger Cases”, accessed at OFT website http: www.oft.gov.uk advice_and_ resources resource_base Mergers_home Mergers_Cases
a et sha es 6. The market share for three key retail banking services—personal current accounts, savings and mortgages—are summarised below.62 The “Big four” banks that have historically dominated retail banking (Lloyds-TSB, Natwest (now RBS), Barclays and HSBC). For each market, recent changes have led to greater concentration and very significantly so for savings and mortgage products. The “Big four” have become a “Big 61 “New Barclaycard is touch-and-pay” http: news.bbc.co.uk 1 hi business 6 5 1.stm. 62 Data was drawn from the following Mintel reports: C ent ac a e an e i cc nts inance nte i ence, June 200 ; e sit an a in s cc nts inance nte i ence, May 200 ; t a es inance nte i ence, March 2010. Ev 200 Treasury Committee: Evidence
5” as Santander has grown following a series of mergers. It is notable that all de-mutualised building societies have failed (with their businesses taken-over by traditional banks or nationalised). ale4 ESTIMATED MARKET SHARE FOR KEY RETAIL FINANCE MARKETS e s na c ent e sit sa in s t a es an s i in s cieties acc nts 2 acc nts 2 2
Lloyds Banking Group 28 25 25 (a) RBS (b) 17 11 13 HSBC (c) 1 11 Santander (d) 12 13 18 Barclays 12 10 Nationwide 8 10 8 Other (e) 23 15 tes: (a) Lloyds TSB, Halifax and Bank of Scotland (b) Royal Bank of Scotland, Natwest (c) HSBC, First Direct (d) Abbey, Alliance and Leicester, Bradford and Bingley (e) Other includes survey respondents that don’t know which institution provides their service. 7. The scale of the changes in recent years is especially notable if considered against market share estimates from 2006, prior to the financial crises, and those measured in the Cruickshank report for the four largest banks.63 ale5 HISTORICAL MARKET SHARE OF THE “BIG FOUR” BANKS e s n ent e sit s in s e nts nts t es
200 (a) 71 5 67 2006 66 7 1 8 (Cruickshank report) (b) 5 1 17 (a) This excludes Santander, which has grown significantly through its acquisition of failed banks over the last three years and recent purchase of branches and accounts from RBS. (b) De-mutualised building societies held 2% share of the deposit savings account market and 8% share of mortgages, these have subsequently all failed or been acquired by the big banks.
et ent n e it 8. Which? has identified a number of potential barriers to entry, drawn from written responses submitted to the te ninCommission by smaller new entrants and representative bodies of customers (retail and SME): — Customer consumer engagement—the perceptions and experience of consumers when dealing with banks that leads to a degree of inertia. Customer inertia is reinforced by the “utility” character of many core banking services; consumers expect these services to work trouble free but spend little time actively using or assessing product performance. — Switching costs—consumers lack information of their own use of bank accounts and struggle to make easy comparisons between different bank offers and are anxious about the switching process. As a result, consumers cannot easily experiment with or “sample” different banks’ offers. — Incumbency advantage—existing banks with large customer bases gain access to privileged and detailed information about customers, facilitating cross-selling. — Price discrimination potential cross-subsidy—all banks, but especially those with larger customer bases are able to price discriminate between customers and potentially cross-subsidise core products, such as personal current accounts which act as “gateways” to enable wider cross-selling. Existing banks may be able to take advantage of their large back books of captive inert mortgage and savings customers. — Access to branches—branch networks remain an important part of customer contact and are valued by consumers. Developing a suitable network of branches can be costly. 63 The “big four”, prior to recent mergers and other market changes, include Lloyds TSB, RBS NatWest, Barclays and HSBC Treasury Committee: Evidence Ev 201
— Regulatory barriers—the cost of capital or solvency requirements for new entrants are higher than for (larger) incumbent banks. — Public policy affecting financial stability—financial stability has taken clear precedence over competition, leading to a preference to maintain existing banks in the market either through managed take-over that encourages growth in incumbents at the expense of smaller entrants, or through direct bail-outs with public money that distorts the wholesale funding costs of very large incumbents giving rise to an implicit subsidy (this is discussed further below). . The recent entry of Metro bank demonstrates that these barriers, although cumulatively substantial, may be overcome. It is not clear yet, however, whether upon entry any new bank can expand sufficiently to seriously challenge the market position of the Big 5. Two other sources of entry, foreign banks and internet banking are considered briefly below. 50. Foreign banks may be considered a competitive constraint if they can relatively quickly enter the UK. However, past entry was focussed on the savings market, without significant entry into the current account market or other key banking services. Banks within the European Economic Area (EEA) may operate in the UK under their home authorities’ regulation, requiring no specific supervision by the UK’s FSA (referred to as “passporting”). Despite the visible failure of Icelandic banks no significant change in EEA passporting has occurred. Consumers are protected via the compensation arrangements of the EEA member state, not the UK compensation scheme. Banks entering the UK outside of the EEA must be fully regulated by the FSA and must contribute to the Financial Services Compensation Scheme. Recent foreign entrants continue to focus on savings products. The extent that passporting of foreign firms has ever acted as an effective competitive constraint is questionable: serious entrants must operate via a UK subsidiary and develop a visible brand and high street presence, not simply an internet portal. 51. Many of the foreign operating banks were able to offer simple to use internet portals for their savings accounts. Internet banking, alongside phone banking, is an important route for consumers to access different banking services. Respondents to Which?’s current account satisfaction survey cited access to better online banking as the third most common reason for switching (equal to the number switching due to a disagreement).6 Which? does not consider that internet banking is a unique or specific advantage to facilitate or promote market entry. It is instead an alternative but necessary distribution channel to connect with consumers. No full-service bank operates on an internet basis alone.65 No full-service bank could remain successful without operating internet banking. 52. The internet has mainly affected the nature of price competition, especially through price comparison services. These services offer another marketing opportunity (or cost) for all banks but do not necessarily lead to clearer or easier comparisons by consumers or enable new brands to reach consumers more easily. For example, not all firms will necessarily be listed on a price comparison site, ranking of firms may be linked to payments of commission, and complex product features may not be reflected or easily compared (or firms may increase obfuscation of their product in response to the risk of price competition).66 The effectiveness of comparison sites will remain limited for current accounts while customers continue to have limited knowledge of their own bank account use. 53. Finally, three issues require particular attention: — The existence, and impact, of barriers to “exit” that restrict or distort market discipline—this is a product of the regulatory regime and public policy towards banks and is discussed in more detail below. Which? considers barriers to exit to be of equal importance to factors that make it costly to enter retail banking markets. — The effect of consumer engagement and switching behaviour on market entry. — The effect of “free” banking on switching decisions and market entry.
C ns e en a e ent an s itchin eha i 5 . The OFT has found that customers’ knowledge of their own use of current accounts and their perceived concerns over switching restricted the effectiveness of competition. This was exacerbated by complex charging structures for overdrafts and low levels of transparency for these additional charges. The OFT has since been negotiating improvements to banking industry practice to address the transparency of information about a customer’s bank account and increase confidence in the switching process.67 This includes work with Bacs, the payment system provider, to address problems with transferring accounts and improve information to consumers.68 55. As part of our customer satisfaction survey, we asked about members’ experience with switching bank accounts. Our findings show that, overall, relatively little has changed. Switching volumes remain low and 6 The 2010 Which? current account survey. 65 For example, First Direct leads Which?’s satisfaction surveys through an internet-only based service, but this is a subsidiary brand to HSBC which offers branch access and extends this service to First Direct Account holders. 66 Paragraphs . 1 110, ssessin the e ecti eness tentia e e ies in c ns e s a ets, April 2008, OFT. 67 e s na c ent acc nts in the a e t, October 200 , OFT. 68 see http: www.bacs.co.uk Bacs Corporate BacsServices Pages Acccountswitchingservice.aspx. Ev 202 Treasury Committee: Evidence
while those that do switch find the process fairly easy it is not without practical problems or errors. The majority of people are still not switching, and have doubts over the benefits to be secured and the risks of errors affecting their regular payments. 56. Overall, only 20% of Which? members have ever switched personal current account. Switching rates amongst Which? members average 6% per year (measured over a five year period), which is the same as switching rates identified by the OFT in its market study. The two main factors driving their choice to switch was to obtain better customer services or a better credit interest, although a fifth reported switching due to a disagreement with their bank or to obtain better internet banking. 57. Of those who did switch, nearly 80% found the process easy. In these cases their banks managed the switch and provided a written and often verbal summary of the switching process. Surprisingly, just over 10% of members that switched reported having to manage the process themselves, and consequently found it much more difficult to do so. Despite the relative ease of the process, nearly 0% experienced a problem with direct debits or standings orders being transferred incorrectly, a problem with the helpfulness of their old bank or with the length of the overall process. 58. Of greater concern are the large proportion of consumers that have never switched and their reasons. For those that did consider switching but chose not to the most commonly cited reasons were “I didn’t think it would be financially worth while” and “I wouldn’t get any better service at the new bank”. This suggests that many consumers still view banks as “all the same” despite the different satisfaction performance reported between the Big 5 and smaller or internet-only banks. 5 . Nearly 30% of respondents cited worries over payment of direct debits or standing orders, amongst other reasons, for why they didn’t switch account and a quarter had concerns with the complexity of the switching process. Although some steps have been taken to improve consumer confidence with switching, and may have made improvements to the actual performance of the process, consumers still perceive switching as risky. Given these circumstances, the provision of “portable account numbers” allowing consumers to switch their account without the worry of transactions going wrong should be considered.
ee an in an its i act n s itchin 60. Which? does not consider that banking is in fact “free”. The charging structure of most bank accounts in the UK follows a “free-in-credit” charging structure, where regular fees for operating the account are not charged but credit interest tends to be low and explicit charges are levied for certain types of transaction of service, which have historically been related to overdrafts. The OFT has previously, shown that “free-in-credit” banking generates £8.3 billion of revenue per year for the banking industry, with 50% of this arising from net interest payments (the difference between interest paid and the income banks earn from interest).6 61. Some new entrants consider that “free” banking hinders the development of competition, supporting customer inertia or apathy and making customer acquisition (and therefore market entry) more costly or difficult. Which? has found that consumers would be very price sensitive if faced with an explicit charge, such as a monthly or annual charges for operation of their current account, and would switch to a non-fee account.70 62. The existence of “free” banking models may appear to be a simple explanation for consumer inertia, with an obvious policy prescription to address low switching rates. This is mis-leading: — The recent entry of Metro bank challenges the extent to which “free banking” alone is a significant entry barrier. — Customers still need to be better informed about their own bank use as well as have information presented in comparable form to make a meaningful switching decision. There is little research that considered the “quality” of switching decisions, not just the volume of switching rates. Explicit fees may drive switching rates, at least in the first instance, but may not improve consumer outcomes if switching to accounts that do not meet their needs or if switching rates cannot be sustained due to poor industry switching processes and lack of meaningful, relevant information. — The only direct measure to change current account charging models would be a form of price- control: regulating banks’ charging structures to ensure explicit regular charges for holding a bank account. This is a complex and significant intervention in the market. Explicit charges do not reflect consumers’ own sense of value added from bank accounts (judged by their sensitivity to the introduction of an explicit charge), especially for the “utility” elements of basic services such as holding money, accessing or transferring money. Any regulation to impose an explicit fee must also then set controls on any other charging options or price structures that may also be adopted, failing to do so risks creation of both an upfront fee an continuation of hidden or opaque charging models that may be difficult to challenge for fairness, leading to a serious risk of untended consequences. 6 Figure C. , annexe C, e s na c ent acc nts in the a a et st , July 2008, OFT. 70 7 % of respondents agreed that it was very or quite likely they would move their account to a non-fee charging bank if faced with a monthly or annual charge. Source: TNS omnibus survey of 1,022 representative members of the public, surveyed September 2007. Treasury Committee: Evidence Ev 203
C nc si ns n s itchin 63. There is no single measure that can improve switching rates and the quality of switching outcomes, and switching alone is not a remedy to the prevailing weakness of banking competition. 6 . For current accounts, Which? would not object to banks offering a wider range of charging structures for their current accounts but this must be conditional upon: better information on customers’ own use of bank accounts (building on the OFT’s plans for an annual statements) and clear and transparent charging (no hidden charges) that aids comparison of accounts. 65. Although the OFT has negotiated some steps to improve product comparison and use by current account holders, its measures are largely a response to the Supreme Court’s ruling that unauthorised overdrafts cannot be assessed for fairness under the Unfair Terms in Consumer Contracts Regulations 1 (UTCCR). This has serious implications for competition. Which? considers that the purpose of such consumer rights legislation is to enable consumers to shop with confidence, allowing consumers to focus on the core elements of a product offer while knowing that they are unlikely to be seriously disadvantaged by the “small print”. This is, to our minds, the purpose of the UTCCRs. Competition should drive transparency in consumer markets. However, where transparency is sub-optimal, the UTCCRs form an important measure to protect consumers and encourage firms to make charges clear. The terms of financial services products are notoriously difficult to understand. Consumers of banking services now lack another important protection from unfair practices, undermining market confidence. 66. Switching in other key product markets supplied by banks, such as mortgages and deposit savings, may be affected by recent developments. First, the prevailing levels of switching for current accounts plays a role because these form an important “gateway” to identify and cross-sell to customers. Second, the significant change to market structure seen in recent years has reduced overall choice. These may be addressed by broad structural remedies that redress the balance of market power possessed by banks and measures to improve price transparency.
The Impact of Regulation on Competition 67. Which? is concerned with the current approach to regulation of banks and the legacy of the Government’s intervention during the financial crises. These have significant effects on the prospects for competition in retail (and likely SME) banking by creating: — Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents thereby strengthening their market power; and — No effective regime to enable market exit by failing banks (whether due to poor management or dissatisfied customers) while preserving financial stability of the economy as a whole. 68. These concerns relate to the public policy for regulation of banks and the role of UKFI in managing taxpayers’ stake in those banks that relied upon state aid to avoid failure. Further reform should also be taken in the overall approach to regulating banks: too often regulators are held accountable for banks’ decisions that create instability or put consumers at risk and those same banks remain in business regardless.
e ati n i icit s si 6 . Which? established a Commission into the t e an in early in 2010, and received evidence from key players amongst banks, regulators and government.71 Evidence to the Commission made it clear that the banking industry enjoys a significant public subsidy, in the form of tax payers’ funds used to protect failing banks from insolvency. Lord Myners noted that “the an in in st eca se it s een n e itten i icit a ainst ai e ith t a in a e i has en e a h e s si ”.72 This was evident in the approach to bank failure during the crises but also marked a long-standing trend, when dealing with risks to financial stability, of preserving the status-quo by state aid or by merger. 70. This subsidy arguably distorts decision making by banks, fostering riskier behaviour than would otherwise be acceptable, while enabling those banks to raise funds more cheaply. For those banks requiring taxpayer support, it has been necessary to support the whole bank, not just the assets and liabilities linked to essential banking activities such as the payment transmission system or securing customers’ deposits. Mervyn King noted to the t e an in C issi n:“ ti ate the hea t the e es c e n in ie t the inhe ent is iness the st ct e an in that e e t an the i c t a in c e i e the th eat n t t ai t the s ste hich is hat is n e innin the i icit s si an c eatin chea n in a e an s ta in is ecisi ns ”73 71 The full report of the t e an in C issi n can be accessed at http: commission.bnbb.org banking sites all themes whichfobtheme pdf commission_report.pdf 72 Evidence session with Lord Myners 18 March 2010, http: www.which.co.uk documents pdf future-of-banking-commission—evidence-session-18th-march—lord-myners- 20 873.pdf. 73 Evidence session with Mervyn King 25 February 2010, http: www.which.co.uk documents pdf future-of-banking-commission— evidence-session-25th-feb—mervyn-king-20 25.pdf. Ev 204 Treasury Committee: Evidence
71. It has been argued that the value of this subsidy, which distorts the cost of capital for banks, has increased over the course of the financial crisis as the implicit subsidy became explicit support, and is greater for larger than smaller banks. For example, Andy Haldane of the Bank of England estimates that the subsidy for the biggest five banks in the UK amounted to £50 billion for the period 2007 0 , representing about 0% of the total implicit subsidy available to the banking industry.7 In its submission to the t e an in C issi n Virgin Money estimated private equity investors demanded a 10 13% higher cost of capital from new entrants than from the largest incumbents: effectively double the cost facing the largest banks. 72. This subsidy results in a significant moral hazard. It fundamentally erodes the ability of small or new entrant banks to become serious challengers to the large, established incumbents. As a result market discipline, the key mechanism of competitive markets, is made ineffectual: good banks are unable to drive out the bad, while big banks remain big.
tate ai the e an sa e anches 73. State aid direct to the UK financial services industry has taken three main forms: public guarantees for lending, recapitalisation and impaired asset relief. The UK Government has applied all of these measures.75 Examples include the Asset Protection Scheme (APS) where, in exchange for a fee, the APS offers insurance on potential losses to eligible financial institutions. Other measures include increasing liquidity through direct purchase of assets by the Bank of England and the credit guarantee scheme that supports borrowing by banks. Re-capitalisation of key banks has occurred with the Government taking shares as collateral, which has mainly affected Lloyds Banking Group and RBS; investments in these banks are managed by UKFI. 7 . UKFI is the company established in November 2008 by the Government to manage UK shareholders interests in failed banking institutions.76 It has three objectives:77 — Maximising sustainable value for the taxpayer, taking account of risk; — Maintaining financial stability by having due regard to the impact of its value realisation decisions; and — Promoting competition in a way that is consistent with a UK financial services industry that operates to the benefit of consumers and respects the commercial decisions of the financial institutions. 75. Prolonged state aid can: — Encourage moral hazard, by weakening or pro-longing undue risky behaviour that is not sustainable, raising competition and systemic risk concerns; — Result in significant and sustained changes to market structure, especially concentrating market power amongst fewer institutions; — Affect the competitiveness of un-aided firms; and — Increase the barriers to entry. 76. The Government has made it clear that it will give up public ownership of banks. The provision of state aid is governed by European Commission rules to maintain cross-border trade and limit competitive distortions between and within Member States.78 These rules require all state aid to be reduced or eliminated in due course and require three steps: — Aided banks must be made viable in the long-term without further state aid; — Banks must carry a fair share of the costs of restructuring; and — Distortions to competition must be limited. 77. The guidance issued by the European Commission notes that “safeguarding systemic stability in the short-term should not result in longer-term damage to the level playing field and competitive markets”.7 Reform of banks must therefore consider the balance between ensuring viability and any specific measures necessary to limit competitive distortions. 78. As part of the agreement to benefit from state aid RBS was required by the European Commission to sell certain branches, mainly related to banking services for SME but also affecting retail deposit holders. It was recently announced that agreement has been reached to sell 318 branches to Santander.80 Which? does 7 Page 6, he i i n esti n, March 2010, Andrew Haldane, Bank of England: http: www.bankofengland.co.uk publications speeches 2010 speech 33.pdf 75 For details see Chapter 3 of the Budget 200 , April 200 , HM Treasury. 76 Page 30, “Reforming Financial Markets”, July 200 , HM Treasury. It was announced on 28 July 200 that UKFI has now taken formal responsibility for those investments in Bradford and Bingley that were not passed to Santander. 77 Letter to Treasury Committee from the Chancellor, 3 November 2008. 78 The European Commission has published guidance on removing state aid and returning state-aided banks to viability: Commission communication, “The return of viability and the assessment of restructuring measures in the financial sector in the current crises under the State aid rules”, 22 July 200 (“the guidance”). 7 Paragraph 20 of the guidance. 80 Press release a an c t an C ees a e anches t antan e , August 2010. Treasury Committee: Evidence Ev 205
not consider this a promising outcome for consumers and view this as a huge missed opportunity.81 As seen above, Santander has consistently been amongst the worst performing banks for customer satisfaction. Its significant growth in market position, so that it now forms part of the “Big 5” is due solely to an aggressive acquisition policy of failed or failing bank assets. Its market position is based on the deep-pockets of Santander and not on winning market share through effective competitive rivalry. 7 . Which? considers that both the European state aid rules and the terms of reference for UKFI have failed to take seriously the long term interests of consumers and taxpayers (largely one and the same), which are best served by a transformation in banking services that will make banking more competitive after withdrawal of state aid than before Government intervention was necessary. This will allow competitive market forces to drive value for consumers, improve productivity and facilitate deregulation where possible. 80. UKFI appears not to have taken any active steps to meet the third of its objectives: promoting competition. We cannot expect the European Commission, through the rules for state aid, to safeguard the interests of UK consumers if UK public bodies are not minded to take such steps. 81. To achieve the necessary changes in UKFI’s approach, Which? consider that UKFI must: — Play an active role in managing public investments, working with other shareholders, to ensure improvements to corporate governance and ensure sustainability of those banks in the public interest. — Apply a public interest test to its disposal of shareholdings that balances the needs of current and future consumers. 82. UKFI should take an active interest to ensure that products offered to customers and sales incentives to staff lead banks to compete “on the merits” of their products. This would contribute to safer, more sustainable, banks by limiting exposure to future compensation payments (such as payment protection insurance mis- selling) and help to restore confidence in banking markets. 83. The public interest test should include objectives to: — Make competition stronger post divestment or withdrawal of state aid than existed before taxpayers money was necessary to bail out the banking system; — Place consumers needs, both households and firms, at the heart of a transformed banking system; and — Seek any necessary wider reforms, with the co-operation of business, consumer representatives and regulatory authorities, to secure the transformation in addition to any change achieved from removal of state aid.
he e c etiti n in the e at e i e an s 8 . Financial services are not subject to the same rules governing competition as most other industries in the UK.82 This has two effects. 85. First, firms regulated under the Financial Services and Market Act 2000 (FSMA) enjoy a degree of immunity from the Competition Act 1 8. Agreements, or conduct by a dominant firm, that would usually breach competition rules are not subject to enforcement if “encouraged by any of the Authority’s regulating provisions”.83 86. This immunity appears largely irrelevant as UK authorities may directly apply European Competition law, for which FSMA does not grant immunity. In addition, the need for any form of explicit immunity is questionable. Firms accused of anti-competitive conduct would usually be able to cite any regulatory obligations or restrictions as “objective justifications” as a defence against enforcement action. 87. Second, unlike many other regulators, the FSA does not have concurrent competition powers with the OFT, which enable a regulator to directly apply competition law, including referring markets to the CC. Instead, when carrying out its functions, it must have regard to “the desirability of facilitating competition between those who are subject to any form of regulation by the Authority”.8 This affects the extent to which the FSA itself must actively consider or facilitate competition in its regulatory approach. 88. The OFT has some specific responsibilities under FSMA 2000, necessary to compensate for the lack of competition objectives in the FSA’s mandate. Section 160 of FSMA requires the OFT to keep the regulating provisions and practices of the FSA under review, and report any significantly adverse effects to the Competition Commission: a process known as “competition scrutiny”. There have been no occasions under current legislation where the OFT has exercised this power.85 81 Which? press release, “RBS branch sale does nothing to improve competition”, http: www.which.co.uk about-which press press-releases campaign-press-releases personal-finance 2010 08 rbs-branch-sale- does-nothing-to-improve-competition-says-which 82 Special arrangements exist for media and public interest issues which includes national defence and recently financial stability. 83 Section 16 , FSMA 2000. 8 Section 2(3)(g), FSMA 2000. 85 An initial complaint about the treatment of investment advice and advisors by the FSA was made under the Financial Services Act 1 86, and subsequently followed up by the OFT after FSMA 2000 came into force. Ev 206 Treasury Committee: Evidence
8 . This special treatment of the financial services industry sends a clear message to both the regulator and industry that the “normal” rules of competition do not apply.
C etiti n an sta i it 0. Competition is a dynamic process of rivalry that rewards firms that deliver good value and quality to consumers. Firms that do not serve consumers well fail. Competition always occurs within an institutional framework which governs the behaviour of firms and individuals. For example, property rights and contract law are pre-requisites to effective competition. Financial regulation, where targeted and proportionate, forms another part of the necessary institutional framework in which competition occurs. This reflects the more complex nature of the services offered by banks and the “bounded” rationality of consumers. It may also be necessary in part due to the instability that may be inherent in financial markets, prone to “irrational exuberance”. 1. Competition between banks, to the extent it was effective, was not the cause of the banking failure. Measures taken to ensure stability, such as the HBoS Lloyds merger have themselves weakened competition, leading to a considerable growth in market concentration. Setting aside the competitive framework through special treatment of banks during the financial crises and within the financial regulatory structure, as set out above, has significantly distorted market structure. This in turn has left consumers exposed to worsening outcomes and, through its greater concentration, has made financial services markets less resilient or stable. 2. On this basis, Which? is not convinced that it is appropriate to consider competition as necessarily a “trade-off” against stability or other regulatory objectives. Regulations, where proportionate and targeted, should exist to serve socially desirable objectives. Competition has a key role to play in delivering value to consumers within this institutional framework. Competition is a key mechanism to deliver financial services that represent value for money, meet the needs of consumers and, where incentives and moral hazard allow, promote greater resilience. Claims that competition is having a detrimental effect on financial stability must be specific, evidence based and scrutinised carefully.
e ti n n et n en e 3. Successful markets need confident, mobile and informed consumers. The nature of consumer protection interventions in banking markets has been intermittent and inadequate, despite a series of mis-selling or other scandals. This weakness of regulation hampers effective competition. . The Financial Services Authority (FSA) has identified a number of weaknesses in the financial capability of consumers, affecting their ability to make informed decisions between competing financial products.86 Overall, the FSA found that consumers take inadequate steps to plan for their financial needs and that a significant proportion fail to shop-around. For example, 33% of those holding general insurance products bought their policy without comparing it to any other product.87 5. Consumers of financial services may possess “bounded rationality” and or “non-standard preferences”.88 This can result in too much reliance on personal recommendations or brand (as a proxy for quality), rather than comparing key product terms. Consumers may also perceive greater risk from switching than warranted.8 6. As a result, for retail banking markets to work effectively, regulatory intervention must be prompt and effective to protect consumers’ interests. The active enforcement of consumer protection law promotes competition by building greater confidence by consumers in the market process. 7. Which? has responded to the Government’s consultation on reform of the Consumer Rights Directive, proposing a principles-based approach to restore consumer protection from unfair prices. 0 Consumers are not at present protected from unfair price terms by the UTCCRs, following the Supreme Court’s ruling. It is unreasonable and inappropriate to expect consumers to read all the small print forming part of their contract. Much of the small print is legal (rather than commercial) essentials, with many of the contractual clauses having little practical significance for the average consumer purchase. Consumers should be able to rely on businesses trading fairly so that where the “small print” becomes relevant, it treats both the consumer and business fairly. 8. Consumers should be confident that once they have entered into a contract, they will not be subjected to any unexpected charges or, if they are, such prices are fair and proportionate. But this rationale will be significantly undermined if the approach set out by the Supreme Court in the bank charges litigation remains unchecked. Under the Supreme Court approach, consumers can behave both responsibly and prudently yet still find themselves to be on the wrong end of an unexpected fee or charge. . More capable consumers will help build market confidence. Which? supports the current measures proposed to increase financial capability of consumers through generic financial advice and a financial health 86 in n i i it in t e : st is in se ine, FSA. 87 Page 5, in n i i it in t e : st is in se ine, FSA. 88 For a summary of these concepts see ssessin t e e e ti eness tenti e e ies in ns e ets, April 2008, OFT. 8 This was considered as part of the OFT’s personal current accounts study. 0 http: www.which.co.uk documents pdf consumer-rights-directive-allowing-contingent-or-ancillary-charges-to-be-assessed-for- fairness-bis—which—consultation-response-226521.pdf Treasury Committee: Evidence Ev 207
check, currently to be supported via the Consumer Financial Education Body. 1 This health check should not, however, simply become a sales channel for banks but should offer relevant advice that suits people’s needs, including debt advice and financial management. 100. The FSA, or its successor, must approach consumer protection regulation both pro-actively and with a mind to the competitive benefits it can bring. Measures to improve price transparency, contract certainty and prompt redress are concrete, meaningful steps to strengthen confidence in banking markets. This can best be served by making financial services subject to an economic regulator, similar to utilities regulation, with an explicit mandate to promote competition.
Conclusions on Competition and Choice in Banking 101. Which? considers that the evidence of poor competitive outcomes for banking services is becoming incontrovertible. Banking markets have been subject to weak competition long before the financial crises. However, the crises has exacerbated these harms to a critical level, leading to a number of harms: — Market power and concentration has increased, leading to the worsening terms for consumers of banking services described above; — A loss of “dynamic” efficiency in banking services and evasion of market discipline, damaging services to consumers and economic productivity. Banks appear to suffer an “x-inefficiency”: a bloated cost base, manifesting in excessive rewards for managers (not owners), as a result of ineffective competitive pressure and a sloppy approach to assessing risk (by banks themselves and by rating agencies); and — A conflict if interest for Government with UKFI tasked to maximise returns for taxpayers but without accounting for wider public interest to ensure a balanced and more competitive banking industry after state aid than before. 102. The root causes of these harms lie in: — The size and market concentration of banks; — Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents; — No effective regime to enable market exit by failing banks while preserving financial stability; and — Consumer inertia where, perhaps more than in any other industry, consumers have an inbuilt tendency to remain with their existing providers. This in turn reduces the incentives for firms to actively compete amongst each other. 103. If these issues are not addressed, then the additional measures that are necessary to make competition effective such as making switching easier or tackling comparability of information will not be successful: market discipline will still not apply to the largest incumbent banks. 10 . Two remedies should be considered: — Significant structural reform considering the economic market power of banks, and those reforms necessary to address financial stability. This may best addressed through a reference to the Competition Commission, which is the only body with the necessary powers to enforce structural change, but must be considered by the Vickers inquiry; and — Significant reform of public policy and regulation of banks to enable poor performing banks, whether due to poor management or customer dissatisfaction, to fail and thus become subject to market discipline. ete e 2
Written evidence su mitted y the Co-operative inancial Services Executive Summary — The Co-operative Financial Services’ (CFS) merger with Britannia, in August 200 , created a strong business with £70 billion of assets, 13,000 employees and nearly nine million customers. — Our purpose is to be a pioneering business delivering sustainable financial services for members, customers and society, while our vision is to be the UK’s most admired financial services provider. — We’re the most diversified member-owned financial services business in the UK, operating in both retail and corporate markets and with the scale and strength to offer a real alternative to the shareholder and government-owned banks. — At the heart of our ownership model are our values which define our business and shape the decisions we make. 1 http: www.hm-treasury.gov.uk d consult_financial_regulation_condoc.pdf Ev 208 Treasury Committee: Evidence
— We have not been immune to the impact of the banking crisis but during the recent period of economic turmoil, CFS has continued to deliver strong profitability and growth. While other banks received government bail-outs, we operated a sustainable model that didn’t lend out more than we had in customer deposits. This strength and trust in our brand has enabled us to attract even more customers. — There is a place for different types of banks and financial services businesses in our market. Our financial success shows that a balanced scorecard approach, which values customer advocacy, colleague engagement and social responsibility alongside profitability, drives our business’ performance. — Being member-owned, customer-led and ethically-guided has served us well throughout the recent economic turmoil, demonstrating our positive contribution to improving competition and diversity in the banking sector. — Throughout the credit crisis CFS has been able to continue lending to both personal and business customers due to high levels of liquidity and little reliance on the wholesale markets. — The banking crisis resulted in a shake-up of the financial services landscape, which in turn has resulted in new entrants and the growth of challenger brands such as CFS. This new landscape should offer the opportunity for more consumer orientated behaviours to develop in the sector. — Regulation, such as increased capital and liquidity requirements, is a significant barrier to growth, particularly for mutual businesses such as CFS which cannot turn to shareholders to raise additional capital.
