House of Commons Treasury Committee
Competition and choice in the banking sector
Written Evidence
Only those submissions written specifically for the Committee and accepted by the Committee as evidence for the inquiry Competition and choice in the banking sector are included.
Ordered to be published 16 September, 12, 19 and 26 October and 16 November 2010 List of written evidence
Page
1 Campaign for Community Banking Services 3, 8 2 Unite 9 3 David Johnston 14 4 Mr and Mrs Ralph 16 5 Ian Kerry 17 6 Consumer focus 18 7 Barclays 27 8 Virgin Money 32 9 Nationwide 41 10 Vocalink 51 11 Building Society Association 54 12 Kensington Mortgage Company 61 13 Intellect 65 14 Consumer Finance Education Body 77 15 Payments Council 82 16 Yorkshire Building Society 85 17 Paragon Group 92 18 Toynbee Hall 97 19 Association of British Credit Unions Ltd 101 20 Which? 108 21 Co-operative Financial Services 134 22 Tesco Bank 141 23 RBS Group Plc 146 24 Lloyds Banking Group 153 25 David T Llewellyn, Professor of Money and Banking, Loughborough University 162 26 Financial Services Authority 171 27 New Economics Foundation 184 28 Financial Services Consumer Panel 193 29 Which? 196 30 Competition Commission 202 3
Written evidence submitted by the Campaign for Community Banking Services (CCBS)
EXECUTIVE SUMMARY
Branch dependent individuals and small businesses in over 1000 urban and rural communities effectively have no choice of banking provider and as the banks and building societies continue to close branches this number is expected to increase because of the post crisis pressure on profits and further consolidation within the industry. New entrants face a big challenge in not having access to a national, neutral branch network.
Against a historic background of active resistance by the industry, the committee is urged to recommend the re-launch of an improved and re- priced inter bank agency service, a trial of neutral shared branching, recognition by the competition authorities of local markets as well as a national market for retail banking services and to press for a UK version of the US Community Reinvestment Act, inter alia, to protect delivery of banking services to local communities.
INTRODUCTION
The Campaign for Community Banking Services (CCBS) is a coalition of 22 national charities and membership organisations who share concerns about the decline in local access to, and choice in, banking services, in particular the closure of local bank branches: see attached statistics. We assist local communities in campaigning against closures and promote viable alternatives including neutral shared branching and inter bank agency arrangements.
CONCERNS
1. CCBS’ primary concern is with those communities, urban and rural, which lose all their bank branches - nearly 1000 have done so- and the adverse impact this has on community commercial sustainability.
2. However, for branch dependent bank customers, the 1050 communities with only one bank branch effectively have no choice of bank unless they are prepared to lose time and incur cost in banking elsewhere. The 500 communities with only two banks remaining offer limited competitive choice.
3. According to 2007 research by the Federation of Small Businesses, 60% of small businesses visit their bank branch at least once a week and 10% do so every day
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4. CCBS has been told by one of the major banks that SMEs account for over 30% of their counter traffic which would seem to reflect the need pattern identified above.
5. Although small businesses are the primary concern, similar limitations of choice apply to many vulnerable individuals, particularly those without convenient local access to free ATMs, cashback, on-line banking, post office access, etc. In that category would be numbers of the elderly, disabled people, those with mobility problems and full time carers.
BRANCH CLOSURES
1. The latest available national statistics on bank branch closures is contained in the CCBS annual BRANCH NETWORK REDUCTION REPORT. That for 2010 is attached and is also available on the CCBS website.
2. The situation is worsening as the dominant retail banks: RBS/NatWest, Barclays, Lloyds TSB and HSBC, who are responsible for 95% of bank presence in communities with only one or two banks, address their post crisis cost base in the light of growing use of technology by some sectors and seek to reduce costs by closing branches and/or reducing hours of availability.in communities perceived to have low sales opportunity.
3. As shown in the attached report, all four major banks have a history of closing branches. Currently the most active is HSBC which has closed 111 branches since 1 January 2009 and continues its attack on communities where it is the last bank or will leave another in that situation. NatWest has closed few recently but has reduced hours of opening (often a prelude to closure) in 80 communities over the same period. Lloyds formally abandoned in 2006 its pledge to remain open where ‘last bank’ and is currently closing the remining 265 Halifax agencies which are often in communities with little or no banking competition.
IMPLICATIONS OF FINANCIAL CRISIS/CONSOLIDATION
1. Britain’s banks and building societies had already experienced very considerable consolidation, compared to other countries, even before the recent crisis.
2. Having lost all its independent local and regional banks prior to 1970, the UK retail banking market is very dependent upon a few, largely multinational, names which make arbitrary decisions on branch closures and take little or no account of community opposition.
EXAMPLE
The 15000 population town of Shepshed, Leicestershire has lost its four retail banks, HSBC was the last to close in January 2007, but the local Shepshed 5
Building Society remains, regrettably unable to offer current or small business accounts.
Even this low level of provision, with no competition, is unlikely to be sustained as the smaller building societies are acquired by larger ones as a result of the crisis and experience shows such locations to be vulnerable to closure.
EXAMPLE
Lloyds closed the only bank branch in Ramsbury, Wiltshire in 2000 leaving only the Ramsbury Building Society, founded 1856, which later was acquired by the Portman Building Society which closed the Ramsbury branch in 2002 before it was itself acquired by Nationwide.
3. In 2005 the last of Britain’s regional banks, Yorkshire and Clydesdale, owned by National Australia Bank, closed 100 branches, 22% of its network,
4. Post crisis these trends are likely to continue.
5. The EU Competition Directorate having imposed branch sell-offs on government backed RBS and Lloyds, the prospect of this producing significant new competition looks extremely doubtful. However the acquisition of the 311 branch RBS network outside Scotland has the potential to give Santander sufficient critical mass in the small business market to make a difference but Santander’s network, even after incorporation of the RBS branches, will not significantly alter the competitive position in sole and dual bank communites. The c 250 Lloyds TSB branches in England to be sold have yet to be identified but will not comprise a viable network on their own
BARRIERS TO ENTRY
1. New entrants to the full service UK retail banking market face a considerable challenge, not least the still extensive branch networks of the established Big Four and the tradition of ‘free’ banking for personal current accounts.
2. A physical staffed presence ‘on the high street’ is still important to customers of the established banks and to potential customers of new entrants to the retail banking market. The reasons include:
• Secure convenience for deposit of cheques and cash, their acknowledgment and instant entry into the banking system • Convenience for withdrawing larger sums of cash in secure surroundings and specifying denominations, including change provision. • Convenient human point of contact for resolving problems with existing accounts, opening new ones and producing identity documentation. 6
• Convenient and private facility for discussion of financial product needs with the bank’s relationship managers and specialist advisers. • Reinforcement of confidence in an institution entrusted with one’s funds.
3. That the bank concerned should have, or have access to, a national network of branches is important to individuals and especially to SMEs in a society that is increasingly mobile. A presence convenient to employment and home, moving home or business location, changing job, travel for business or pleasure, adding business sites, acquiring additional or replacement businesses. These and similar events should not, of themselves, necessitate a change from an established banking relationship. 4. In view of its Bank of Ireland financial services partnership agreement the Post Office is not seen as a neutral network, has question marks over service delivery standards and in any event could not cope logistically with small business agency counter traffic on behalf of the major banks.
ISSUES REQUIRING ATTENTION
Inter Bank Agency Arrangements Facilitates use of a local bank’s counter by small business customers of other banks (established and new entrant), thus preserving competitive choice and helping to sustain existing branches and the communities they serve.
1. The absence of a convenient branch of the account holding bank, or an easily accessible agency arrangement with another bank on “fair, reasonable and non-discriminatory terms” (Competition Commission 14 March 2002), significantly reduces the SME opportunity for a new entrant bank or smaller bank seeking to expand. For branch dependent customers in communities with only one or two banks it also militates against customers switching accounts and relationships between the established Big Four.
2. An improved and promoted IBAA service could help in both the above circumstances. The banks’ failure to meet their commitment to improve the awareness and operation of IBAAs (14 March 2003) was confirmed by OFT research in 2007 which found only 25% awareness amongst those who might benefit. See attached chronology.
Neutral Shared Branching Basic counter and related services, to agreed operating standards, delivered by a third party provider(s) on behalf of participating banks through a variety of delivery channels – retail/social enterprise franchises, mobile vehicles, community banks and banking centres – as appropriate to each community and locality. The model, which uses existing common technology, can replace existing branches and make it cost -effective to establish an ‘open to all’ banking presence in new communities.
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3. A step further would be the introduction of neutral shared branching in secondary and tertiary locations, although it could be argued that transactional activity and cash handling has become a commodity service in the eyes of the banks in which case the CCBS model has the capability to be extended. . Regrettably the banks continue to oppose any proposals for experimentation of this model which has been academically validated in the UK as “operationally feasible and financially viable” and is successfully operated in a retail banking context in 45 US States Full details in ’Bank Closure Problems-One Solution Fits All’ available in the REPORTS section of the CCBS website www.communitybanking.org.uk
4. To aid competition further the UK should consider following the example of other European countries and recognise the existence of local markets for banking competition. As recently as 21 December 2007 the Competition Commission confirmed its view that in the UK retail banking is a national market.
EXAMPLE In 2006 the merger of Banca Intesa with SaoPaoloIMI in northern Italy resulted in the Italian competition authorities enforcing the sale of 193 Intesa branches (plus two savings bank subsidiaries) to preserve local competiton. The branches were acquired by Credit Agricole of France to enlarge its presence in Italy.130 branches of Banca Monte dei Paschi di Siena are currently being negotiated for sale to a foreign bank to satisfy anti trust concerns arising from its purchase of another northern bank, Antonveneta.
5. In the USA the Community Reinvestment Act imposes, inter alia, service obligations on licenced banks which lead to the retention of local bank branches; a poor CRA record can block bank mergers and acquisitions requiring State/Federal approval. The UK possesses no legislative teeth to ensure banks continue to service communities adequately.
6. It is of concern that Cabinet Office Minister Nick Hurd MP is reported (Regeneration & Renewal interview 12 July 2010) as having no plans to introduce CRA type legislation and CCBS urges government to reconsider this urgently as legislation of this type would provide a suitable vehicle to impose social obligations on banks.
August 2010
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Further written evidence submitted by the Campaign for Community Banking Services
Since the August evidence submitted by CCBS, and acknowledged by the Committee Secretariat on 25 August, details of further branch closures and announced closures by HSBC have been received.
For 2010, ie since the data submitted, a further 55 (following 75 in 2009) will be closed of which 20 are ‘last bank in town’ and a further 14 leave another bank in that situation.
Of the 780 remaining communities in England & Wales which have only one bank, HSBC has more than halved its share since 2003 to 9% leaving Barclays 29%, Lloyds 25%, NatWest 31%. The HSBC closures have not reduced the number of communities having only two banks although that bank necessarily now features less in the composition of the approx. 500 communities in that category.
The fear is that, without the network and competition protections referred to in our submission, other banks will follow the HSBC example in short order. The Issues Requiring Attention section of our submission assumes greater urgency in the light of this later information.
September 2010 9
Written Evidence submitted by Unite the Union
This response is submitted by Unite the Union. Unite is the UK’s largest trade union with 1.5 million members across the private and public sectors. The union’s members work in a range of industries including financial services, manufacturing, print, media, construction, transport, local government, education, health and not for profit sectors.
Unite is the largest trade union in the finance sector representing some 150,000 workers in all grades and all occupations, not only in the major English and Scottish banks, but also in investment banks, the Bank of England, insurance companies, building societies, finance houses and business services companies.