Introduction 1. The Co-operative Financial Services (CFS) is part of The Co-operative Group, the UK’s largest mutual retail business with around five million members, more than £1 billion turnover and core business interests in food, financial services, travel, pharmacy and funeral care. The Co-operative Group has more than 5,000 trading outlets. 2. CFS’ merger with Britannia, in August 200 , created a strong business with £70 billion of assets, 13,000 colleagues and nearly nine million customers. 3. This submission aims to show how our business, which is the most diversified member-owned financial services business in the UK, operating in both retail and corporate markets, has the scale and strength to offer a real competitive alternative to the shareholder and government-owned banks. . The banking crisis resulted in a shake-up of the financial services landscape, which has resulted in new entrants to the market and the growth of challenger brands such as CFS. 5. However, whilst new entrants to the market should lead to increased competition and a better deal for the consumer, the experience of the failed Icelandic Banks, which were clearly not good for consumer trust in the industry, shows that this is not always the case. It is important to ensure that the new financial services landscape offers the right regulatory framework for more sustainable consumer orientated behaviours to develop in the sector. 6. We welcome the coalition government’s commitment to “bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry”. It is vital that this commitment is translated into meaningful actions, supporting a vibrant mutual sector that results in a healthy competitive and consumer focused banking sector in the UK.
Putting our Members and Customers First 7. Our ownership model means that we manage our business in the interests of our members and customers. 8. At the heart of our ownership model are our values which define our business and shape the decisions we make: — We put our members and customers first in all we do. — We take personal and social responsibility. — Together we will create a great place to work, grow and develop. — We strive relentlessly to be faster, better, more successful. — We are open and fair and are committed to excellent communication. . We place customer advocacy, social responsibility and colleague engagement alongside financial performance as measures of our business success using a balanced scorecard approach. 10. The balanced scorecard measures our performance across four areas: financial, customer, people and process. This ensures that we do not just focus on financial performance when measuring the performance of our business. Treasury Committee: Evidence Ev 209
11. Thanks to this focus we’re leading the way in customer service and advocacy and this has been recognised by the industry: — In 200 , CFS won the Which? Award for Best Financial Services provider and was shortlisted for the same award again in 2010. — Both The Co-operative Bank and Smile were named in the top three in the Which? People’s Choice survey—15,000 members asked to rate their satisfaction with their current accounts, savings and credit cards. — The FSA recently announced that The Co-operative Bank has the lowest ratio of complaints with just 2.1 for every 1,000 accounts and that over 5% of the complaints received were closed within eight weeks. 12. Our strength in customer service and advocacy is underpinned by our unique customer council, which provides a forum for customers to engage with executives to discuss all aspects of the business including strategy, products, ethics and people policies, and provides an essential “sense check” on business proposals.
Ethical Finance—The World’s Most Sustainable Bank 13. Our commitment to principled finance, which takes account of our social and environmental responsibilities, is stronger than ever and an overarching theme of sustainability permeates every aspect of our business. 1 . Most notably, The Co-operative Bank is the only UK high street bank with a customer-led ethical policy which sets out the way we do business, including, who we will, and will not, lend money to. 15. The ethical policy covers all of the bank’s corporate, business and wholesale market assets and is reviewed regularly to ensure it continues to reflect our customers’ views. We’ve turned away more than £1 billion of lending since 1 2, based on customer’s ethical concerns. 16. CFS also provides a comprehensive portfolio of sustainable products and services targeted to specific sectors, including free banking to the co-operative, voluntary, charity and social enterprise sectors, basic bank accounts, and affinity products which raise millions for partner charities. 17. Meanwhile, our dedicated Social Banking Unit directs finance towards social enterprise, charity, social housing, microfinance, energy and co-operative and credit union sectors. We are one of the leading financiers for community scale renewable energy schemes. 18. Our ethical leadership and financial strength culminated in the business becoming the Financial Times’ Sustainable Bank of the Year in 2010, outperforming 110 financial institutions from countries. 1 . Such recognition is not built on a few good deeds, nor a year’s achievements alone, but a longstanding approach to sustainability that is embedded and uncompromising.
CFS Position in the Financial Services Market 20. During a time of great economic turmoil, CFS has continued to deliver strong profitability and growth. While other banks received government bail-outs, we operated a model that didn’t lend out more than we had in customer deposits. This strength and trust in our brand has enabled us to attract even more customers. 21. In 200 we saw major sales increases across core product lines including current accounts, savings and motor insurance. Current account sales saw a year on year increase of 38%, with a big increase in customers switching from the big four banks—overall new current account market share has doubled in the year to %. This year we have seen that growth continue, with an increase in total current account balances of 5.8% in the first half of 2010. Mortgage applications have also increased by 31% and our new policies in our General Insurance business were up 32%. 22. We have increased our lending to corporate business customers by over 0% over the last three years and plan for further growth in 2011 and beyond—because we have maintained high levels of liquidity from customer deposits, rather than relying on wholesale markets, as customers continued to trust us with their savings. 23. In recent months, we were one of the first mortgage providers to bring back an affordable 0% loan-to- value option across our mortgage range, which has proved popular with first time buyers. 2 . We are investing heavily to ensure our members and customers receive the products and services they rightly expect from The Co-operative, with some £250 million of improvements planned in 2010.
Banking at the Margins 25. CFS takes a lead in promoting social inclusion and providing access to financial services including for the most marginalised in society. Ev 210 Treasury Committee: Evidence
26. As a socially responsible organisation, we already offer basic bank accounts and understand they are an important way to give access to banking for those who are otherwise financially excluded, whilst also helping to tackle wider social problems in society. 27. Unfortunately there are discrepancies in the basic bank account market, with some providers offering much more than others: — Our Cashminder account basic bank account is available to any adult. However we are one of only two providers offering basic bank accounts to undischarged bankrupts and have no restrictions on branch counter access to our basic bank account holders. We contributed to the recent Citizens’ Advice report, Called to Account, which highlighted the need for other banks to provide access to undischarged bankrupts. — We believe that other measures must be introduced to ensure all banks, including new entrants, genuinely perform on this issue. These measures would include compelling all banks to publish their market share figures for existing and new basic bank accounts, in addition to offering their basic bank accounts to undischarged bankrupts and reducing restrictions on branch counter access. 28. We have also introduced a pioneering project which enables prisoners to open a basic bank account prior to release. The scheme has had a positive effect on reducing prisoner re-offending rates as the provision of a bank account is often essential for an offender to get a job or accommodation on release from prison. 2 . The Co-operative Bank is also the largest provider of banking to the credit union sector, providing facilities to more than 60% of credit unions in the UK. With the credit union movement, we pioneered the credit union current account. The current account forms part of our contribution to supporting the scaling up strategy for the provision of affordable credit through mainstream financial products. 30. We firmly believe that to tackle the wider problems of financial exclusion, the industry should work together to look at what has been learned so far and what different types of action may be needed going forwards.
Financial Education and Capability 31. We recognise the need for the next generation of consumers to be better informed and more confident so that they are able to take greater responsibility for their financial affairs and choose products and services that meet their needs. 32. Our Skills Schools programme supports young people of different ages and mixed ability to be prepared for the future by helping to develop essential financial skills for learning, life and employment. The programme is delivered with the support of over 1000 members of staff, who volunteer through Skills Schools. 33. In 200 , CFS’ Skills Schools programme enabled over 8,000 young people to improve skills such as numeracy, money management, employability and even safe driving. 3 . Our aim is to focus on skills linked to the National Curriculum—to develop financial skills through their work in Mathematics, Physical Social Health Education (PSHE) and citizenship.
Accessing Information About Financial Products 35. Informed and more confident consumers will make the best financial decisions when financial services products are easy to understand and compare. This is critical to a competitive financial services market, as a return to a higher number of competitors in the banking market is likely to result in a more complex range of products. 36. At CFS we support efforts to develop simple and transparent products and focus on ensuring that our communications with customers are straightforward, whilst using our financial education activities to grow an informed base of future consumers.
Competition Concerns / Opportunities a e a ts e n ent- ne an s 37. The on-going sale of parts of the government-owned banks offers a real opportunity to ensure that the needs of the customer are put at the forefront of the asset sale process. 38. The sales should not just be predicated on the highest bidder winning, but should make it a pre-requisite that: there is a clear commitment to maintain the branch estate; there is an obligation to provide all types of bank accounts including basic banking services; and that a fixed percentage of current accounts held in that branch estate are basic bank accounts. 3 . When banks, or parts of banks, are sold we believe there should be conditions, including a requirement that branches remain open for five to ten years. Treasury Committee: Evidence Ev 211
e at n i n ent 0. Regulation is a significant barrier to growth. For example, increased capital and liquidity requirements can have a disproportionate impact on mutual businesses such as CFS. 1. We believe that any banking levy should be proportionate to the risk of the bank’s activities. There is a risk that the banking levy, as currently proposed, will disproportionately penalise deposit taking institutions such as ourselves. We also believe that the application of the threshold for inclusion on the levy disproportionately bites on those institutions which are only marginally over the threshold. Finally, the inclusion of lower tier 2 capital in relevant liabilities does not reflect the long-term stable nature of this funding.
n ast ct e 2. In addition to the regulatory environment, one of the main barriers to entering and expanding in the banking sector are the substantial set-up costs relating to systems, branches and staff. CFS is investing £250 million in customer service and a new banking platform, which will significantly increase our capability to bring products to market more quickly and efficiently and provide the potential for significant growth.
inancia e ices C ensati n che e 3. Mutuals such as CFS, which have maintained a high level of balance sheet funding from retail deposit balances, have had to bear a disproportionate impact of the cost of funding the Financial Services Compensation Scheme (FSCS). This is due to the current allocation of FSCS levies, which are based on the size of each contributor’s retail deposit balances. This is proportionately more than those banks that have relied on wholesale funds from the markets—even though such a reliance on wholesale funding was one of the main causes of the financial crisis. . We believe that there need to be new depositor protection arrangements, which accurately reflect the relative risks faced by institutions with different types of balance sheet funding and some consideration needs to be made on managing the unpredictability of levy increases. We are particularly concerned by requirements proposed by the European Commission to build up a deposit guarantee fund (equivalent to 1.5% of eligible deposits), which will place an additional and unsustainable burden on businesses such as us.
Current Account Switching 5. Despite our recent experience of a 38% increase in current account customers switching from the big four banks, we acknowledge that the UK continues to have one of the lowest current account switching rates in the EU and more needs to be done as this is a key barrier to competition in the sector. 6. We believe that there is a need to set-up a dedicated working group to find a way forward to make current account switching easier. We need to find a solution, which makes it as easy to switch current accounts, as it is now for people to switch utility providers or to port their mobile telephone number. 7. In the meantime, we have reviewed and improved our own processes to make the switching process smoother for customers wanting to move to and from the Bank and further, we believe that ongoing industry and regulatory communications to increase customer awareness in terms of the ease of switching and how products and services differ by bank would help.
Identification and Verification 8. A further constraint on consumer ability to benefit from the range of competition within the banking industry is the requirement for repeated provision of identification, either within a single banking entity or between entities. We would support investigation into options to ease this requirement for consumers, possibly through use of electronic methods of identification such as electronic signatures.
Conclusions . Our recent performance has shown that being member-owned, customer-led and ethically-guided has served us well throughout the recent economic turmoil and that we offer a positive contribution to improving competition, diversity and stability in the banking sector. 50. Despite our recent successes we recognise that there are barriers to improving competition in our sector. The regulatory environment needs to take account of different ownership models so that businesses such as ours are not impacted disproportionately in efforts to create a more stable and prudent regulatory regime. 51. We have also highlighted the need to set-up a dedicated working group to find a way forward to make current account switching easier, which will enable improved competition in the crucial current account market. 52. There is a need to introduce measures so that all banks, including new entrants, genuinely perform on basic banking and the discrepancies in this market are addressed. These measures include the provision of accounts to undischarged bankrupts and disclosure of each banks’ basic bank account market share. Ev 212 Treasury Committee: Evidence
53. We have also suggested that the sales of parts of the government owned banks should not be predicated on the highest bidder winning but there should be a pre-requisite that there is a clear commitment to maintain the branch estate and an obligation to provide all types of bank accounts including basic banking services. 5 . We believe that we have demonstrated the contribution that a member- owned, customer-led and ethically-guided business can bring to a vibrant and competitive banking sector. ete e 2
Written evidence su mitted y esco Bank Executive Summary 1. We welcome the Committee’s Inquiry into Competition and Choice in the Banking Sector and the opportunity to submit written evidence. 2. Tesco Bank offers insurance products, savings accounts, unsecured loans, credit cards and travel money. We have over six million customer accounts, a loan book worth £ .8 billion and total savings deposits of £ .5 billion. 3. Our aim is to bring simplicity to a complex market, and to give banking customers the same good value and service that customers receive in Tesco stores. Our longer-term goal is to create a full-service retail bank for Tesco customers, offering more services through branches in our stores as well online and by telephone. . We are a small player in most of the banking product markets in which we operate, with currently no presence in the two most important retail financial product markets, namely current accounts and mortgages. This, coupled with Tesco Plc’s experience of bringing competition into new markets and championing the cause of competition, gives us a unique perspective on the opportunities that exist to improve competition and therefore consumer choice in the banking market. 5. It is through competitive markets that we see innovation and positive outcomes for customers, in terms of choice, service and value. This means markets in which: — real choice exists and is easily accessible—simple, easy product comparisons and switching information; — a level playing field, such as is created by access to information (or undermined by the lack of it); and — the regulatory system is simple, risk-based, proportionate, does not impede market entrants and small players and actively encourages competition; 6. Our experience has shown that there are three main factors which advantage the large incumbent players and act as barriers to effective competition and market entry: i. a ie s t s itchin . Personal current accounts are fundamental to building a relationship between banks and their customers. However consumers rarely switch due to the perception (often borne out) that doing so would be difficult, time consuming and costly. They can also find it difficult to compare different product offers, particularly given often complex charging structures. There are cultural and systemic reasons for this inertia. But the result is reduced competition. ii. ccess t in ati n. To ensure that we lend responsibly banks must capture and validate detailed information on a customer’s overall financial position. This favours the large current account holding banks who have access to this data and the network to meet the customer face-to-face. Furthermore, the established banks routinely share current account data which can be used to calculate income and expenditure, as well as wider product holdings, through a closed user group. This puts smaller players at a disadvantage. iii. e ati n. There is a clear need for a proper and robust regulatory system. However the current regulatory framework is complex, lacks transparency and is subject to constant change. This makes it difficult for smaller banks in particular to navigate. 7. We provide more detail on our concerns in these areas in the response that follows.
Promoting Competition and Choice 8. As summarised above, we believe that barriers to effective competition exist in three main areas:
I. actica a ie s t s itchin . It is well-known that a current account offer is fundamental to building a strong and wide customer base; it is the core gateway and relationship product. As the OFT’s review of Personal Current Accounts (PCAs) in July 2008 stated: “Consumers often select additional financial products from a bank with whom they have an existing relationship, without shopping around.” It also highlighted low levels of switching as one of six potential barriers to entry and expansion in this market. Treasury Committee: Evidence Ev 213
10. Around 5% of the adult population already has a current account. Therefore, the focus for new entrants is necessarily on encouraging customers to switch. However, the switcher market is small. Recent customer research showed us that over half of customers have never switched their current account and more than two in five customers have been with their existing provider for ten years or more. Each year, as few as one-in- seventeen people switches their current account 2. Therefore, building up a reasonable customer base is a significant issue faced by any new entrant. By comparison, in our grocery business, consumers can and do switch on a regular basis. For example, over the past year, the average value of sales in any 12 week period moving between Tesco, Sainsbury’s, Asda, Morrisons and Waitrose was around £1bn, with each retailer gaining and losing customers as a result of stiff competition and low barriers to switching.
11. The effect of this inertia is most seriously and negatively felt by new entrants seeking to establish themselves in the current account market. Such players are placed at a further disadvantage by the ability of the incumbent banks to offer attractive rates to new customers, which they pay for by giving very low rates to their existing customers. This is also common practice in the savings account market.
12. There are a number of explanations for this customer inertia. Dissatisfaction with their existing bank (e.g. heavy charges or unhelpful staff) or occasionally an attractive offer from a competitor (eg better account features or a switching payment) can encourage a customer to switch. But the overarching view of customers is that switching their current account is difficult, time consuming and costly. The problem is not necessarily with the banks—who have established dedicated switching teams to ensure a smooth process—but with a customer’s Direct Debit payments. Notwithstanding that the Service User’s Guide and Rules to the Direct Debit Scheme states that service users must action change of account requests within three working days of receipt, all too often these companies (utilities, councils, telecoms and media providers) either continue to take money from the wrong account, or finding that they cannot threaten to cut off the service. This causes much frustration on the part of the customer and this frustration is often misdirected at the banks
13. Another barrier to switching is the difficulty that consumers face in accessing information about the different products and services available. Feedback from our customer research, tells us that in many cases, consumers do not understand banks’ charging structures. This adds to the perception that it is easier to remain with their existing bank. We are committed to keeping our pricing and communications with customers simple and transparent.
1 . Much work has already been done to encourage switching but has failed to deliver the desired results. Given the importance of this switcher market to competition, it is vital that a proper, simple, robust switching process is put in place to ensure that all parties perform their responsibilities in a timely fashion. This could be through: — penalties—the company forfeits payment for the month if they attempt to take funds from the old account; — incentives—league tables for the best worst performers; — contractual liability to the customer—the Direct Debit payee is liable to pay damages for late transfer; or — enforcement through a central agency, possibly funded by Direct Debit payees, which would undertake the switching process on behalf of customers.
II. ess t in ti n e e in e
15. There is, rightly, an increasing focus on responsible lending—most notably in the OFT guidance published recently 3 but also in the FSA’s approach to the supervision of banks and the recently published consultation on affordability tests and income verification for mortgages. However, this places an increasing burden on lenders to capture and validate detailed information on a customer’s overall financial position, and favours the large current account holding banks which have access to this data and the infrastructure to meet the customer face-to-face. In addition, the established banks routinely share current account data on income and expenditure, as well as wider product holdings, through a closed user group which only those with a sufficiently large current account base (as determined by the bank members themselves) can access.
16. This access to shared information gives the large banks sight of information about account movements which can help demonstrate income and expenditure without having to take the customer through a detailed application and verification process. This is particularly useful in low value, unsecured lending—such as credit cards and loans—where customers expect a quick and easy process. Without access to this data, verifying income and expenditure can involve the customer in protracted postal correspondence, filling in budget forms, sending in copies of payslips etc. This gives a competitive advantage to the established banks because it means that customers without the time and patience to go through a lengthy application process will chose their current account provider, potentially missing out on a better deal at a smaller bank. 2 Source: GfK NOP. 3 es nsi e en in i n e e it s tt : t s e t siness e ets ene t Ev 214 Treasury Committee: Evidence
17. Given the essential nature of this information and the additional requirements on banks to ensure that they are lending responsibly, we question whether denying access to this data to small banks or banks not offering current accounts is in the interests of effective competition.
III. eat 18. Another barrier to entry comes from the current regulatory framework. We recognise that there is a clear need for a proper and robust regulatory system to ensure that the market functions properly and consumers are protected. Regulation may also have a role to play in delivering better outcomes for currently disengaged consumers (by increasing competition and excluding from the market irresponsible or unsafe institutions). But it is important that regulation is risk-based, proportionate and consistent or it could have the perverse effect of discouraging new market entrants. 1 . We have a number of concerns about the current regulatory system: — he e is a ac ce taint a t the cess an tc es. The timeline and the requirements for the FSA approval process are unclear. We recognise that imposing statutory approval deadlines or strict requirements on the FSA may not be appropriate, but target deadlines and more detailed guidance would provide greater clarity and transparency about how long it will take and what is required. This could include setting out the key steps within that process and the administrative timetable to which the FSA and applicant will work. This would make it significantly easier for businesses to plan and make the necessary arrangements for product launch (involving staff recruitment, new systems and training and customer communications). By way of example, the FSA guidance indicates that the Variation of Permissions application will take six months from submission to the FSA. However, should the FSA choose to stop the clock’ with questions or new requirements on any specific aspect, this creates uncertainty on the end deadline and therefore uncertainty in programme launch plans and the required resource of the applicant up to this point. — he e is a ac sta i it an c nsistenc . Constant regulatory reform and a lack of consistency between the UK, Europe and beyond create instability and make it very difficult to plan and make long-term business investment decisions. It also diverts resources away from developing new products and the business, as they are instead focused on implementing regulatory change, and creates an additional compliance challenge. An example is in the area of consumer credit, where changes were made to the Consumer Credit Regulations in 2005, 2006, to the Act effective in 2007 08, via the Payment Services Regulations in 200 , by the introduction of the Lending Code in 200 10, the OFT’s Irresponsible Lending Guidance in 2010, the upcoming implementation of the Consumer Credit Directive in 2010 11 and the additional review of consumer credit announced by BIS on 1 July 2010. — t is es ce intensi e a tic a s a e an s. As the above example highlights, there is a huge volume of regulation. And it is not clear that all regulation is necessary (as there has not in the past been the discipline of removing redundant regulation). The move to principles-based regulation is an example of an approach that has posed a disproportionate burden on small banks such as ours. Banks are expected to interpret and justify their approaches in the context of guidance, rather than prescribed rules. This requires an additional level of experience and expertise, either requiring resources internally or costly external advice. To manage the regulatory requirements and the relationship with the regulator, our business, with a relatively small, low risk banking offering, requires a team of 16 specialists in addition to the large amount of senior management time for regulator engagement. In addition to the cost of monitoring and compliance, regulation also creates cost by requiring businesses to make certain investments in infrastructure and systems—for example the Anti-Money Laundering or Know Your Customer and Information Security requirements. This adds to the already high costs of IT and systems needed to operate in the banking industry. Moreover, much of this investment is required prior to revenues being generated. ete e 2
Written evidence su mitted y BS Group Plc Executive Summary — RBS Group believes that competition is good for markets and that a competitive market is the best way to raise standards and deliver excellent services for consumers. — We are committed to increasing transparency across our product range to make it easier for customers to understand what they are purchasing and how they are charged. A number of initiatives agreed with the OFT are already underway in this regard. — The UK banking sector, in line with other capital intensive industries, has consolidated in recent years as shareholders have required a sustainable return on their investment. In future, any barriers must remain low if the market is to encourage new entrants. Treasury Committee: Evidence Ev 215
— Our focus as a business will remain on competing in the market to serve our customers in our chosen businesses to the best of our ability.
Introduction 1. We welcome the opportunity to contribute to this Inquiry. Many of the issues to be covered by the Committee are also being considered by the Office of Fair Trading and by the Independent Commission on Banking. Furthermore, many of these issues have been considered in depth by OFT and Competition Commission market studies and inquiries, and we do not propose to go into detail about their findings in this submission. 2. We believe that competition is good for markets. RBS welcomes competition because we firmly believe that a competitive market is the best way to raise standards and deliver excellent services for consumers. Whilst we believe that banking in the UK is very competitive, the industry must do more on the issue of cultural change: reconnection with customers and communities; restoration of management excellence; reform of pay structures that have become hard to defend. The financial services industry is integral to our economic system and as such, its weakening comes at considerable peril to society’s broader wealth creation and stability. But our more intangible licence to operate from society is at present rather battered. Our integral role requires that we restore it. 3. In this response we propose to address the terms of reference set out in the Press Notice of 13 July in turn.
Assess the Impact of the Financial Crisis on Competition and Choice in Both Retail and Wholesale Markets . The financial crisis has had a significant impact on the banking sector. The crisis accumulated a varied list of casualties, from Northern Rock and Bradford and Bingley to Icelandic and Irish banks. Failures encompassed big banks and small, specialised and universal, investment and retail. The illiquidity of securitisation markets also weakened the ability of banks to compete. 5. The number of players may have decreased since the period before the financial crisis, and therefore arguably competition, but it is important to draw a distinction between effective competition and that which is based on business models which carry significant risks to financial stability. The latter is based on the cheap wholesale funding, leverage, mis-pricing of risk and unsustainable lending practices. There is a broad consensus in the industry and beyond that the industry should not return to these practices. We believe that post crisis there remains an adequate level of competition and choice in the banking sector. 6. Increased regulatory requirements for capital and liquidity have increased costs for all banks. The cost of wholesale and deposit funding have increased significantly, pushing up costs of lending for customers over the base rate. The availability of funding is a further constraint. As many banks seek to attract more deposits, the price we have to pay increases. The ability of banks to drive competition further will be impacted by these constraints on their balance sheets. These increased costs, applying across the industry, should not be mistaken for increased pricing power. 7. As the Committee will be aware, the UK market is a very mature one across both wholesale and retail banking with intense competition across all product ranges. One product area which has been particularly impacted by the financial crisis is that for deposits. Given the withdrawal during the financial crisis of a number of sources of wholesale funding, many banks have increased their focus on securing relatively stable retail and commercial deposits, and this trend has been encouraged by regulators’ liquidity requirements. This has sharply increased competition particularly for fixed term deposits, with both new and existing providers offering attractive rates of interest to attract these deposits; this is clear evidence of competition benefiting the consumer.
Assess the Impact of Widespread Consolidation Among Banks and Mutuals 8. The UK banking industry, in common with those existing in many other major economies, has grown more concentrated over recent years, in line with the concentration of other capital intensive industries. Larger, more diversified companies have the ability to achieve greater synergies and create economies of scale. This enables banks to provide services at lower cost to the consumer whilst also delivering a sustainable return to investors. However, the market share of the four largest banks is now lower than it was in the 1 70s and 1 80s, and with the expansion of Santander it is now more accurate to speak of the “big five” than of the “big four” banks. Moreover, there has been a significant deconsolidation of financial services relationships, leaving current account providers less likely to provide their customers with additional products such as mortgages, credit cards or loans. . As with other consolidated industries, the UK retail and wholesale banking markets remain competitive, as major players compete effectively with one another and new entrants with lower customer bases and smaller back books can compete and grow. Nevertheless, the players in the market must be able to make an adequate return on equity over the cycle in order to cover the cost of capital and satisfy the cost of investment to shareholders. Recent regulatory reforms have made banking more capital intensive, which will only be sustainable if investors are content to bare this and are adequately compensated. This is especially important for the ultimate beneficiaries who include pension funds and the taxpayer. Ev 216 Treasury Committee: Evidence
10. The conditions imposed on RBS and Lloyds Banking Group by the European Commission in connection with state aid will also impact the market place subject to certain conditions including regulatory approval. RBS will divest the Royal Bank of Scotland branch-based business in England and Wales, the NatWest branch network in Scotland, its Direct SME customer base and certain mid-corporate customers across the UK to Santander. This will result in the divestment of 318 branches and supporting infrastructure and services. The business will include approximately 1.8 million retail customers, 230,000 SME customers, 1,150 corporate customers and £20 billion of assets. This represents approximately 2% of the UK retail banking market and 5% of the UK SME and mid-corporate markets respectively and will increase Santander’s share of both these markets. 11. By 2013 Lloyds Banking Group will have divested more than 600 branches and part of Northern Rock is likely to be privatised. There are financial services providers who are poised to enter the PCA market, including Tesco Bank, Virgin Money and the Post Office, as well as new banking brands such as Metro Bank which opened the doors of its first branch on 2 July 2010. These changes in the UK retail banking sector illustrate the dynamic nature of the UK retail banking sector.
Examine the Key Barriers to Entry Inhibiting Increased Competition—Including Regulation 12. There is significant evidence of new entrants to the market, planned or active (eg Tesco Bank, Virgin Money and Metro Bank). 13. The financial crisis has in fact created opportunities for potential new entrants. The reputation of several incumbent banks has been damaged by the financial crisis (to the advantage of new or newer entrants). Furthermore, recent advances in technology have resulted in an increase in the number of channels through which customers can access banking services. The internet and telephone banking have made access more convenient for customers and reduced the level of reliance on a physical branch network for the savings market. 1 . On regulation specifically, the fact that banking is a capital intensive industry and that proposed regulatory reforms are increasing the capital requirements further is likely to reduce prospective returns. This may be a dis-incentive for some market entrants, however these are challenges which impact on all market players, not just new entrants. 15. The cost of compliance with regulation is increasing in the financial services industry as the financial crisis has prompted a significant increase in the pace and volume of regulatory change and this increase seems likely to continue for some time. If regulators and Government are to avoid creating a very significant, unnecessary burden on the industry going forward, it is important that regulatory changes are proportionate and well-considered, that sufficient time is given for implementation and that supervision of firms is also proportionate and consistent. 16. Previous reports have looked at the issue of payments systems (for example, the Northern Ireland PCA banking report and OFT 2003 Market Study into payment systems) and have identified no significant concerns. The direct access and governance criteria for UK payment systems have been subject to extensive regulatory scrutiny in recent years. We believe they are fair, open and objective and are the minimum necessary to encourage competition without compromising the systems’ safety. There is active competition between settlement members to provide indirect access. The low barriers associated with access to payment systems are borne out by the fact that new entrants such as Tesco Bank, are coming to the market via agency arrangements. 17. Access to financial risk information for the provision of personal banking services is a not a barrier to entry or expansion (either for personal and SME banking) and this has not been impacted by the financial crisis. This issue was considered by the Competition Commission in the Northern Ireland PCA banking report, which concluded that access to information regarding customer risk was not particularly complex or expensive. 18. There are many different business models and ways to compete in the personal banking sector. For example a new entrant can enter the market and build up a customer base, even on a relatively small scale (see the business model which Metro Bank is adopting in relation to PCAs). Many economies of scale (eg in payments processing) are accessible at relatively small sizes through arrangements with specialised processing companies. 1 . It is also possible to enter the market for a product on a larger scale by leveraging a strong position or well-known brand from other financial services products or indeed other industries. Examples of this include former building societies such as Nationwide entering the PCA market or Virgin Money and Tesco Bank extending a well-known brand from personal loans, credit cards and insurance to PCAs. Tesco Bank and Virgin are also prime examples of how a brand can be leveraged from another industry into financial services. 20. Customers are increasingly accessing their banking services in new ways. Improvements in technology, such as internet banking, have changed the nature of the market and reduced the direct usage of branches. Therefore, an extensive branch network is not a prerequisite for expansion in personal or SME banking. Whilst access to physical premises is considered an attractive feature by some customers, there are other viable ways to expand a customer base, such as through investing in direct channels. Firms such as Virgin Money and ING Direct have successfully used this strategy to achieve a viable and competitive scale in the savings market. For some products another option is to utilise third party intermediaries as a distribution channel to expand. Treasury Committee: Evidence Ev 217
21. Some firms have looked to focus on certain characteristics or customer segments to build up their customer base. For example, Triodos Bank has highlighted an “ethical” approach to banking that has enabled it to build up a targeted customer base. Finally, the State Aid remedies imposed by the European Commission provide opportunities for smaller banks to expand their customer base.
Examine Whether Competition is Inhibited by Difficulties Faced by Customers in Accessing Information About Products
22. It is straightforward for customers to compare different products across the personal banking sector, through the use of comparison websites and to switch between competing providers. As the comparison websites become more sophisticated, they allow for ever more meaningful comparisons between products. 23. There are already a number of legislative and industry led initiatives in place to provide customers with product details prior to entering into a contract for the product, eg key facts documents and summary boxes. These measures provide customers with the information they need in order to make an informed decision, and highlight the costs involved in taking out the product including the level of interest rate and the charges. 2 . Further enhancements to make prices even more transparent are in train with current account interest rates due to be printed on customer statements by end 2011 followed by Cash ISA interest rates by Spring 2012. 25. Particular concerns have in the past been raised regarding the ease with which customers can compare current accounts. This concern has been addressed by the industry working with the OFT to agree some representative customer scenarios that consumers can use to assess which current account product best meets their needs. It is important to recognise, however, that customers may choose between providers on the basis of a number of different factors not limited to price, such as service quality. 26. Despite the current high level of transparency, RBS is committed to further increasing transparency across our product range to make it even easier for customers to understand what they are purchasing and how they are charged. In our recently launched Customer Charter (see http: www.natwest.com global customercharter.ashx) we pledged to help customers to make the right choices by providing a clear product range with simply explained features and charges. All of our branch literature will be simplified and rewritten in line with customer feedback. We’re also introducing a new Customer Service Review programme to make it easier for our customers to choose the right product for them.
Explore the Government and Competition Authorities’ Strategy to Increase Competition in Banking, including the Likelihood that new Entrants will Successfully Enter the Market
27. As the Committee is aware, both the OFT and the Independent Banking Commission are reviewing the level of competition in the UK banking market. We look forward to working with these bodies as well as the TSC as they explore these issues. For our part, RBS is complying with the decision of the European Commission to divest the RBS branch-based business in England and Wales and the NatWest branch network in Scotland, its Direct SME customer base and certain midcorporate customers. 28. It is difficult to predict the likely success of new entrants. RBS believes that the industry is competitive and the unprecedented disruption in the market will present new opportunities for new entrants (such as Metro Bank) as well as for existing players to increase market share (such as Santander) or to move into offering new products (Tesco Bank and Virgin Money). Barriers to entry must remain low if the market is to encourage new entrants.
Consider the Relationship Between Competition and Financial Stability
2 . The relationship between competition and financial stability is complex. In the years before the crisis, competition was facilitated by a plentiful supply of inexpensive wholesale funding which gave rise to financial instability.
30. More broadly, one would expect a competitive financial system—one which facilitates the exit of weaker financial players and the entry of new firms—to demonstrate greater long-run durability, by encouraging stronger and more innovative participants. But whilst the system as a whole may thus demonstrate greater stability, it is an environment which by definition is likely also to exhibit greater instability at the individual firm level. This might prove disconcerting from a consumer perspective, if the rate of change is high, and threatens short-term instability given the potential for contagion effects within financial services (and banking in particular).
31. There is thus a balance to be struck in the level of competition one might ideally wish to see in a financial system. Levels of exits need to be managed such that adverse impacts on confidence and consumer interests are kept to an acceptable level. Regulation both reduces the probability of failure and its impacts; it also raises costs and thus the overall supply of and demand for financial services. Regulation therefore has an impact on competition and growth, and needs to be calibrated accordingly. Ev 218 Treasury Committee: Evidence
Consider the Impact of Free Banking on Effective Competition 32. There is a widespread perception amongst the UK public that core banking services such as current accounts and credit cards should be provided for free. This is in contrast to the position across the Continent where monthly fees for current accounts are more common. 33. Consumer Focus’ report “Free or Fee: Are free’ products good for consumers?” describes the drivers that led to “free” services as well as some of the consequences. It was intense competition in the market following the introduction by Midland Bank of “free-if-in-credit” in 1 8 that led all other banks to swiftly follow suit (Midland gained approximately 50,000 customers in the year following the introduction of this pricing structure while NatWest lost 60,000 current account customers and estimated that it had lost a further 100,000 potential customers with no previous bank account to competitors that had adopted this pricing model). Competitive pressures also mean that it would be commercially difficult for a bank, as a first mover, to start charging for hitherto free services. 3 . There are, however, significant costs incurred in providing these core banking services including the cost of operating the physical branch network, staffing and support services and the technology platform including the ATM network.
Look at the Role of Foreign-Based Operators and Whether they are Likely to Return to the UK 35 In August, the Bank of England uarterly inflation report found that the withdrawal of foreign lenders from the United Kingdom has played a key role in the weakness of corporate lending. However, contacts of the Bank’s Agents reported that a number of foreign banks had recently entered, or re-entered, the UK market. Since the end of 200 we have seen foreign lenders increasing their share of syndicated lending. Lenders such as Handelsbanken have expanded their presence in the SME market and we have previously noted the purchase of RBS’s assets by Santander. ete e 2
Written evidence su mitted y Lloyds Bankin Group Introduction 1. Lloyds Banking Group welcomes this opportunity to submit written evidence to the Committee. 2. The breadth of the Select Committee’s Terms of Reference acknowledge the complex trade-offs and inter- relationships implicit in the regulatory reform agenda, eg: — Between greater financial stability and more competition. — Between higher prudential hurdles and more market entry. — Between the benefits of low prices, short-term, for consumers and the long-term benefits consumers gain from investment by producers in innovation and product development. — Between the impact of regulation on the levels of returns and the ability of a wide range of providers to remain sustainable in the market. — Between the level of prospective returns for efficient providers and the incentives for market entry. — Between prudential conservatism and economic growth. It will be important that these trade-offs and their implications are considered thoroughly and in the round in order that the overall framework is able to maximise consumer and taxpayer interest. The Committee will also be aware of the many initiatives which are already taking place to improve financial stability and consumer outcomes. 3. A short written submission cannot do justice to the full breadth of the Committee’s Terms of Reference. This written evidence therefore seeks to provide observations and factual information on a key sub-set of the ground the Committee wishes to cover, specifically: — Consumer outcomes in the current market. — Barriers to market entry and growth. — Aspects of the Competition Authorities’ strategy to increase competition in banking. — The current structure of the UK banking market and impact of the financial crisis on that structure. — The role of regulation as a complement to competition in the market, to benefit the consumer.
Consumer Outcomes in the UK Market . International benchmarking evidence suggests that the UK banking market is producing outcomes consistent with a competitive market. Treasury Committee: Evidence Ev 219
5. The economic consultancy Oxera produced the “Price of Banking Report” in 2006. This research compared a range of banking services internationally. It covered the UK, a range of continental European markets, the USA, Canada and Australia. It found that banks in the UK are among the most transparent and that the UK banking market offers one of the broadest ranges of services. In addition the research found that the costs of UK current accounts are consistently among the lowest in developed markets. When adjusted for underlying interest rates the research also found that personal loans in the UK are cheaper than in virtually all developed markets. Credit cards are the only product where the UK was mid-ranking. 6. Lloyds Banking Group has commissioned further third-party international comparative research, covering nine developed banking markets. We would be happy to share the outcome of this research with the Committee when it is concluded. 7. Emerging findings from this research suggest that across a basket of typical products (savings, loan, current account and mortgage), the UK is at the upper end of international competitiveness on price. The UK consumer is in the top quartile for price quality for savings returns, transactional services, loans, savings mortgage spreads and breadth of market range. 8. The banking market in the UK is also innovative, certainly relative to other European markets. The UK has been a leader in the introduction of internet banking, the extension of ATMs (of which there are now 6 ,000), advances in card technology and in the types of savings, mortgage and insurance products available to consumers. . While the overall deal is good for consumers, as in any market there are some imperfections. Across all banking products, there is a trade off for consumers between simple, easy-to-understand products, suitable for all consumers regardless of their level of personal financial capability, and the additional benefits that more complex products can provide for those consumers who have the capability and time to take full advantage of such products. “Simplicity” sounds attractive but can lead to “one size fits all” products that fail to satisfy the variety of consumer demands. Complex products can satisfy that variety of demand but can lead to focal competition’, where the market focuses on simplistic measures, such as headline rates, to differentiate rival products in consumer eyes. So, both simplicity and complexity have their benefits and drawbacks. 10. Even vigorously competitive markets can also produce market structures in which consumer benefits are not evenly distributed across the customer base as a whole. The OFT for example has identified such concerns in the supply of personal current accounts. 11. Lloyds Banking Group recognises that even a competitive market does not necessarily produce socially optimal outcomes, either because of distributional effects or other market failures. LBG is therefore taking a range of steps to improve consumer outcomes. For example by: in t ans a enc — Providing annual current account statements and charging scenarios to our customers (through the OFT Transparency Implementation Group). — Making the information about our savings accounts clearer when we advertise the accounts, when customers open the accounts and throughout the time the customers have the accounts. LBG has, for example, committed to putting interest rates on paper and online statements. in the s itchin cess c ns e s — Introducing “one-stop-shop” switching for current accounts and introducing the ISA promise and automated ISA transfer service. nc easin ease se — Offering products with very clear, simple charging structures in personal current accounts and credit cards (eg, Reward and Clarity); — Reducing unauthorised overdraft charges, providing “free” buffer zones that benefit the majority of overdraft users and broadening the charge base; — Implementing the Payments Services Directive and the SEPA Credit Transfer and Direct Debit Schemes to increase transparency, simplify and harmonise payments charging, offering services across Europe to further increase competition. We believe that these initiatives, some of which are LBG specific, some of which are industry-wide, will improve the offering for a wide range of consumers. We are committed to ensuring that prices, terms and quality are as transparent as possible to our customers and to taking the necessary actions to make this happen.
Market Entry in the UK 12. There is a perception that there has been little substantive new entry into this market in recent years and that this is due to the high barriers to entry. In our view such a concern would be misplaced. It is true that there are regulatory requirements to fulfil in order to provide banking services but market entry has taken and is taking place: new players have entered successfully and have expanded their operations. Ev 220 Treasury Committee: Evidence
13. Up until 2008, there was a large number of foreign operators who had entered the UK market. Their withdrawal was not due to barriers to entry but to the consequences of the financial crisis and their need to retrench to their home market. There are however long-term, sustainable, entrants to the UK market. 1 . Since its entry to the UK market in 200 , Santander has significantly expanded its operations. It has acquired Alliance & Leicester and part of the Bradford & Bingley business, and is using the combined Abbey A&L platform to market an enhanced range of products and services. It now has a network of 1,300 branches in the UK and has acquired a further 318 branches from RBS under the RBS EU-led divestment programme. 15. Other entrants (eg, Tesco and Virgin Money) have made known their plans to expand the range of retail banking services which they offer. Metrobank has launched a retail banking business in the London region. New entrant, NBNK, has received initial City capital backing and has the declared ambition to acquire the branch network of Northern Rock and the 600 branch bank network Lloyds Banking Group will be placing on the market (see paragraphs 18 to 22 below). 16. Other firms have, for many years, participated in UK banking markets by offering a small range of core products, and providing other banking services on a relatively small scale, which they find to be a sustainable business model. All of this provides useful evidence to show that entry into these markets has taken, and continues to take, place. 17. Thus, it appears that there are no insuperable barriers to entry and expansion. However, uncertainty as to the scale and scope of future regulation—both prudential and conduct of business—may deter entry or expansion, at least temporarily.
The Competition Authorities’ Strategy to Increase Competition in Banking 18. The divestment proposals made by Lloyds Banking Group and approved by the European Commission as part of the State Aid agreement are designed to create substantial further competition in the market. Lloyds Banking Group’s final approved restructuring plan consists of: — A retail banking business with at least 600 branches, a .6% share of the personal current accounts market in the UK and up to approximately 1 % of the Group’s mortgage assets. The business would consist of: — The TSB brand. — The branches and branch based customers of Lloyds TSB Scotland and a related banking licence. — The branches, savings accounts and branch based mortgages of Cheltenham & Gloucester. — Additional Lloyds TSB branches in England and Wales, with branch based customers. — The Intelligent Finance brand and all its customers and accounts. 1 . The number of branches to be disposed of represents approximately 20% of the current LBG network. 20. Under the agreement with the European Commission, it is a requirement that the buyer or buyers of the divested business have a current account market share of no more than 1 % in the United Kingdom. 21. Under the agreement, Lloyds must complete the divestment by November 2013. The assets above, if sold today, would enable a new entrant to the UK market to become the 7th largest bank in the UK. 22. Following approval of the Group’s restructuring plan last November, the then European Competition Commissioner, Ms Kroes, said t is n e e ti e esses t e issi n s etiti n n e ns n t t e s e ti e ens es t e et n s n in t n te i i it t is is t t e e ene t stesnt es
Customers can Choose from a Wide Range of Providers Operating with Different Business Models 23. Individual product markets—savings, mortgages, insurance—have literally dozens of competing providers, many of whom have entered the market over recent years. Data from Moneyfacts from February 2010 shows that consumers can choose from a wide range of providers. There are: — Nearly 0 different providers of current accounts with many offering multiple accounts. — Over 120 different providers of savings accounts. — There are over 100 different providers of mortgages, with many offering multiple accounts. 2 . There has been significant consumer switching in savings and mortgages. The replacement of the standard 25 year repayment or endowment mortgage by hundreds of competing, shorter-term, mortgage deals is testament to the vigour of competition in that segment of the market. The rapid growth in Halifax’s share of personal current accounts over the past decade is further evidence of the impact of switching in the personal current account sector of the market. 25. Many retail banking products can readily be provided without use of a branch network and, as a result, UK customers have a choice of channels. Many providers offer products without use of a branch, for example, Treasury Committee: Evidence Ev 221
MBNA and Capital One provide credit cards; Egg provides credit cards and savings products; and ING provides a range of products. In addition, some providers (eg, First Direct) provide current account services using principally non-branch channels of communication (ie, telephone and internet) with customers. 26. Some foreign banks have extended their activities and expertise with particular emphasis on the small and medium enterprise sector. For example, Handelsbanken are increasing their presence and now have 70 branches. International banks serve larger corporates directly and many operators, such as GE Capital, provide specific services such as asset based finance. The switching rate for main business accounts in the SME sector has increased from around 3% to around 5% per annum and, combined with the natural turnover in businesses, a new entrant to SME banking has prospectively around 20% of the business market each year which it can target.
Market Concentration and the Consumer 27. There has been some consolidation in the UK banking market in recent years. Among the drivers have been the consolidation of the de-mutualised building societies and the exit of a number of foreign banks from the UK market. 28. Analysis of the standard test of concentration (HHI) in different industries conducted by Frontier Economics suggests that the market for banking services is significantly less concentrated than for utilities, grocery retail, mobile telecommunications, and the fiercely price-competitive home broadband and pay TV markets. 2 . This analysis is reinforced by the emerging findings from the independent international research commissioned by Lloyds. Based on retail deposit balances, the UK is not highly concentrated relative to other international banking markets (Figure 1 below). The current structure of the UK market is common internationally. Most importantly for consumers, the evidence suggests that there is no correlation between market concentration and price levels at the product level. Indeed, the most concentrated of the banking markets studied—Canada—also produced some of the lowest prices for consumers.
iure1 Breakdown of concentration ratios Market shares1 of the five largest banks (PCA) 100 90 80 70 60 50 40 30 Market share (%) 20 10 0 Canada Australia Sweden France UK Italy Spain US Germany
PCA HHI 1,771 1,784 1,678 1,248 1,229 1,198 1,114 436 386 Min product HHI 1,201 1,784 1,609 828 493 563 578 436 386 Max product 1,771 1,905 2,507 1,877 1,229 1,198 1,114 1,156 1,654 HHI
1. Market share estimates based on distribution of personal current account balances in each country Source: Bankscope, Datamonitor, Oliver Wyman analysis
30. There is a wide range of factors, other than relative market concentration, which determines consumer outcomes. What makes for a good market for consumers is more complex but contains these factors: — Healthy structure (fierce rivalry between several full-service national banks and strong competition from smaller and niche providers). — Market that new providers can enter. — High levels of transparency and relative ease of switching. — Significant levels of innovation. — Keen, market-driven, price levels, convenience and availability. Ev 222 Treasury Committee: Evidence
Regulation and Competition 31. In sectors which are characterised by complex products and services and with long product life-cycles, good regulation can be a valuable complement to competition. Measures which enhance product and price transparency and which make consumer switching easier, can help competitive markets work more effectively for consumers. No one provider can unilaterally re-shape the market. Good regulation can enhance an even- handed move by all providers to a solution which provides better consumer outcomes. The recent work by the OFT with the banks on transparency in current account charges and in cash ISAs is a good example. 32. Overall, the OFT has put in train a range of suitable and well judged measures, designed to enhance competition. These measures will come fully into play between now and 2012. The impact of these measures should, we believe, be taken into account in any assessment of competition in the market. 33. For retail consumers, a key component of good regulation is conduct risk regulation which governs the fair treatment of customers. This is a formal component of the Financial Service Authority’s current supervisory approach and will in future be taken up by the Consumer Protection and Markets Authority. This represents the most intensive approach to customer conduct regulation in the EU and indeed by any other international regulator. The impact of this aspect of regulation also needs to be fully evaluated.
Conclusion 3 . We are emerging from the biggest global crisis in banking for 80 years. The authorities in the UK and internationally are evolving the shape of the new framework to prevent the re-emergence in future of a crisis on a similar scale. As the Chancellor of the Exchequer noted earlier this year, this framework involves complicated and profound trade-offs between prudential safety and competitive risk taking, between protection for the tax payer and returns for the economy. Lloyds Banking Group recognises that the framework for these trade-offs is central to this Committee’s Inquiry, as a significant contribution to that public debate. 35. While the new framework is evolving, much has already happened: the banks have been repairing the balance sheets and significantly increasing the core capital that underpins the necessary lending to businesses and individuals. We have a chance to build a system which is more stable, more secure and can also serve the consumer and the wider economy better. 36. To date, the system has been characterised by strong rivalry among providers which has delivered benefits for consumers, which compares well with many other countries’ banking markets. But the nature of competition has been such that it has not invariably worked to the consumer’s interest . In addition, since the crisis, the banks must all work hard to regain consumers’ and taxpayers’ trust. Lloyds Banking Group is ready to do all it can to support the current reforms; and is committed to improving customer outcomes and customers’ understanding of financial services by ensuring that our products are as transparent as possible. 37. A suitable balance between regulation and economic growth is also needed, as is an understanding of the reforms already set in train. If the UK goes significantly beyond the global consensus on the pace or severity of new regulatory measures, this could put the economic recovery at risk. It could also have longer term consequences for the future of the attractiveness of the financial services industry and make new market entry less likely. On the other hand, good regulation can complement competition, enabling the market to deliver to the full in the consumer interest. ete e 2
Written evidence su mitted y the inancial Services Authority 1. We are submitting this memorandum as part of the Committee’s inquiry into competition and choice in the banking sector and in advance of our evidence session on 23 November. The initial sections cover: — the FSA’s overall role and responsibilities in relation to competition; — the consolidation of banks and building societies; — new entrants into the banking sector; and — the FSA’s consumer protection activities and competition. 2. The final section of our memorandum offers some broader reflections on competition issues in financial services and explores how these could be taken forward in the future regulatory regime in the UK.
The FSA’s Overall Role and Responsibility in Relation to Competition 3. We are not a competition authority and do not have a statutory objective to promote competition. However, under the Financial Services and Markets Act (FSMA) we must have regard to the need to minimise the adverse effects on competition that may arise from our rules, guidance and policies, and to the desirability of facilitating competition between those subject to our regulation. Under FSMA, the Office of Fair Trading (OFT) must keep our rules and practices under review and consider whether they have a significantly adverse Treasury Committee: Evidence Ev 223
effect on competition. If the OFT considers that they do, it may make a report to the Competition Commission. Ultimately, this could result in the Treasury requiring us to take specific action to remedy a situation. . Much of our work is focused on addressing market failures that affect our ability to deliver our statutory objectives. These market failures include information problems (eg poor explanation of the key features of a product), negative externalities (eg when the failure of a bank causes depositors of other banks to withdraw deposits, resulting in a run on those banks) and moral hazards (eg if a bank knows it is protected by a lender of last resort, it may make riskier decisions than it would if it were not protected). In developing policy to address these, knowledge of how competition works in the relevant market(s) and a thorough assessment of the likely effect of proposals on competition are key to achieving the desired outcomes, and may be relevant in public law terms to our decision on whether we take action. We undertake this assessment by conducting market failure analyses and publishing a cost-benefit analysis (CBA) with any proposed changes to our rules. Our CBAs for strategic policy initiatives consider the impact of proposed rules on the effectiveness of competition. For example, in our analyses prepared to support our Mortgage Market Review (MMR) and Retail Distribution Review (RDR) we commissioned competition impact assessments of our proposals, which became an integral part of our CBA. 5. Many of our rules implement European Directives designed to increase competition within the internal market. Some European legislation specifically precludes us from taking economic considerations (of which competition may be one) into account when taking certain decisions. For instance, the Capital Requirements Directive prohibits member states from examining an application for authorisation by a credit institution in terms of the economic needs of the market.
Consolidation of Banks and Building Societies 6. There are two major types of bank and building society consolidation: — mergers and acquisitions, which aim to achieve scale and scope economies, better efficiency and improved financial metrics; and — consolidation, which supports one critically weak firm by merging it into a stronger one. 7. In our supervisory capacity, banks and building societies must satisfy us that a proposed merger can be properly undertaken and that, for example, the merged institutions will have a viable business model, adequate capital and liquidity, and will not lead to detriment for the customers of the two merging entities. We expect to discuss a proposed merger with the firms involved early on to address these issues before they make a public announcement. We engage with firms to ensure they review all available options. For building societies, this includes a consideration by its board of whether members’ interests would be best served by merging with another, stronger society. When a firm’s board decides a merger is the best option, we work closely with the firm to facilitate the process. Our key priority in reviewing proposed mergers and acquisitions is to ensure the prudential soundness of the merged firm, to maintain stability in the financial system and to protect consumers. We do not consider the impact of the merger on competition in the relevant sector. The OFT undertakes an initial review of any competition issues arising from such mergers. 8. Our intensive supervision approach has led us to take a more challenging and intrusive stance on mergers and acquisitions than in the past. For a number of mergers or acquisitions over the last 18 months, we have been at the heart of the analysis and judgements being made by the relevant firms’ senior management, ensuring that customers’ interests are protected, that there are financially viable plans in place, that integration does not bring undue regulatory risk and that management and governance are able to deliver. In the past our role was more passive in assessing the change of control of the firm, and much later in the process. . We will continue to proactively challenge acquisitions, as we recently did in relation to the proposed Prudential takeover of AIG’s Asian operation, American International Assurance. However, our focus will remain on the prudential soundness of the merged institution rather than on the impact of the merger on competition in that sector.
einte ns i tin ns 10. Before the 2007 to 200 crisis, most bank mergers in the UK aimed to achieve economies of scale, efficiencies and better financial metrics. Since the start of the crisis, most consolidations have arisen because a critically weak firm required support (eg the HBOS-Lloyds TSB and Alliance & Leicester-Santander mergers). Working closely with the Treasury and the Bank of England, we have been involved in negotiating the consolidation transactions and their terms and conditions, as well as their suitability and longer-term viability, and any potential detriment to the firms’ clients. For instance, we conducted stress-testing and peer-analysis exercises before we approved the transactions.
e in t e ns i ti n i in s ieties 11. In relation to building society mergers we have a prudential supervisory role (under FSMA) and a regulatory role (under the Building Societies Act 1 86—“the Act”). The Act sets out the regulatory procedures We have not been required by the Treasury to take a specific action to date. Ev 224 Treasury Committee: Evidence
and processes to be followed in mergers, including three roles we must undertake: giving consent (if we deem it appropriate) for the merger to be approved by board resolution (if requested); approving the Transfer Statement sent to members requesting their agreement to the merger; and confirming the merger against statutory confirmation criteria (if these have been satisfied), after considering any representations from members. 12. In addition to mergers that have come about solely on the basis of discussions between two boards, where a building society is under financial pressure, including where it is considered it may not be viable as a continuing basis, we engage proactively with the board to ensure it reviews all available options. This includes whether the interests of members would be best served by a merger with another, stronger building society. Where a board then decides that a merger is the best option, we work closely with the society to facilitate the process, while at the same time ensuring that it carries out effectively and appropriately its regulatory functions under the Act. 13. If we consider it will best protect shareholders’ or depositors’ interests, we can use our regulatory powers under the Act to direct a building society to merge with another society (without a vote being required). We used this power four times in 2008 and 200 (in relation to the Derbyshire, Cheshire, Barnsley and Scarborough Building Societies).
eins t ce it nins 1 . We recognise that credit unions contribute to competition in, and the diversity of, financial services markets. Successive governments have generally seen credit unions as a way to combat financial exclusion and provide services to people who are not served by mainstream financial institutions. We register credit unions under credit union legislation and regulate them under FSMA. To improve the resilience of the sector, we are planning to increase the minimum levels of capital and liquidity required by most credit unions and to focus our supervision on credit unions’ governance standards. These plans are proportionate, supportive, and take account of the special characteristics of credit unions. They will come into effect at the same time as a Legislative Reform Order, which aims to increase the extent to which credit unions can be an alternative to other institutions. We support these reforms, and have worked closely with the Treasury to ensure they are consistent with our regulatory responsibilities.
New Entrants Into the Banking Sector 15. Our overall philosophy is to encourage new entrants in financial services, on the basis that it is, in principle, good for consumers. We facilitate competition by operating a transparent and efficient process for considering applications from new entrants. Our role remains, however, an enabling one; we do not proactively seek to generate new applications.
e a th isati ns 16. Since 2008, several new banks have gained authorisation (see the table in paragraph 17). Some are new entrants to the UK market while others are the result of an internal reorganisation and the creation of a new legal entity requiring authorisation. There has only been one new “start up” retail bank since 2008—Metro Bank. In addition to those that have gained authorisation, seven withdrew their applications, with four re- submitting when they could meet the threshold conditions. 17. The details of bank authorisations since 2008 are as follows: etai Wh esa e
Intelligent Management Services Ltd European Finance House Ltd Guaranty Trust Bank (UK) Ltd Macquarie Bank International Ltd The Access Bank UK Ltd Gatehouse Bank Plc First Rand Bank Ltd Intercontinental Bank (UK) Plc DBS Bridge Bank Ltd 5 China Construction Bank (London) Ltd Northern Rock plc 6 Emirates NBD PJSC Metro Bank PLC Export Import Bank of India Bank of Ceylon (UK) Ltd
As well as the new authorisations listed above, we allowed one firm to vary its permission to become a bank and four UK banks have been subject to a change in control.
he a th isati n cess 18. To be authorised, banks must meet our threshold conditions in relation to legal status, location of offices, suitability and adequacy of resources. In addition, they must have no close links that could prevent effective supervision. 5 Formed as a resolution vehicle for Dunfermline Building Society. 6 Northern Rock plc is a new banking entity that arose from the split of the good bad assets of the previous bank. Treasury Committee: Evidence Ev 225
1 . As part of intensive supervision we have strengthened our scrutiny of new applications, whether they are new start-up banks or existing authorised firms applying for deposit-taking permission. We have learnt the lessons of the financial crisis and consider it critical that only prudentially sound and well-managed firms enter the banking sector. We also now place much greater emphasis on the role of senior management in firms and interview individuals holding Significant Influence Functions, such as the Finance Director. Our aim is to ensure that new entrants to the banking sector do not pose risks to consumers, financial stability or market confidence. 20. Our authorisation process is necessarily robust, and we do not consider it to be an unfair or unreasonable barrier to entry. Following feedback from firms seeking authorisation we have implemented a number of improvements to support applicants and help create a smooth process, while maintaining appropriate entry standards: — We encourage potential applicants to attend pre-application meetings with us. Through these we can better understand the applicant’s business model and offer tailored guidance on the threshold conditions and how applicants can provide evidence that they meet them. — While processing the application, where appropriate, we provide a letter saying we are “minded to” approve the application subject to any remaining conditions being met. — We keep applicants better informed about how their application is progressing. — We have updated our website to explain the high-level framework within which deposit-taking applications are assessed.
ei n ent ants 21. The nationality of bank ownership is not a factor we take into account when determining whether to grant an authorisation. In the European Economic Area (EEA) the principle of a single home country authorisation applies. Under this principle, a bank authorised in an EEA country can conduct business in other EEA countries without being subject to further authorisations by the host countries. The standards applied on entry vetting are agreed at European level in EU law. The EU is currently establishing European Supervisory Authorities to ensure consistent supervisory standards that will help prevent the problems suffered in the crisis.
FSA Consumer Protection Activities and Competition e a c ns e tecti n st ate 22. Our overall approach to consumer protection has historically been principles-based and essentially reactive. We have tended to focus on high-level systems and controls analysis and information disclosure by firms to consumers, and we reacted to crystallised risk and consumer detriment when observed. This approach reflected among other things our view that, equipped with the right information, consumers could exercise informed choice on which products and services were suitable for their needs. It was also designed to help improve competition on quality and price between suppliers through consumers understanding and comparing the quality and costs of financial products and being able and willing to shop around. 23. However, in the light of experience we have concluded that, overall, a more interventionist approach is required. Our new conduct risk strategy (launched in March 2010) signalled a move to a more prescriptive regime. We now seek to proactively intervene earlier in the product’s life cycle (influencing product design, not just sales and marketing processes) to anticipate consumer detriment and to stop it before any significant detriment is caused. This strategy includes analysing business models, using intensive supervision to identify and mitigate conduct risks, using enforcement tools more aggressively, making sector-wide interventions and improving the delivery of redress to consumers.
he e c ns e in ati n in c ns e tecti n 2 . Our rules on product disclosure and financial promotions aim to support informed decision-making by consumers. For instance, we require a standardised form of charges disclosure for investment products to help in the comparison of product costs. And we regularly sample the quality of the information provided by firms to consumers and require them to improve it where necessary. 25. However, although we supervise and enforce our rules to ensure retail consumers receive the prescribed disclosure documents, there is substantial evidence to suggest that consumers generally do not use the information provided to make decisions or shop around. Even when they read the documents, research indicates that many find them daunting, with some terms difficult to understand. Products are becoming increasingly complex (the growth of the structured product market is one example), and as a result it is increasingly difficult for consumers to understand descriptions of a number of mainstream retail products. Even when consumers read and understand the prescribed documents, they may rely on other sources of advice, such as friends and family. As part of our new conduct risk strategy, we acknowledge the limitations of disclosure, by itself, to facilitate effective consumer choice and to secure good outcomes for consumers. 26. At the same time, we recognise that consumers need skills and confidence to make the best use of information provided by firms. The Financial Services Act 2010 established the Consumer Financial Education Ev 226 Treasury Committee: Evidence
Body to take forward the financial capability work we previously undertook and to help consumers understand financial matters and manage their finances better.
an in C n ct e i e 27. We took over regulation of banks’ and building societies’ conduct of retail banking services (excluding non-mortgage lending) on 1 November 200 . This replaced the previous self-regulatory regime under the Banking Code. Our new rules help consumers make informed and timely decisions, so they can choose the best accounts and know what they are entitled to expect from their account providers. The rules require banks and building societies to provide important information at the points when people really need it. Banks and building societies must also provide a prompt and efficient post-sale service, such as when switching accounts. This should help to enhance competition. 28. In line with the overall approach outlined above, we intervene early when we find that banks and building societies are not meeting expected standards. For example, earlier this year, we found that firms were not dealing with unauthorised transactions properly, as they were failing to provide immediate refunds to their customers. All major banks and building societies (representing around 0% of the current account market) have now improved their processes so that customers get the immediate refunds to which they are entitled. We are monitoring this to make sure it is happening.
etai ist i ti n e ie 2 . Competition problems can also arise in markets where there are large numbers of participants. Although the market for retail investment advice in the UK is very diverse—involving banks, building societies, thousands of independent financial advisers and other players, competition is hindered by information and incentive problems, with the result that firms’ and customers’ interests are not aligned in full. We set up the Retail Distribution Review to review how investment products are sold in the retail market and to address these problems. Our new rules, in force from 2012, will apply to all firms that give investment advice, including banks. The changes aim to: — improve the clarity with which firms describe their services to consumers; — address the potential for adviser remuneration to distort consumer outcomes; and — improve advisers’ professional standards. 30. Banks, like other investment product providers, will no longer be able to offer commission in return for adviser firms recommending their products. Instead, adviser firms will charge for their services. Equally, where they distribute through in-house investment advisers, banks must separate their product and adviser charges to ensure equivalent standards apply across the whole industry. 31. In preparing the RDR, we commissioned an analysis by economic consultants 7 of the impact of the proposals on competition and the supply of advice. They recognised that market exit by firms may lead some consumers to experience reduced choice in the short term. However, even if demand outstrips supply, the consultants reported that entry barriers are unlikely to be prohibitive and, in the longer term, new entry or expansion by existing players is likely to fill the gap.