Executive Summary
Unite does not believe that the Coalition Government is doing enough to promote diversity in the sector;
Unite believes that takeover and mergers must be fully investigated by the Competition Commission to ensure that such business decisions are in the best interests of all stakeholders including consumers, shareholders and the workforce;
Unite would argue that companies operating in an increasingly regulated market should be more aware of their social obligation and give greater consideration to whether they are ‘socially useful’;
Unite believes that a re-evaluation of the banking business model which incorporates a moral and ethical dimension to the business is required;
Unite is calling for guarantees to be put in place in takeover situations which will protect the terms and conditions of the workforce including pensions and a commitment to no compulsory redundancies or site closures for a negotiated period.
Introduction
1. Unite welcomes the opportunity to respond to this inquiry and is keen to work with employers to ensure that the financial services sector remains competitive, profitable and sustainable with customers treated fairly and the workforce valued and rewarded appropriately.
2. Unite supports the Coalition Governments intentions to ‘promote mutuals and create a more competitive banking industry, increasing competition and encouraging diversity.’
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3. Unite stated in a previous submission1 that the UK needs a diverse finance sector, which includes retail banks, building societies, mutuals, cooperatives and credit unions, providing different products and services, relationships and experiences. A diverse finance sector is better placed to serve the needs of a diverse population including those who presently find accessing financial services difficult.
4. However, Unite does not believe that the Coalition Government is doing enough to promote diversity in the sector. Indeed it would appear that recent announcements within the sector show an increase in consolidation and amalgamation rather than diversification or increased competition.
5. All the evidence points to existing players in the market buying up other existing organisations which Unite would argue reduce choice and creates a homogenous banking sector. This is evident with Lloyds TSB taking over HBOS; Abbey, Alliance and Leicester, Bradford and Bingley and RBS branches bought by Santander Group and Nationwide adding Derby and Cheshire Building Societies to their portfolio.
6. Unite believes that takeover and mergers must be fully investigated by the Competition Commission to ensure that such business decisions are in the best interests of all stakeholders including consumers, shareholders and the workforce. Workers representatives and consumer groups should be consulted to ensure the interests of stakeholders are included in any consultation process prior to the final decision being made.
7. The Government has set up the Independent Commission on Banking2 to carry out a review on reforming banking and promoting competition and has set one of its objectives as:
Promoting competition in both retail and investment banking with a view to ensuring that the needs of banks’ customers and clients are efficiently served, and in particular considering the extent to which large banks gain competitive advantage from being perceived as too big to fail.
8. However, while Unite welcomes this review, the date given for reporting of September 2011 would appear to be too far in the future to influence the outcome of the sale of those banks that are wholly or part owned by the state as buyers are likely to become apparent before this date.
Sales versus services
9. While Unite welcomes increased competition which would bring opportunities for employment, we would not wish to see increased competition at any price;
1 Unite response to HM Treasury discussion paper on building society capital and related issues 2 http://www.hm-treasury.gov.uk/d/banking_commission_terms_of_reference.pdf 11
where customers and employees feel unfairly treated and unable to challenge the might of the large banks. Indeed Unite would argue that new entrants as well as existing companies operating in an increasingly regulated market should be more aware of their social obligation and give greater consideration to whether they are ‘socially useful’. 3
10. Unite has evidence of dysfunctional selling where products and services were sold to customers which were deemed inappropriate for their needs and the workforce then faced with the prospect of disciplinary action if they failed to reach targets on sales. This does not create an environment for delivering fair treatment to consumers or employees. 4
Business and banking
11. The UK needs a competitive banking sector which takes account of the needs of customers, including business customers, by providing the ability to access funding in order to grow and expand which is an important part of creating a sustainable and successful economy.
12. There are over 4.5 million small and medium sized businesses in the UK requiring banking services. However, it could be argued that not all businesses have been served well in recent times by the existing players in the market. A lack of access to affordable finance and a shortage of working capital, coupled with late payments, are making the situation difficult for many SMEs.
13. The Federation of Small Business Annual Survey 2009 found that “in the absence of fair lending from the banks and with only 13 per cent of members who have borrowed new finance in the last year seeing interest rates decrease (in line with the Bank of England base rate), businesses have resorted to using bank overdrafts (28%) and their own savings (24%) to stay afloat.” 5 The FSB is seeking to restore the trust that has been lost between small businesses and banks by ensuring banks ‘lend more finance more fairly’.
Encouraging diversity
14. The sector has much to do to re-engage consumers and despite the negative experiences many people have, they remained relatively loyal to their bank. The lack of transparency in the charging structures together with a perception of the difficulties associated with switching banks has meant that in 2009 only 1.2 million of the 60 million current account holders in the UK switched banks.6 This is despite the biggest financial crisis in modern times and the apparent disaffection many consumers had with their bank.
3 Adair Turner FSA Chairman described some of the work of banks as socially useless. 4 Unite survey on Sales versus Service 5 FSC-ICM Voice of Small Business Annual Survey 2009 6 Guardian 1st August 2010 12
15. In view of this, new players may find it difficult to penetrate the dominance of existing high street brands or will be required to provide a different banking experience that will capture the market.
16. Metro Bank has made an attempt to break in to the UK high street banking market by opening a branch in central London with a business model aimed at ‘service not price’ and calling on customers to ‘love your bank at last’. The branch opened on Sunday 1st August and it is too early to see whether the focus towards better customer service will entice consumers away from existing banks.
17. Unite will however pay close attention to Metro Bank as an employer as it may be that this approach will come at a price as the bank advertises the fact that it is opening longer and later than other banks which may impact on the workers employed at the bank. 7
Consolidation not diversification
18. The recent announcement that Santander is to buy 318 RBS branches appears to contradict EU rules on competition as well as the Coalition Governments own Coalition Agreement statement on encouraging diversity.
19. Santander has more bank branches than any other bank in the world 8 and through its purchase of other UK high street brands such as Abbey National, Alliance and Leicester and the savings arm of Bradford and Bingley, has captured a significant proportion of the banking market in the UK.
20. With Northern Rock likely to be sold off in the near future and LBG also being forced into selling off branches due to EU competition rules, Unite would wish to ensure any sale of Northern Rock, LTSB or Cheltenham and Gloucester branches are sold to a competitor which increases competition and choice in the market but also by provides the workforce with a degree of job security.
21. Unite is calling for guarantees to be put in place in takeover situations which will protect the terms and conditions of the workforce including pensions and a commitment to no compulsory redundancies or site closures for a negotiated period. These practices should be recognised as good corporate governance and provide employees with some degree of protection as significant stakeholders in a business. Those at the top of a company often have comfort in contractual protections in takeovers and the workforce should be able to have this level of protection also.
22. Unite has expanded on its views regarding the conduct of takeovers in its submission to the Takeover Panel Codes Committee and this can be viewed on the undernoted weblink. 9
7 Unite has written to Metro Bank on two occasions to set up a meeting however has not yet received a response. 8 About Santander www.santander.co.uk 9 Unite response to Takeover Panel consultation 13
23. Unite believes that a re-evaluation of the banking business model which incorporates a moral and ethical dimension to the business is required; one which regards good customer service as equal to good sales techniques; one which gives regard to fairness in employee relations as well as treating customers fairly. This should be a prerequisite in expanding competition and choice in the UK banking sector and should be enforced.
September 2010
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Written evidence submitted by David Johnston
Re: Lloyds Group and Santander conveyancing panels
I write to draw your attention to a concerted attempt by the above two banks to use their dominant market position to drive small conveyancing firms out of the mortgage market and therefore to restrict consumer choice; presumably for their own financial advantage. Given Lloyds in particular is 41% owned by the taxpayer, is this Government Policy?
I am a solicitor with 30 years post qualification experience. In 1984, I set up my own firm Clifford Johnson and Co in south Manchester. I no longer own the firm but continue to work fir it as a consultant. I believe that the firm has a good reputation and has served its clients well over the past 26 years.
In particular, over this time, I have carried out conveyancing mortgage work for the above two organisation. The firm has been on panels for both organisations for 26 years. I am not aware of any complaints or concerns from either organisation over this period.
I was therefore surprised to receive letters from both organisations recently removing the firm for which I work from their conveyancing panels with immediate effect on the grounds of “low volume” of work. The decision is being appealed but, if confirmed, will have a serious effect on the firm’s ability to carryout conveyancing business in the future and if other lenders follow a similar course may threaten the future viability of the firm itself. Lloyds also threaten to carry out a further cull in the not too distant future.
According to the Law Society, the rationale behind the decision is to reduce both organisations exposure to fraud and negligence. I would strongly questions this for two reasons. Firstly, I believe that small, tightly controlled, well run firms such as the form for which I work stand comparison with the large “conveyancing factories” on grounds of customer satisfaction; negligence; fraud prevention and complaints. Indeed, my personal experience of such large organisations over the years is that their services ranges from poor at best to appalling at worst. Such organisations pay large referral fees to, for example, mortgage brokers to get volume conveyancing business.
Secondly, I believe that the real reason for this decisions is to reshape the conveyancing market by driving out small providers to maximise the referral fee income which large conveyancing providers are prepared to pay for volume conveyancing business. This restricts consumer choice and, in my view, compromises the ability to provide truly independent advice. I have always been opposed to paying referral fees and I do not believe you can give properly independent advice if you receive them.
Lloyds action is particularly troubling as when they were created the then Government waived competition requirements to allow their creation do to the parlous state of HBOS. They now seek to use their dominant market position to reshape the conveyancing market to their long term financial advantage.
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They are also 41% owned by the taxpayer. Is there decision in line with Government policy to promote small businesses?
I am also concerned that these letters have appeared at roughly the same time. Is this coincidence? Or has there been collusion between these organisations to attempt to shape the conveyancing market to their advantage?
In short, I believe this development will be bad for consumers as it will restrict consumer choice; compromise consumers ability to receive truly independent advice, and coupled with the other threats faced, hasten the closure of small, locally based high street firms, thereby restricting access to legal services.
I would be most grateful if you would consider these concerns and respond appropriately. If you need any more information please do not hesitate to contact me.
August 2010
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Written Evidence submitted by Mr and Mrs Ralph
Review of Retail Banking Competition
We read that you are seeking comments from organisations and individuals regarding banking competition as part of the newly commissioned review. We further understand that in advance of that review, you support the break-up of partly owned banks such as Lloyds and RBS – we find this extremely disappointing.
Could we ask that you bear in mind the plight of several million small shareholders, including ourselves, who’ve lost a substantial part of their savings as a result of the Lloyds/HBOS merger. To enforce a demerger beyond that required by the EU would be devastating to share value. Lloyds did the previous government, and by implication, the present coalition, a huge favour by taking over HBOS at the height of the credit crisis. We believe it has managed the integration process well but it is surely not right to destroy value to its shareholders (including the taxpayer) by further government intervention beyond that required by the EU state and roles.
In our view, there is adequate competition on the High Street and the banks which survived the crisis without direct government assistance will, in any event, but stronger entities and therefore control the market. Lloyds and RBS are weakened and will need many years to recover, but further demands on them could well destroy them only for foreign banks to take over.
We would be grateful for these comments to be taken into account in your deliberations.
July 2010 17
Written evidence submitted by Ian Kerry
As with trying to work out which utility company is the cheapest, it is very complex to work out whether one bank is cheaper that the rest. And then once you have made a decision it is hugely complex to change banks. Opening new accounts (mainly I assume for terrorism and laundering on money issues) is very long winded. When I changed my business accounts from Abbey to Co-op 18 months ago, I regretted doing so on several occasions.