Broader Reflections on Competition in Financial Services 32. The reform of the regulatory structure in the UK, including the establishment of the Consumer Protection and Markets Authority (CPMA), provides an opportunity to improve consumer protection legislation and regulation in the light of experience. In this section we set out five issues which we suggest the Committee may wish to consider: — the nature of effective competition; — the right level of concentration; — the consequences of “free banking” and other forms of bundling for competition; — a possible competition mandate for the CPMA; and — potential structural options for a competition mandate for the CPMA. And we conclude with some observations on the relationship between competition and financial stability, on which the Committee has invited comment.
ecti e c etiti n 33. We believe that, generally, effective competition works in consumers’ interests and leads to better products, services and outcomes for consumers. To achieve our statutory objectives, we seek to remedy underlying market failures, such as information asymmetry and negative externalities, which prevent competition from being effective. 7 www.fsa.gov.uk pubs policy oxera_rdr10.pdf. Treasury Committee: Evidence Ev 227
3 . The OFT and the Competition Commission have found important competition weaknesses in markets related to retail banking, including the provision of current accounts, lending to small businesses, and payment protection insurance. As a sectoral regulator with a different kind of remit, the FSA starts from a different place. We allocate resources in response to the risks of consumer detriment or of negative externalities in the markets we regulate. However, when we act to limit those risks, we have to take into account how competition works in those markets in analysing why the risks arise. We also consider the impact on competition of different options to resolve them.
35. It is crucial to understand, however, that the concept of competition relates to more than market concentration. Our experience suggests that in financial services non-size based barriers are more important. As noted earlier, competition can be ineffective even where there are many providers. It can also be difficult for consumers to understand and compare products and their charges—particularly if the product is complex. Besides, in many markets, such as long-term investment or insurance products, consumers often cannot learn from their mistakes in ways that allow them to discipline providers. In such circumstances, firms may seek to benefit from using opaque charging structures or lowering quality levels.
36. As noted above, through the RDR we are implementing major structural changes in the investment advice market to align intermediary and consumer interests. Due to a combination of information problems and mis-aligned incentives the demand side of this market has not adequately responded to differences in the prices and quality of products and services firms offer. This kind of demand-side weakness is characteristic of retail markets that do not work well: as a result even where there are only a few providers, the main reason why competition is ineffective is down to non-size based factors.
37. Overall, our experience leads us to believe that it is inherently more difficult for competition in retail financial services to be as effective as it is in other consumer sectors. In retail financial services a contestable market with a number of providers and clear product information is often a necessary but not sufficient condition for good consumer outcomes. In response to the persistent and sometimes intractable market failures outlined above, our new conduct strategy takes a much more direct approach. It seeks to achieve, through regulatory action, outcomes which should have been delivered by effective competition.
38. Nor are wholesale markets immune from weak or distorted competition, through incentive effects and information problems. For example, there is now broad consensus that competition in the market for credit ratings was not working well and that this ultimately had adverse effects on financial stability. We also note the OFT’s investigation into competition in providing investment banking services.
What is the i ht e e c ncent ati n
3 . The right level of concentration in financial services is one that balances consumer and producer benefits so consumers benefit from the lowest price that is consistent with producers earning a risk-adjusted return equal to their cost of capital. This ensures that producers fully account for all the risks they incur in providing financial services. In theory, the market will tend to this level of competition if it is contestable and free from subsidies that favour particular producers. By “contestable” we mean the ability of a producer to easily enter and exit the market.
0. The EU single market has helped remove regulatory barriers to contestable markets in UK financial services. Under EU Directives, credit institutions in other EEA member states enjoy freedom of establishment and freedom of services. EEA firms from outside the UK, such as Santander UK, have a considerable presence in the UK banking services market and have contributed significantly to competition in the UK.
1. It should be noted that competition in the banking sector derives not only from other banks, but also from other products that are substitutes for the credit and deposits that banks offer. For instance, non-banks provide credit in the form of bonds, trade credit and store credit, while savings can be invested in bonds, unit trusts and other securities—not just deposits.
2. Competition takes place within a broader social policy context. Deposit guarantees effectively standardise the risk that an insured deposit represents: it may tend to push competition toward being based on return alone rather than on a combination of risk and return. To the extent that governments follow a “too big to fail” policy, this effect would extend to wholesale funding as well as retail deposits. But correcting such distortions is not something that competition policy can cure—that is for resolution policy.
3. Competition will not necessarily correct shortcomings in the ability of consumers and or businesses to evaluate financial products. Society therefore considers it necessary to require firms to take measures to ensure that their products are suitable for the client, that loans are affordable and that customers are treated fairly. These are requirements that all producers must meet, and they impose a mixture of fixed and variable costs on firms. Ultimately, customers in aggregate must pay for these costs, if financial firms are to earn a sufficient return. Ev 228 Treasury Committee: Evidence
C nse ences ee an in an the s n in an c ss-s si isati n n c etiti n . One factor which affects the ability of new institutions to enter the banking market is so-called “free banking”. Consumers in credit typically receive minimal interest on their balances and lose interest during settlement: the interest on these balances and flows give banks a major source of income. In return, consumers receive a bundle of services at no cost, including payment and collection services and, in some cases, a committed overdraft facility without the payment of a commitment fee. During the crisis, the volume of transaction services provided to consumers has remained steady or has risen slightly; the compensation banks have received for providing those services has fallen (due to the decline in market interest rates, consumers are forgoing less interest in exchange for services). So the price of transaction services has fallen. 5. We have also seen the number of customers with packaged accounts increase significantly over the last few years. Customers pay a monthly fee for these accounts, which include a mixture of banking services, insurance policies, and unregulated services. We believe that over 1 million customers hold such accounts. These accounts now provide a significant source of fee income for banks. 6. It is possible that “free banking” is one source of limited competition in the retail markets in which banks operate. The OFT has stated that the opaqueness of the effective costs to consumers (implicit in the free- in-credit model) reduces the incentives for banks to compete on these costs. However, previous OFT studies have also highlighted brand recognition and branch networks as key challenges to successful competition in retail banking. This is probably why the main interest in entry comes from large firms with strong brands, or from large overseas banks, and takes the form of competition to purchase established networks and customer bases. 7. Current accounts are of course only one part of the services provided by banks. Cross-subsidisation arises in the retail banking business model not just through packaged products, but in other ways. The model is based on providing a range of services such as deposit-taking, savings accounts, home loans, unsecured credit, and insurance. Cross-selling and cross-subsidisation are integral to this model, and the advantages of offering a portfolio of services can have major effects on the scope for entry. It would be very challenging for firms to enter and compete solely as deposit-takers against banks providing an integrated portfolio of services. Similarly, it would be difficult for a firm to enter the loan market profitably as it risks taking on poorer quality credit, as shown by the experience of the former building societies which competed aggressively in mortgage lending. Overall, there are strong drivers forcing potential new entrants to adopt an integrated model, and this acts as a barrier to entry to any firms without substantial resources and banking expertise. This barrier is in addition to the need to have a branch network and trusted brand. 8. If banks were required to charge for in-credit banking services, consumers might be better able to understand and compare these charges, so providing a greater incentive for them to switch banks and for banks to compete on the level of these charges. However, the complexity of banks’ business models, barriers to entry such as branch networks, and the weakness of demand-side disciplines, means there can be no guarantee that the charges paid by consumers would fall or that this would create additional opportunities for new entry.
C etiti n an ate the C ns e tecti n an a ets th it . The government proposes to provide the CPMA with a primary objective of ensuring confidence in financial services and markets, with a particular focus on protecting consumers. This provides an opportunity to consider afresh whether new regulatory approaches, such as a competition objective, should be part of the CPMA regulatory toolkit. There are several issues to consider in this debate, including the need for adequate analysis, powers and challenge. As noted above, we have adopted a more interventionist conduct strategy due to the persistence of ineffective competition, information problems and incentive problems in retail markets. To protect consumers effectively, the CPMA must also be able to recognise and understand how the particular conduct problems it deals with may arise from ineffective competition. In doing so, it could build on our consumer protection strategy and consider what role competition tools could play in its consumer protection toolkit. 50. It is clear that, in order to discharge its responsibilities, the CPMA will have to analyse problems related to whether there is a competitive working market. The issue will be how the CPMA will interface with the competition authorities, so their powers can be brought to bear where structural remedies or other competition policy tools are needed to protect consumers. 51. The new framework will also have to take into account the uncertainties and limitations around the use of regulatory tools, and to manage the risk that some interventions may distort the way competition works. One way to mitigate this risk would be for the CPMA, in addition to carrying out CBAs, to be obliged to monitor markets and to review the impact of regulatory interventions.
tentia st ct a ti ns n a c etiti n an ate the C 52. There are three broad ways that the CPMA could take competition considerations into account. These are for the CPMA to inherit the existing FSMA requirement to have regard to the need to minimise the adverse effects of regulation on competition and the desirability of facilitating competition (see paragraph 3 above); Treasury Committee: Evidence Ev 229
the removal of this requirement, to allow the CPMA to focus purely on consumer protection; and for the CPMA to have a more explicit competition mandate. 53. If the CPMA has a more explicit competition mandate, there are at least three ways in which it could be delivered: — an ate t e i e ette a ets the ene t c ns e s th h s eci c a et inte enti ns The CPMA could be explicitly directed to deliver effective competition in retail markets by intervening to remedy market failures, but falling short of intervening to change industry structures or market concentration. The simplest way of requiring this would be by giving the CPMA the power to make its own market references to the competition authorities. This power could of course be allied with changes to the mandate of those authorities. There are also other options, including: — giving the CPMA the power to make rules on competition and consumer protection grounds; — using powers that currently sit in the FSA to make rules on abusive product features or charging structures where it deems this necessary—short of requiring product approval; and — conducting periodic market studies, with the necessary resources and powers to obtain information and to follow up as appropriate. These interventions, deployed in a way careful to minimise the risk of harmful unintended consequences, would seek to ensure effective competition that would deliver good value products to consumers. — nteteiestt ne—The CPMA could be asked to deliver better outcomes for consumers through structural change in markets. There may be markets where competition can be made more effective by increasing the number of providers. However, as previously noted, competition in retail markets can be ineffective even where there are many providers and products. In this case, the typical structural approach—breaking up firms—may not improve the position. The kind of structural change that is more relevant to consumer protection may often be forcible separation of bundled products in certain markets, as the Competition Commission has concluded is necessary for the sale of certain kinds of payment protection insurance. — n te t e i e e n i e ti n n t e e ti ities e t s In one sense, the CPMA will inevitably be an economic regulator, as we are now, as it will seek to achieve better outcomes for consumers—with some combination of lower prices and better quality—by affecting market incentives and influencing how competition works. However, most financial services markets are not characterised by the same kind of natural monopoly power as utility networks. Retail financial services markets offer a higher number of products, which are also more varied. Setting efficient prices for more than a handful of retail financial services or products would be a task beyond any conceivable regulatory model. Price regulation would directly affect firms’ business models and their ability to raise finance, so it would have to be closely coordinated with the Prudential Regulation Authority. Price regulation in financial markets could be carried out by the CPMA or another body.
e ti ns i et een etiti n n n n i st i it 5 . There is a complex relationship between competition and financial stability. Reflecting this, the government has set up the Independent Commission on Banking, chaired by Sir John Vickers, to consider the UK banking sector’s structure and look at structural and non-structural measures to reform the banking system and promote competition—reducing systemic risk, moral hazard and the likelihood and impact of firm failure, while ensuring that banks’ customers and clients’ needs are met. However, it is important to note that, although the UK banking sector may look concentrated relative to Germany and US, this is not the case relative to Australia, Canada, France, the Netherlands, and Sweden. It is also notable that some of the countries perceived to have had weathered the financial crisis better than others (Australia and Canada) have concentrated banking industries. 55. The objectives of competition and financial stability can be in conflict, but they can also be mutually complementary. On the one hand, more competition in banking could lead to more risk-taking by banks. Taking on more risk is not necessarily problematic for banks, as long as the risk is accurately priced and fully capitalised. Banks may seek to maintain profit rates by taking on more risk on other parts of their balance sheet where competition for deposits or loans leads to lower margins for these products. This may result in banks under-pricing risk in loans to consumers and or businesses, resulting in them temporarily benefiting from the increased risk-taking. Although taking on greater credit, market or funding risk usually raises returns, it leads to greater losses in economic downturns. Banks may not take full account of the potential for losses in extreme circumstances, due to uncertainty, myopia and if they believe that governments will act to support the banking system in a crisis. For this reason, regulation to protect financial stability may be more important in countries with more competitive financial markets. 56. On the other hand, effective competition and financial stability can also go hand in hand. The financial crisis has shown that individual financial institutions can be a risk to financial stability due to their size, complexity, and interconnectedness. Addressing these problems, and allowing firms to exit the market safely, may make competition more effective. Those banks currently considered to be “too important to fail” benefit Ev 230 Treasury Committee: Evidence
from lower wholesale borrowing costs. Reducing expectations of public support would reduce this benefit and so make banking markets more competitive. 57. We are working with international regulators to agree strengthened capital adequacy and liquidity standards and to align these more closely with the risks banks take and their potential impact on financial stability. Strengthening these standards need not reduce competition or create new barriers to entry. ct e 2
Written evidence su mitted y the inancial Services Consumer Panel I am delighted to accept the Committee's kind invitation to spend some additional time with Committee members on 18 November to answer questions on competition and choice in the banking sector, after the discussion with my two colleagues on the Financial Services Practitioner Panels on the future of regulation. I thought it might be helpful to write to you ahead of this latter discussion setting out the Panel’s main thoughts in this area. The Panel will shortly be submitting evidence to the Independent Commission on Banking which the Committee might also find useful. Structural change could of course be a stimulus for greater competition and we will be able to assess this once the Commission’s options for change are published in the spring of 2011. I will arrange for the Panel’s Secretariat to send a copy of our evidence to the Clerk to the Committee, once it has been submitted.
Competition in the Banking Sector While we do not regard competition as a panacea, we believe that there are barriers to entry into the retail banking sector and to competition within it that must be removed if consumers are to have a real choice of banking services. The current concentration of business in the large banking groups, together with common ownership of financial firms, severely limits the options for consumers to effect real change. The position is particularly acute in Scotland, where the retail banking sector is dominated by just two banks. When consumers are in a position to exercise effective choice the pressure will be on banks to improve customer service and introduce fairly priced products that meet consumer needs. This is a fundamental issue in banking. It is an example of a market with ostensibly competing businesses where competition is ineffectual in achieving good consumer outcomes and where regulation has been ineffective in delivering good value for consumers.
“Too Big to Fail” If the market is to be opened to more new entrants there needs to be resolution of the implicit Government subsidy of banks that are “too big to fail”. This distorts competition by weakening the ability of small or new entrants to become real challengers and destroys the functioning of an effective market. The issue of regional monopolies in both Scotland and Northern Ireland warrants specific attention.
Competition and Real Choice Competition and choice are not the same thing, although effective competition can lead to greater choice for consumers—but it must be a ea choice. In retail banking this means a wider selection of products and services, rather than essentially the same product sold a number of times under different brands. The chances of customers having this real choice would be greatly enhanced if there were more banks or banking service providers in the market, creating an environment where new or innovative products can be developed. It is difficult for consumers to “vote with their feet” when they are dissatisfied with the service provided by their bank when the process is, or at least is perceived to be, problematic and when there is no really different alternative. We have heard lack of account switching described as a result of consumer apathy. We do not think this is necessarily true. Rather it is often a recognition that another bank has nothing new to offer. Consumer Focus published research 8 on October which showed that only 7% of customers moved their current account during the last two years, compared with 31% who switched energy supplier, 26% who switched telecom provider and 22% who switched home insurance. The Panel wants to see consumers in a position to shop around for banking services which meet their needs and have something alternative to offer.
So-called “Free Banking” The pricing of banking services, including the erroneously named “free banking” model, is another barrier to competition. There is a perception that so-called free banking has become a basic customer and market expectation and this has the potential to restrict the development of different models by fledgling market participants. In other retail sectors, where effective competition prevails, consumers benefit from lower costs and genuinely innovative products designed to meet their needs. So-called “free banking” makes it hard for new entrants to offer fee-based current accounts even though this might provide many customers with better value for money overall. In this respect the lack of transparency about interest forgone on current accounts, 8 “Stick or twist: an analysis of consumer behaviour in the personal account market” at consumerfocus.org.uk. Treasury Committee: Evidence Ev 231
and the difficulty of establishing the total cost of a current account work against customers making a rational decision about which bank to use for their main current account.
Payment Services or Transactional Accounts Consumers need access to and have confidence in, a resilient transactional payment service in order to buy basic utilities such as water and electricity supplies—as well as other consumer goods—at the best price. For example, direct debit is the cheapest way to pay utility bills. In the future, the trend towards electronic payment systems away from cash and cheques means that everyone will need a transactional account. There has to be clarity about the cost of the provision of such a service, which currently tends to be hidden in the overall cost of other banking facilities, or masked by the label of “free banking”. In many respects this aspect of banking service is a utility but the access to customer information which it provides gives the bank holding this information a competitive advantage which works against effective competition in the market for financial services and raises the barriers for new entrants.
Regulation and Competition in Banking It is not possible to consider competition in banking without taking into account the impact of regulation. For example, lack of transparency over product costs and charges in the market, where the growth in packaged accounts can only serve to blur the real cost of products still further, together with the legislative constraints in the Financial Services and Markets Act on the regulator’s ability to publish information which it collects in carrying out its duties—such as data on customer complaints—does limit consumers’ ability to exercise market freedom and so help to drive down prices. A legislative presumption in favour of transparency in the regulation of retail banking, including the contentious question of complaints data, could do a lot to support effective competition. In our response to HM Treasury’s paper on a new approach to regulation we called for, among other things, a clearer remit and stronger powers for the new Consumer Protection & Markets Authority to protect and uphold the interests of consumers. In certain circumstances this would include promoting effective competition that delivers clear consumer benefits. Such powers will be needed to deliver real regulatory change in the retail banking sector that will encourage effective competition. ahiis Chair Financial Services Consumer Panel ee2
urther written evidence su mitted y Which FINANCIAL REGULATION—OFT COMPETITION COMMISSION MERGER 1. Following our recent submission to the Committee on financial regulation we set out below our views on the proposed merger of the Office of Fair Trading (OFT) and Competition Commission (CC). Regardless of the institutional framework Which? wants to ensure that individual consumers can access impartial and accurate advice, that systematic and widespread infringements of consumer law are tackled promptly, and that competition enforcement addresses abuses in national and local markets. 2 At present few of the details of the proposed merger or allocation of the bodies’ relevant powers are known. Which? considers that any changes must: — ese e the ita c ns e tecti n ncti ns c ent n e ta en the . The OFT is able to tackle very large businesses on a nationwide basis and co-ordinate with agencies in the EU or wider to tackle firms based in other jurisdictions. Any successor body must have the capacity and capabilities to offer joined-up enforcement against any firm affecting UK consumers. — ns e c etiti n iss es a e a esse c ehensi e Market failures, rooted in weak competition, can only be addressed effectively if remedies are comprehensive, both affecting firms and improving the experience of consumers. A pure competition agency should continue to draw on the lessons learned from consumer enforcement and apply suitable remedies that affect the supply and demand side of markets. In this respect, the market investigation reference (MIR) powers of the CC, which are unique to the UK, give us an effective and dedicated tool to address market failures through a wide-range of remedies. The MIR powers must not be lost or weakened due to the proposed merger. 3. The OFT’s work in competition enforcement has been scrutinised by the National Audit Office in recent years. The NAO made a number of recommendations to address its concerns. The competition regime has been subject to a number of criticisms, in particular over the speed of investigations and the length of time it The NAO have published two key reports: e ie the s C etiti n an sca e (http: www.nao.org.uk publications 0 10 competition_landscape.aspx), and ess e t n aintainin c etiti n in a ets (http: www.nao.org.uk publications 080 progress_market_competition.aspx). Ev 232 Treasury Committee: Evidence
takes for issues to reach the Competition Commission under MIR powers. The proposed merger does not appear to directly reflect the NAO’s concerns or recommendations. Which? notes that the effectiveness of the competition regime more generally would required a wider set of reforms than merely re-structuring two of the UK’s enforcement bodies, for example, by consideration of the role of sectoral regulators and the burden and standard of proof developed through the Competition Appeal Tribunal’s (CAT) judgements.
Preserving the Vital Consumer Protection Functions of the OFT
. The OFT has a number of duties that are not currently part of the CC’s role: — Consumer credit licensing and enforcement of some rules under money laundering regulations. — Enforcement of consumer protection legislation, usually on a national basis in co-operation with Trading Standard Services (TSS). — Reviewing and granting OFT Approved Codes status to trade bodies’ complaint handling schemes. — Providing information and advice to business and consumers on consumer protection issues, for example scams.
5. Which? is very concerned that any successor to the OFT has the ability and resources to take national enforcement action and, where necessary, liaise internationally. Which? does not consider that current “home region” basis of the Trading Standard Service is sufficient to tackle national issues. National enforcement actions may arise against very large and well-resourced firms that would be beyond the resources of any single Trading Standards department to deal with.
6. The clearest example of a national action is that of the bank charges case, where the OFT took a test case under the Unfair Terms of Consumer Contracts Regulations (1 ) on the fairness of unauthorised overdraft charges. Ultimately, the OFT lost this case. However, this was a significant action necessary to clarify the law and taken against a very powerful industry at considerable risk to the OFT that. We are concerned that this type of case may not be taken up in the future due to a lack of resources, skills or experience in a “local” trading standards office.
7. Other functions of the OFT may be transferred or broken up. Which? has previously raised concerns with the split of consumer credit regulation between the OFT and the FSA. We consider that only one regulator should have full oversight of consumer credit, regardless of which types of businesses supply the credit (from banks to car finance to debt collectors). It is clear that to date the OFT has had insufficient resources, with some 100,000 licensees, to properly enforce obligations under the Consumer Credit Act. Whatever body takes over these functions a review of financing for enforcement is necessary and should include a review of the cost of consumer credit licences that are very low compared to equivalent fees levied by the FSA.
8. The Government should be clear over who will hold responsibility for specific actions. In the meantime, Which? is in discussions with the department for Business, Innovation and Skills (BIS) about how we can increase our role to support all consumers whilst remaining independent of government funding.
Ensuring Competition Issues are Addressed Comprehensively
. Which? is concerned that competition enforcement remains effective and that it is able to respond to concerns in national and local markets. At present the OFT and CC have different but complementary functions, these are summarised in annex 1 below.
10. We have outlined specific concerns in our submission of 6 September to the Committee with the role of competition within the current regulatory regime applying to financial services.100 These focus on the absence of a clear competition mandate for financial services and the split in responsibilities between the OFT and FSA, which weakens effective enforcement. The merger itself would not appear to address these issues. Which? believes that the most appropriate way to address these issues would be through our proposals to give the Consumer Protection and Markets Authority (CPMA) a primary duty to promote effective competition and for it to have concurrent competition powers.101
11. As noted above there have been a number of criticisms of the competition regime. The proposed merger may help or hinder these outcomes but do not appear directly targeted at resolving these concerns. For example, the speed of investigations or the types of investigations that the merged body undertakes will be determined by its own process to select cases, existing competition law, the standard of proof and way in which the competition appeal tribunal interpret these requirements.
12. We consider that there are some features of the current regime that should be preserved or strengthened: 100 See paragraphs 8 8 of Which?’s submission into Competition and Banking of 6 September 2010, http: www.publications.parliament.uk pa cm201011 cmselect cmtreasy memo banking m20.htm 101 See paragraph 12 of Which?’s submission into Financial Regulation of 13 October 2010, http: www.publications.parliament.uk pa cm201011 cmselect cmtreasy memo financialreg m3 .htm Treasury Committee: Evidence Ev 233
— The MIR powers are unique to the UK, allowing a comprehensive, time-limited review of an issue with powers to implement significant reform. These powers should remain but to date have been under-used. However, the merged body must be transparent when it considers using market investigation powers and provide clear reasoning for its decision of whether or not to undertake a market investigation. There is a risk that the current visibility of decision making that arises due to two separate bodies is lost. — Some critics of the competition regime have suggested that market studies (undertaken by the OFT) and investigation references (undertaken by the CC) have strayed too far into consumer protection issues, when they should only be focussed on competition issues. Which? considers this a fallacious argument. Market failures may require a wide range of remedies that affect both the supply side (eg structural reform of firms) and demand side (eg the process by which goods are sold). A merged body should continue to draw on the lessons learned from consumer enforcement where necessary to ensure its remedies are comprehensive. — The CC operates on the basis of advice from a reporting panel of members. These are drawn from a wide variety of backgrounds and offer the CC insights and challenges to improve the quality of its decision making. The benefit of this structure should be preserved for specific market investigations, where the unique circumstances of each case benefit from the experience of panel members. 13. There remain a number of powers for which clarity is required of how these will be dealt with in the future. At present, the OFT is the primary recipient of super-complaints, Which? expects that the merged body will adopt this responsibility. The Competition Commission acts as an appeal body for sectoral regulators’ decisions on price controls, which the CAT may refer to the CC for final determination in the event of an appeal. The Government should be clear on what will happen to these functions within a merged competition body. Which? notes that certain sectoral regulators, including Ofgem and Ofwat, are under review by their relevant departments. These may consider the pros and cons of similar reform in these sectors. Ev 234 Treasury Committee: Evidence Annex 1 months to complete al Tribunal (not the CC). independent “commissioners”, which actofficials as undertaking critical the friends investigationCompetition for (a Act the feature investigations). missing from normal in deciding whether to make address the restrictions to competition it identifies. isc eti n E ISTING COMPETITION DUTIES AND FUNCTIONS OF THE OFT AND CC studies. Instead, they are conductedof under “obtaining, the compiling OFT’s and generalmatters keeping powers relating under and to review duties the information carrying about out of its functions.” The OFT is grantedraids), powers require of information investigation, etc. It to may make impose visits remedies (dawn infringement. (directions) It and may financial alsouncovered. penalties pursue to criminal end cases an Exemptions where from a competition cartel law hassome may been cases apply, remove which (withdrawing thea the OFT specific benefit can agreement) of in a block exemption from should be referred forThe a OFT detailed may analysis. acceptThe “undertakings OFT in and lieu” CCmergers. of have a recently reference published to joint the guidance CC. on assessing MIR references to theCertain CC tests must beOFT met also before emphasises a thata reference it reference. can has be made. However, wide range of powers to gather information and impose All remedies mergers to operate to a strict timetable that is rigidly adhered to. an investigation (imposing remedies may take longer). It also has a CC reports tend to be authoritative. They benefit from the use of cti it e s e CC s e Market Studies No formal power or requirements rest on the OFT to undertake market None. European competition rules. sectoral regulators (Ofgem, Ofcom etc) may also investigate. MergersMarket Investigation References The OFT is the relevant body (alongside sectoral regulators) to make The OFT is responsible for If “phase referred, I” the scrutiny, CC deciding has which a mergers statutory deadline of The 2 CC is the referral body for “phase II” detailed merger analysis. Competition Act investigations andenforcement, including exercise OFT of is the only enforcement dominance body and for anti-competitive competition agreements), law except (abuses where of certain Appeals None. are referred to the Competition Appe Treasury Committee: Evidence Ev 235 n It has discretion overcomplaint. what actions (if any) may follow a super- and may refer thereview. issue back to the Competition Commission for in a number of cases, powers of the OFT to refer issues also exist for the secretary of state. te: cti it e s e CC s e Accepting or reviewing“undertakings in lieu” ormade “Orders” by the CC undertakings in lieu, to ensure they are complied with. The OFT is tasked with reviewing existing Orders made by the CC, or The CC It reviews also any advising Order on that whether the they OFT should refers any remain, to changes. be it, varied and or decides revoked o Super-complaints The OFT is the relevant body to which super-complaints are made. None, unless an MIR is made. Ev 236 Treasury Committee: Evidence
Written evidence su mitted y Sir Don Cruickshank
Nothing Much Changes
Since the Banking Review of 2000, there have been some 15 formal competition investigations of banking markets and numerous other studies, some by the Treasury Select Committee. Yet the competition analysis of the 2000 Review would broadly stand today. There have been some advances eg money transfer and governance of credit card infrastructure, but these are probably outweighed by further concentration of supply, notably the creation of the Lloyds Banking Group. This is an odd outcome. Why should it be so? The answer, I believe, lies in understanding the nature and effect of the “regulatory contract” between government and banks. Chapter 2 of the 2000 Review described it thus: “In return for cooperating in the delivery of government objectives of delivering public confidence in the banking system and avoiding systemic failures, the banking industry escapes the rigours of effective competition. This leads to unnecessary barriers to entry, discriminatory access to money transmission systems, barriers to efficiency and innovation, barriers to consumers switching suppliers and significant information problems for consumers.”
Notwithstanding that over the centuries the banks’ side of this contract has been repeatedly broken, governments across the world have systematically returned to it as the best means of managing the flow of money through the economy and, in particular, of effecting the art of transformation of short term deposits into wealth producing long term investment. Governments have, in principle, been right to do so. So the question is not “How to get rid of this special regulatory contract and expose banks to fully effective competition?” but the more subtle “How continuously to modernise the regulatory contract in the best interests of the economy at large?”. That is the question we asked and attempted to answer in the 2000 Review, leaving the detail of the precise terms on which banks do business with customers on say, credit card penalties or current account pricing, to the competition authorities from time to time. We found that the contract as it was in the late nineties was already far too generous to the banks, their shareholders and managers, and the Review’s recommendations focussed on getting a better balance between benefits for the economy and profits for the banks, while keeping the essence of the contract “secure systemic soundness” firmly in place. The government’s response was wordily positive eg “We will legislate to ensure that the UK payments system is open to new competition” (Chancellor, Budget Speech 2000). But nothing much happened, so not surprisingly, nothing much has changed.
Failures in Government Response
There are at least three recommendations of the 2000 Review that still merit action today: that the industry specific regulator (the FSA but now to be the CPMA ) should have a statutory objective to promote competition in banking markets: that the banking industry should be stripped of its control over the shared network infrastructure over which banks provide services: and the regulatory framework should provide better clarity and integration of prudential and consumer protection regulation. There were other second order recommendations that would be helpful if implemented eg divestment in the markets supplying SMEs and provision of basic banking services , but I would like to concentrate my evidence on these three and to add an over arching comment on the sector’s failings.