Could there be a set number of fees and charges that all banks had to produce so that the poor consumer could see at a glance how competitive each account/bank was? Mind you they seem to change the fees etc fairly often. Perhaps they should be allowed to anytime they want but hold them the same for a 24month period.
This probably has nothing to do with the enquiry but the situation of when you do an online transfer and get one digit wrong on the sort code. At the moment the bank KEEPS this money (even if the account doesn’t exist). They don’t return it (even though the name on the account and the account code differ). They don’t let you know that there has been an error. So after 5 months from me paying £10k corporation tax, thinking the govt has been paid, I receive a letter from HMRC saying why hasn’t it been paid? It seems one digit was wrong, the bank keeps the money, gets the interest, tells no-one, takes a further two months (and counting) to get the money back. AND ALL THIS IS LEGAL!!!!
I will put aside all my anger at the bonuses bankers are still receiving when the rest of the country are losing their jobs or suffering cutbacks. Either you guy’s can’t do anything about it or you find it acceptable, either way it makes the whole country angry!
September 2010 18
Written evidence submitted by Consumer Focus
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:
• Encouragement of new models (not just new entrants) and consumer oriented innovation, including retail only models, that both provide real choice and safety for consumers • Promoting 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 • Guaranteeing 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 • Enhancing 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. Assess the impact of the financial crisis on competition and choice in both retail and wholesale markets.
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 crucial1, 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
1 Antony Elliot, Financial Services for All, in Consumer Focus, Rethinking Financial Services, June 2010, 38. 19
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 Zopa. 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. Assess the impact of widespread consolidation among banks and mutuals. 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, and the prevailing model of hidden charges, as impediments to banking and choice.4 Without the encouragement of different models banking will become an exclusive service for the well-off.5
2 HM Treasury, Financial Inclusion Taskforce, Policis, Realising Banking Inclusion: the achievements and challenges May 2010 3 39 per cent 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. Personal current accounts in the UK 2008, 91. 4 Consumer Focus, On the Margins, Society’s most vulnerable people and banking exclusion, March 2010 and Opportunity Knocks, Providing alternative banking solutions for low-income consumers at the Post Office, January 2010. 5 Financial Services for All, Rethinking financial services, Consumer Focus, June 2010. 20
3. Examine the key barriers to entry inhibiting increased competition – including regulation. 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. 3.4 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 per cent, the highest in 10 years.8 The Faster Payments Service (FPS) is the first new payments service to be introduced in the
6 Competition in UK Banking, A Report to the Chancellor of the Exchequer, 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. 21
UK for 20 years9, 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. 3.9 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
9 http://www.chapsco.co.uk/faster_payments/ 10 Competition in UK Banking, A Report to the Chancellor of the Exchequer, Don Cruickshank, March 2000 11 OFT1071, Review of the operations of the Payments Council, March 2009, 25. 22
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.14 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).
4. Examine whether competition is inhibited by difficulties faced by customers in accessing information about products. 4.1 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 4.2 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
12 Consumer Focus, Opportunity Knocks, Providing Alternative Banking Solutions for low income consumers at the Post Office, January 2010, 9 and Keeping the Plates Spinning, 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/financial_services/inquiries/sec_2007_106.pdf 14 Recent figures from the British Retail Consortium estimate that the average credit card transaction costs retailers 34p, 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://bit.ly/cmiROL 15 Office of Fair Trading, Personal Current accounts in the UK, 2008, 90. 16 FSA, DP09/3, Mortgage Market Review, October 2009 17 FSA, PS 10/6, Distribution of retail investments: Delivering the RDR – feedback to CP09/18 and final rules, March 2010 23
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 and safe. 4.3 Consumers generally would welcome a set of basic and safe products that met their needs18. 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.19 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. Explore the Government and competition authorities' strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market. 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. 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
18 Consumer Focus, Opportunity Knocks, Providing alternative banking solutions for low-income consumers at the Post Office, January 2010 19 Ibid. 20 The Coalition: our programme for government, May 2010. 24
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 5.4 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 per cent for the last 10 years, whereas utilities such as energy and phones show switching rates well in excess of this, starting at 26 per cent. 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
21 Consumer Focus, Opportunity Knocks, Providing Alternative Banking Solutions for low income consumers at the Post Office, January 2010. 22 Office of Fair Trading, Personal Current Accounts in the UK, Unarranged overdrafts, March 2010 23 Consumer Focus, Upcoming research report 25
• 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. 5.9 Public monitoring, audit and review of the divestment process to ensure conditions are being met needs to be ensured.
6. Consider the relationship between competition and financial stability. 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.24 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. 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. Consider the impact of free-banking on effective competition. 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
24 See, EIRIS, What’s needed to mainstream green and ethical finance? November 2009 and Neville Richardson, How can the consumer gain a voice in reform of financial services? in Rethinking Financial Services, Consumer Focus, June 2010, 45. 25 Consumer Focus, On the margins, Society’s most vulnerable people and banking exclusion, March 2010, 26 Consumer Focus, Keeping the Plates Spinning, August 2010 26
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
September 2010
27 ISA Super complaint, http://www.consumerfocus.org.uk/campaigns/super-complaint-cash- isas 27
Written evidence submitted by 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.
4. 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 (e.g. 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 (e.g. 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 example of the Building Societies sector where it believes low net margins and a difficult macroeconomic environment 28
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.
9. Since the crisis began, Barclays Core Tier 1 capital ratio has more than doubled from 4.7% to 10%, and our liquidity buffer has increased from £19bn to £160bn. 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 (e.g. 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 (e.g. harmonised implementation of Basel 3 and CRD 4, 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 Cajas and Landesbanken 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 29
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).
14. 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.
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 1. 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
1 http://ec.europa.eu/competition/sectors/financial_services/inquiries/retail.html 30
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.
19. 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, will3: o 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 o 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 (e.g. 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 inquiries4 5. 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
2 http://www.oft.gov.uk/shared_oft/personal-current-accounts/oft1216.pdf 3 http://www.oft.gov.uk/news-and-updates/press/2009/122-09 4 http://www.competition-commission.org.uk/inquiries/subjects/banks.htm
5 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. 31
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-FX and FX-Moneycorp provide foreign exchange services.
24. 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 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 AXA SA’s UK risk and pension insurance businesses for a total consideration of £2.75bn. 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 2009, Barclays Capital has been involved in more than USD 260bn of equity underwriting and played a role in over USD 2,000bn of debt underwriting for public and private sector clients6. 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.
29. 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.
September 2010
6 Source: Dealogic
32
Written evidence submitted by Virgin Money
1. 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. Background and introduction
2.1 Virgin Money was established in 1995. 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 33
capabilities, to support our business expansion, we acquired a small bank, Church House Trust, in January.
2.4 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. Quantitative research from February 2010 shows that consumer 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
Market structure
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 90% of PCAs and over 90% 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.
34
3.4 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 3.14), 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.
Personal Current Accounts (PCAs)
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: 35
• 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.
Conclusion
3.9 We recommend that the TSC should acknowledge the need to bring fairness and transparency to current account bank charges.
Small Businesses (SMEs)
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”. 36
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
3.14 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.
Growth by a new entrant through acquisition
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: 37
• 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)
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.
3.19 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.
Regulation
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.
38
Commentary
3.24 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.
Government initiatives
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
3.29 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 39
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.
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
3.34 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. 40
4.0 Recommendations
4.1 Structural reforms Consider splitting large retail banks into smaller units as well as to splitting large banks between retail banking and investment banking. 4.2 Current accounts 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.
4.3 Regulation Remove any regulation which, however well-intended, is unfairly onerous for new entrants to retail banking and could therefore discourage new entrants.
4.4 New entrants 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.
4.5 Acquisitions 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.
September 2010 41
Written evidence submitted by Nationwide Building 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 £190 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.
42
Foreign-based operators remain strong competitors in the savings market but are unlikely to re-enter the mortgage market in the medium term.
I. Widespread consolidation has led to the mortgage, savings and current accounts markets being dominated by the largest high street banks
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 2009; 47% to 62% in savings; and 79% to 84% 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 2009, 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. In the short to medium term, greater competition in banking is more likely to come from existing participants than from new entrants
4. 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 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 43
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.
9. 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. Building societies provide much-needed diversity
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 44
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:
Inherently less risky with a long-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.
Trust – 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 stability – 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.
Member engagement – 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. There are a range of significant barriers to entry and expansion in banking
45
The regulatory response to the financial crisis must recognise the needs of the mutual business model, particularly with regard to its capital requirements
14. 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
46
19. The development of a strong brand is vital but is hugely costly and can only be 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 branch network remains necessary to achieving 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 margins in a highly competitive, mature market, where existing players are all seeking to attract the best customers, create a strong barrier 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 be 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, 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 considering greater transparency of financial products, a balance must be struck to avoid information overload, potentially increasing consumer inertia
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.
24. 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 47
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’ (i.e. 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? survey1 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. Foreign-based operators remain strong competitors in the savings market but are unlikely to re-enter the mortgage market in the medium term
29. 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
1 As referenced in: Which? Magazine, ‘No such thing as free banking’, September 2010. 48
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.
September 2010
Appendix 1: Market share, 2007 and 2009, of mortgages, savings and current accounts
Mortgages (% balances) Savings (% balances) Current Account (% accounts)
2007 2009 2007 2009 2007 2009
Top 5 55 68 Top 5 47 62 Top 5 79 84 Rest of market 45 32 Rest of market 53 38 Rest of market 21 16
LBG 8.8 29.0 LBG 6.5 21.1 LBG 19 30 Santander 9.6 13.4 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 9.3 HSBC 14 13 Barclays 5.9 7.4 Barclays 6.0 8.7 Santander 6 9 HBoS 20.3 a HBoS 16.1 a HBoS 14 a
Northern Rock 7.6 5.1 HSBC 6.0 70 Nationwide 6 7 HSBC 3.7 4.5 A&L 3.7 b CFS 2 2 A&L 3.7 b B&B 3.4 b Post Office 2 2 B&B 3.3 b Britannia BS 1.8 c Yorkshire Bank 2 2 Bank of Ireland 2.2 2.4 CFS 0.4 2.2 Clydesdale 1 1 Britannia BS 2.0 c ING 1.0 2.0 CFS 0.3 2.0 NAB (UK) 1.5 1.9 Yorkshire BS 1.3 1.3 Northern Rock 1.1 1.8 Coventry BS 1.0 1.2 Yorkshire BS 1.3 1.3 NAB (UK) 0.9 1.1 Coventry BS 1.0 1.2 Other building 3.0 2.3 Other building 6.3 4.2 societies societies a – part of LBG; b – part of Santander; c – part of CFS
49
Appendix 2: Cumulative asset share of top 15 banks/mutuals
100% 80% 2007 60% 2009 40%
Cumulative Share 20% 0% 2468101214 Rank Within Top 15
Appendix 3: The impact of consolidation
Change in Net Mortgage Balances, 2009
£40bn
£30bn
£20bn
£10bn
£0bn Other Societies
-£ 1 0 b n O ther Lenders
-£ 2 0 b n
-£ 3 0 b n
Change in Savings Balances, 2009
£25bn
£20bn
£15bn
£10bn
NS&I £5bn
Other Societies
£0bn Others
-£5bn
-£10bn
50
New Current Accounts, 2009
6m
5m
4m
3m
2m
Other Societies 1m
Others 0m
51
Written evidence submitted by VocaLink
Summary
• VocaLink processes automated payments in the UK, including all Direct Debits, Direct Credits and Faster Payments; this accounts for approximately half a billion payments a month. It also operates LINK, the world’s busiest ATM network of over 63,000 cash machines. • Bacs services (Direct Debits and Direct Credits) have been available for many years, work well and are readily accessible by market participants. • The UK Faster Payments Service has been available since 2008, delivering real innovation to consumers.
• We do not believe that access to systemically important payment systems represents a barrier to entry in the banking market • We believe the consumer inconvenience in switching banks has been largely removed by the ToDDaSO service, although there is potential for further innovation in this area • We believe that there is considerable scope for better delivery and further innovation in mobile payments offerings to consumers
1. VocaLink welcomes the opportunity to contribute a submission to the HM Treasury Committee’s Inquiry into competition and choice in the banking market.
2. VocaLink is a specialist provider of transaction services. We process automated payments in the UK including Bacs Direct Debits and Direct Credits, the method by which 95% of salaries and 98% of state benefits in the UK are paid. It is estimated that over 70% of household bills are paid by Direct Debit, and the total value of payments flowing through the Bacs system in 2009 was £3.8 trillion.
3. We provide the real-time central infrastructure for the UK Faster Payments Service – which enables payments, including state benefits, to be made between accounts within seconds. Our services operate in highly secure data centres on ‘never fail’ technology which ensures total reliability and availability, 24 hours a day.
4. The specific purpose of this submission is to demonstrate that access to payment systems does not, in our opinion, represent a significant barrier to entry in the banking market.
5. The Bacs service has been in existence since 1968, and in 2004 following the Cruickshank Report it was divided into a scheme company (Bacs Payment Schemes Limited) and an infrastructure company (originally called Voca, now VocaLink following the merger between Voca and LINK in 2007). The separation of scheme and infrastructure provides a level of separation between the customers and the 52
owners of the service. This model has been followed for the Faster Payments Service, launched in 2008, and has been widely copied in Europe and elsewhere. The Faster Payments scheme is managed by CHAPSCo and the infrastructure is provided by VocaLink.
6. The Bacs service (Credit Transfers and Direct Debits) has been running for over 40 years and its potential market is approaching saturation, although there are ongoing efforts by Bacs and the industry to encourage even higher levels of adoption of Direct Debits by consumers. The Faster Payments scheme was launched in May 2008 and banks are currently completing the migration of Standing Orders and remote banking transactions to this service away from Bacs. The Faster Payments Service has the potential to attract other types of payment, including lower-value CHAPS transactions and support new payment methods such as mobile payments and on-line payments (as an alternative to cards). There has been wide interest in the concept of Faster Payments from other countries seeking to learn from our experiences.
7. We do not perceive access to the Bacs and Faster Payments services as a barrier to entry or expansion in UK banking. The agency bank model works well for Bacs although it should be noted that after two years operation there are still no agency banks providing access to Faster Payments services directly. This may be due in part to the technical complexity of building or purchasing a gateway and then integrating this to the bank’s back office systems. We have recognised the demand for a managed service offering in this area and have developed a Faster Payments Managed Service to offer an easier channel for agency banks and other potential FPS users.
8. The provision of the ToDDaSO service (Transfer of Direct Debit and Standing Orders) has largely removed the customer inconvenience of cancelling Direct Debits and Standing Orders with one bank and then having to re-establish them at the new bank. This service has worked well for a number of years and has removed the major obstacle to account switching.
9. Further enhancement to ToDDaSO to provide linked electronic transfer of associated funds, the extension of the service to investment accounts such as ISAs and the migration of the service to real-time operation would significantly enhance the benefits to the consumer.
10. The near universal use of mobile phones and the sharp growth in availability of smart phones provides a compelling base for innovation in delivering mobile banking, and in particular mobile payments. The launch and widespread take-up of mobile banking services from major banks in the past two years shows that there is significant consumer demand for further innovation in delivering mobile payments. The key driver for future demand is likely to be the ability to clear funds between 53
accounts within a few seconds1, utilising existing services such as Faster Payments and LINK. We believe that there is a compelling case for industry collaboration to facilitate full account reach and widespread take up of such services. Mobile payments will deliver credible alternatives to cheque and cash usage, and allow consumers greater control of their finances.
September 2010
1 VocaLink consumer research August 2010; available on request 54
Written evidence submitted by the Building Societies Association
Executive Summary
• Mutual lenders and deposit takers benefit the operation of the banking sector by nature of their ownership structure, which delivers diversity, lower risk, competition, democracy, high levels of service and trust, and a long-term perspective to the market.
• Although mutuals have been affected by the financial crisis and recession, they have generally performed better than their plc competitors, and, in comparison, have drawn on very little support from the Government. However, current market conditions remain challenging for all financial firms, especially deposit takers.
• In response to the events of recent years, mutuals have adapted their operations significantly, both by innovating and by reaffirming their core strengths. These have included controlling costs, continued focus on high-quality lending funded from retail sources, exploring shared services and continuing to improve corporate governance. Some mutuals have merged to create stronger institutions that are better placed to deal with the current market conditions and to grow in the future.
• Regulatory changes should not discriminate against mutual institutions. It is essential that the Government ensure that amendments to the Capital Requirements Directive enable mutuals to raise external capital that is consistent with mutual ownership.
• The Government should consider restricting the activities of banks that it owns so that markets are not distorted. The long-term payback from remutualising Northern Rock also merits consideration.
• Substantial barriers to entry to banking exist. These include increasing regulatory requirements, networks of systems, branches and staff and, vitally, the need for trust.
• Further changes to the banking sector need to be carefully evaluated so as not to cause unintended consequences, such as excluding groups of customers from the market or reducing stability.
Introduction
1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK including all 49 UK building societies. Mutual lenders and deposit takers have total assets of over £365 billion and, together with their subsidiaries, hold residential mortgages of almost £235 billion, 19% of the total outstanding in the UK. They hold more than £245 billion of retail deposits, accounting for 21% of all such deposits in the UK. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.
2. This submission sets out the positive contribution that mutuals make to the banking sector in the UK in terms of competition and stability. Mutual lenders and deposit takers have not been immune to the financial crisis and recession of the last three years, and the effects of the financial crisis on mutuals are examined, and the sector’s responses to these challenges are set out. The Government’s role in banking is then addressed, before other aspects of the Committee’s inquiry are covered, including barriers to entry, free banking and competition from foreign banks. Mutuals’ contribution to the banking sector 55
3. There are a number of inter-related features of mutual financial service providers that enhance both competition and financial stability in the banking sector. These all follow from the organisations being owned by their customers.
4. Firstly, mutuals add to the diversity of the sector. While publicly quoted banks might be expected to try to maximise returns to shareholders, mutuals pursue alternative strategies that are a consequence of the customer being the primary stakeholder. In a speech in 2009, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, highlighted the increased homogeneity of business strategies in the run up to the crisis, which reduced the resilience of the system as a whole1. A strong mutual sector with different incentives to plcs can potentially reduce herd effects.
5. Mutuals also tend to take less risk than quoted banks. This is partly because it is difficult for mutuals to raise new capital (apart from via retained profits), but also because the majority of their members are savers, who are risk averse because they would not benefit from any upside, but could be subject to any downside from risky strategies. Mutuals have been less reliant on wholesale funding than plc banks, with more stable retail funds accounting for 70% or more of total funding. And the proportion of mortgage loans that is in arrears is typically much lower at mutuals than across the market as a whole.
6. Competition in banking and mortgage markets is enhanced by the presence of mutual lenders and deposit takers. As they do not have to pay dividends to shareholders, mutuals can offer more competitive rates of interest on savings and mortgages than can banks. For example, Moneyfacts found that 73% of consistently high-paying savings accounts were offered by building societies2. Mutuals therefore impose a competitive constraint on the pricing activities of their bank rivals.
7. Mutuals are accountable to their owners, their customers. Members of building societies can vote to appoint directors to the Board, so directing the strategy of the organisation. Furthermore, at mutuals customer feedback may command more direct attention than at quoted banks as it does not compete with the needs of external shareholders. Mutuals have made considerable improvements to their corporate governance in recent years, with greater disclosure of information (including the voluntary disclosure of directors’ remuneration, which on average is approved by over 90% of members who cast their vote), increased proportions of members voting at Annual General Meetings, and deeper and more consequential direct contact between members and directors3.
8. Research has consistently shown that mutually-owned financial firms deliver higher levels of satisfaction and trust than plc banks. Research conducted this year showed that mutuals outperformed plc banks across eleven aspects of customer service (see chart)4. This is because the interests of customers are paramount at mutuals, and not in conflict with those of shareholders, as is potentially the case at other banks. Staff at mutuals are aware that they are dealing with an owner of the business, so the customer relationship is quite different from that at plc banks.
1 ’Credit is Trust’ Haldane, A, Bank of England, http://www.bankofengland.co.uk/publications/speeches/2009/speech400.pdf 2 Moneyfacts press release, 19 January 2010 http://www.moneyfactsgroup.co.uk/press/pressreleases/displaypressrelease.asp?id=727 3 ‘Conversations with Members’, BSA, 2010: http://www.bsa.org.uk/docs/publications/conversations_with_members.pdf 4 ‘Customer service at mutuals is better than at banks’, BSA, 2010: http://www.bsa.org.uk/docs/consumerpdfs/customerservice.pdf 56
Source: GfK NOP survey of 1,968 adults, 11 - 16 March 2010
9. Finally, the economist John Kay has noted that “the special value of mutuality rests in its capacity to establish and maintain relational contract structures” which are well suited to the long-term nature of mortgage lending5. The trusted relationships necessary in mortgage and savings markets can only be built up over a protracted period. Mutuals are not subject to the same short-term pressures that might apply to banks that must maximise returns to shareholders.
The effects of the financial crisis on mutuals
10. Mutual lenders and deposit takers have obviously not been immune from the financial crisis and recession. At the height of the crisis, mutuals were the recipients of substantial deposit inflows from worried customers of banks. In the last year or so some of these deposits have since moved elsewhere as the banks (including those failed banks now supported by the taxpayer) have competed aggressively for retail funds due to the closure of wholesale markets and the need to roll-over many hundreds of billions of maturing wholesale funding over the next few years. Households are struggling to save, and the low interest rate environment causes them to seek higher returns from riskier investments. As a result deposits from households grew by just 2% in 2009. Mortgage lending has also fallen substantially across the market. In 2009 outstanding mortgage balances grew by just 1%. The low interest environment continues to put considerable pressure on profit margins at all retail banks, mutuals included. These pressures are added to by regulatory changes, including increased capital and liquidity requirements, and the levies of the Financial Services Compensation Scheme, which fall disproportionately on retail-funded mutuals.
11. However, mutuals have generally been less affected by the financial crisis than publicly quoted banks. The FSA has observed that “although building societies, like banks, have been weakened by adverse economic and financial market conditions, the extent of that weakening has to date been less than that experienced by the banks mainly because of the lower exposure to wholesale funding and complex financial instruments”6. It is noteworthy that of the former building societies that demutualised, none remains today as an independent entity.
5 Kay, J, 1991, ‘The economics of mutuality’ Annals of Public and Co-operative Economics, 62, 3 6 Specialist Sourcebook For Building Societies, FSA, http://www.fsa.gov.uk/pubs/cp/cp09_17.pdf 57
12. Although the Dunfermline Building Society did require resolution under the Banking Act, the sector overall has called on very little direct assistance from the authorities during the crisis7. Instead, the sector has addressed any problems that have arisen itself, including a number of mergers between mutuals (though not all of these have occurred out of distress). There remain 49 separate building societies, and the brands of many merged societies also continue to be present on high streets, and there are several mutual lenders and deposit takers, including the combined business of Co-operative Bank and Britannia. Consolidation has helped to ameliorate some of the immediate issues facing certain societies, resulting in stable and secure institutions, such that the mutual sector continues to provide meaningful diversity and competition in banking markets.