Competition Objective
While we were conducting the 2000 Review, the FSMB was wending its way through Parliament. It is often forgotten that we published an Interim Report in 1 “Competition and Regulation in Financial Services: Striking the Right Balance” recommending some profound changes to the Bill. It is appendix F to the final report and may well be the most useful section of the 2000 Review for Committee members to peruse. The Interim Report was embarrassing for Treasury Ministers and officials and led to a distinct breakdown of relations between the Review Team and senior Treasury officials (notably Andrew Turnbull and Gus O’Donnell) to the extent that one member of the bill team was given, and presumably rewarded with a bonus for achieving, the objective “minimise changes to the Bill following the BRT report”. Treasury officials’ anxieties were understandable. The Bill was on their own admission badly drafted. They said they had almost 2000 amendments to get through Parliament. Our recommendations were disruptive of the basic shape of the Bill. So we were rebuffed, and the FSA came into being shorn of powers either to give proper weight to the effect of their actions on competition or to pursue banks for abuse of their dominant position. Only since John Fingleton’s arrival at the OFT has there been the energy to tackle the weakness of competition constraints on banks’ behaviour. Some of the OFT’s investigations have been useful, but taken together have not produced material improvements for customers or the wider economy.
Therefore, my first recommendation is to accept the case made in the 2000 Review’s interim report and arm the new CPMA with a primary objective to promote competition. I note that in its only conclusion to date, the Vickers Commission concurs. Treasury Committee: Evidence Ev 237
Control of Money Transmission Systems However, this change on its own is unlikely to be sufficient. We must also recognise that there are some serious peculiarities in the banking system, and special rules and regulations are needed if competitive dynamics are to operate to customers’ and the economy’s benefit. Government intervenes with special rules in many parts of the economy to good effect—for example in utility markets and the delivery of health services where I have some direct experience. Banking markets suffer from more underlying problems than these other sectors. The 2000 Review focussed on one such problem—control of money transmission systems—the major source of banks’ market power and their capacity to consistently earn super normal profits. Would we allow Google to manage the internet? Would we allow BT to re-establish its control over the UK numbering system and the terms of access to its dominant network? No. Never. So why do we allow banks, acting in concert, almost absolute control over the money transmission systems over which all financial transactions take place? The 2000 Review identified in some detail in Chapter 3 and Annexes D and E the authority that should be exercised by an independent regulator over these systems, analogous to the powers of Ofcom or ICANN. We were criticised at the time for recommending the creation of another regulatory office but that was the necessary logic of the Treasury’s refusal to give the FSA the required authority via the FSMA. It would now be possible, Treasury officials willing, to give the CPMA those powers set out in the 2000 Review. A second criticism levelled at the 2000 Review recommendations on money transmission was that it wasn’t clear what benefits would flow from the actions of the new regulator. On rereading the Review, I have some sympathy with the critics, so let me summarise the case for such a change. Retail banking markets lack a dynamic seen in most parts of the economy in that customers chose not to switch supplier even after having been subject to high costs and or very poor levels of service. The obstacles to switching are several. Most obvious is the cost to the customer of time, hassle and, it is feared, the potentially costly disruption of relationships with providers of other services who rely on standing orders or direct debit payments. Despite recent improvements to the switching process, this is still a major problem. But there are other reasons for banking markets being undynamic. Some products are very long term.. So, whether a product or service is good value for money may not be obvious or easy to judge for some time, so what’s the rationale for switching provider thinks the customer? Another reason is that the cost of core banking services such as a current account is very hard to compare—this is one reason, incidentally, why UK banks are so tied to “free” banking. And finally, customers, especially small business customers, fear that by switching banks they may be penalised at some future date when they have a financial problem. Surely, loyalty will be rewarded if they stay with their present supplier? More fool them, as the current crisis has shown—and not for the first time. Interestingly, banks also face a problem here. For a number of their products they don’t know how expensive the product is to provide until long after they have sold it. Loans, insurance and annuities fall into this category. So, even if consumers are willing to switch, the usual motivation on the supplier side may be muted. But for whatever reason, without this dynamic of more people and businesses being able and confident to switch banks and deal with multiple banks, managers of banks sleep easily knowing that there is little chance of a sudden loss of market share or profitability. Their pricing and service behaviour towards customers betrays this knowledge and we have the anomalous situation that the subsidy that the economy keeps paying into the banking system (mainly in the form of cheap money) stays inside the banking system, with far too much of it going to senior executives. The fact that this subsidy doesn’t get competed away and that banks, even in dire times like today, make super normal profits is the surest sign of uncompetitive markets. The fact that successive formal competition investigations have failed to effect any material change is because they focus on either behavioural remedies or specific, quite slight , interventions in pricing of banking services eg the requirement to pay interest on SME current accounts or offer “free banking” to SMEs (CC 2000) or the requirement to provide more information to customers. In my judgement, none of these investigations in the last 10 years have effectively improved the dynamic of banking markets. Even new entry—and it is telling that we seem to have had only one really new high street bank in the last 100 years, and that was this year—may not have the desired effect. Making it easier for new entrants into retail banking may be missing the fundamental point about these markets. Indeed the capacity of investment banks, in markets where there is no shortage of players, to hold onto the subsidy offered by cheap money makes the point well. However, a regulator, armed with independent authority over money transmission systems would make a huge difference, certainly in retail markets where the current account market is key. Why shouldn’t a retail customer’s bank account numbers be personal and recognised as that by the systems used to communicate between banks and to transfer value between bank accounts? Why shouldn’t the hassle and cost of transferring a personal account from one bank to another be suffered by the banks and their engineers (who incidentally, if my experience of introducing number portability for telephony is anything to go by, would relish the challenge). There are other changes that an independent regulator of money transmission systems could deliver eg credit card transactions at cost, but improving the dynamic of the market for current accounts would be key. Therefore, my second recommendation is to provide for the CPMA to have the powers with respect to money transmission systems set out in the 2000 Review. Ev 238 Treasury Committee: Evidence
Integration and Clarity in Banking Regulation But there is a pattern here. We have regulation that is either narrowly consumer protection or prudential. Consumer protection interventions use a conventional “normal” competition framework of analysis. Prudential regulation floats free from integration with market dynamics. Neither approach gets to the bottom of the problem, and neither creates market dynamics that operate in the customers’ and wider economy’s interests. This, in my view, is unsurprising. Banking markets, more than most markets, are highly interconnected systems with very high levels of trading between the players. Recognition of that and, therefore, recognition that consumer protection and prudential regulation interact, is vital. The 2000 Review wasn’t asked to opine on prudential regulation of banks but my experience of telecommunications regulation said very clearly that competition in, and regulation of, a market are inextricably intertwined. Indeed, all markets are regulated to some degree. They are all man made. The questions to be answered are “What regulation is required beyond the operation of general competition law?” and “What regulatory structure, statutory objectives and powers for the regulatory body or bodies?”. The 2000 Review identified serious weaknesses in the objectives, structures and powers of the soon to be created FSA. The most serious was the absence, anywhere in the regulatory regime outside the general competition bodies, of an objective to promote competition, and, to make things worse, structures and processes within the FSA favoured the very banks (and other financial organisations) being regulated. The absence of a duty to promote competition is discussed above. Other recommendations are summarised in paras 23 to 35 of the Executive Summary to the Review. Some, but by no means all were implemented by the government over the following years. These recommendations flowed from the fact that banking markets are so different from other markets in the economy that they must be subject to a whole raft of laws and regulations, growing by the day, some national, some international, that have as their principal objectives securing (1) systemic soundness and (2) a level playing field for the operation of global banking. These aspects of regulation are not, I know, the subject of this enquiry by the Committee, but I would comment in passing that any ill thought through unilateral action by the UK government or regulators, sometimes even the discussion of such possible action, on matters such as “breaking up the banks” or “UK determined bonus arrangements” is harmful to the UK economy—probably already has been harmful as the puzzled enquiries I receive abroad about “what do you think you’re doing to London?” exemplify. This another example of the network issue I touched upon earlier. The banking system is not national. It is global. This does not mean that nothing can be done locally (for instance my recommendations above would have the effect of making UK banks more competitive internationally) but it does mean that actions taken within a single jurisdiction can have unexpected consequences unless this interconnectedness is taken into account. The 2000 Review, even though it was not faced with the crisis of the past few years, nevertheless identified serious weaknesses in these aspects of regulation and it made some specific suggestions concerning the relationship between HMT and the FSA and the operation of, or rather the predicted almost certain failure of, the MOU between HMT, Bank of England and the FSA. Some of these were about process and might have been helpful if implemented. Others were more fundamental. For instance, uniquely amongst sector regulators in the UK, the Chancellor has no powers to instruct the FSA, although its powers to instruct the Bank of England are untrammelled, save with regard to monetary policy. The naivety of this policy was amply demonstrated from the Northern Rock debacle onwards. The FSMA disapplies general UK competition law when a firm’s behaviour is required or contemplated by the FSA. This is an unnecessarily wide defence. The MOU was (and continues to be) silent on who makes the final trade off between different outcomes. It is, and will continue to be, not “integrated” in one organisation. Nor is it “hierarchical” with one organisation having the final say. Neither is it “arbitrated” by an outside body—although arguably the bond market de facto plays this role No, it is just seen as “no problem”. HMT’s rather woolly consultation paper “A New Approach to Financial Regulation” (July 2010) doesn’t deal with this issue. Indeed, at 3.15 is the giveaway: “the Government will specify in secondary legislation precisely who does what” Therefore, my third recommendation is that the legislation giving effect to the CPMA , PRA and consequential changes to the Bank of England responsibilities and powers must address these and other similar flaws in the present arrangements. An updated analysis along the lines of the Interim Report of the 2000 Review would identify the necessary policy. I am presently gloomy on this as there is precious little in the Treasury’s “consultation” document to suggest that such an analysis is underway.
System Wide Frame Of Reference There is one final point I would like to make in relation to any competition or regulatory analysis of the banking sector. My observation of the crisis, albeit from a distance, is that a decade of failing to look at banking and financial services as a system applies to the banks as well as the government and regulators. There are very large (orders of magnitude) difference between the gross and net assets and liabilities of the financial system taken as a whole. The objective of the finance sector in the economy is to provide services to the wider economy and to customers. Banking is, after all, an intermediary service. How then was that objective promoted by the ballooning of the gross positions within the sector. The 2000 Review had a table showing the gross liabilities of the major banks in 1 totalling c1.2 x the UK’s GDP. By 2007 that ratio was over 3. Over the same period the total indebtedness in the economy doubled. Did that lead to more efficient and effective Treasury Committee: Evidence Ev 239
services to the rest of the economy? The industry claims this to be the case and justify the myriad “innovations “because this is what they claim they achieved. I have never seen any end to end, system wide, analysis that even begins to justify this claim. Much of this activity within the sector is also highly compartmentalised, in part because of the complexity of banks’ “innovation”. As was amply demonstrated at the time of crisis, the banks did not seem to have a good picture of their overall position, nor how one bit related to another, especially in liquidity crisis mode. Now, in the aftermath of the crisis, much of the problem seems to have stemmed from the banks not knowing where their assets and liabilities really were, or the risks attached to them. Each knew about its narrow activities, but no-one seemed to know how they all fitted together, even within the same bank. This ignorance— shared by the government and regulators—is what allowed the alchemy to flourish. The apparent disappearance of risk, the flawed mathematics, the generation of apparent not real profits, the failure to distinguish between the creation of value and the random outcome of necessarily uncertain investments, and the outcome of complex zero sum games. This sort of behaviour—by market participants, government and regulators—would not be tolerated in other parts of the economy that exhibit the same degree on network connectivity and interdependence and the same importance to the economy. At Oftel, I spent a lot of time developing rules that were more specific than general competition law to make sure that the interconnection conditions were right for both system stability and the right competitive dynamic to serve customers. Ofgem and other regulators have done the same. The internet has independent regulation and rules. This does not happen by accident. It requires the regulators and the firms affected by the regulation to understand how the system operates and how to improve it. In financial services, many of the issues have been left to the industry to resolve. Not surprisingly, they have resolved the issues in their own interests. Therefore, my final recommendation is that developing some sounder system wide frame of reference for government, regulators and competition authorities is required. This Committee’s findings would be a good place to start. And I am hopeful that John Vickers’ recommendations will improve our understanding of how better to integrate sound prudential regulation and dynamic markets. There is no silver bullet. Change is likely to be slow and steady—and will certainly be opposed by the banks. In the meantime, action “Monday morning” by the government and its agencies is likely to be counterproductive and best avoided, especially anything that risks the UK’s position as a leading provider of financial services to the world. In particular, the government’s rearrangement of regulatory structures needs to provide for HMT, the Bank of England and regulatory agencies to have a shared system wide frame of reference and an agreed process for making trade offs. ee2
Written evidence su mitted y the f ce of air radin Summary 1. We are submitting this document as part of the Committee’s inquiry into competition and choice in the banking sector. The document covers: — the OFT’s role and responsibilities; — the OFT’s recent interventions in the banking sector; and — options for making further progress. 2. Overall, although there has been some progress in achieving greater competition and choice in banking, the pace of change remains slow and has required significant and continuous intervention from the OFT. If banking was a consumer-focused, competitive market, these changes would have occurred naturally as banks sought to compete with rivals. 3. Looking forward, it is critical that the new Consumer Protection and Markets Authority (CPMA) takes a strong competition stance to ensure that market outcomes favour consumers. Further structural change in the market may be considered appropriate and this is currently being looked at by the Independent Commission on Banking (ICB).
The OFT’s Role and Responsibilities . The OFT is an independent, non-ministerial government department whose mission is to make markets work well for consumers. Markets work well when businesses are in open, fair and vigorous competition with each other for the consumer’s custom. We pursue our mission by: — encouraging businesses to comply with competition and consumer law and to improve their trading practices through self-regulation; — acting decisively to stop hardcore or flagrant offenders; — studying markets and recommending action where required; and — empowering consumers with the knowledge and skills to make informed choices and get the best value from markets, and helping them resolve problems with suppliers through Consumer Direct. Ev 240 Treasury Committee: Evidence
The OFT’s Recent Banking Work: Overview and Outcomes 5. If financial services markets worked well, providers would thrive by providing what consumers wanted, better and more cost-effectively than their rivals. Consumers would have the confidence to shop around and choose between providers. Providers that did not offer value for money would be left with no choice but to improve their products or face declining market share. This competitive environment would drive innovation and generate growth in the economy. 6. The costs of badly functioning financial services markets are borne by consumers (both individuals and businesses) through high charges and low confidence—so a financial services market that is not working for consumers is not working well for the economy. 7. Over the last few years the OFT has observed numerous problems in the retail banking market102, such as high levels of consumer inertia due to difficulties around switching providers and low levels of transparency. The OFT has completed several pieces of work aiming to improve the market, and improve outcomes for consumers. These include market studies, reviews and investigations on specific issues, references to the Competition Commission (CC) and merger analyses103. 8. Two of our most high profile pieces of work in recent years have been around personal current accounts and barriers to entry, expansion and exit in retail banking.
Personal Current Accounts . The OFT launched a market study on Personal Current Accounts (PCAs) in 2008. We found low levels of transparency, difficulties in switching providers and problems relating to unarranged overdraft charges (UOCs). Subsequently, we worked with the industry to improve the switching process, increase transparency of charges and take steps to give consumers greater control over unarranged overdraft charges, making them subject to competition. 10. Many of these initiatives have already been implemented. For example, we have worked with Bacs (the payments processor) to improve the process of switching between banks, and banks have now published illustrative charging scenarios on their websites. Following the judgment of the Supreme Court on the assessability of UOCs under the Unfair Terms in Consumer Contracts Regulations (1 ), the OFT worked with industry to implement a series of voluntary initiatives to address its outstanding concerns in this area. These include minimum standards on opt-outs from unarranged overdrafts and best practice guidance on treating customers in financial difficulty who incur UOCs. Throughout 2011 we expect to see more improvements, both across the industry, such as the introduction of annual summaries of the cost of running an account, and by individual banks, such as the introduction of greater control and choice.
Barriers to Entry and Exit in Retail Banking 11. The OFT published a review of barriers to entry, expansion and exit in retail banking in November 2010. The review was designed to contribute to the wider debate on the future of banking, including the work of the Independent Commission on Banking (ICB). 12. While the review found that most prospective entrants were able to meet regulatory requirements, and source the necessary inputs to offer retail banking services, new providers faced difficulties in attracting customers and expanding market share. This was due to the reluctance of personal and small business customers to switch providers, their loyalty to established brands, and their preference for banks with a local branch. This was most marked for personal and business current account customers—personal customers were more likely to shop around for loan products.
Making Further Progress 13. It is too early to assess fully the impact of our initiatives. Some initial indications are encouraging. For example, there has been a reduction in the number of problems that arise from the switching process (data from Bacs shows the number of consumers encountering problems fell from 32% in 2008 to 8% in 201010 ) and increased transparency through the introduction of “charging scenarios” to assist comparisons of unarranged overdraft charges. 1 . However, while improvements are welcome, the pace of change has been slow and banks have not readily agreed to make these improvements, especially around PCAs. In a competitive market, banks would have taken these steps themselves in response to consumer demands, rather than needing considerable pressure from the OFT to implement the changes. 102 The OFT is also currently carrying out a market study examining how the equity underwriting market works and assessing whether there is potential for improving the way it functions. This will be published in late January 2011. This submission focuses on retail banking. 103 See Annexe for a list of some of our work in financial services. 10 See e s na C ent cc nts in the : ess ate, September 2010 (OFT1275) for more details on current developments in the market. Treasury Committee: Evidence Ev 241
15. Further interventions could help deliver faster change. For example, the new CPMA and the Consumer Financial Education Body (CFEB) could use their powers to tackle consumer inertia in the retail banking market directly by: — requiring banks to provide information to consumers on the things that matter to them (such as clear cost information), in formats which they can use and relate to their personal circumstances, and — creating an effective comparison tool for PCAs. 16. The CPMA presents an opportunity to promote better outcomes for consumers through interventions that help consumers take an active role and make informed choices. As well as having regard to avoiding the potentially anti-competitive impact of regulatory activity, consideration should be given to a positive duty on the CPMA to promote effective competition as a means to deliver improvements for consumers. 17. In some cases, regulatory intervention may prove necessary if market-based solutions do not go far enough. Where the CPMA deems regulatory intervention is necessary, a focus on competition could help deliver solutions which work with, rather than against, the grain of consumer and business behaviour.
Structural Changes
18. While the remedies outlined above can address consumer inertia, and have the potential to move the retail banking sector to a more consumer-friendly position, they may not be sufficient on their own—structural remedies may be required.
1 . Structural remedies can take a number of forms. The most obvious form relates to asset sales from incumbents, either to smaller players or new entrants. This has the effect of potentially increasing the number of players and reducing the level of concentration. However, while in many markets an increase in the number of market participants will have a positive impact, where there are high levels of consumer inertia, increasing the number of players may not result in an increase in rivalry between them. This will be the case if new entrants are not incentivised to act as “challengers”, ie to price and innovate aggressively to attract new customers.
20. Structural remedies can also encompass vertical separation, such as creating common infrastructure platforms to promote entry. While such actions were useful when the OFT considered the governance of payment systems, their significance in other aspects of retail banking is less clear. For example, our barriers to entry review suggested little appetite for sharing branches as a way to promote entry competition. 21. Other potential structural changes relate to separating retail and investment banking activities, although we see this as primarily an issue around financial stability rather than competition. 22. These issues are currently being considered by the ICB.
Annexe
OUTCOMES OF SELECTED OFT INVESTIGATIONS IN RETAIL FINANCIAL SERVICES Personal Current Accounts and Other Core Banking Products
the n e an an in 2 in a s e -c aint Which 105 — The OFT found evidence of weak competition between banks in Northern Ireland, as well as a lack of transparency and lows levels of switching. The CC recently published its amended Northern Ireland Banking Order which addressed many of these concerns.
C a et st 2 106 — Having found lows levels of transparency, perceived and actual problems around the switching process and the lack of control over the use of unarranged overdrafts, the OFT worked with the industry to implement, on a voluntary basis, a range of initiatives designed to improve consumer outcomes.
na an e e a t cha es in esti ati n an est Case 2 107 — Following the judgment of the Supreme Court that these charges could not be assessed in full for fairness under the UTCCRs, the OFT is working with industry to implement a series of voluntary initiatives to address its concerns around these charges. These improvements are ongoing. 105 See www.oft.gov.uk OFTwork markets-work super-complaints northern-ireland-banking. 106 See www.oft.gov.uk OFTwork markets-work completed personal . 107 See www.oft.gov.uk OFTwork markets-work completed personal personal-test-case . Ev 242 Treasury Committee: Evidence
Cash s 2 in a s e -c aint C ns e c s 108 — The OFT secured agreement from banks to publish clearly the interest rates on the face of cash ISA statements and revise industry guidelines on the length of ISA transfers, down from 23 to 15 working days. The OFT also made a number of recommendations to ensure that, if delays occur, consumers are no worse off than they would have been if timelines had been met—this has now been incorporated in industry guidelines.
ie s t ent e nsi n n e it in et i n in e ie 10 — The review found that most prospective entrants are able to meet regulatory and infrastructure requirements but new providers face difficulties in attracting customers and expanding market share largely due consumer inertia. This review was submitted to the ICB.
Secondary Banking Products ent te ti n ns n e in s e int iti ens i e 110 — The OFT found problems with the structure of the market (such as switching barriers and costs and information asymmetries), the conduct of firms (such as a lack of transparency) and the lack of active consumers. Following a referral, the CC published a draft Order addressing these concerns.
SME Banking nin eie net ins111 — Following a referral to it the CC, in 2002, found the SME market to be characterised by a reluctance by firms to switch providers, a number of practices that restricted distorted price competition and a number of barriers to entry and expansion. The CC subsequently received a number of undertakings from banks to address these issues. In 2007, the OFT advised the CC on lifting price controls and the retention of behavioural undertakings agreed in 2002, including an agreement to ensure that SMEs are able to switch accounts quickly and simply.
Credit and Debt et nsi tin 112 — Following a study that found potentially unfair practices, the OFT launched an awareness campaign on consumer credit and worked with the Debt Managers Standards Association to complete stage one of the OFT’s Consumer Codes Approval Scheme.
e e it in s e int t e ti n ns e n i 113 — The OFT found many home credit customers were in a poor bargaining position, had difficulties in making comparisons and were tied to existing lenders. The OFT referred the market to the CC, who, in 2006, announced a number of measures designed to increase competition in the market.
t e s in n in i isin it ent e t t e e s e e t ittee 11 — The OFT found that there were features of the sector that appeared to prevent, restrict or distort competition. The OFT referred the market to the CC. In 2006, the CC announced remedies to improve competition in the market.
eit e t es 115 — Following this work, the OFT set a threshold for intervention on credit card default fees. This gives priority to addressing default charges which exceed a threshold of £12. This led to a reduction of default charges by providers116.
eit isn in s e int Wi 117 — The OFT made a number of recommendations including, the introduction of an independent credit card price comparison website run by the FSA, improvements to how information is presented in summary boxes, standardisation of terminology, and improvements to consumer education. 108 See www.oft.gov.uk OFTwork markets-work super-complaints cashISAs . 10 See www.oft.gov.uk OFTwork markets-work othermarketswork review-barriers . 110 See www.oft.gov.uk OFTwork markets-work completed payment. 111 See www.oft.gov.uk OFTwork financial-and-professional SME-banking . 112 See www.oft.gov.uk OFTwork markets-work completed debt-consolidation. 113 See www.oft.gov.uk OFTwork markets-work super-complaints home-collected-credit. 11 See www.oft.gov.uk news-and-updates press 200 7 0 . 115 See www.oft.gov.uk news-and-updates press 2006 credit-cards. 116 See for example es e in n i e i es t e e st e e t es, www.oft.gov.uk news-and-updates press 2008 08. 117 See www.oft.gov.uk news-and-updates press 2008 1 08. Treasury Committee: Evidence Ev 243
ihcstceiteie 2 118 — The OFT found that the market for high-cost consumer credit was working reasonably well in some respects, but it had some concerns on the relatively low levels of ability and effectiveness of consumers driving competition and the limited available of additional sources of supply. A number of recommendations were made and the Government’s response is being coordinated by BIS.
Market Infrastructure a ents C nci 2 e ie a ainst ecti es sent -chai e a ent s ste s tas ce in 2 119 — The OFT reviewed the work of the Payments Council after two years of operation and found there had been some improvement, but more work was needed to improve the focus on flexibility and efficiency of systems and to make sure benefits were passed on to consumers.
Merger Decisions e ati na c s 2 2 120 — Having considered the issues, the OFT found that the proposed acquisition would lead to the elimination from the market of one of the most significant branch-based competitors to the largest four banks and gives rise to a clear possibility of a substantial lessening of competition, primarily in the market for current accounts. The OFT referred to the merger to the CC which recommended the merger be prohibited.
s c 2 e t a e t ec eta tate121 — The OFT submitted a report to the Secretary of State which found a realistic prospect that the anticipated merger would result in a substantial lessening of competition in relation to PCAs and banking services for SMEs. The OFT’s concerns on PCAs were nationwide, while its concerns about SMEs were focused on Scotland. The Secretary of State did not refer the anticipated merger to the CC.
C - e ati e inancia e ices i ite itannia i in ciet 2 122 — Based on the evidence available to it, the OFT did not make a reference to the CC and the merger was cleared.
i t n i in ciet ca h i in ciet 2 123 — Based on the evidence available to it, the OFT did not make a reference to the CC and the merger was cleared.
shi e i in ciet Che sea i in ciet 2 12 — Based on the evidence available to it, the OFT did not make a reference to the CC and the merger was cleared. an a 2
Supplementary written evidence su mitted y the inancial Services Consumer Panel 1. The Financial Services Consumer Panel’s current statutory role is primarily focused on advice to and scrutiny of the regulator and our involvement in competition issues has been limited to where these issues are related or create issues for the regulator’s role. Our interest in competition is twofold: — Is competition delivering good consumer outcomes and if not is there a need for regulation. — Can regulation be used to stimulate competition that will deliver good consumer outcomes? 1.1 The Panel has therefore focused on a regulatory path to delivering fairness for the consumer. The Panel provided evidence to “The Future of Banking Commission” and had the benefit of considering the extensive evidence provided by Which? to this inquiry, which we support as providing a comprehensive consumer view on competition and barriers to entry issues. 118 See www.oft.gov.uk OFTwork credit review-high-cost-consumer-credit . 11 See http: www.oft.gov.uk news-and-updates press 200 3 0 120 See www.oft.gov.uk OFTwork mergers mergers_fta 2001 abbey-national-1. 121 See www.oft.gov.uk OFTwork mergers Mergers_Cases 2008 Lloyds. 122 See www.oft.gov.uk OFTwork mergers Mergers_Cases 200 cooperative3. 123 See www.oft.gov.uk OFTwork mergers decisions 200 Skipton. 12 See www.oft.gov.uk OFTwork mergers decisions 200 Yorkshire. Ev 244 Treasury Committee: Evidence
1.2 The Panel is also providing with this further evidence our recent responses to the OFT’s inquiry into the Review of Barriers to Entry and Exit in Retail Banking and our submission to the Independent Commission on Banking.
2. “Free” Banking—Costs and Implications 2.1 There is no such thing as free banking and in the interests of transparency and comparability this notion needs to be dispelled. The number of consumers enjoying the benefits of the current “free” banking model is small and limited to those who use their current accounts frequently, have small balances and never go overdrawn. The rest pay through interest foregone and penalty charges that are often not disclosed in advance. 2.2 Because charges are hidden they present a barrier to comparison. A consumer is unlikely to make comparisons on the basis that they may encounter financial difficulties, and even if they do have this expectation then the charges are often not disclosed in advance125 and labelled in different ways that prevent comparison.126 2.3 The nature of the financial services market; long term, often complex products purchased irregularly; means that competition tends to be based on a headline characteristic which is usually the immediate cost. Where competition exists it is in areas such as mortgages with low start interest rates or savings products with high interest rates for the first year. Consumers are then locked in because of the difficulties and cost of switching.127 The current free banking model is the genesis of the long running competition cases and inquiries into PPI and bank charges. 2. Free if in credit banking and its associated fee structures form a barrier to low income consumers entering the market or using mainstream financial services providers. The lack of transparency undermines budgetary control and planning for those who need to be micro-managers of their money. Many consumers choose high cost options such as Pay Day lending because they find the fee structure easier to understand.128 2.5 Another feature of free banking is “free” advice. However there is a very real danger that products sold benefit sales staff and the bank more than the consumer and this may lead to sales of products that are not always suitable, as happened with PPI and may be happening with investment bonds. It is hard to see compliance with the Treating Customers Fairly principles regarding the selling of products that are suitable to consumers’ needs and circumstances when limited options are presented.12 Free banking is also a significant impediment to competition. 2.6 The Retail Distribution Review recommendations will go some way towards dealing with this problem and restoring consumer confidence. It is imperative that the momentum behind the RDR is not lost, as it will deliver significant consumer benefit. Alongside this, we have been promised a more active role by the regulator in delivering on TCF through monitoring products and services designed, marketed and sold to ensure that they are safe and fit for purpose. More intelligent regulation that involves scrutinising products at an early stage to ensure they are fit for purpose will be a significant step forward. We hope the proposed new CPMA will embrace this important aspect of regulation. 2.7 The current model presents a barrier to new entrants and new models. Existing institutions maintain a competitive advantage through the cross subsidies in place. They have the established business from which to divert resources and therefore are able to compete on a below cost basis (at least in the short term) for business, knowing that subsequent changes to the product will recoup their investment and that customers are unlikely to switch once signed on. There is the further advantage of utilising the customer’s information and inertia to cross-sell products. Often customer inertia reflects the consumer’s inability to differentiate in any significant way between retail banks’ products. 2.8 Another issue in moving to the option of fee based accounts is determining the costs. It is a significant indictment on the current combined model of banking that there is a tendency to run the retail banking business without reference to the cost of its components and that the level of the cross-subsidy is not even clear to the banks themselves.130 This increases risk and undermines market efficiencies. 2. The Panel doesn’t underestimate the difficulties of improving effective competition in banking. It is commercially and reputationally very difficult for a bank to unilaterally start charging for a “free” service. HSBC offered a fee based current account and was pilloried in the media. It has had little take up, perhaps 125 Eg Information about overdraft charges does not have to be specifically disclosed to a customer opening an account, it is enough that the charges are made available via a telephone helpline, a website; or by asking staff. Lending Code, 6 . The voluntary agreement by the major PCA providers to introduce further transparency initiatives in response to the OFT’s personal current accounts study extends only to information after the event on monthly statements or annual statements of cost that an illustration of charges is available on the website. Personal Current Accounts in the UK, Progress Report, September 2010, para 3. . 126 Office of Fair Trading, Personal Current Accounts in the UK, 2008, p2. 127 Consumer Focus, Stick or Twist, An analysis of consumer behaviour in the personal current account market, October 2010. 128 Consumer Focus, Keeping the Plates Spinning, August 2010. 12 Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly. Outcome : Where consumers receive advice, the advice is suitable and takes account of their circumstances. http: www.fsa.gov.uk pages doing regulated tcf 130 Competition commission, Personal current account banking services in Northern Ireland market investigation, May 2007. Treasury Committee: Evidence Ev 245
because the monthly fee seemed high. New entrants are similarly unlikely to attract business to a current account that charges fees where the option is no upfront fees. 2.10 A transparent summary statement about the total cost including interest on balances foregone could help raise awareness of the real cost of banking by providing comparative information relevant to the individual customer’s circumstances so facilitating value for money comparisons between banks.131 The most recent work was the OFT’s study in 2006 which demonstrated that in 2006 a current account cost the average customer £152 a year, two thirds of this coming from interest foregone. The OFT’s update of this work in 200 132 concluded that: Whi e the n that c ns e s c ene a n e stan the c nce t inte est ne e n that c ns e s i n t n thei c e it inte est ate an the esea ch c n cte the e ea e that t a s a sa e c ns e s the a it n e esti ate thei a e a e a ance s e e 2.11 There is a place for both fee and free products and an assessment of these products for different segments of the market. In the move to greater transparency in pricing and cross-subsidies there also needs to be a recognition that some areas of the market are not profitable and are not provided for. The Panel has called for a system of simplified 2.12 Greater capital requirements and regulatory controls may have the effect of restricting access to services and products because the consumers or products are considered too risky. The essential service nature of banking also demands a policy and regulatory response to ensure access to services and control of prices. There has been great support for the development of services currently provided by the Post Office, a trusted institution, into a fully functional payment system accessible to all.133 But the Post Office alone will not meet the potential requirement. 2.13 In the new regulatory environment a regulator would ideally have responsibility for regulating all aspects of retail banking with a duty to promote competition and an ability to intervene where the market is not working. In doing this, it will need to consider economic aspects and be able to limit the scale of cross- subsidy in order to reduce barriers to entry.