Responses by the mutual sector
13. Mutuals have responded in a number of ways to the challenges of the financial crisis. As has already been mentioned, several mergers have occurred and there will doubtless be other societies that decide to merge in the future, but this is by no means a certainty for all mutuals, and there are likely to be limits to the benefits from increased size and scope in financial service providers8. Very many building societies, small and large, have performed well over the last few, challenging, years.
14. This has been achieved by a number of approaches. Ongoing efforts to manage costs have intensified, with several societies taking difficult decisions to scale back activities in geographical or market segments that are not core to their operations. However, measures continue to be taken to ensure the high levels of service and trust that distinguish the mutual sector are preserved. Mutuals have reduced their use of wholesale funding, which peaked at 30% of funding, much lower than most banks. As stood them in generally good stead going into the crisis, mutual lenders are focussing on high quality assets and are pricing cautiously for risk.
15. Mutuals are also exploring ways to work together to share services or to develop methods of pooled funding. Steps to improve corporate governance at mutuals continue to be made, with a working group chaired by the Financial Reporting Council investigating this issue. The BSA has also helped to share ideas and best practice in engaging members effectively.
The role of Government
16. The Coalition stated in its Programme for Government that “we will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry.”9 The previous Government also stated its strong support for the mutual sector10.
17. The BSA would like to see this support translated into action in the European Commission’s consultations on capital. One drawback of the mutual model is that it is difficult for mutuals to raise additional capital, particularly when market conditions are stressed. An extremely important consequence of this is that current consultations at a European level on
7 No building society received any public money under the Bank Recapitalisation Programme nor took part in the Asset Protection Scheme. Use of the Credit Guarantee Scheme and the Special Liquidity Scheme by building societies was relatively modest. 8 ‘The $100billion question’ Haldane, A, Bank of England: http://www.bankofengland.co.uk/publications/speeches/2010/speech433.pdf 9 Coalition Programme for Government: http://programmeforgovernment.hmg.gov.uk/files/2010/05/coalition-programme.pdf 10 ‘Reforming financial markets’ HM Treasury, http://webarchive.nationalarchives.gov.uk/20100407010852/http://www.hm- treasury.gov.uk/d/reforming_financial_markets080709.pdf 58
what constitutes core capital must give due consideration to alternative organisational forms to the plc. The definition of core capital needs to be consistent with mutual ownership (and be marketable to investors) if it is not to disadvantage mutual firms. The BSA and its members have urged the UK authorities to take the initiative in the consultations in Europe to ensure diversity and competition are promoted11.
18. Banks that received direct State-backing during the crisis have subsequently distorted the operation of the UK’s mortgage and savings markets, and now dominate these markets. The direct Government support gives deposits held with these banks an implicit guarantee. Conditions should be applied to these institutions’ activities to limit unfair distortions to competition, at least, and we welcome the review by the Independent Commission on Banking into the future structure of the industry.
19. If a long-term view is taken in relation to divesting the State’s ownership of Northern Rock, converting the failed bank back to a mutual becomes a viable option. This could be achieved by arranging for Northern Rock to pay returns to the taxpayer over a number of years to repay the injection of capital12. Remutualisation would help to foster diversity and promote mutuals, and deserves serious consideration by the Government.
Barriers to entering the market
20. There are significant barriers to entry and expansion in retail banking, and the BSA welcomes the OFT’s review, to which we made a detailed submission13. In that submission, we drew attention to the principal importance of consumers’ trust in financial services, since banking is relational rather than transactional, and this has implications for how barriers to entry and exit are interpreted. Consumers, and the wider public interest, would not be served by a proliferation of fly-by-night deposit takers.
21. The establishment of trust and reliability are in addition to other substantial set-up costs relating to systems, branches and staff, and are more fundamental than simply investing in a new brand. Trust is built on consumer perceptions and moral judgements, which can be developed only over a prolonged period of time.
22. Therefore, while consumer inertia does exist, this may reflect the necessity of long-lasting trusted relationships as much as consumer confusion. There are now more ways than ever before for consumers to find out about products, and the wide range of options available often represent features tailored in response to demands from specific market segments rather than providers’ desire to obfuscate.
23. Regulation is another significant and growing barrier. As well as increased capital and liquidity requirements, there is the Mortgage Market Review, changes to the Financial Services Compensation Scheme (FSCS), and just for building societies, a Specialist Sourcebook. It is not at all clear that the cumulative effects of all these regulatory changes have been assessed. Nor is it apparent that the potential trade-offs between competition, financial stability, distribution (reducing financial inclusion, for example) and supporting economic growth have been actively managed.
11 The BSA’s submissions relating to capital can be found via these links: HM Treasury: http://www.bsa.org.uk/policy/response/capital_related_issues_response.htm CRD4: http://www.bsa.org.uk/docs/policy/prudentialandfinreg/CRD_4.pdf Basel: http://www.bsa.org.uk/docs/policy/prudentialandfinreg/basel_164_and165.pdf 12 ‘Converting failed financial institutions into mutual organisations’, BSA, 2009, http://www.bsa.org.uk/docs/presspdfs/remutualisation.pdf 13 BSA submission to OFT review into barriers to entry: http://www.bsa.org.uk/docs/policy/OFT_B2Ebanking.pdf 59
24. For example, new regulation to preserve stability has tended to favour large incumbent organisations, protecting them from competition, with additional prudential regulation typically representing a greater proportionate cost to small firms. As a result, in 2009 Lloyds Banking Group had a 24% share of new mortgage lending and 28% of the increase in deposits, and Santander, which combined Alliance & Leicester and the savings business of Bradford & Bingley banks with its Abbey brand, took an estimated 18% share of new lending and 23% of the increase in retail deposits in 2009. And some small societies are inclined to interpret the increased regulatory burden as being driven by a hidden agenda for the consolidation and marginalising of smaller institutions.
25. Another regulatory barrier is the FSCS. The BSA is extremely concerned about the requirements proposed by the European Commission to build up a deposit guarantee fund (equivalent to 1.5% of eligible deposits) at a rate that would be crippling for the entire existing retail banking sector, and would pose an additional barrier to potential entrants. The Government needs to ensure any changes to deposit protection can realistically be achieved.
26. The wider mutual sector incorporates credit unions, which can now offer basic banking services. Credit unions are not subject to the European banking directives and therefore it is much easier to establish a new credit union than, for instance, a new building society. It may be appropriate to increase the coverage of the Building Societies (Funding) and Mutual Societies (Transfers) Act to facilitate the transfer of engagements between credit unions and other types of mutual so that expansion is not constrained.
Free banking
27. Account terms and conditions and charges should be reasonable and presented clearly to consumers, and the OFT has been working with current account providers to improve the transparency of charges, as well as the account switching process. Mutual financial service providers offer simple products, primarily through branches, with many savings accounts that can be opened with just one pound. And mutuals have tended to keep their branches open to a greater extent than banks.
28. However, when considering policy relating to the pricing of banking services, it is important to consider the potential distributional effects of any changes, as alternative fee structures may increase financial exclusion. It is likely to be especially helpful to those on low incomes if, by keeping their account in credit, they are able to operate a bank account for free.
Foreign-based operators
29. Although several foreign-based lenders may have left the UK market following the credit crunch, it is not clear that foreign-based deposit takers have been so deterred. Many of the most competitive savings interest rates currently available are offered by institutions based in other countries, and often outside the EU. The role of foreign-based banks is complicated by potential issues such as instability if increased competition from abroad results in a greater amount of entry and exit from the market, and also the risk that foreign-owned banks enter to attract the most profitable customers, with the possibility that less profitable customers are excluded. It is also pertinent to question whether foreign-based deposit takers that compete for UK savings then play their part in providing credit to UK households or businesses, or whether the money is deployed overseas, possibly at greater risk (as the Icelandic banks episode demonstrated).
Conclusion
30. The mutual sector provides a valuable alternative to the large plc banks, and mutuals have responded to the economic challenges to ensure that they continue to do so in the future. 60
31. We welcome the Coalition Government’s support for mutual financial service firms, but this needs to be translated into action. This is most pressing in the need for the definition of core capital consistent with the mutual model. And in policy making mutuals should not be considered merely as an afterthought to the hegemony of shareholder (and Government) owned banks.
September 2010
61
Written evidence submitted by Kensington Mortgage Company
Executive Summary
• The landscape of the UK mortgage market has changed dramatically over the past three years. The majority of UK mortgage lenders, as a response to the financial crisis and market downturn, have restricted their lending to consumers, while other providers have pulled out of the market altogether.
• In addition, much of the consolidation within the market has resulted in a lack of diversity of mortgage products and providers, which has, in turn, restricted mortgage provision to a select number of customers (eg those with an exceptional credit rating or with a significant level of deposit).
• With a lower number of first-time buyers in the market in England and Wales than at any time in the last 35 years1, we believe it is more important than ever that mortgage lenders do their utmost to help people fulfil their aspirations of homeownership consistent, of course, with their ability to fund those loans sustainably.
• We believe that the best way to do this is to ensure a competitive, diverse market, which is able to meet a range of customers needs in different circumstances and which is not just reliant on a small number of super-dominant lenders.
• We believe it is important for the Government and regulators to support a level playing-field between lenders of every kind – whether large and small, monoline and full service, private sector and part-nationalised – to maximise the level of competition in the mortgage market and make sure that every lender is, like us, playing their full part.
1 Introduction
1.1 Kensington Mortgage Company (“Kensington”) welcomes the opportunity to contribute to the Treasury Select Committee's important and timely inquiry into competition and choice in the banking sector.
1.2 Kensington is a leading intermediary only mortgage lender with approximately 47,000 customers and a mortgage book of £4.54 billion. It offers mortgage products – through a controlled distribution of intermediaries – aimed at customers who are overlooked by the high street and its products are tailored to meet a range of different circumstances2. With the support of its parent, Investec, a leading specialist bank and asset manager, Kensington became the first lender driven out of the market by the credit crunch to return to lending.
1 Statistics supplied by Home Builders Federation, 5 August, 2010 2 These include self-employed workers, people whose income includes salary plus bonus or commission, people with more than one income source (eg from two part-time jobs), customers who have missed one or two of unsecured payments in the past but are now back on their feet financially and people without personal information on record to fit a standard credit score. 62
1.3 As an intermediary lender, Kensington plays a key role in ensuring greater diversity and competition for mortgage customers and potential homeowners, as part of ensuring a sustainable recovery in the UK mortgage market – particularly, at a time when there have been mixed signals about the direction in which the housing market is heading. In a sector which has been subject to significant levels of state support through the nationalisation and part-nationalisation of some of the big banks and mortgage lenders, we believe that the promotion of greater competition and diversity is of paramount importance for the benefit of consumers.
1.4 Kensington are committed to running a responsible, sustainable business. We make sensible considered lending decisions based on the information provided us from a variety of verifiable sources. We check robustly a customer’s ability to afford a mortgage taking into consideration the specific characteristics of the customer’s financial situation and we further stress test this to allow for the potential of further interest rates increases.
2 The impact of the financial crisis on competition and choice
2.1 The landscape of the UK mortgage market has changed dramatically over the past three years. The majority of UK mortgage lenders, as a response to the financial crisis and market downturn, have restricted their lending to consumers, while other providers have pulled out of the market altogether.
2.2 The market in mortgages saw a reduction of products from 28,413 in June 2007 to just 2,177 in July 2009 according to Money Supermarket. That figure had risen slightly to 2,990 by August 2010.
2.3 With a lower number of first-time buyers in the market in England and Wales than at any time in the last 35 years3, we believe it is more important than ever that mortgage lenders do their utmost to help people fulfil their aspirations of homeownership consistent, of course, with their ability to fund those loans sustainably. We believe that the best way to do this is to ensure a competitive, diverse market, which is able to meet a range of customers’ needs in different circumstances and which is not just reliant on a small number of super-dominant lenders.
3 The impact of widespread consolidation among banks and mutuals
3.1 There has been significant consolidation in the UK mortgage market over the past three years. In addition, much of government support has focused almost exclusively on larger deposit-takers, reinforcing the lack of overall competitiveness in the mortgage market for first time buyers and those facing negative equity.
3 Statistics supplied by Home Builders Federation, 5 August, 2010 63
3.2 Much of the consolidation within the market has resulted in a lack of diversity of mortgage products and providers, which has, in turn, restricted mortgage provision to a select number of customers (eg those with an exceptional credit rating or with a significant level of deposit). Many credit-worthy consumers – including those, for example, who are self employed – are still being denied the opportunity to buy their own homes and are unable to enjoy the clear benefits associated with home ownership. A diverse and responsible mortgage market that supports the recovering in the housing market would, in turn, give a much needed fillip to the broader national recovery.
4 The key barriers to entry inhibiting increased competition — including regulation
4.1 It is crucial for the Government, regulators and the industry to ensure the necessary conditions for a return to a diverse and vibrant market in which there are more kinds of lenders – both small and large – with different funding models.
4.2 Following the financial crisis, there have been a number of new or proposed regulatory requirements affecting the mortgage market including the FSA’s Mortgage Market Review and the Bank of England’s proposed market measures on monetary policy4. While the intention to further stabilise the system is entirely welcome, there needs to be greater recognition and understanding of the cumulative effects of all these regulatory changes on market competition and scope for product innovation. There is a danger that these new and proposed regulations will tend to favour large incumbent organisations, protect them from competition (in some cases with taxpayers’ money), with additional prudential regulation typically representing a greater proportionate cost to small firms.
5 Whether competition is inhibited by difficulties faced by customers in accessing information about products
5.1 Kensington believes that there is currently a lack of transparency in the market, with many of the products promoted by the mainstream providers being restricted to only a very small number of borrowers. Credit scoring systems are used to cherry pick customers for the best rates. The criteria behind these scores are undisclosed and many customers can be denied access to products promoted as best buys without knowing why.
5.2 In addition, Kensington believes that it is important to promote greater understanding in financial services, with more emphasis put on the value of product transparency and professional independent financial advice. We support the work of Independent Financial Advisers (IFAs) and Mortgage Intermediaries as the fairest financial services institutions inspiring trust and consumer confidence as well as continuing the roll out of free impartial generic financial advice.
4 Monetary Policy After the Fall – Paper by Charles Bean, 28 August 2010 64
6 Explore the Government and competition authorities’ strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market
6.1 We believe it is important for the Government and regulators to support a level playing-field between lenders of every kind – whether large and small, monoline and full service, private sector and part-nationalised – to maximise the level of competition in the mortgage market and make sure that every lender is, like us, playing their full part.
6.2 Kensington is determined to play its role to support the continuance of a sustainable, responsible recovery in the UK mortgage market though helping homeowners and potential homeowners.
7 Conclusion
7.1 Kensington has been delighted to offer these thoughts to the Committee which it trusts the Committee will find helpful. We would be delighted to discuss these important issues with you in further detail.
September 2010 65
Written evidence submitted by Intellect
Executive Summary
Intellect believes that the current regulatory focus on the banking sector in the UK must be supplemented by a greater understanding amongst policy-makers and regulators of the critical role that technology plays in the functioning of this critical industry.
Technology and financial services are inextricably linked. A durable and effective regulatory programme that tackles the issues of competition, transparency, systemic risk, and lack of capital for SMEs (amongst other issues) must reflect what technology can facilitate today and, crucially, what it will enable in the future.
Intellect believes that there are a number of competition challenges that need to be dealt with by Government and industry together if issues such as lack of choice for consumers are to be rectified. These include:
• Customer inertia – how can competition be increased (and new entrants be encouraged to participate in the market) when customers are not inclined to change banks?
• Poor flows of financial risk information on SMEs – an untapped market that banks do not currently want to tap
• Costs of complying with regulation and high capital requirements
• High cost of establishing a branch network – how can this be overcome by new entrants?
• Banks that are unable/unwilling to exit unprofitable markets
Intellect believes that there are a number of ways that competition and choice within the retail banking market could be improved. These include:
• Individual bank account numbers that can be taken from bank to bank – to facilitate easier switching
• Offer innovative, convenient, technology-facilitated banking products for customers that do not necessarily have to rely on a branch network
• Use of innovative back-office IT to reduce up-front capital expenditure and counter-balance other high entry costs 66
• Increase the quantity and accuracy of financial risk information (especially on SMEs) that is collated and flows between banks
• Engagement with industry, via a continuing dialogue, to maximise the opportunity for innovative technologies to improve the process – be it in payments, online access, or, fundamental for all services, flows of information
1. Intellect Financial Services Programme
1.1 Intellect is the UK trade association for the IT, telecoms and electronics industries. Our members account for over 80% of these markets and include blue-chip multinationals as well as early stage technology companies, and play a crucial role in virtually every aspect of our lives. In the UK these industries together generate around 10% of GDP and 15% of trade, directly employing over one million people.
http://www.intellectuk.org/content/view/23/3/
1.2 We are a trusted partner for Government, both in terms of policy development and policy implementation across numerous sectors. We look to ensure that all relevant engagement of policymakers and regulators with industry is both easy and as valuable as possible in order that the technology industry may play the fundamental role it merits in the success of UK plc.
1.3 Intellect’s Financial Services Programme brings together over 150 suppliers of information systems, services and consultancy to the financial services sector. Global IT service providers sit alongside many specialised smaller companies and all play an active role in imparting their expertise and experience to better inform the development of financial services policy at a cross roads in the industry’s development.
1.4 Many of Intellect’s members are heavily involved in providing the fundamentally important technology platforms upon which the UK’s financial services industry is built. For example, these members help facilitate the 5.7 billion automated payments that are made through the banking system on an annual basis. Indeed, through Intellect our members are working with the Payments Council to develop the future technology that will afford consumers and businesses alike more convenient, secure and efficient ways to conduct their transactions. Similarly, the 40 million online bank accounts that are registered in the UK would not function without the technological capability that our members design and supply.
1.5 The relationship between the financial services industry and the technology sector is one of fundamental importance. Technology not only plays a critical role in the functioning of the financial services industry, it is a hugely important factor in ensuring that these institutions can operate more responsibly and remain competitive in the global marketplace. 67
1.6 Consequently, if the UK’s banking sector is to be reformed to meet the challenges posed in recent years and provide the backdrop to economic recovery, policy not only needs to reflect what technology can facilitate today, but what it will enable in the future. Regulation will only be effective and durable if it takes into account how it will be implemented and how the application of technology can be complementary. For an industry like financial services that relies so heavily upon technology, it is essential that policy is developed at all stages with a full understanding of it.
2. Intellect Response to the Inquiry’s Terms of Reference
2.1 Please note: Intellect has not responded to all the issues set out in the Inquiry’s Terms of Reference. Answers that are given to questions below are based upon Intellect’s Members’ expertise in the field of financial services.
2.2 Given the word limit for this response, Intellect is unable to cover the wide spectrum of issues in great detail. However, more detail on issues of interest to the Select Committee is available upon request.
3. Financial services reform & technology – inextricably linked
3.1 Intellect welcomes the focus that the Government, Independent Banking Commission and other authorities are taking on competition within the banking sector. However it is clear that there needs to be a shift in attitude amongst policy-makers and regulators about the role that technology has in this particular industry. Whether it is because of the dominance of the ‘traditional’ stakeholders in this industry, or a prevailing misconception that technology is merely a means to implement legislation and is treated as an afterthought, to date there has been insufficient attention paid by the Government to how technology can offer solutions to many of the challenges the financial services industry currently faces.
3.2 Technology has played a significant role in the development of the banking market in recent years. The banking system as we know it would not function without the fundamental technology platforms that underpins all activity, both customer-facing and back office. This will continue to be the case as consumer technology converges and organisations (not necessarily just retail banks) develop a variety of technologies to provide banking services to an increasingly digitally-native market. In the future, how technology is applied will be a key differentiator between operators in a market that is in a state of flux. Those willing and able to embrace new technologies (both front-end and in terms of infrastructure and back-office) will be able to adapt to accommodate changing consumer demands and expectations. Not only can technology reduce systemic risk and increase flows of capital to SMEs, it can increase 68
competition and provide a platform for new entrants to expand within the retail banking industry.
3.3 As the UK’s financial services sector is reformed to meet the challenges posed by the recent banking crisis and provide the backdrop to economic recovery, the development of policy must reflect an understanding of how technology continues to be the driver of change in the financial services industry. Understandably there may be an inclination in some quarters to move from principles-based regulation to a rules-based approach. Whilst not offering arguments in favour of either, Intellect believes that before committing to any changes to the regulatory system, the possibilities that technology offers for increasing competition (and increasing transparency, stability and consumer protection) should be examined in detail by policy-makers and the financial services industry alike.
3.4 Currently the level of understanding amongst policy-makers and regulators about the technology systems that provide the fundamental platforms for nearly every transaction across the financial services industry, is poor. It is common sense that if policy-makers and regulators are to ensure that regulation is effective, but not unnecessarily restrictive, they need to have an understanding how banks operate. It is now impossible to do this without appreciating the technology that not only underpins existing institutions in this sector, but will also underpin new entrants to the market as well and is constantly evolving. Intellect provides an ideal source of neutral expertise for policy makers and regulators to tap into, representing the aggregated expertise of the companies that provide the platforms which underpin much of the financial services industry.
4. Barriers to entry & technology solutions
4.1 As outlined above, the application of technology will afford new entrants the opportunity to build up a foot print within the retail banking market. This increase in competition will have resulting benefits for customers (both individuals and SMEs) and will have the effect of diversifying the risk that is posed to an economy that has been overly reliant upon a small number of large banks.
4.2 Intellect believes that there are a number of competition challenges that policy- makers will have to deal with over the coming months. However, more often than not there is a technology solution that can complement or even reduce the need for regulatory activity. Some of these challenges and solutions are set out below:
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4.3 Customer inertia
Both the Office of Fair Trading and HM Treasury have identified customer inertia as a key barrier to competition within the retail banking industry. As noted in HM Treasury’s Reforming Financial Markets consultation paper of 2009, both the reality and the perception of the difficulty of switching bank accounts increase customer inertia. Nearly two-thirds of people have held their current account for more than 10 years and 60% of people are still using the first current account that they ever opened (HM Treasury).
4.3.1 In the banking sector especially, customer inertia represents a significant challenge not only to potential new entrants, but to any provider of financial services that is looking to expand their customer base. If banking providers are aware that customers are more inclined to stay with them than leave, then there is less motivation to ensure that its customers are its number one priority. However, there are a number of technology-based means to reduce customer inertia:
4.3.2
• Individual, portable bank account numbers
Intellect believes that by creating a bank account number that is specific to the individual rather than the bank and that could also be transferred from one bank to another, market stagnation that results from customer inertia will be alleviated to a significant degree and competition within the banking sector will be enhanced (with knock on benefits for the availability of capital for SMEs and individuals – through greater choice). There has been significant regulatory focus in recent years on the porting of individual phone numbers as a means to increase competition in the mobile phone industry and from April 2011, mobile phone customers will be able to transfer their existing number to a new provider in just one working day rather than the current two days. That switching of bank accounts takes a matter of weeks, not days and is a significant barrier to competition suggests that this should be a priority issue for Government.