3. Current Models and Culture 3.1 We would like to see the banking industry driven by and responsive to the needs of customers. Good retailers succeed by being sensitive and responsive to the needs of their customers and will differentiate on customer service, safety and quality of their products. Their existence does not eliminate the need for statutory regulation, but reduces it. The UK banking market is essentially characterised by one model—the mixed, commercial model—with retail or high street’ banking often being overshadowed by the more profitable activities of investment banking; in effect, creating a tension between deriving profit from the commercial strategies employed for risky banking services and the delivery of retail services to consumers and SMEs that are of “value”. Where the culture has become sales driven, it is undesirably so with widespread mis-selling and poor value products being cross-sold to existing customers. 3.2 New entrants are promoting difference. Metro Bank refers to itself as a retailer and to its branches as stores, and will be competing on service and convenience. Tesco claims they will offer a different retail experience to the traditional banks, based more on customer satisfaction. A more effective competitive market, facilitating new entry, would not only allow but also encourage businesses to adopt a reputational and value for money approach to financial services.
. Transparency .1 Transparency in charging and costs is essential in providing customers with a basis on which to make a choice, but this transparency will simply result in information overload if the complexity of charging and costs and contingent fees continue to prevail. We need to see competition on true costs and where other charges are relevant these must reflect a reasonable estimate of costs of the additional administration undertaken by a firm as a result of a customer being overdrawn, rather than being used as a vehicle to generate further profit.13 .2 The growth of packaged products has added to the complexity. Research by Which? has shown that only 12% of those who used packaged accounts said they used all the benefits it offered. Increasingly credit cards or loan facilities are being offered only if you have a current account with the same provider. These packaged products are more difficult to compare and the value to consumers is dubious; competition and choice is reduced. The current right of set-off provides an incentive to offer these products to the potential detriment of consumers. 131 Eg The Carphone warehouse has established league tables in relation to mobile phones which rank products taking into account the range of variables and not just up front costs. 132 Personal current accounts in the UK A follow up report October 200 advice and simplified products for low income consumers which would help address some gaps in the market. 133 Financial Services Consumer Panel, Submission to Independent Commission on Banking, November 2010. 13 The FSA’s Mortgage Market Review has proposed this in relation to arrears charges on mortgage lending. Additionally firms should only include costs that they can objectively justify and the can be identified with reasonable precision., FSA, CP 10 16, Responsible Lending, July 2010. Ev 246 Treasury Committee: Evidence
.3 A legislative presumption in favour of transparency in the regulation of retail banking could do a lot to support effective competition providing consumers with real information about the practices of financial institutions.
5. Barriers to Switching 5.1 Actual and perceived barriers to switching such as exit fees on mortgages or long time scales for switching have a significant effect on competition in the market. It should not require a super complaint for the industry to finally co-operate in make switching easier.135 Consumers perceive the cost of switching outweighs the benefits with their being little differentiation between the banks. The prevalence of electronic transactions, particularly for essential services such as accommodation, power and water, makes the risk of error crucial. Issues around errors in switching are particularly a concern where the consumer has little control over payments mechanisms, such as direct debits.136 Consumer controlled payment mechanisms would go some way to removing that risk.137 The Panel has added its voice to the call for portable bank account numbers which would bring the convenience which consumers have experienced in the mobile telephone market to the account transfer process.
6. Lack of Confidence in the Sector and Promoting Trusted Models 6.1 There is a serious lack of confidence in the sector which has potential implications for the economy and long term savings goals. Lack of trust and confidence also presents a significant impediment to being banked amongst low income consumers.138 It is an environment where consumers will be wary of new startups, particularly given they know that the existing big banks will be underwritten by Government. 6.2 The lack of confidence amongst consumer is not without significant justification. Whilst realising banking inclusion has been a central social policy goal for more than a decade, half of those who are newly banked are not benefiting from the move. “The gains from any savings they make from paying bills by direct debit have been all but entirely outweighed by the costs associated with penalty charges, resulting in a net loss for the lowest income households.”13
7. Too Big to Fail 7.1 The market share for the three key retail banking services; personal current accounts, savings and mortgages; continues to be dominated by the “big four” with the addition of Santander after a series of mergers and acquisitions to make it the big five. It is notable that all demutualised building societies have seen their businesses fail, and have either been taken over by traditional banks or nationalised.10Consolidation has stifled diversity and provided us with one predominant banking model, that of the combined or mixed commercial model. 7.2 The big banks have been able to see off competition through the control of information and cross-selling opportunities as well as attracting implicit loyalty because of the widely held view that they are all the same and it is too difficult to switch.11A recent report by Deloitte comments that the ability to attract current accounts with their cross-selling potential will be a key feature of most new entrants’ plans, but current account focused business models have not been straightforward for those seeking to take market share in the past.12 7.3 The concentration of the sector in a time of crisis led to a Government bail out for some of the major players and managed take-over for others, with the perception that some organisations were too big to fail. Government subsidies for the large and unsuccessful has had a significant impact on competition. In a time of economic downturn, the small and successful are struggling against the formidable combined resources of State and multi-national. 7. Plans for divestment need to have both a market focus in fostering real and different competition and also a public focus in providing access to basic retail banking services at an affordable cost and minimal risk. These aims will not be achieved if we merely see a passing of the baton from one big player to the other, as occurred in the sale of RBS branches to Santander. There needs to be an independent monitoring, audit and review of the divestment process to ensure that divestment conditions are being met. 135 Consumer Focus, http: www.consumerfocus.org.uk news consumer-focus-issues-super-complaint-to-officeof-fair-trading-about- uk-cash-isa-market 136 Consumer Focus, Stick or Twist, An analysis of consumer behaviour in the current account market, October 2010. 137 Consumer Focus, Opportunity Knocks, Providing alternative banking solutions for low income consumers at the Post Office, January 2010. 138 HM Treasury, Financial Inclusion Taskforce, Policis, Realising Banking Inclusion; the achievements and challenges, May 2010. 13 HM Treasury, Financial Inclusion Taskforce, Policis, Realising banking inclusion: the achievements and challenges; www.hm- treasury.gov.uk d fitf_research_unbanked.pdf 10Lloyds TSB, Natwest (now RBS), Barclays and HSBC have all increased their market share since the Cruickshank review in 2000 with personal accounts collectively at 71%, deposit savings accounts at 5 % and mortgages at 67%, The Future of Banking Commission Report, commission.bnbb.org banking sites all themes ... commission_report.pdf, June 2010. 11Consumer Focus, Stick or Twist, An analysis of consumer behaviour in the personal current account market, October 2010. 12Deloitte LLP, Opportunity Knocks, Considerations for new entrants in UK retail banking, 2010. Treasury Committee: Evidence Ev 247
7.5 Section 172 (1) (d) of the Companies Act 2006 provides that in promoting the success of their company directors must have regard to “the impact of the company’s operations on the community and the environment” and this seems to provide a useful starting point for conditions associated with divestment in the common good.
8. Too Big to Innovate
8.1 Established banks are like tankers and slow to respond to change. They do not have much to gain from change and need considerable time periods to adapt to external factors such as changes to legislation. In particular there has been little development in alternative payment models within the regulated sector and existing payments systems restrict new entry into financial services. Payments are not made in real time and clearing fees provide real hurdles for small providers. The developments that have taken place, eg prepaid cards and mobile and online payment providers, have largely occurred outside the system.
8.2 The Cruickshank Review identified profound competition problems and inefficiencies in the market for payment services.13Issues such as slow clearing cycles for cheques and automated payments, high charges for cash withdrawals and interchange fees levied by monopoly providers still prevail despite some improvements leveraged by the Payments Council. The Payments Council is dominated by the major financial institutions and needs to do more to lead the future development of services. The Faster Payments Service (FPS) is the first new payments service to be introduced in the UK for 20 Years. Historically, innovations have disproportionately arisen from small companies, however small stakeholders expressed a measure of dissatisfaction with the access and support they received from the Payments Council when proposing innovations.1 A monitoring body that is more pro-active in supporting innovation and enforcing adoption and has a more open membership structure is needed to remove barriers to innovation and market entry.
8.3 In an ideal world, new entrants are more likely to have an advantage in IT systems and new payment technology, but the authorisation process favours those who have established branch networks or who buy an authorised body off the rack and the Payments Council has not been particularly supportive of small companies proposing new innovations.15However buying into existing architecture may mean outdated systems less responsive to new models of operating. It is illustrative that a recent report records that firms’ investment plans for information technology are broadly flat for the next 12 months while the balance for those planning to spend more on marketing in the coming year has risen to 53%, the highest in 10 years.16New payment methods need to be fostered within the system, not outside it, in order to provide the safety that consumers need along with products that meet changing times and deliver more efficient service.
. Too Poor to be Serviced
.1 Combined banking models standardise operations across their network by way of a “single customer view”. There is little differentiation according to needs of different communities or different segments of the population. The recession and failures of firms has seen services increasingly being withdrawn from less profitable areas, evidenced by branch closures, rationing of credit provision, and withdrawal of products that were less risky propositions for low income consumers such as the National Savings and Investment scheme.
.2 Barriers such as the application of money laundering legislation with its inconsistent and sometimes onerous requirements for identification can act as barriers for consumers and new entrants (particularly those offering e-commerce models). Financial capability presents another barrier, even if there was clarity and transparency in charging practices.
.3 There has been rapid growth in payment cards, micro-finance models, peer to peer lending, and high cost lending, which require less onerous entry requirements than mainstream banking products but regulation, fraud, theft and compensation remain a problem with many of these services. We are concerned that customers will increasingly have to seek services outside the regulated market because the market does not provide for them.
See attachments not printed : — Financial Services Consumer Panel Submission to Independent Commission on Banking. — Financial Services Consumer Panel’s response to the OFT Call for evidence to the Review of Barriers to Entry, Expansion and Exit in Retail Banking. an a 2
13C etiti n in an in e t t the Chance the che e , Don Cruickshank, March 2000 1 OFT1071, Review of the operations of the Payments Council, March 200 , 25. 15OFT 1071, Review of the operations of the Payments Council, March 200 . 16CBI PWC Financial Services Survey, 28 June 2010 Ev 248 Treasury Committee: Evidence
Written evidence su mitted y Metro Bank Competition is the key to customer choice and Metro Bank is the first of new competitors who will challenge the present oligopoly. British banking has developed into a commoditised market in which there is very little service differentiation and players compete solely on product and price. This has led to a degradation of service and mass customer dissatisfaction. Metro Bank is the first new entrant in Britain in over 100 years. It is a “community bank” model focusing on gathering deposits, without wholesale funding, and lending within the UK. Our basic proposition is a retail service model where our customers become fans and where the human being is the “deliverer of profit”, as commented by TSC member John Thurso, “not a generator of cost”. There are many examples outside of banking, ie Apple, where a better value proposition creates successful and sustainable business models. We believe that new competitors with differentiated business models would improve the economic and banking climate in Britain. As in every market, there are barriers to entry and we have noted some we think apply in the UK: 1. A lack of entrepreneurship in the banking field as all the banks have consolidated into a few very large commodity providers. 2. Financial Services Authority (“FSA”) approval is required for new entrants and, indeed, should be required. This process needs to be thorough but responsive and we understand that the FSA is streamlining the process. 3. The application of modern integrated information technology is central to the implementation of a service-based bank and the lack of external providers such as Fiserv and Fidelity, is a serious barrier to new entrants. The formation of new entrants would encourage the development of this important support segment. . New banks rely on customers exercising their freedom of choice to switch banks. The account switching process in Britain is complicated and needs to be streamlined and improved. We would make the following suggestions to improve competition: 1. Account mobility: Members of your Committee suggested a standardized account mobility program similar to the mobile phone account mobility program. After discussing this with our management team we believe that this can be done and is a practical solution to providing customers more freedom of choice. We urge that this option be explored. 2. Deposit Insurance: The deposit insurance scheme is not well understood in Britain. It does not have the same degree of customer confidence as the Federal Deposit Insurance Corporation (“FDIC”) in America. The FDIC requires its banks to display words to the effect: “All deposits are insured by the FDIC.” On inquiry, the UK deposit insurance scheme, the Financial Compensation Scheme (“FSCS”), does not require such advertising and in fact, the FSCS advises we are not allowed to make such a deposit insurance statement. A change in this area would encourage competition. 3. Small and Medium Enterprises (“SME”): This segment is the most under-served portion of the British banking society. I call to your attention the Enterprise Finance Guarantee scheme which provides limited loan guarantees to the SME segment. While worthy, this scheme is underfunded and severely restricted and we urge the government to consider an expansion of this scheme including: (a) allowing new banks to enter as lenders; (b) increasing the size of the loans subject to guarantee; and (c) removing the barriers to taking residential homes as collateral for loans. As you may know the Small Business Administration (“SBA”) lending guarantee program in America has been extremely successful. I have enclosed a brief paper, which discusses the two schemes. . Planning: The development of new retail sites is essential to new bank competition. While the existing banks are located in the premier retail areas, the existing planning permissions exclude banks from A1 locations, thus providing a location advantage to existing banks. Allowing banks (which currently require A2 consent) to use A1 locations would level the playing field. As to compensation, we believe that the granting of stock options encourages individual performance, focuses the team on the total performance of the bank while aligning staff and shareholder interests.
Annex Purpose — Comparison between US Small Business Administration (SBA) 7(a) Loan Scheme and UK Enterprise Finance Guarantee (EFG) Scheme and recommendation of action to take forward. — The SBA is a multi faceted independent agency of the U.S. Government, created to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation. Details of the 7(a) Loan scheme are attached in Appendix 2. Treasury Committee: Evidence Ev 249
— The EFG Scheme is managed by Capital for Enterprise Limited a wholly owned subsidiary of the UK Government managed by the Department for Business Innovation and Skills. Details of the EFG scheme are contained in Appendix 3.
Background — The EFG Scheme is a relatively new scheme introduced in January 200 to replace the previous Small Firms Loan Guarantee Scheme. — Metro Bank PLC have made approaches to Capital for Enterprise Ltd, to participate in the EFG Scheme, but been advised that it was closed to new entrants in July 200 . Further approaches have been made and our request is currently under consideration. — The Scheme is offered by lending institutions in the UK, but has not been extensively publicised by the government member lenders. — The current funding pot (£500 million) has been fully allocated to existing member lenders through to 31 March 2011 (the extension date for the scheme revised in December 200 pre budget report). At present there is no level of commitment beyond then. — By comparison a wide range of material is available on the US SBA 7 (a) Scheme, it is long established and the SBA is looking to expand the Scheme by increasing the maximum loan which may be part guaranteed to 5 million. — Whilst there are a number of similarities between the two schemes, the opportunity exists to bring the two schemes closer together in terms of content to help support small businesses.
Comparison
The table below and additional attachments (Appendices 1 and 2) provide details of both schemes and a comparison.
Product — Bank provides funding, government — Bank provides funding, government provides guarantee provides guarantee Eligibility — ualifying US Businesses up 28.5 — ualifying UK Businesses up to £25 Criteria million pa turnover (criteria varies million pa turnover. dependent on sector). Purpose — Established or new businesses — Established or new businesses — Purchase of land & buildings (for — Business expansion, includes own businesses own use), equipment premises purchase fixtures & fittings, supplies and materials — Long term working capital — Refinance existing loans where security reducing or cashflow not adequate to meet current payments — Refinance existing debt (if not — Conversion of overdraft to meet structured reasonably) working capital requirements. — Short term working capital — Guarantee to support additional invoice financing facilities — Purchase an existing business — Short term working capital (to support new increased overdraft). — Working Capital Maximum Loan — Maximum loan 2 million — Maximum loan £1 million Guarantee — Guarantee 85% for loans up to — Guarantee 75% 150,000, 75% loans 150,000 to 2 million Maximum term — 25 years for Real Estate purchase — 10 years construction refinance — 15 years for business acquisition, equipment, fixtures — 10 years for working capital Fees — 2 3.75% initial guarantee fee — 2% per annum on outstanding (dependent on amount of loan). guarantee balance — 0.55% per annum fee on outstanding — Bank arrangement fee subject to guarantee balance negotiation — No lender fee Ev 250 Treasury Committee: Evidence
Interest Rates — Variable rate loans subject to — Negotiable negotiation — Fixed rate loans maximum margin (over base rate) of 2.25% .75% depending on loan size and term. Collateral Security — Up to 85% Government Guarantee — Up to 75% Government Guarantee — No restriction on business personal — Personal main residence may not be assets which may be given as taken as security security Lenders — Most US Banks and financial — UK Banks and financial institutions institutions
The principal similarities between the two schemes are: — Both are designed to encourage lenders to support small businesses where the request for funding meets Bank criteria with the exception of the level of security available. — Both delegate the assessment process fully to the lenders who are members of the scheme. — Both have seen significant volumes of business: — SBA 7a Scheme in 200 guaranteed .2 billion to ,222 small businesses resulting in over 50,000 jobs being created retained. — Of the EFG Scheme budget allocation of £1.3 billion for 200 10 (ending 31 March 2010) a total of £1.30 billion to 11,6 8 small businesses has either been drawn or is in course, of which £ 31.1 million to ,127 businesses has been drawn to date. (No information provided on jobs created retained). A new fund allocation of £500 million has been made for the year to 31 March 2011.
The main difference is one of approach by the lenders governments to the two schemes: — The SBA 7a scheme: — Actively pushed by the participating lenders, has been running for a number of years and the government are looking to expand (proposal to increase loan maximum from 2 million to 5 million being considered). — Focuses on and readily provides information on successes such as jobs created. — Apart from the guarantee fees, the lenders are not allowed to charge additional arrangement fees. — The scheme is generally more flexible—longer terms, more flexibility around security, other guarantee schemes available with specific target markets. — The EFG scheme: — Established in 200 to replace the previous Small Firms Loan Guarantee Scheme, and funding is only approved by the government so far for a year at a time. The forthcoming election may well have an impact on the approach going forward. — Whilst the numbers are still significant, the scheme managers advise that the attitude of lenders varies, but certainly you have to look harder to find information on the scheme from the major lenders. Experience from working within some of these institutions is that the scheme is not pushed forward. — There is a restriction on other security taken to exclude the personal residence of guarantors business owners. — There is no certainty beyond the 31 March 2011, and the outcome of the forthcoming election in May is likely to impact, although it is likely that whatever the outcome, the new Government will want to be seen to be supporting Small Businesses.
Conclusion
Whilst the EFG Scheme is more closely aligned than it’s predecessor to the SBA 7(a) Scheme, an opportunity exists to help shape how the government and lenders approach providing support to small businesses going forward, and to bring it closer into line with the US scheme.
Metro Bank PLC are ideally placed because of their US experience to have an input into both shaping and pushing this going forward, and with the current scheme presently only extended through to March 2011, we believe now would be an ideal time to start this process. Treasury Committee: Evidence Ev 251
APPEND 1 EFG Scheme — Product: — Lending Bank other lending institution provides debt, Government provides partial guarantee to lender. — Eligibility Criteria: — ualifying UK Businesses up to £25 million pa turnover. — Most sectors—principal exclusions are Coal, Real Estate and Insurance. — Purpose: — The guarantee will cover the following types of lending: — New term loans (with terms of between three and 10 years). — Refinancing the existing term loans, where the loan is at risk due to deteriorating value of security or where for cashflow reasons the borrower is struggling to meet existing loan repayments. — Conversion of an existing overdraft into a term loan to meet working capital requirements. — Guarantee on invoice finance facilities to support an agreed additional advance on a SME's debtor book. This will supplement the invoice finance facility already in place. — Guarantee on new or increased overdraft borrowing for the SMEs experiencing short term cashflow difficulties. — The guarantee will fund: — working capital; and — investment by businesses seeking to grow or develop. — Maximum Loan Guarantee: — Loan amounts from £1,000 to £1 million. — EFG Scheme will guarantee 75% on all loans. — Maximum Term: — Up to 10 years. — Collateral Security: — 1st charge on assets funded. If less than 100% cover (on discounted basis) the lender will look to the guarantors personal assets, but cannot take a charge over guarantors principal residence. — Remuneration: — Interest rates: — Subject to negotiation between borrower and lender. — Fees: — 2% per annum guarantee fee based on the balance of the guarantee. — Loan arrangement fee is subject to negotiation between borrower and lender. — Supplier Lender: — UK Banks lending institutions.
APPEND 2 SBA 7(a) Scheme — Product: — Lending Bank other lending institution provides debt, SBA Government provides partial guarantee to lender. — Eligibility Criteria: — Designed to be as broad as possible: — Operate as a for-profit company. — Do business (or propose to) in the United States or its possessions. — Must meet SBA definitions of Small Business. A range of sector specific criteria: — 500 employees for most manufacturing and mining industries. — 100 employees for all wholesale trade industries. — 6 million for most retail and service industries. Ev 252 Treasury Committee: Evidence
— 28.5 million for most general & heavy construction industries. — 12 million for all special trade contractors. — 0.75 million for most agricultural industries. — Be an eligible type of business. While the vast majority of businesses are eligible for financial assistance from the SBA, some are not (including Real Estate Investment, Banking Finance Insurance, Gambling Speculation, anything illegal). — Plan to use proceeds for an approved purpose. Loan proceeds may be used to establish a new business or to assist in the operation, acquisition or expansion of an existing business. — Have reasonable owner equity to invest. — Use alternative financial resources, including personal assets, before seeking financial assistance. SBA does not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the financing. Both business and personal financial resources are reviewed as part of the eligibility criteria. If these resources are found to be excessive, the business will be required to use those resources in lieu of part or all of the requested loan proceeds. — Ability to repay the loan on time from the projected operating cash flow of the business. — Good character. SBA obtains a “Statement of Personal History” from the principals of each applicant firm to determine if they have historically shown the willingness and ability to pay their debts and whether they have abided by the laws of their community. — Management expertise and commitment necessary for success. — Feasible business plan. — Purpose: — Loan proceeds may be used to establish a new business or to assist in the operation, acquisition or expansion of an existing business. Eligible use of proceeds include (non-exclusive): — To purchase land or buildings, to cover new construction as well as expansion or conversion of existing facilities. — To acquire equipment, machinery, furniture, fixtures, supplies, or materials. — For long-term working capital, including the payment of accounts payable and or for the purchase of inventory. — To refinance existing business indebtedness that is not already structured with reasonable terms and conditions. — For short-term working capital needs, including seasonal financing, contract performance, construction financing, export production, and for financing against existing inventory and receivables under special conditions. — To purchase an existing business. — Ineligible Purposes: — To refinance existing debt where the lender is in a position to sustain a loss and SBA would take over that loss through refinancing. — To effect a partial change in business ownership or a change that would not benefit the business. — To permit the reimbursement of funds owed to any owner, including any equity injection or injection of capital for the businesses’ continuance until the loan supported by the SBA is disbursed. — To repay delinquent state or federal withholding taxes or other funds that should be held in trust or escrow. — Maximum Loan Guarantee: — Maximum Loan 2 million. — SBA can guarantee as much as 85% on loans of up to 150,000 and 75% on loans of more than 150,000. — Other guarantees ranging from 50% to 0% of the loan balance are reserved for sub-programs targeting specific borrowers (veterans or underserved markets: rural areas or areas of, high unemployment or poverty) or loan purposes (export finance). — There is currently a proposal under consideration to increase the loan size from 2 million to 5 million. — Maximum Term: — 25 years for purchase, construction or refinance of Real Estate. — 15 years for business acquisition, equipment and fixture purchase. Treasury Committee: Evidence Ev 253
— 10 years for working capital. — If for more than one purpose, the term is blended. — Collateral Security: — 1st charge on assets funded. If less than 100% cover (on discounted basis) the lender will look to the guarantors personal assets (guarantees from all owners of 20% of the business). — Remuneration: — Interest rates: — Variable rate loans (linked to base or LIBOR) subject to negotiation between borrower and lender. — Fixed rate loans subject to maximum margin (over base rate) between 2.25% and .75% depending on loan size and unexpired terms. — Fees: — 2 3.75% guarantee fee dependent on amount of loan. — 0.55% annual fee (calculated on the outstanding balance of the guaranteed portion of the loan). — No lender arrangement fee. — Supplier Lender: — Most US Banks and other lending institutions. an a 2
Letter from Hector Sants Chief Executive inancial Services Authority to the Chairman of the Committee
In the light of comments made on the FSA’s authorisation processes in the course of your Committee’s evidence session with Metro Bank on 13 December, I hope it will be helpful if I provide some further information. I of course also recall the Committee’s interest in this subject when my Chairman and I gave evidence on 23 November.
We welcome Metro Bank’s overall positive comments on our process and their recognition of the measures we have now introduced to improve our authorisations process.
The FSA has a statutory obligation to authorise firms within six months of receiving a completed application, and 12 months if it is incomplete. Our experience is that the vast majority of the applications we receive are incomplete. This led to an average authorisation time for deposit-taking authorisations received since 2005 of between seven and ten months, which is the figure I mentioned in my evidence. It was clear that firms were struggling to give us the information we needed at the outset of the application process. At the same time, as part of learning lessons from the financial crisis, we were in the process of raising our standards in terms of business model analysis and capital and liquidity.
Against this background we concluded that applicant firms needed further help, and that we needed to give them more guidance and be prepared to meet them on a regular basis to work through that process. Since Summer 200 we have therefore made a number of improvements to our authorisation process, including establishing a dedicated Banking team; implementing a banking application framework; and encouraging early engagement with firms who are considering applying for authorisation.
Metro Bank’s application process experienced many of the difficulties I have referred to. Vernon Hill said to the Committee that the FSA authorisation took just under 18 months. However, I should note that during this time they chose to withdraw their original incomplete application and submit their second application to US in July 200 . We processed this second application within seven and a half months. Since this application was also deemed incomplete on receipt, seven and a half months was within the statutory deadline.
In the hearing on 13 December, the Committee also raised the issue of firms having to commit resources before knowing whether they would receive authorisation. We recognised from our initial dealings with Metro Bank that this was an area that needed to be addressed. We now offer all new entrants who meet our criteria, if they should find it useful, notification that we are minded to authorise in advance of final approval of their application. This process is designed to give more security to the firm in question at a time when they need to obtain the final elements of capital or to finalise IT systems.
Finally, I would make one general point. As you know the FSA takes its accountability to Parliament very seriously, and we entirely reject, and indeed find offensive, any suggestion that we would lie to your Committee. 22 ece e 2 Ev 254 Treasury Committee: Evidence
Supplementary written evidence su mitted y the f ce of air radin Following my appearance at the Treasury Select Committee, I am writing to you to provide further details on two issues that were discussed at the session—payment systems and fraud.
Payment Systems By way of background, from 200 until early 2007 the OFT chaired the Payment Systems Task Force, made up of consumer, industry and government bodies, set up to tackle competition problems identified in the payments industry. For example, in 2006, the Task Force made a number of recommendations on improving the openness of both Bacs (the bankers’ automated clearing scheme for processing electronic transactions) and LINK (the UK ATM network) to stakeholders. One of the outcomes of the Task Force was the creation of the Payments Council, an umbrella body for the payments industry. The Task Force considered that one of the main duties of the Payments Council should be to ensure open access to the payment schemes under its remit. To ensure this, one of the three main objectives of the Payments Council was agreed to be “to ensure payment systems are open, accountable and transparent”. In March 200 , the OFT published a review into the operations of the Payments Council. In reviewing progress against that objective, no significant concerns over access to membership of individual payment systems emerged. As well as the development of the Payments Council, payment systems (or money transmission systems) in the UK are now subject to the Payment Services Regulations 200 (PSRs 200 ) that implement the EU’s Payment Services Directive into national legislation. These regulations require payment service providers to be authorised or registered by the FSA and to comply with certain rules about the provision of payment services. In addition, they aim to support competition among payment service providers, by stipulating that rules governing access to payment systems should be objective, proportionate and non-discriminatory, subject to certain exemptions. Under Part 8 of the PSRs 200 , the OFT has the power to take action to enforce a prohibition on restrictive rules on access to payment services not designated under the Financial Markets and Insolvency (Settlement Finality) Regulations 1 , such as the UK ATM network (LINK) and Visa and MasterCard credit and debit card systems. In addition, the OFT can, of course, investigate relevant potential competition issues related to these (and other) systems under the Competition Act 1 8 or Articles 101 and 102 of the Treaty on the Functioning of the European Union (TFEU) or consider them under its Enterprise Act 2002 powers. As part of our review on barriers to entry, expansion and exit in retail banking, we examined whether new entrants faced difficulties in gaining access to payment systems and if the costs are prohibitive. We found that new entrants have the choice of either becoming a direct member of payment schemes such as Sacs, CHAPS and Faster Payments, or accessing these schemes through an agency agreement with an existing member. The choice between these two options depends on the necessity of direct access, the relative costs and the eligibility criteria. Our review found that new entrants and smaller players typically enter into agency agreements with existing member banks to access automated payment systems such as Sacs, CHAPS and Faster Payments. The main reason for this is that they do not process sufficient numbers of payment transmissions to find it profitable to apply for direct membership of the schemes. Indirect access to payment systems is subject to the criteria set out by the clearing bank serving as agent. These relate to connectivity, their credit policy, rules and procedures laid down by the schemes and criteria set by regulators. We did not receive evidence from institutions holding agency agreements suggesting that the cost of these was prohibitive and hindered access to payment schemes, although the cost was reported to be higher for new services, such as Faster Payments, compared with older schemes. While not every member of payment schemes provides for agency arrangements for indirect members, there appear to be enough to allow an indirect member to compare competing offers. It is possible for indirect members to switch providers, albeit after incurring certain costs. However, it is worth noting that some respondents to our review did report that they had encountered difficulties in the past in finding a clearing member willing to act as their agent. It is worth noting in that context that the PSRs 200 , as described above, have clarified the authorisation and prudential regime for payment service providers that are not banks, building societies or e-money issuers (already authorised or certificated by the FSA), as well as the rules governing access to payment systems. These regulations have the potential to remove ambiguity surrounding the regulatory regime to which a payment service provider is subjected to, and may remove some of the difficulties faced by firms with unconventional business models being accepted as an indirect member of a scheme by one of its members. Overall, our review found that direct and indirect access to payment networks does not appear to raise insurmountable barriers to entry or expansion. Fraud Treasury Committee: Evidence Ev 255
You mentioned a concern that consumers may worry that switching provider may increase the likelihood of being subject to fraud. For example, there may be a fear that individual customer details are not securely transferred during the switching process, leading to the possibility of falling victim to identity theft. This risk of identity theft may be perceived to be higher across certain banking channels than others. For example, consumers may be reluctant to switch to online providers for fear of falling victim to internet scams. Similarly, if online providers still require potential customers to post identity documents, this may dissuade customers from switching. Indeed, as identified in our e-consumer protection study, there is a common perception that the internet is susceptible to fraud; with concerns over the security of financial details the most often cited reason for not buying goods and services online. However, this concern is often uncorrelated with the number of fraud cases occurring. For example, in 200 , reported internet fraud in the UK decreased by 15% from 2008, whilst internet transactions increased by 1 % during the same period. As part of our retail banking work we have explored the reasons why consumers are reluctant to switch. Our research has not identified the fear of fraud as a key factor—the most significant factor deterring switching was a fear that the process was too complicated and problems occurring that disrupt regular financial transactions. It is also worth noting that in our review on barriers to entry we found that many providers often take an overly risk averse approach in requesting documents to meet requirements sent out in the Money Laundering Regulations 2007 when there is scope for a wider range of documents to satisfy these requirements. For example, they often request original copies of identity documents, such as passports, when other documents may suffice. A wider approach to meeting these requirements might allay customer concerns about fraud if they are able to send less sensitive documents (that are less likely to facilitate fraud) or if identity can be reliably verified by other means that still meet regulatory requirements. Similarly, there may be value in providers publicising the redress mechanisms available to customers if they are subject to fraud as a result of the switching decision. It is also worth considering that the Data Protection Act already requires financial institutions to ensure that appropriate technical and organisational measures are taken against unauthorised or unlawful processing of personal data and against accidental loss, destruction or damage of such data. I hope that the Committee will find this useful and look forward to its findings. an a 2
Supplementary written evidence su mitted y the Co-operative inancial Services CORE CAPITAL FOR MUTUAL AND CO-OPERATIVE BANKS Thank you for the opportunity earlier today to explore our thoughts on competition and choice in the banking sector. During the hearing, you indicated that it would be helpful if I set out details of the issues faced by mutuals and co-operatives in the current changing regulatory landscape. Accordingly I set out our thoughts below.
Context If mutuals were not to have access to Core Tier 1 capital other than through retained earnings, the sector will be affected in three main areas: The boards of mutuals will not have the ability to manage and grow their balance sheets flexibly and, as a result, will be hampered in their ability to ensure that their members’ interests are best served and protected. Balance sheet growth will be constrained to the uneven (and currently very modest) rate at which organic capital can be generated from retained earnings, and this will have an unwelcome procyclical effect. (Nor can organic capital be generated overnight to respond to—for instance—sudden increases in capital requirements, or the step change effect of regulatory capital deductions which are increasingly taken against core capital). This means mutuals will be less able to maintain lending in a downturn, and will be less able to provide effective competition to banks. So the playing field will be far from level and competitive disadvantage will result from no access to external core capital. Reserves built up from retained earnings are expected to remain the predominant form of capital overall for mutual and co-operative deposit-takers in the UK, but from time to time some of them will need access to external capital for specific reasons. The sector will also be viewed as second tier as it has not been afforded equal treatment to financial institutions which are organised as joint-stock companies with the resulting negative connotations associated with such a view. This is inconsistent with HM Government’s commitment in its document e iti n: e e n ent which states: We i in et i e s s t ste i e sit in n n i se i es te t s n e te e etiti e n in in st The ratings agencies will also be forced to take a negative view on the sector compared with financial institutions organised as joint stock companies, as the ability of mutuals to create capital will have been restricted and will become more dependent on the economic cycle. This restriction will not only apply to Core Ev 256 Treasury Committee: Evidence
Tier 1 but will also affect the ability of the sector to issue contingent capital as there will not be a valid “go- to” instrument. This negative view could well translate into ratings downgrades across the sector as a whole which will have a knock-on effect on the ability of the sector to access the wholesale markets for funding. None of this is positive for financial stability in the UK.
Background The UK’s mutual sector has outlined a principles-based approach to modification of the core capital criteria proposed in Annex IV of the European Commission’s February 2010 consultation document on CRD . We argued that such modifications should not be based on existing national peculiarities or special pleadings, but on transparent, existing pan-European principles. The relevant principles are those already recognised in European law in the recitals to the Statute for the European Co-operative Society, namely limited interest on capital, open membership and disinterested distribution. Together with the Building Societies Association, we have worked with the European Association of Co-operative Banks, in order to press this case in pan- European terms. The final guidelines from the Committee of European Banking Supervisors (which since the beginning of the new year has become the European Banking Authority) on Article 57a (core capital) instruments and the accompanying feedback statement, were in fact most helpful in advancing the cause of mutuals and co- operatives. That said, CRD2 and CEBS guidelines unfortunately do not accommodate the legal structure of UK co-operatives in the modifications applicable to mutuals and cooperatives, and amendments are required. This structure and the related issues are described in detail below on cate in c - e ati es It is also important to ensure that the CRD drafting is both sufficiently explicit on these matters—as the CEBS guidelines were—so as to avoid what we call “interpretation risk” and also does not introduce any other provisions that are damaging to mutuals’ and co-operatives’ ability to raise core capital. Indeed CRD should seek to create parity between mutuals, co-operatives and other banking entities. On a positive note the Treasury has recently proposed the following wording for inclusion in CRD . We welcome the Minister’s support for this so far, and encourage the Minister to give this a high priority in UK negotiations at a European level. 58(1) “Common Equity Tier 1 capital instruments set out in paragraph 1a of Article 57a shall include any other instrument: (a) issued under the specific constitutional and legal structure of a mutual, cooperative society or similar institution; or (b) issued by a credit institution in which, and for so long as, a mutual, co-operative society or similar institution holds 100% of the ordinary shares; and which is deemed fully equivalent to an ordinary share in terms of its capital qualities regarding loss absorption, and does not possess features which could cause the condition of the credit institution to be weakened as a going concern during periods of market stress,” 58(2) “Instruments issued in accordance with Article 58(1) may be subject to a dividend cap provided that the primary purpose of the cap is to limit distributions to investors and protect the reserves of the credit institution. The credit institution may indicate to the market that where possible it intends to pay dividends at or below the level of the cap, provided that at all times the credit institution shall retain full discretion over the payment of dividends and shall exercise that discretion to stop or reduce dividend payments in order to protect reserves in accordance with the level of distributable items or to build up reserves where necessary to do so . The credit institution shall regularly review the cap and whether it is appropriate to use the cap as a level of intended dividend.”
Specific Policy Proposals (i) Cate in c - e ati es There remains a challenge for co-operatives. UK co-operatives are generally incorporated as industrial and provident societies and consequently cannot undertake banking business directly. In order to accommodate UK legal and regulatory requirements, in 1 71 what was previously the banking department of the Co-operative Wholesale Society had to be separately incorporated as the Cooperative Bank, a wholly-owned company subsidiary of an I&P society. That is why the BSA has consistently urged the Authorities to ensure that principles-based modifications for mutuals or co-operatives in CRD should apply to their respective groups, whether or not specific group entities are structured as companies, and this is clearly needed where the use of a company subsidiary is necessitated by national law or regulation. For a banking business which is a subsidiary of a UK co-operative, this means that the bank should be able to issue capped core tier one instruments to raise external capital without prejudice to its ability to make uncapped distributions to its I&P parent. Treasury Committee: Evidence Ev 257
The structure of a mutual group with a joint stock company as a subsidiary is also required under UK law specifically in the Building Societies (Funding) and Mutual Societies (Transfer) Act 2007 ( the “Butterfill Act”) which provides a framework for merger of one type of mutual with another type of mutual. It is a requirement of the Butterfill Act that any merger of two different mutuals must be effected by the transfer of the business of the transferring mutual to a subsidiary of the acquiring mutual, with membership rights conferred in the acquiring mutual itself. The acquiring mutual’s subsidiary must be a Companies Act company or a body corporate incorporated in another EEA state. Given that such a UK co-operative structure is prescribed by UK law, clearly it needs to have the ability to issue a core tier one capital instrument of a similar nature and with similar features to the instrument proposed for mutuals which are building societies. Indeed there seems no legal basis to draw a distinction between such a UK co-operative structure and building societies in respect of the issue of core tier one capital instruments since they adhere to the same mutual principles. To underline this point, that the subsidiary, although having the form of a joint-stock company, operates as a co-operative business, we draw attention to the feature, in the C Co-operative Bank structure, that the bank’s customers are entitled to membership of the top co-operative, and that anyway membership in the new holding mutual is a requirement for any kind of transfer under the Butterfill Act.
(ii) e i i it n ca s The CEBS guidelines fully accept the principle of capping distributions on the core capital instruments of mutuals or co-operatives, making the further, and helpful, link that these caps operate to protect the reserves from over-distribution, and are therefore prudentially desirable. The final guidelines have also taken the step that such a cap may be provided for eithe in national law in the constitutional documents (ie Rules or Articles) of the mutual or co-operative. There may however be potential ambiguity as to how this needs to be specified. In this context it is important to avoid being drawn too closely towards the current French model, where the Ministry of Finance determines the cap (ie the actual numerical percentage rate) twice a year and this applies to all French mutual or co-operative banks. Instead, we need to clarify that national law, or the Rules, needs to provide for there to be a cap, but that the actual percentage level of the cap should be left for the different issuers to decide. The desired outcome is (i) that different mutual or co-operative institutions can make their individual decisions on where to set a cap, (ii) this can be decided in the context of an actual issue (whereas enabling rule changes will have been made some time in advance) and (iii) if possible, setting different caps for different issues by the same institution should not be precluded.
(iii) nte etati n is There is a wider concern, deriving from the experience of the UK discussions on Mutual core tier 1 and CRD 2 CEBS, which we describe as “interpretation risk” that is, provisions which are initially taken to have a clear, explicit meaning may be subject to later interpretation, on a “purposive” basis, producing a result some way from the explicit meaning of the provisions (and connected perhaps to the separate agendas of the interpreting authority). In that context we note inter alia the potential future risk from binding rulings of the European Banking Authority in place of the persuasive but non-binding guidelines of CEBS. CRD drafting must therefore minimise any interpretation risk to mutuals and co-operatives. A particular instance of this concerns “pre-indication”. As we have argued recently, all securities, even ordinary shares, are sold with some pre-indication of expected return. In the case of an IPO of ordinary shares, this takes the form of a formal dividend forecast for the current or next accounting period, and a dividend policy: these cannot be contractual, but they must be made or given in good faith after due diligence, since they are intended to, and do, influence the behaviour of prospective investors. The current language in the CEBS guidelines (paragraphs 6 to 71) sensibly recognises that institutions (both proprietary and mutual co-operative) may disclose a dividend policy. But the term “pre-indication” is too vague and more clarity is required. I trust this addresses your request for further background information that you might raise with the Financial Secretary to HM Treasury at the next meeting of the Treasury Select Committee on 2 February 2011. ea2 Ev 258 Treasury Committee: Evidence
Supplementary written evidence su mitted y Lloyds Bankin Group Following our Treasury Select Committee appearance we agreed to write back to the Committee with additional information on a number of areas. I hope you will find this information helpful.
Market Share Data The Committee requested the following market share data: — Small and Medium sized Enterprise banking (defined as those firms with a turnover of between £0 to £15 million)—22% of the market in 2010, number two position in the market. — Retail Investment Products (including insurance, pensions, mutual funds and structured deposits)— around 11% in 2010, number one position in the market. This figure includes all retail investment products sold both in bank branches and by Independent Financial Advisers (IFAs).
Product Cross-holding The Committee requested the correlation between Personal Current Accounts (PCAs) and retail investment products. We have calculated that at the end of September 2010, % of our active Lloyds TSB PCA customers also hold an investment and or pension product with another Lloyds TSB brand (this includes Scottish Widows). Similarly, 8% of our active Halifax PCA customers hold an investment pension product with another Halifax brand. The figure is broadly similar for Bank of Scotland customers. These figures include customers who have acquired an investment product through an IFA as well as those who have bought it through one of our branches.
Account Portability We recognise the concerns expressed by the Office of Fair Trading and members of the Committee around the problems faced by some customers in switching account providers. At Lloyds we are taking steps to improve our systems and processes so that customers enjoy a better experience when they switch. We are also engaging at an industry level to consider how we can build upon existing industry systems and processes and drive behavioural change in direct debit originators. We believe the quickest and most efficient way to improve the switching process would be through the creation of an industry wide standard that would make switching seamless and deliver the error-free transfer of a PCA account within a short, defined period. It would ensure that when a customer switches service provider, all direct debits, standing orders and credits are made from and to the correct account. The system would be paid for by the industry and could be independently supervised by the Payments Council, which exists to ensure that UK payment systems and services meet the need of customers. We think that such a system could be operational within 2 months from reaching agreement on the solution and we estimate that once the system is fully operational, a customer’s transition to the new account would be guaranteed within two weeks, a timeframe which has been achieved in the Netherlands. In the short term, Lloyds would also support other changes such as the universal adoption by all banks of the automated switching tools that are available already. We have also considered a number of other options including full account portability, ie, the transfer of account number and sort code with a customer when they change financial services provider. While total account portability is possible it would take significantly longer to be operational and would be substantially more costly than the approach outlined above, while delivering essentially the same outcome for customers.
Profitability of Personal Current Accounts The most reliable data we can provide in relation to profitability is published in the annual and interim accounts. This looks at Retail Banking in its entirety and therefore includes the five markets of PCAs, Savings, Personal Loans, Credit Cards and Mortgages. The figure published in the 200 accounts was £1.382 billion Profit Before Tax from income of £ .77 billion. Income only is separated out for Consumer Banking (the subset of Retail Banking which includes PCAs, Personal Loans and Credit Cards) and was reported in the 200 accounts as £6.107 billion.
Halifax Current Account Charging Structure The Committee requested information on customer movement following changes to the Halifax and Bank of Scotland current account charging structure in December 200 . Treasury Committee: Evidence Ev 259
A small number of customers transferred to another provider while others chose to change their account behaviour. Due to the extremely confidential nature of such data it would be inappropriate for us to disclose the precise figures.
Remuneration e ne ati n hi s h Lloyds Banking Group is a retail and commercial bank, where typically our employees earn an average salary of around £25,000 per annum. The payout under the annual bonus schemes for 200 was a small percentage (low single digits) of overall revenues, as compared to the 30 0% of revenues you might have seen for some of our competitors. Remuneration philosophy for the Board, code staff and the Group as a whole is decided further to extensive consultation with our shareholders. Remuneration for 2 will be aligned with the FSA’s remuneration code and best practice. We have said that we believe deferral and c1awback are the way-forward, and we will continue to apply those principles. We will take into account changes in disclosure requirements as they are formalised and will reflect them in our Report & Accounts 2010.
i h ea ne s Taking into account my total package for 200 (including the annual bonus, which I chose to waive), the number of people who earned more than me is very small—in the single digits. As I mentioned at our evidence session these are specialist professionals whom it is impossible to attract without paying the market rate, which is clearly not determined by Lloyds. Of course, actual take-home pay will be based on performance against stringent targets that align reward with prudent risk management and will be subject to deferral and clawback if the performance for which the award was originally made is not found to be sustainable.
Education Allowance and Tax-planning As with all senior executive directors, the remuneration package can be made up of a number of bespoke benefits that are negotiated at the time of recruitment. Cash benefits at Lloyds Banking Group can include the flexible benefits plan ( % of base salary for all staff across the group), tax planning allowances, cash in lieu of a company car and education allowances. My education allowance ended in 2008 and is, therefore, no longer detailed in the Annual Report and Accounts. I trust this additional information is sufficient for the Committee but please let me know should you have further questions. an a 2
Supplementary written evidence su mitted y Santander This is Santander’s response to the Treasury Select Committee’s request (dated 18 January 2011) for supplementary evidence on the Santander Group’s subsidiaries structure.
About Santander’s Structure Santander UK plc (“Santander”) is part of the Santander Group as a wholly owned subsidiary of Banco Santander, a retail and commercial bank based in Spain with a presence in 10 main markets in Europe, North America and Latin America.
Grupo Santander
Santander Santander Santander Santander Santander Santander Sovereign Santander Banco Santander UK Brasil Chile México Rio Totta (US) Consumer (Argentina) (Portugal) Finance
(Germany, Poland)
The Group operates a geographic subsidiary structure, as opposed to a cross-border branch structure. This means the major operations in each market are effectively managed as separate businesses. Each subsidiary unit, such as Santander UK plc, has its own local Board and management team. Each unit manages its own capital and liquidity, with its own funding sources and managed as separate businesses, with clear arms length separation between subsidiaries and parent—in funding, capital and businesses—and operates with customers, Ev 260 Treasury Committee: Evidence
institutional players and investors based on its own credit rating and capital ratios. Broadly, this means that money raised in the UK is used to lend to businesses and individuals in the UK. At the same time, the Group applies corporate controls for all its subsidiary units which means that they share a common policy framework in areas such as risk management, internal audit and financial management. Subsidiaries share best practice and experiences in product development, not to mention a common IT operational framework and a common brand that is judged to be among the world’s best brands.
Benefits for the Group We believe this structure to be the best fit for our business model as a retail and commercial bank. In our experience, retail and commercial banking is a local business that requires proximity to the customer. Each local market has its own particular characteristics and we believe that as a bank you have to adapt to the local environment in order to thrive. Moreover, our experience is that customers demand this approach. Hence our structure provides Santander with the best means of competing in each market in which we operate. The structure also provides the right incentives for local management since they are fully accountable for the performance of their respective business area. We have our own Board in the UK that incorporates independent non-executive directors, our own local management team and operational sites around the country in places like Leicester, Liverpool, Glasgow and Belfast. The local management team is responsible for ensuring that risks are managed appropriately within their business area and that the unit is adequately capitalised and holds sufficient liquidity buffers in the event of a period of stress. The structure of the Group provides greater transparency to the market, allowing analysts, investors and shareholders to better understand our business and rate our performance. This is particularly the case where the subsidiary unit is itself partially listed and therefore subject to the disclosure requirements of the applicable stock exchange. As mentioned above, the sharing of resources (eg the IT operational framework) and the use of common policy frameworks within the Group help to drive cost efficiencies. Santander UK now has a cost-to-income ratio of around 0%, thereby making it the most efficient bank among its peers.
Benefits for Financial Stability The subsidiary structure has considerable benefits from a supervisory perspective. In “peace time”, the existence of locally managed legal entities facilitates the work of the local (“host”) supervisor—in our case, the FSA. At the same time there is also a second tier of supervision from the “home” supervisor—in our case, the Banco de Espa a (Bank of Spain). In crisis periods the existence of subsidiaries, plays a role in promoting financial stability. The subsidiary structure acts as a “firewall” or “firebreak” within the Group to reduce the risk of contagion and therefore to reduce the systemic risk posed by the institution. In the unlikely event that a subsidiary unit were to fail, then the structure ensures that there is much reduced complexity in the insolvency process, since it would be more straight-forward to disentangle the rights and liabilities in line with just the host country’s insolvency laws rather than via multiple (home and host) jurisdictions. Importantly, there is no legal guarantee in place between Santander UK plc and its parent, Banco Santander. If necessary, a subsidiary unit could be severed from the Group. Cutting off a subsidiary would certainly be unpleasant, but not deadly, especially when compared to the alternative of maintaining the problematic subsidiary which could see the overall Group suffering a prolonged period of instability and ultimately even failure itself. Banco Santander was one of the first major international banking groups to submit its “living will” (or Recovery & Resolution Plan) to its supervisor, the Bank of Spain; its ability to do so was at least in part due to the relatively straight-forward nature of its structure. One of the functions of the living will is to set out how the separation of a failing subsidiary could be achieved in practice, such as how shared global manufacturing units would continue to operate unaffected.
Caution about a “One Size Fits All” Approach We should stress that we are not seeking to advocate a “one size fits all” approach in which all internationally active financial institutions are required to operate a subsidiary structure. It may not be appropriate for all business models to operate along these lines. That said, we do believe that international regulatory authorities should recognise the positive contribution of the subsidiary structure to financial stability, and acknowledge it accordingly in the regulatory approach to systemic risk. For example, if the regulatory authorities pursue the idea of requiring systemically important financial institutions to hold an additional amount of capital (a capital surcharge), then we believe this should be risk sensitive. In other words, the capital surcharge should vary according to the precise risk that each institution poses to the financial system. In this way, institutions that take steps to reduce their systemic risk— for example by operating as subsidiaries, embedding a strong risk management culture and corporate governance policies—would face a lower capital surcharge. Institutions would therefore be incentivised to Treasury Committee: Evidence Ev 261
reduce the systemic risk they pose to the financial system, reducing the likelihood of their failure and the likelihood that taxpayers would be called upon to bail-out a failing institution. ea2
Supplementary written evidence su mitted y Barclays On Tuesday 11 January 2011, Bob Diamond and Antony Jenkins gave evidence to the Treasury Select Committee’s inquiry into Competition and Choice in Banking. At that hearing, the Committee asked for additional information in the following areas: — Corporation Tax paid in 200 ; — Barclays fiduciary responsibilities with respect to maximising tax efficiency; — Ratios of investment and retail banking employee variable remuneration; and — Account number portability.
Corporation Tax In 200 , Barclays paid over £2 billion to HM Revenue & Customs. Of this, £113 million constituted Corporation Tax, given Barclays (like other banks) had UK losses brought forward principally arising from credit write downs.
i cia es nsi i ities an ta e cienc Barclays takes its tax obligations very seriously and has agreed to the HM Revenue & Customs (HMRC) Code of Practice for Taxation of Banks (“the Code”). Barclays has confirmed to HMRC that it will have regard to the spirit of the law and the intent of Parliament in managing its tax affairs. The Code includes some of the key principles that Barclays applies to ensure proper compliance with the law. This includes respect for and transparency in dealing with HMRC in explaining its tax affairs. This is a practice Barclays has adopted for many years, and it has long maintained an open and transparent relationship with HMRC.
ei n inc ate entities As a global bank, Barclays has a significant number of foreign operations that are incorporated locally. It also uses foreign incorporated companies for securitisations, fiduciary services, and wealth fund management purposes. UK and foreign subsidiaries are reported as part of an Annual Return filed with UK Companies House, as required by the Companies Act 2006. The number of foreign incorporated entities disclosed in that Annual Return filed in October 2010 is in line with the figures referred to by Mr Umunna at the hearing on 11 January 2011. All foreign subsidiaries have been included in returns to HMRC either because they are UK tax resident and file UK tax returns or because they are listed on returns giving information on income earned that may be subject to UK tax under what is referred to as the controlled foreign company (CFC) legislation. Barclays Wealth, part of Barclays plc, has a number of subsidiaries incorporated in the Crown Dependencies, offering banking, investment management, fiduciary and brokerage services. The principal subsidiaries are long established major local employers. The total number of companies incorporated in the Crown Dependencies increased significantly as a result of Barclays 2007 acquisition of Walbrook, a competitor with fiduciary operations. The division has made efforts to reduce the number by liquidating a number of the acquired entities. The commercial relationship between Barclays UK companies and the Crown Dependency subsidiaries is governed by arms’ length transfer pricing arrangements. Barclays Wealth takes into consideration the terms of the Code and the requirements of the UK disclosure regime in dealing with its own and its client affairs. The division also ensures that it complies with all other fiscal disclosure requirements, including the European Savings Directive, the US ualified Intermediary reporting programme and, where required, specific disclosures of client information to HMRC. As regards Cayman Islands incorporated companies used by Barclays, the majority of these are managed and controlled in the UK and are therefore subject to tax in the UK. Income arising in a company that is non UK resident is subject to UK taxation under the UK CFC legislation unless the company fits within a specific exemption. The UK tax position in respect of the income earned in CFC’s is agreed with HMRC as part of Barclays tax filing obligations. There is an annual review process which looks at the number of legal entities and as part of that programme Barclays is committed to reducing a significant number of Cayman companies during 2011. Ev 262 Treasury Committee: Evidence
Ratios of Investment and Retail Banking Remuneration The Committee requested an approximate split of bonus pools between investment banking staff and other employees, recognising that the provision of an exact amount could be commercially sensitive for Barclays. The distribution varies over time in line with performance and between jurisdiction according to Barclays presence, business mix and extent of deferral. However, in the UK, the investment banking share of the bonus pool ranges from 60 70%.
Account Number Portability Committee members were keen to explore whether portable account numbers would aid the switching process for customers and thus increase switching levels, in turn facilitating greater competition in the sector. Barclays is pleased to provide the Committee with some additional information on this issue as requested. It is worth noting that whilst absolute switching levels do appear low, at around 6%, these numbers represent only part of the picture. Many consumers “try before they buy” and so run current accounts in parallel and manage the switching of direct debits and other regular payments over time. Since there is no cost to the customer of holding a current account with a zero or credit balance, there is no incentive for customers to close old accounts when they open a new one. Switching numbers cannot, therefore, be relied upon to paint an accurate level of current account switching. It is also worth noting that many customers multi-bank permanently. Research shows, for instance, that customers in the UK hold more than one bank account (2. on average). Another explanation for apparent low switching levels is the high level of customer satisfaction with their existing bank account provider. In October 2010, an independent survey identified that 1% of Barclays customers were satisfied, with only % dissatisfied. On the question of whether portable account numbers would make switching easier, Barclays considers that the financial and convenience cost of the necessary systems changes would be prohibitive and far outweigh any incremental benefit which might or might not result from higher levels of switching. It is worth noting that the Office of Fair Trading (OFT) has examined the issue of account number portability and concluded that the cost of introducing portability would not warrant the assumed benefits. In addition, in 2002 the then Monopolies and Mergers Commission (MMC) looked at switching as part of its inquiry into small and medium sized banking and concluded: “2.52 : We also mentioned...the possibility of introducing portable account numbers. Having discussed this with the parties, we believe it likely that this would require major investment and significant changes to the operation of the current clearing systems. As the inconvenience of changing account numbers is only one of many constraints on switching, the costs of such a development are very likely to exceed the benefits.” Some have drawn comparisons between the concept of portable account numbers and the mobile phone industry and argued that since mobile phone numbers can be switched between providers the technology exists and could be applied to bank accounts. However, comparisons between bank account portability and switching mobile phone providers are misleading and irrelevant as the payment systems infrastructure is much more complex than simple mobile voice or short message service (SMS) data. Implementing account number portability would require an overhaul of every payment system (CHAPS, FPS, BACS, Link, cheques) together with all banks having to change their accounting systems and delivery channels. Debit cards would also need to be reissued to all customers unless a change to the international standards for BINs (the first six digits of the card number) was possible. So the implications would reach beyond the UK. No estimate has been made of the likely costs (and to make an estimate would in itself be a costly exercise), however, they are expected to be very significant. One recent calculation that might serve as a useful comparator is an estimate of the industry’s cost of completely rebuilding the cheque clearing process. This was in the region of £700 million. The introduction of account number portability would at least require a re-build along similar lines and an overhaul of every other payment system taking costs well into billions of pounds. Beyond the financial cost, which cannot be accurately quantified, consumers would be considerably inconvenienced. The systems changes necessary would mean changing every record of these numbers to a new portable number. Whilst this might be considered a one-off cost, the inconvenience to consumers and businesses (small and large alike) should not be underestimated. There is a further risk of instability and insecurity in the payment systems, leading to a loss of confidence and unquantifiable problems for consumers in carrying out their day to day transactions, of which there are millions in the UK every day.
ecent i e ents t s itchin Much has changed over the last few years to make switching easier. Bacs (Bacs Payments Schemes Ltd) and their members, including Barclays, introduced a manual switching service in 200 and this was automated Treasury Committee: Evidence Ev 263
in 2007. Bacs have since introduced further enhancements and information to assist consumers in switching their account providers. Indeed, the OFT has recently written to Bacs commending their improvement to the switching process. The OFT also commended Bacs and its members, as part of their investigation into Personal Current Accounts, on improvements they have made to switching. Barclays is currently reviewing and simplifying its current account opening processes to make it quicker, clearer and more convenient for customers. This work includes activity to understand what we can do to increase consumer understanding of and confidence in the switching process, as well as to make the process as simple as possible for customers. ea2
Supplementary written evidence su mitted y HM reasury 1. Background 1.1 This note follows the oral evidence provided to the Committee by the Financial Secretary to the Treasury on Wednesday 2 February 2011. 1.2 It provides additional background information on: — the relationship between HM Treasury and UK Financial Investments (UKFI); — divestments by the investee banks and the return of the investee banks to private ownership, and the framework for thinking about competition in this context; — further information on the Financial Services Compensation Scheme funding model; and — Confirmation of the current membership of the Banking Reform Committee. 1.3 The Treasury Committee has conducted an authoritative and wide-ranging inquiry. The Government hopes that this note will further inform the debate and looks forward to receiving the Committee’s final report.
2. Relationship Between UK Financial Investments and HM Treasury
2.1 UKFI’s mandate is to develop and execute a strategy for disposing of the Government’s investments in financial institutions in an orderly and active way, within the context of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and to acting in a way that promotes competition. This overarching objective includes: — Maximising sustainable value for the taxpayer, taking account of risk, consistent with HM Treasury’s stated aim that it should not be a permanent investor in UK financial institutions; — Maintaining financial stability by having due regard to the impact of the transactions; and — Promoting competition in a way that is consistent with a UK financial services industry that operates to the benefit of consumers and respects the commercial decisions of the financial institutions. 2.2 The Framework Document agreed between HM Treasury and UKFI requires that UKFI manage the investments on a commercial basis and not intervene in the day-to-day management decisions of the investee banks, including with respect to individual lending or remuneration decisions. The nature of UKFI’s engagement with the investee banks is required to be proportionate to HM Treasury’s ownership interest. UKFI engages with the wholly-owned investee banks—Northern Rock Plc, Northern Rock Asset Management and Bradford & Bingley—in a manner similar to that in which a financial sponsor would engage with a wholly- owned portfolio company. UKFI engages actively with the listed investee banks—the Royal Bank of Scotland (RBS) and Lloyds Banking Group (LBG)—in accordance with the Financial Reporting Council’s Stewardship Code, to which UKFI is a signatory. 2.3 HM Treasury is determined that the investments in financial institutions do not prevent or distort effective competition, or contravene normal merger control or competition law restrictions. The Framework Document requires that UKFI: — Ensures there are no cross-directorships between the investee banks, in relation to the appointments in which UKFI has a specified role, as well as UKFI itself; — Puts in place robust barriers to ensure that commercial information relating to any investee bank is not exchanged with or leaked to any other investee bank; — Exercises its rights in relation to the investee banks individually if required to comply with merger control and competition law restrictions; — Does not manage the investments in a manner which may prevent, restrict or distort effective competition; and — Abides by the Code of Market Conduct and other rules and guidance laid down by the Financial Services Authority. Ev 264 Treasury Committee: Evidence
eas 2. UKFI is a company that is wholly owned by HM Treasury. The success of the relationship between HM Treasury and UKFI depends on the nature and quality of the relationship between the UKFI Board and Treasury Ministers and officials. In particular, overall responsibility for ensuring that the intentions set out in the Framework Document are carried out in practice lies ultimately with the Chairman of the UKFI Board and the Chancellor of the Exchequer. 2.5 UKFI’s Investment Mandate describes the extent to which decision-making requires the prior approval of HM Treasury. It states that UKFI must obtain HM Treasury’s approval before undertaking any disposal transaction. It also sets out that representatives of HM Treasury and the UKFI Board (or other UKFI representatives) should meet regularly to review the strategic options available for delivering UKFI’s objectives. These meetings take place on a quarterly basis and focus on UKFI consulting and engaging with HM Treasury on actions and decisions taken, or proposed to be taken. In addition to these meetings, UKFI is required to keep HM Treasury informed about the status of any disposal transactions, as well as UKFI and its advisers’ views on the design, development and execution of any transactions. 2.6 HM Treasury remains responsible for coordinating the Tripartite Authorities’ actions in relation to the investee banks. 2.7 HM Treasury also remains responsible for the Government’s overall policy stance on the financial services sector. This includes the commitment made by the Government to foster diversity and promote competition in the banking sector.