4.3.3
• ‘3 Cs’ technology-facilitated products By using technology to provide banking products and services of convenience to their customers, such as mobile payments, online banking and use of social media, financial services providers will challenge customer inertia in some sectors of the market where ‘digitally native’ consumers look for banking services that encompass the ‘3 Cs’ – Customer Focused; Convenient and Converged. The development of these products will ideally be demand- led. Those banking providers that are able to accurately anaylse customer sentiment and quickly develop technology-enabled products that cater for a 70
relevant market sector will find that they are in a good position to increase their market share. The challenge for established banks (as outlined below) is that their legacy IT systems, which are comprised of layer upon layer of IT platforms that have been built upon over many years, do not easily allow new systems for new products to be easily added without significant disruption to existing services. New entrants will find that because of their ‘technological blank slate’ they are more agile when it comes to rolling out innovative technology-led services for their customers.
4.3.4
• Flexible and efficient payment systems
The main objectives for new entrants into the banking sector will be simplification, quality of service and lowering costs. It is anticipated that new entrants, because of their technological blank slate, will drive towards integrated systems that can handle payments from any channel, whether consumer or corporate, from start to finish - with no redundancy of technology or duplication of processes and labour. This type of integration will enable financial institutions to manage transactions quickly and effectively, with less need for manual intervention and costly interfaces between different systems. Crucially, it will allow these new entrants to consider all payment forms – from smart phone applications to contactless payments – based on customer demand. This will be tied in with the likelihood that new entrants will turn away from large traditional back office IT departments which require an initial high outlay of capital, to outsourced IT operations that can expand as the new entrant expands. Increased use of Software as a Service (SaaS) and cloud computing, provided by IT outsourcers directly to new lenders, will mean that their services are scalable, easily updatable and importantly, new entrants will only pay for what they use. In the short to medium term this will represent significant cost savings as new entrants will be able to ‘rent’ the services they require without any upfront capital costs.
4.4 Costs of compliance and capital requirements
With such a wide ranging raft of regulation on the horizon, all of which requiring changes of varying cost to individual financial services providers’ internal systems, coupled with the huge cost that capital reforms (Basel III) will have across the industry, the drain on resources is going to be acute over the coming months and years. Such high costs, in addition to the costs of setting up a bank, will act as a deterrent to entry to potential new entrants to the retail banking market.
4.4.1 It is therefore critical that if new entrants are to be encouraged to participate in the retail banking market, that they are not over burdened with compliance 71
costs for regulation whose objectives could be achieved through other means. Lessons can be learned from recent regulation which, in some cases, is still being implemented. The estimated costs of changes to the IT infrastructure of deposit takers to implement the Financial Services Compensation Scheme’s Single Customer View (SCV) initiative – circa £1 billion – is huge. Although Intellect welcomes technology investment by financial institutions, there is a question whether the requirements of the FSCS’s SCV could have been met by the commercially focused SCV that many banks were already working towards, with a reduction in associated compliance costs. New entrants, if they are to comply with this specific legislation and develop a means to better identify their individual customers, will therefore have to pay to implement two versions of a Single Customer View.
4.4.2 Whilst Intellect fully supports regulatory efforts to improve the stability, transparency and performance of the financial services industry, we believe there is a responsibility for regulators and industry to take a broader view of how proposed policy/regulation is going to be implemented in reality – especially with regard to likely impact that changes will have upon financial service providers’ IT systems. This should be undertaken at an early stage to avoid unnecessarily expensive or time-consuming changes that could further add to the start-up costs for potential new entrants, and indeed reduce disruption to existing institutions, the market and customers. A means to achieve this could be through an adaption of Intellect’s Government-supported Concept Viability scheme.
4.5 Inability of established banks to exit specific markets
One of the major obstacles to competition in the banking sector stems from a specific barrier to exit – large incumbent banks offering products and services that are loss leaders, but whom are unable/unwilling to exit the market for these products and consequently allow other actors to enter and expand.
4.5.1 As banks on the most part do not employ detailed analytics that can offer information on product profitability they are, in many cases, unable to determine which products to discontinue and which to actively promote. Amongst other reasons, products may be failing because they do not reflect the needs of customers or that they may not be targeted at the right sectors of the market. However, the real issue is that a market awash with similar products combined with a public that is, generally speaking, more inclined to take up products from their incumbent banking provider than shop around (regardless of whether or not these products are the best fit for them), makes it hard for new entrants to compete on a level playing field and gain a foothold in the banking market. If banks can be encouraged to identify their unprofitable products, it would be better for them, the wider market and the consumer.
4.5.2 Where products have been removed from a market, there has not been enough importance attached to learning how and why these projects failed. By 72
establishing what could be done better, there is an opportunity to ensure that new entrants to the retail banking market can offer technology-facilitated banking products and services with a reduced chance of them failing. Product failure at an early stage of a new entrants’ existence could also have significant negative consequences on its reputation, its resources and its ability to gain a foothold in the retail banking market.
4.5.3 Intellect believes that there could be a role for regulators to ask banking providers for their views on why particular projects did not succeed so that the wider market, and indeed the consumer, can benefit from this hindsight. Similarly, for the sake of greater competition and efficiency, Intellect believes that retail banks should be encouraged to actively evaluate the performance of their products in this sector. State-owned retail banks should, in the interests of reducing costs, be compelled to do so. In both instances, a short term investment in appropriate analytics software would be required, but the longer term savings made from leaving unprofitable markets and greater insight on how to target more profitable products would justify this expenditure many times over.
4.6 Legacy systems
In the instance that an unprofitable product is identified, it is often difficult for banks to remove them from the market because of the effect that doing so would have upon their interdependent legacy IT systems. These legacy systems, the multiple layers of IT platforms within banks that have been built upon over many years, are at the heart of established financial service providers’ operations. They are business critical, intertwined with other elements of a bank’s IT infrastructure and are often running 24 hours a day. Adding new elements or removing them from these legacy systems (i.e. to remove IT systems that facilitate specific banking products or services) is a very complex and expensive process that will impact upon a multitude of different aspects of the bank’s operations. In many cases it is not in the broader interests of a bank to remove a product from the market because of the costs and the disturbance to core systems that unwinding these un-needed systems would incur.
4.6.1 A lack of information about the performance of specific products can be addressed more easily than the issue of IT legacy systems. For this very reason Intellect believes that regulators should do more to understand the impact that legacy systems have upon banks’ abilities to provide high standards of customer service and remove loss-making products from the market. Incentives, such as capital tax breaks, could be made for banks to replace their ageing legacy systems and allow them to become more efficient and customer friendly. For state-owned banks, a reduction in the repayment of public debt could be made in the immediate term so that investment could be made in banks’ IT systems. This would allow a quicker repayment of public money in the medium term as the banks become more efficient and more commercially viable.
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4.6.2 However, as outlined above, where legacy IT systems reduce established banks’ abilities to innovate, their existence does provide a significant opportunity for new entrants to the retail banking market to establish a foothold. Every year, banks invest hundreds of millions of pounds in new technology, yet it can take years before a new product reaches the consumer. New entrants without these legacy systems hold a distinct advantage as they are able to adapt quickly to changing customer demands or the availability of new technology.
4.7 FSA licensing regime – auditing of ICT suppliers
Intellect fully supports the ‘litmus-testing’ of organisations wanting to enter or expand their provision of banking services and the protection of the customer (and of the wider economy) is of paramount importance.
4.7.1 However, Intellect does believe that there should be a balance between transparent and appropriate auditing of suppliers to potential entrants in the retail banking market, and unnecessary and costly oversight that prolongs the licensing process (extending ‘go to market’ time for the entrant) and which ultimately will itself act as a barrier to entry. The role that the Financial Services Authority (FSA) currently plays, whilst necessary, should be evaluated and refined where appropriate (especially if this role is passed on to a new prudential regulator within the Bank of England) to ensure that it does not suffer from ‘mission-creep’. A specific issue is the FSA’s ‘adopted’ role of scrutinising the contractual relationships between the market entrant and its service suppliers – especially ICT suppliers that supply its systems and infrastructure. This could potentially cause a barrier to entry as the FSA does not have the necessary level of technical expertise to adjudge what ICT technology is appropriate, what represents a satisfactory level of risk and what is in the consumers’ best interests with regards to ICT provision. A solution to this would be the development within the FSA (and its successor) of a greater level of technology-based knowledge amongst relevant staff. Intellect provides an ideal source of neutral expertise for policy makers and regulators to tap into, representing the aggregated expertise of the companies that provide the platforms which underpin much of the financial services industry.
4.7.2 This prolonged time frame, as a result of increased FSA scrutiny, could also have the effect of discouraging smaller ICT providers from forming commercial relationships with prospective and new entrants to the retail banking sector. It is simply not as profitable for smaller ICT providers to be involved in such projects as it would be for them to be involved in other, less scrutinised markets. If it is taken that innovative IT-enabled customer services and infrastructure are important to new entrants’ entry and expansion in order to differentiate themselves from incumbents a reduced field of suppliers to choose from will harm this ability. The public sector has, in recent years, seen a similar problem where smaller, innovative suppliers were discouraged from tendering for government contracts because of the costs of embarking on a time consuming and administration-heavy process. There is a danger that through increased 74
regulatory scrutiny of ICT suppliers, the financial services industry could be sleep- walking into a similar situation.
5. The acquisition of SME customers – an untapped market for new entrants?
5.1 Intellect acknowledges that the limited availability of capital for SMEs from banks is a separate (but related), ongoing concern for Government at the current time. However, it is also the case that by addressing this issue, a side benefit could be an increase of competition within the banking sector.
5.2 Financial services organisations generally have a good track record on information sharing. For example, the advent of increasing customer applications for credit, have heightened the industry’s interest in information sharing. Furthermore, collaborative events to tackle financial crime have increased the speed in which information sharing can take place. However, these incidences typically relate to data sharing on individuals, a similar flow of information between institutions on potential SME customers is not nearly as developed. Generally, ) larger incumbent banks have been guilty of viewing SMEs as one large group (or groups by sector & size), all posing the same level of risk regardless of their own specific business models, financial health etc. This has led to a reduction in the availability and cost of credit to SMEs – a lack of detailed information sharing on SMEs has led to risk-averse banks becoming even less likely to lend to SMEs, and the conditions that are attached to the loans that they are willing to make are often so high that they do not represent realistic options for SMEs.
5.3 Now, more than ever, it is critical that access to financial risk information is available to all operators in the financial services market. On a general level, higher levels of data interoperability can facilitate better credit flows between banks, ensure greater accuracy of data and consequently more informed decisions on lending can be made. Technology has a crucial role in facilitating the flow of credit to individuals and SMEs in the UK, but has to be accompanied by a change in mindset within the banking community – i.e. that SME’s are an important source of business for the retail banking industry, and that the availability of credit will beget more business for banks that are willing (and able) to lend to them.
5.4 The challenge for smaller and new entrants to the retail banking sector is to expand their information base to gain as comprehensive a picture of their potential SME customers as possible. If the range and quality of information that can be gleaned can be increased, not just from potential customers but also from other financial institutions, smaller and newly established banks will be able to make more informed decisions about who they lend money to in the SME sector and, in theory, acquire more SME customers. In order to achieve this, data 75
interoperability standards across the financial services ecosystem need to improve significantly.
5.5 Additionally, the issue of data accuracy is also applicable here. However effective the ability to share information might become, it can only be as useful as the accuracy of the information being shared. The greater the ability to make an accurate assessment of the credit worthiness of individual SMEs, the greater the ability of new or less-established entrants to attract more commercially-viable business from SMEs. This will lead to greater competition and choice in the banking sector, with a beneficial effect on the UK economy in the longer term.