3. Divestments and the Return of the Investee Banks to Private Ownership i est ents the in estee an s 3.1 i est ents As a condition of EU State Aid approval for the aid they have received, RBS are required to execute a number of divestments including a UK retail divestment amounting to a 5% market share in the UK SME market along with 318 branches. 3.2 The terms of the State Aid agreement required that the buyer of the divestment must, in combination with the divestment business, have a UK SME market share of no more than 1 %. 3.3 On August 2010 RBS announced the sale of this divestment to Santander UK. Santander UK currently have a small presence in the UK SME market and the sale will serve to increase competition in that sector. Both banks continue to work closely to enable the separation and transfer of the business. Before the deal can close the FSA has to approve that an acquisition by Santander UK is consistent with financial stability. 3. i est ents As a condition of EU State Aid approval for the aid they have received, LBG are required to execute a UK retail divestment amounting to a .6% market share of the personal current accounts (PCA) market and at least 600 branches. 3.5 The terms of the State Aid agreement require that the buyer of the divestment must, in combination with the divestment business, have a UK PCA market share of no more than 1 %. 3.6 LBG are working on a longer timeframe than RBS to complete their divestment and are currently engaged in the complex process of identifying and separating the branches, customers and associated assets from the Group for eventual sale. LBG are required to approach potentially interested buyers no later than the 30 November 2011, and are required to complete the divestment by no later than the 30 November 2013.
et n the in estee an s t i ate ne shi 3.7 he et n the n c c t i ate ne shi UKFI is tasked to develop and execute a strategy for returning Northern Rock Plc to the private sector. There is no presumption at this stage that any particular option will be pursued and the sale process has not yet been formally initiated. Northern Rock Plc is a savings and mortgage bank (distinct from Northern Rock Asset Management) that holds and services all pre-existing customer savings accounts and some pre-existing mortgage accounts. 3.8 As of 30 June 2010, total assets of the company were £1 .8 billion, of which £11.2 billion were mortgages. Northern Rock Plc is authorised and regulated as a deposit taker by the Financial Services Authority. The Government injected £1. billion of equity to capitalise the bank at inception. As a result of the restructuring, there are a number of state aid measures Northern Rock Plc has to adhere to, such as limiting new lending volumes to £ billion in 200 , £ billion in 2010 and £8 billion in 2011, 2012 and 2013 (for 2012 and 2013 the cap only applies if Northern Rock remains under HM Government ownership). 3. is sa sha es in an As outlined above, UKFI’s remit is to devise and execute a strategy for disposing of the Government’s investments in an orderly and active way in line with its overarching objective to create and protect value for the taxpayer, paying due regard to financial stability and competition. 3.10 UKFI will look at a full range of alternatives for the transactions they are responsible for, and will make decisions based on market conditions and investor demand at the time when a transaction is considered. Because any decision needs to be taken in the context of changing economic and market conditions, UKFI do Treasury Committee: Evidence Ev 265
not think that it is possible or desirable to state hard goals (such as price or timetable) that would drive the sale of HM Government’s shareholdings. Circumstances under which UKFI are likely to be able to sell shares will be those in which the economy and investor confidence is recovering and in which bank share prices are stable. 3.11 Given the size of the holdings, UKFI expect to undertake several capital market transactions in each bank’s shares and expect that these transactions will take place over a sustained period. This has several implications for the conduct of the sale programme. In particular, UKFI have said that they would expect to deliver better pricing for the taxpayer over the course of the disposal programme if they are able to earn investor confidence. Conversely if they are seen to act opportunistically or unreasonably in general or in any given transaction, then UKFI consider that they could face resistance from buyers in the future, resulting in investors seeking a “risk premium” for participating in a UKFI transaction.
e nance 3.12 i est ents an Subject to complying with the terms of the State Aid agreement with the European Commission, the sales are being managed and led by each bank’s independent management team with a view to maximising shareholder value (including that of HM Government). 3.13 In accordance with State Aid requirements, and with the Commission’s approval, LBG have appointed Mazars LLP as monitoring trustee with the overall task of monitoring and ensuring, under the Commission’s instruction, compliance with the State Aid requirements. Likewise, RBS have appointed Grant Thornton as monitoring trustee to monitor and ensure their compliance with the State Aid requirements. The UK authorities have also committed to submit regular reports on the measures taken to comply with the State Aid requirements. 3.1 is sa the n c c an e n ent sha eh in s in an When UKFI believe the conditions for a potential disposal are right, they will make a recommendation to the Chancellor of the Exchequer in line with the UKFI Investment Mandate. This necessarily requires them to consider the Exchequer impact, financial stability and competition aspects of their recommendation. 3.15 The Investment Mandate agreed between UKFI and the Treasury requires UKFI to seek the Treasury’s views in relation to disposal transactions before entering into any substantive engagement with the investee banks.
C etiti n a e in this c nte t 3.16. The UKFI Framework Document makes clear that any disposal recommendations put to HM Treasury must have due regard to competition. Without prejudice to any future recommendations that UKFI may make, the factors that HM Treasury would expect to be considered as part of a competition assessment include: — he e ecte i act n the st ct e the an in a et This may include consideration of the market shares of different institutions before and after the transaction in question, as measured by numbers of accounts or volumes of activity. The expected impact may be different for different product segments (such as mortgages or savings products). — he e ecte i act n an c st e s This may include consideration of a range of factors relating to outcomes for bank customers. The expected impact may be different for different customer groups and or regions within the UK. 3.17 HM Treasury expect that the analysis would consider both the short-run (static) and long-run (dynamic) changes the transaction may precipitate. For example: — Short-run changes may include the transfer of customer accounts between financial services providers, or any immediate changes in the scale and reach of branch networks at the affected institutions. — Long-run changes may include transformational changes in the market that flow from the behaviour or business strategy of one or more affected institutions. Some long-run benefits may accrue to bank customers generally even if they are not directly affected by the transaction being assessed (by virtue of the impact on overall competition in the marketplace). 3.18 Necessarily the analysis will incorporate both quantitative and qualitative work. HM Treasury recognises that many of the issues are inherently uncertain and that a significant degree of informed judgment will be required in any assessment. 3.1 The detail of any assessment that may be made will depend in large part on the specifics of the particular transaction in question. HM Treasury notes that there need not be an assumption that competition and value benefits will need to be traded off against one another. It is both conceivable and desirable that one or more options may deliver good outcomes against both criteria. 3.20 Any recommendation made by UKFI must also comply with UK and European competition law, including normal merger control and anti-trust rules. Ev 266 Treasury Committee: Evidence
ina ecisi ns n is sa s
3.21 The UKFI mandate was constructed to reflect the key factors that will drive the Government’s decisions about the investee banks. Good outcomes for the Exchequer, financial stability and competition are all clearly in the public interest.
3.22 As described above, the Chancellor of the Exchequer retains ultimate responsibility for the disposal decisions required to return the investee banks to private ownership. HM Treasury believes that this delivers the right outcome in terms of final accountability for the public’s stakes in the banks.
. The Financial Services Compensation Scheme (FSCS) Funding Model Review
.1 The funding model for FSCS compensation payments has operated since 1 April 2008. It comprises five broad classes: deposits; life and pensions; general insurance; investments; and home finance. All of these (except the deposits class) are further divided into provision and intermediary sub-classes. Each sub-class has an annual limit as to the amount it can be asked to contribute to compensation costs. Once this limit is reached, any further levy requirements are met by the parent class, and then by other classes as necessary.
.2 Deposit taker and investment intermediary defaults over the past two years have generated pressure for the FSA to review this model. This pressure, combined with amendments to the existing European compensation related directives (the Deposit Guarantee Scheme Directive, the Investor Compensations Schemes Directive and the potential Insurance Guarantee Scheme Directive) resulted in an FSA commitment in 200 to a fresh review of the FSCS funding model.
.3 This review is considering numerous issues relating to FSCS funding including class (and sub-class) composition and structure, the annual compensation thresholds for each class, the methodology for apportioning levies to individual firms, and the cross-subsidy between different classes.
. In October 2010 the FSA took the decision to delay proposals on the review. This is because European proposals, along with changes to the domestic regulatory architecture, may have consequences for the funding and structure of the FSCS. In particular, negotiations to agree a revised Deposit Guarantee Schemes Directive and Investor Compensation Schemes Directive are underway in the EU Council and Parliament. Both draft Directives include proposals to reform schemes’ funding arrangements. The revised Directives are expected to be agreed in summer or early autumn this year. With this in mind, the FSA believe it is not appropriate to consult on funding arrangements to the timetable originally planned. Once the debate on the European proposals is clearer the FSA will contact industry stakeholders with a revised timetable.
5. Membership of the Banking Reform Committee
5.1 The Banking Reform Committee (BRC) has the following membership: — Chancellor of the Exchequer (Chair) (The Rt Hon George Osborne MP). — Secretary of State for Business, Innovation and Skills (Deputy Chair) (The Rt Hon Dr Vincent Cable MP). — Lord Chancellor, Secretary of State for Justice (The Rt Hon Kenneth Clarke C MP). — Chief Secretary to the Treasury (The Rt Hon Danny Alexander MP). — Minister of State—Cabinet Office (The Rt Hon Oliver Letwin MP). — Financial Secretary to the Treasury (Mark Hoban MP). — Minister of State for Trade and Investment (Lord Green of Hurstpierpoint).
The Chief Secretary to the Treasury attends in his role providing Ministerial support to the Deputy Prime Minister in the Cabinet Office
5.2 The membership of Cabinet committees is in the public domain and is published on the Cabinet Office website at: http: www.cabinetoffice.gov.uk resource-library cabinet-committees-system-and-list-cabinet- committees
6. The Minister of State for Trade and Investment
6.1 The Department for Business will write to the Committee with respect to the questions raised by the Committee regarding Lord Green’s appointment to the BRC. ea2 Treasury Committee: Evidence Ev 267
Supplementary written evidence su mitted y Which Competition in Banking na th ise e a t cha es 1. Which? does not believe that the current voluntary, market driven initiatives to address concerns about unauthorised overdraft charges are delivering sufficient improvements for consumers. Nor do we think that sufficient improvements will be delivered without the Government taking legislative action. 2. As was highlighted by the Court of Appeal in the bank charges case, banks do not compete on the basis of their unauthorised overdraft charges. They compete on other features, such as the rate of interest when the account is in credit or the additional services (such as insurance products) available to consumers taking a current account at an all-inclusive or otherwise special rate. Even though there is now greater consumer awareness of both the existence and high cost of unauthorised overdraft charges, they are not at the forefront of consumers’ minds when opening a new current account (not least because the vast majority of consumers expect to run their account in credit). Accordingly, the incentives for market driven improvements are muted at best. 3. It is accepted that unauthorised overdraft charges are a significant income stream for banks, particularly in times of low interest rates (as is currently the case). Unless the banks can recoup this income from alternative sources, banks will have little incentive to reduce this income stream unless their hand is forced. Given the success of the “free-while-in-credit banking model” it will difficult for banks to start overtly charging their customers for current accounts, particularly to any significant degree. . These facts are borne out by the developments in the market since the Supreme Court handed down its decision last year. While banks are becoming more transparent about their unauthorised overdraft charges, the fees are still extremely high and, for some consumers, are now higher than prior to the Supreme Court decision as shown by our market analysis below. 5. For these reasons, we believe Government action is necessary. Legislative action should not be delayed further as with each day that passes more consumers are subjected to excessive overdraft charges.
What chan es a e e i e 6. The Supreme Court decision significantly clipped the wings of the OFT and other regulators. Prior to this decision, the regulators understood that the main contractual price was protected from any fairness assessment, but the general understanding was that other “prices” were not so protected. This was in keeping with the purpose of the Unfair Terms in Consumer Contracts Regulations 1 (UTCCRs) and the underlying EU directive, which was to protect consumers from unfair terms hidden in contractual small print, including charges or costs that may never arise and would not reasonably have been considered by the consumer prior to purchase. 7. The Supreme Court decision has created a loophole in the UTCCRs that was not intended by legislators; is not in the interests of the people the regulations were designed to protect (i.e. consumers) and has unforeseen consequences going far beyond unauthorised bank charges. The Government should therefore act to close this loophole as soon as possible. It is important to note that such a measure would not impose an additional regulatory burden on banks as, prior to the Supreme Court decision, everyone was operating on the basis that such a loophole did not exist (as evidenced by the fact banks were settling early claims and only sought to challenge the law once the significance of their oversight became apparent). 8. In closing the loophole, the Government has two main options: either introduce changes in relation to current accounts or financial services contracts only; or introduce changes for all consumer contracts. The latter option is one we prefer as the issues and principles apply equally to all consumer contracts, and it would seem somewhat strange that consumers are afforded more protection with the purchase of certain services compared to others. That said, we recognise the issue has arisen most significantly in relation to bank charges and that it may be desirable to address that first. If a narrower solution is favoured by Government then it should be introduced on the understanding this is the first step of a multi-stage process.
sa chan e ith es ect t st nancia se ices c nt acts . We believe the following simple amendment to the Unfair Terms in Consumer Contract Regulations 1 would close the loophole with respect to financial services (as was suggested in the Private Members Bill proposed by Lorely Burt MP:17 te e ati n inse t 2 a a a h 2 sha n t a t a c nt act the s e s na nancia se ices inc in a s ch c nt acts c ent in ce te e ati n 2 inse t a n s a as it is in ain inte i i e an a e the assess ent ai ness a te in a c nt act the s e s na nancia se ices sha n t e ate 17See http: services.parliament.uk bills 2010 11 financialservicesunfairtermsinconsumercontracts.html Ev 268 Treasury Committee: Evidence
t the e niti n the ain s ect atte the c nt act c t the a e ac the ain ice e ne ati n as a ainst the s se ices s ie in e chan e When assessin hethe a cha e is is n t a ain ice e ne ati n ithin the eanin a a a h acc nt sha e ta en a the e e ant ci c stances at the ti e the c nt act as c nc e inc in hethe the i siti n the cha e is c ntin ent n the nce tain e ents an hethe the cha e is i e t ha e een c nsi e e the c ns e i t c nc in the c nt act Whe e a te a c nt act the s e s na nancia se ices i es the cha in a c ns e an the ci c stances in hich that cha e can e i se a e n t ce tain t a ise in the te the c nt act then s ch ice e ne ati n sha n t a ithin the ain ice e ne ati n the ses this e ati n n an cee in s in hich e iance is ace n this e ati n a cha e sha e ass e n t t e the ain ice e ne ati n as a ainst the s se ices s ie in e chan e n ess the c nt a is e
sa chan e ith es ect t a c ns e c nt acts 10. Given the breadth of consumer contracts to which the UTCCRs apply, we believe a slightly different approach is appropriate for a wider solution. As a matter of principle, we do not believe the regulations should seek to dictate the pricing structures used by businesses. Rather, they should incentivise firms to trade fairly and in so doing encourage competition between firms on the merits of the product or service. However, simply incentivising firms to increase pricing transparency is not, in itself, sufficient. In some circumstances, this leads to information overload and causes consumers to “switch off” during the purchase. In others, the consumer will be aware of the charge but disregard it when assessing the bargain as they view that particular charge as unlikely to ever apply to them. 11. Accordingly, Which? considers a price should only be exempt from a fairness assessment if: — the circumstances in which that price may be levied will definitely arise during the course of the contract; or — it is the only price that could be payable by the consumer under the contract. providing that price is one — on which the business typically competes i.e. the headline advertised shop window price (as judged on the basis of the business’ marketing strategy and commercial practices); or — that is otherwise prominently provided in good time to consumers prior to conclusion of the contract. 12. We believe this objective test would be straightforward for firms to apply. The greater clarity will also increase consumer confidence in markets and enforcers’ ability to take effective action where necessary. Such an approach is similar to that introduced by the Australian Government.18 13. We consider it is appropriate for the scope of any exemption to be relatively narrow. A key policy objective from any amendment to the UTCCRs should be to ensure the regulators have, wherever the need arises, the ability to challenge unfair contract terms. It should also be remembered that where a price term falls outside the exemption, this only means that terms can be assessed for fairness—it does not mean that term is automatically unfair—and with our proposal, firms have the freedom to adopt price structures that suits their business needs, choosing whether to compete on a certain price term, or to subject that term to a potential assessment under the UTCCRs.
Unauthorised Overdraft Charges—Evidence Based on Market Analysis a 1 . Despite the changes introduced by a number of banks, unauthorised overdraft charges levied by a number of banks continue to be high, unfair and Which? believes disproportionate to the costs incurred by the banks. Total revenue from unauthorised overdraft charges was £2.52 billion in 200 , compared to £2.6 billion in 2006.1 15. Many banks have reduced charges for unpaid items and in some cases changed charging structures and levels resulting in lower charges for consumers who might exceed their overdraft limit by a small amount for a short period of time. However, in some cases these have been balanced by a move to daily charges which can result in higher charges for consumers who are unable to pay money into the account to move out of unauthorised overdraft. 16. Lloyds TSB presents its changes to overdraft charges from February 2011 as a significant cut. However, the maximum monthly fee which could be incurred is (at £85) only £5 less than the maximum monthly fee 18Trade Practices Amendment (Australian Consumer Law) Bill (No. 2) 2010, s26(2), to come into effect as the Competition and Consumer Law Act on 1 January 2011. 1 OFT data Treasury Committee: Evidence Ev 269
which could be incurred in 2006. The bank is able to superficially present it as a cut because of the significant increase it made to its unauthorised overdraft charges in September 2007. 17. Daily charges also reduce consumers’ ability to control their unauthorised overdraft charges as under previous models they were able to prevent charges from escalating by ceasing to make transactions on the account. These charging structures could be more likely to lead to a “snowball” effect with significant charges stretching low-income consumers’ budgets, and leading to further charges being imposed. 18. Some major banks covered below such as HSBC and Santander continue to levy high charges for rejected transactions. For example, a consumer who has a transaction with a value of £30 rejected will be charged £25 by Santander and £25 by HSBC. Other banks not covered in detail in this research also levy high charges for rejected transactions—Clydesdale and Yorkshire Banks charge £35, Bank of Ireland charges £21, First Trust Bank charges £35. 1 . None of the banks have put forward any information or facts to justify their charges or any information regarding the costs they incur when a customer uses their unauthorised overdraft or has a transaction rejected. 20. At the same time as banks have been making changes to their unauthorised overdraft charging structure the interest rate on authorised overdrafts is at the highest level since records began in 1 5. Two banks have also introduced fixed fees alongside or instead of interest charges resulting in significantly increased costs for consumers.
Total Revenue from Unauthorised Overdraft Charges 21. Despite the multitude of different changes, unauthorised overdraft charges continue to represent an important source of revenue for the banks. The OFT has found that overall revenue from these charges had only declined very slightly in the three years since the market study had been conducted.150 The total revenue from current accounts has increased from £8.3 billion in 2006 to £ billion in 200 . ea e en e na th ise e a t Cha es
2006 £2.6 billion 2007 £2. 8 billion 2008 £2.76 billion 200 £2.52 billion
Trends in Pricing of Authorised Overdrafts 22. Despite the falls in the Bank of England base rates, the interest rate charged on authorised overdraft is— at 1 .0 %—the highest since records began in 1 5.151 The spread between the overdraft interest rate and the Bank of England base rate is also significantly higher than in the period before the financial crisis. Two banks have introduced fixed charges alongside or instead of interest payments. For example, in December 200 , the Halifax brand of Lloyds Banking Group introduced an authorised overdraft policy of a minimum £1 per day fee for all of its current accounts. Ostensibly this is a simpler, more transparent overdraft policy. However, a consumer would need to have an overdraft of nearly £2,000 in order to pay less than the average authorised overdraft rate. The OFT’s 2008 market study estimated that, of those accounts in overdraft, no more than 10 per cent of accounts were over £1,000 and no more than 5% over £2000 in debit. This leaves 0 5% of consumers, that regularly use an overdraft, likely to be significantly worse off if paying £1 per day. For example the implied effective annual overdraft rate of £1 per day on a £250 overdraft is 1 6% APR. Lloyds TSB is introducing a £5 a month charge—known as a “Monthly overdraft usage fee” on top of charging interest on authorised overdrafts.152 From March 2011, Santander will move to charging £0.50 per day, with the maximum number of days per month on which this charge will be levied varying according to the type of account.
150 http: www.oft.gov.uk shared_oft reports financial_products OFT1275.pdf page 27 151 Source: Bank of England 152 http: www.lloydstsb.com media lloydstsb200 pdfs banking_charges_brochure.pdf Ev 270 Treasury Committee: Evidence
Authorised Overdrafts Bank of England base rate
25 Overdraft interest rate
Spread between overdraft rate and base rate 20
15
10 Interest rate (%)
5
0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Changes to Unauthorised Overdraft Structures
23. The following tables present the structures currently and previously used by a number of major banks. Charges for unauthorised overdrafts have been divided into three types: — nauthorised overdraft char es: Monthly or daily maintenance charges made by the bank once the consumer is in unauthorised overdraft. In some cases these are combined with additional charges for each item paid or transaction processed when the consumer is in their unauthorised overdraft. — nauthorised overdraft interest rate: The interest levied on the amount exceeding their overdraft limit. — npaid item re ected transaction char e: A charge paid by the consumer when the bank does not process their transaction.
Analysis of Overdraft Charging Structures of Individual Banks
s
2 . In 2007, Lloyds moved from charging a higher rate of interest on unauthorised overdrafts to charging the same rate of interest alongside a daily fee. They have announced that they will be reducing this daily fee from early 2010 and received some credit in the media for “cutting” their overdraft charges. However, the result has been that the maximum charge each month for unauthorised overdrafts is now £85, compared with £ 0 prior to 2007.153 Daily fees are now charged even if no additional transactions are made on the account. This gives consumers less scope to stop the additional charges escalating than under the arrangements which existed prior to 2007. Charges will also continue to escalate in subsequent months even if consumers do not make any additional transactions on the account. Whilst the interest rate has been reduced slightly, this only makes a very small difference to the total monthly amount paid by the consumer. For example, a consumer with an unauthorised overdraft of £250 for the whole month would save less than £2 a month from the reduced interest rate. cess e a t ee na th ise na th ise ea e a t ee e a t inte est ate et ne t ansacti n cha e
2006 £30 when the customer exceeded their 2 .8% APR £35 for each payment overdraft limit. An additional £30 would be rejected (max three per day) charged each day they made a payment which increased the customer’s overdraft. There was a maximum fee of £ 0 a month 153 http: www.lloydstsb.com media lloydstsb200 pdfs banking_charges_brochure.pdf Treasury Committee: Evidence Ev 271
cess e a t ee na th ise na th ise ea e a t ee e a t inte est ate et ne t ansacti n cha e
2007 Monthly fee of £15 Aligned with £20 for each payment Up to 10 daily fees depending on the authorised overdraft rejected (max three per day) amount outstanding: interest rate (10. % to Less than £25 to £6 1 .3% APR) £25 to £100 to £15 Over £100 to £20 The maximum monthly fee was £215 2010 Buffer zone of £10 introduced, below which Aligned with the rate £10 for each payment of no charges are payable. paid on authorised more than £10 rejected Monthly usage fee of £5 overdrafts (10. % to (max three per day) Up to 8 daily fees depending on the amount 1 .3% APR) outstanding: Less than £10 to £0 £10 to £25 to £5 Over £25 to £10 The maximum monthly fee is £85
aia 25. Halifax made a significant change to their unauthorised overdraft charging structure in December 200 .15 This moved from charging a monthly fee together with charges for each paid or unpaid transaction to charging a daily fee. The daily fee can be equivalent to a very high APR. For example if a customer has an unauthorised overdraft of £300 then a £5 daily fee is equivalent to 608% APR. The application of a daily fee also means that customers can do little to stop the charges escalating if they are unable to pay money into the account. Student accounts continue to be offered under the old charging structure of monthly fees and additional charges for paid and unpaid items. It is not clear why Halifax decided to exclude the Student account from these changes. 26. At the same time as introducing the daily charge for unauthorised overdrafts, Halifax also introduced a daily charge of £1 for authorised overdrafts. This was a substantial increase in the cost of authorised overdrafts compared to the previous arrangement of charging interest at around 1 %. For example a £1 a day charge on an authorised overdraft of £250 is equivalent to 1 6% APR. na th ise e a t na th ise ea cha e e a t inte est ate n ai ite ee
Prior to December 200 £28 per month (Maximum of 28.8% £35 for each payment £28 per month) rejected (max three per £35 for each paid item (up to day) a maximum of three per day) December 200 £5 per day (Maximum of No additional interest Not charged £155 per month) charged Student account155 £28 per month (Maximum of 2 .2% £10 for each payment £28 per month) rejected (max one per £20 for each paid item (max day) one per day)
27. RBS initially cut their overdraft charges in September 200 . In particular there were significant cuts to unpaid item fees. From February 2011 they will be introducing a daily charge for unauthorised overdrafts. This will result in an increase in charges for those consumers who are in their unauthorised overdraft for a significant proportion of the month. It will also reduce the ability of consumers to stop charges increasing by ceasing to make transactions using the account. RBS have also taken the opportunity to increase their unpaid item fee.
15 http: www.lloydsbankinggroup.com media pdfs halifax 02100 Halifax_daily_overdraft_charging_structure.pdf 155 http: www.halifax.co.uk bankaccounts rates-rewards-fees Ev 272 Treasury Committee: Evidence
na th ise e a t na th ise e a t ea cha e inte est ate n ai ite ee
Prior to September 200 Monthly maintenance 2 .8% £38 (max three per day) charge of £28 Paid item fee of £30 (Max £ 0 per month) Guaranteed card payment fee of £35 From September 200 Monthly maintenance 1 .8%1.8% £5foreach payment charge of £20 rejected (up to a Paid item fees of £15 (up maximum of 10 per to a maximum of £ 0 a month) month) From February 2011 Daily charge of £6 for No additional interest £6 for each payment each day an unauthorised charged rejected (up to a overdraft of over £6 maximum of 10 per exists (Maximum of £186 month) per month)
antan e
28. Santander introduced a graduated fee structure for paid and unpaid items in September 2007. They also increased the monthly charge from £20 to £25. In March 2011, Santander will be making further changes to their overdraft pricing structure. The maximum unpaid and paid item fee will be one of the highest at £25 and there are no restrictions on the number of unpaid paid item charges which can be incurred each day or month. They charge one of the highest unpaid item fees for basic bank accounts. Santander have abolished their previous graduated approach to paid and unpaid item charges meaning an increase in charges for consumers who only exceed their overdraft limit by a small amount. They have also introduced different unpaid item charges for different accounts meaning that, for example, customers with a basic bank account are charged a higher amount for unpaid transactions than a customer with a packaged account.
2 . They have also moved to a £5 daily fee for unauthorised overdrafts although they are capped at a maximum of 20 days a month for most types of current account and at 10 days a month for the packaged accounts where the consumer also pays a monthly fee.
30. The changes in March 2011 are alongside changes to the cost of authorised overdrafts. Santander has moved to charging £0.50 per day with a maximum number of daily charges in each month of between 10 and 20 depending on the type of account held. For premium packaged accounts it is typically a maximum of 10 days per month and 20 days for other normal types of current account. na th ise e a t na th ise e a t cha es inte est ate n ai ite ees
Prior to September 2007 Monthly fee of £20 Unknown £35 for each payment Paid item fee: £30 rejected September 2007 Monthly fee of £25 28.7% The higher Unpaid item fees vary by Paid item fees vary by the unauthorised overdraft the amount of the amount of the transaction interest rate is applied to transaction £0 to £ . : £5 the whole balance of the £0 to £ . : £5 £10 to £1 . : £15 overdraft including both £10 to £1 . : £15 £20 to £2 . : £25 authorised and £20 to £2 . : £25 £30 or more: £35 unauthorised amounts. £30 or more: £35 From March 2011 Preferred In Credit Rate £5 each day (capped at 20 Daily fees charged £25 for each unpaid Account, Premier Direct, days in each monthly instead of interest transaction Premier & Current statement period) Accounts, Preferred £25 for each Paid item Overdraft rate account Reward, Travel, Family, £5 each day (capped at 10 Daily fees charged £10 for each unpaid Premier 50 and Premier days each monthly instead of interest transaction 21 current accounts, statement period) Premium current account £5 for each paid item Basic bank account Unauthorised overdrafts Unauthorised overdrafts £25 for each unpaid not available not available transaction Treasury Committee: Evidence Ev 273
acas
31. In 2008, Barclays introduced a system known as “Personal Reserve” which charges £22 for each period of five consecutive working days or less during which customers utilise their “Personal Reserve”. Consumers are able to opt-out of having a personal reserve and in this case, Barclays will reject transactions which would take a consumer over their overdraft limit. na th ise e a t na th ise e a t cha es inte est ate n ai ite ee
Prior to August 2008 £30 per paid transaction (up 27.5% £35 per returned to 3 per month) transaction (one charge per day) From August 2008 £22 for each period of up to No additional interest £8 per unpaid item (Max five consecutive working charged five per day) days
C
32. We believe HSBC156 has not made any changes to its unpaid item charges in the last three years. It still has relatively high unpaid item fees for rejected transactions which exceed £25. na th ise e a t ea na th ise e a t cha es inte est ate n ai ite ees
Current Arrangement fee of £25 charged for each 17.%1.% Foreach returned overdraft request made (This includes transaction -Payment of: requests the customer makes to process a Less than £10: no charge payment which would result in them £10 to £25: £10 exceeding their current overdraft limit). Over £25: £25 Maximum of £150 per month Arrangement fees not charged for the first unauthorised overdraft request made every six months, where the unauthorised overdraft is less than £10 and the fee will not exceed the amount of the overdraft eg a total unauthorised overdraft of £15 will incur a charge of £15
ati n i e
33. Nationwide made changes to their charging structure in November 2010.157 They also introduced a facility for consumers to change the “reserve limit” or the amount above a consumer’s overdraft limit in which Nationwide will authorise transactions. Whilst this might give consumers more control it does not help them avoid charges since Nationwide charges the same amount—£15—for a paid item (a transaction it honours) as for an unpaid item (a transaction it rejects). Previously it did not impose a paid item fee other than for guaranteed cheques. This means that consumers who have transactions paid under the new structure will incur higher charges than under the old structure. na th ise e a t na th ise e a t cha es inte est ate n ai ite cha e
200 £20 maintenance charge per month 18. % £30 for each rejected £21.50 for guaranteed cheques paid transaction 2010 £20 maintenance charge per month 18. % £15 for each rejected £15 paid item fee transaction Maximum overdraft fees which can be incurred in one month is limited to £85
156 http: www.hsbc.co.uk 1 PA_1_5_S5 content uk pdfs en 0030_ _bankacctcards_trav_q1_new_web.pdf 157 http: www.nationwide.co.uk current_account overdraft-changes.htm Ev 274 Treasury Committee: Evidence
Supplementary written evidence su mitted y esco Bank As outlined in our written and oral evidence to the Treasury Select Committee’s inquiry into Competition and Choice in Banking, Tesco Bank remains concerned that access to information remains an advantage to large incumbent players. As a result of their evidence to the inquiry, we will discuss further with Callcredit to establish what can be done to create a more level playing field.
PEFC/16-33-622 Printed in the United Kingdom by The Stationery Office Limited 2011 008363 1 585