5.6 Lack of a Single Customer View (SCV)
Competition in the retail banking sector will be restricted if new entrants are unable to form a SCV of their individual SME customers. As outlined above, a SCV is a longstanding commercial aim of the retail banking industry and will allow lenders to not only build up a detailed view of a customer’s individual credit risk, but also to identify other services and products that can be sold to the customer. It is equally important to have a similar SCV of SME customers if a new entrant is seeking to grow its business. Generally, in the experience of Intellect’s members, new entrants in the retail banking field do not have a common facility management system in place that can facilitate a single point of access to information about a specific SME customer. Consequently they are not as adept as more established operators at spotting risk, increasing processing efficiencies and generally providing customers with a more tailored customer service. This has a knock on effect on customer retention and growth of existing customer business.
5.6.1 The simple solution to this is that a common loan origination system should be in place for all new entrants to the retail banking sector. If better flows of information between banks on SMEs can be supplemented by better use of information within individual banks, it will have benefits for the banks themselves, SMEs and ultimately the economy.
6. Conclusions
6.1 Intellect believes that three is currently an opportunity to ensure that efforts to safeguard the future safety of the wider financial services sector also act as a catalyst for greater competition and benefit for consumers. As Intellect has looked to demonstrate in this submission, technology must be the foundation upon which competition is enabled – as it is the foundation upon which the banking sector is already built and upon which it will continue to be developed.
6.2 The aim for all parties must be to facilitate a retail banking market that encourages participation from new entrants, has unhindered opportunities for 76
expansion and does not artificially block retirement from specific markets for banks or products that are commercially unsustainable.
6.3 Intellect would urge the Treasury Select Committee to recommend that the Government thinks laterally in its approach to competition in the banking sector (as new entrants to the retail banking market will be doing). It should consider:
• A greater focus on the fundamental technology platforms that the banking system is built upon, as a means to increase competition. The appropriate application of technology within the banking sector will go a long way to increasing competition and it should be considered alongside and, potentially, instead of some legislative remedies
• A greater focus on increasing the quality of the analysis and flows of information, both within and between banks
• Ensuring that financial services regulators and policy makers have a greater understanding of how technology impacts upon the functioning of the banking sector.
6.4 Those banking providers that are able to harness convenient, demand-led banking products, greater analysis/information and cost efficiencies that the application of technology can bring, will give themselves a greater chance of establishing themselves in this market. This is to the benefit of the consumer, the shareholder and, of course, UK plc.
September 2010 77
Written evidence submitted by the Consumer Financial Education Body
About CFEB
The Consumer Financial Education Body (CFEB) is an independent body, created in April 2010 as a result of the Financial Services Act 2010. Our mandate is to develop consumer financial education in the UK, as well as to enhance the public’s understanding and knowledge of financial matters and their ability to manage their finances.
CFEB welcomes the opportunity to submit written evidence.
Summary of our response
• The main point of interest in this inquiry for CFEB is “whether competition is inhibited by difficulties faced by customers in accessing information about products”. • There are barriers to accessing information and also barriers to acting on that information.
Barriers to accessing information
• Product disclosure has limitations. CFEB is happy to work with industry and regulators to identify what works in adequately informing consumers of risks and benefits. • Transparency is important and desired by consumers. We welcome the Government’s announcement around simple products. • Packaged accounts and different systems of overdraft charging create barriers to comparability and transparency of accounts. • Some consumers have very limited choice – such as undischarged bankrupts and people without conventional proof of identity. • Our impartial information and advice can help competition. Evidence from the Money Guidance Pathfinder shows people using the service to compare products and taking action afterwards.
Barriers to acting on information
• There are several reasons why information and advice do not have a stronger influence in the market. • There are clear differences between types of consumer, not least in terms of their financial capability. People are less financially capable when they are going through major life events, such as unemployment and divorce. • Financial capability will have less impact in markets where consumers do not feel powerful and where competition is limited. • Evidence from Centre for Competition Policy and from the FSA provides some explanation for why switching of bank accounts is low, including confidence and the perceived time needed. 78
• But the difference between banking and other markets is not fully explained. Behavioural science may have some explanations – we welcome research and ideas from firms and others about changing financial behaviour. • Remedies are needed on the demand and supply side, and at their interface. CFEB has a role on the demand side and we are exploring interventions, such as a Financial Health Check, at key financial decisions.
1.0 Introduction
1.1 This is a response to the Treasury Committee’s call for evidence to inform its inquiry into competition and choice in the banking sector. A number of the issues the Committee is addressing in this inquiry can ultimately impact on consumers’ ability to manage money, and it is clear that the financial crisis has affected competition and choice in retail and wholesale markets. For example, there is less scope and arguably less incentive to switch in a highly consolidated market. But the main point of interest in this inquiry for CFEB is “whether competition is inhibited by difficulties faced by customers in accessing information about products”.
1.2 Our expertise is important to this inquiry because the way consumers use information about products is central to our statutory function. We were set up to enhance: public understanding and knowledge of financial matters; and the ability of members of the public to manage their own financial affairs. We consider that there are barriers to accessing information and also barriers to acting on that information. This submission considers each of those issues in turn.
2.0 Our Response
Barriers to accessing information
2.1 CFEB considers that there are barriers to accessing information, which can partly be addressed by a better process of providing information, and ensuring transparency.
2.2 The report by the Commission on the Future of Banking, as well as research by the FSA and others, note the limitations of product disclosure – both in its volume and the extent to which consumers engage with it, remember it accurately or recall seeing it at all1. Previous Treasury Select Committee inquiries have also made very helpful contributions to this debate. CFEB is happy to work with the Government, industry and regulators to discover what works best in terms of adequately informing consumers of the risks and benefits of a particular product or service.
1 For example, Future of Banking Commission, 2010 [commission.bnbb.org]; Disclosure in the Prime Mortgage Market, FSA 2009 [www.fsa.gov.uk/pubs/consumer-research/crpr82.pdf]; Warning: Too much information can harm, Better Regulation Executive and National Consumer Council 2007 [www.bis.gov.uk/files/file44588.pdf] 79
2.3 Central to the purpose and effectiveness of disclosure is product transparency: the consumer should know what they are buying. Research for the Treasury’s Retail Financial Services Forum found that transparent products with clearer labelling were desired by consumers2. The Government has announced its intention to consult on a new range of simple products, into which CFEB will seek to input. The sales process should also be transparent – one of the problems identified with the Payment Protection Insurance market was that many consumers did not know it was optional3.
2.4 Developments in the personal current account market have meant that products are not necessarily transparent, readily comparable or understandable. Firstly, increasingly available packaged accounts and other products tied to current accounts compete, by their nature, on a variety of features as well as price. The FSA has flagged that this may not be of benefit to all who use them4. Consumers should be encouraged to consider whether the extra features offered provide good value for money and, where insurance products are included, the cover they need. Secondly, it is well documented that overdraft charges are not consistently applied from firm to firm, which limits transparency and comparability5. Regardless of any developments in the market and regulation of overdrawn bank accounts, it is important that efforts are made to ensure consumers are able to understand and compare the costs they may face when borrowing in this way, and better able to compare the overall cost of different forms of credit.
2.5 The Committee should also give consideration to the limited choice available for some consumers. Current accounts increasingly have conditions attached, such as a minimum monthly deposit. The features of basic bank accounts vary significantly and, as highlighted by Citizens Advice in their recent report, Called to Account6, the choice available to groups such as undischarged bankrupts is very limited and not always clear. Those without conventional forms of proof of identity, such as homeless people and recent migrants, may also struggle to access a bank account and information about it. The outcome is that many people remain unbanked, with the individual and social costs that entails. Rural consumers may have little meaningful choice if they wish to use face-to-face banking – and the OFT found that branch location was the main reason for choosing a bank account7. An increasing number of accounts are only available online, which restricts choice for those without internet access.
2 ‘Simple transparent products’ research paper, HM Treasury 2010 [www.hm- treasury.gov.uk/fin_retail_finservices_forum.htm] 3 See, for example, The sale of PPI – results of thematic follow-up work, FSA 2006 [www.fsa.gov.uk/pubs/other/ppi_thematic.pdf] 4 Financial Risk Outlook, FSA 2010 [www.fsa.gov.uk/Pages/Library/corporate/Outlook/fro_2010.shtml] 5 See, for example, Personal Current Accounts in the UK – an OFT market study, OFT 2008 [www.oft.gov.uk/shared_oft/reports/financial_products/OFT1005.pdf]; Which? magazine September 2010 6 Called to Account, Citizens Advice 2010 [www.citizensadvice.org.uk/called_to_account] 7 OFT ibid. 80
Barriers to acting on information
2.6 As we have noted above, consumers do face difficulties in accessing clear information about products; but perhaps more important is their ability and motivation to act on that information.
2.7 Financially capable consumers can drive competition. Our definition of financial capability is made up of five domains: making ends meet, keeping track, planning ahead, choosing financial products and staying informed. Choosing products is clearly crucial, and the other domains are all relevant, to a consumer’s ability to exercise choice and encourage competition.
2.8 We believe CFEB’s impartial information and advice can help competition – shopping around for the best deal and comparing products are among the main activities we help people do. In the Money Guidance Pathfinder8, users were helped to gather information on and compare products in 30% of face-to-face and 47% of telephone sessions. Evaluation found that 21% of users had applied for, bought or changed a product within two months of a session. The Moneymadeclear website contains information on bank accounts, including packaged accounts, and our comparison tables can be used as a tool to inform switching9. In future, CFEB aims to make it easier for users to make informed decisions about products.
2.9 However, there are several reasons why information and advice do not currently have a stronger influence on consumer behaviour in the market. It is worth acknowledging that consumers are not one homogenous group. There are clear differences between types of consumer, not least in terms of their financial capability. Our research shows that people are less financially capable when they are going through major life events, such as unemployment and divorce, both of which tend to increase in an economic downturn10. This is likely to impact on their ability and inclination to exercise choice.
2.10 In markets where consumers do not feel powerful, the impact of financial capability will be limited. In sectors that are not competitive, due to consolidation for example, even active consumers may benefit less from switching and are therefore less likely to be able to drive competition.
2.11 Research by the Centre for Competition Policy shows that active consumers are more likely to switch bank accounts: the best predictor of whether someone will switch is whether they have switched in another market. A person’s confidence in predicting gains and costs was a better predictor than what they estimated those gains or costs to be. Consumers thought it would take much longer to search and to switch bank accounts than other contracts. But even allowing for consumer characteristics, experience and expectations, there was an effect that
8 The Money Guidance Pathfinder provided information and guidance by telephone, face-to-face and online. Money Guidance Pathfinder evaluation, CFEB 2010 [www.cfebuk.org.uk/pdfs/20100709_pathfinder.pdf] 9 See www.moneymadeclear.org.uk. 10 The impact of life events on financial capability: evidence from the BHPS [www.fsa.gov.uk/pubs/consumer-research/crpr79.pdf] 81
meant that switching was lower in the current account market11. This warrants further research and the CCP are following up this study. This suggests that increasing knowledge and confidence is an appropriate remedy but will not be the whole solution.
2.12 An omnibus survey of 2000 adults in Britain conducted on behalf of the FSA in January 2010 found that people with only a bank account were less likely to have switched or considered switching in the last year. Across all product holdings, most consumers who considered switching in the past year did actually switch; and the reasons given by those who switched were very closely matched to the reasons given by those who only considered switching. These reasons were predominantly financial: dissatisfaction was not the main driver of switching12. More research would be welcome into the reasons people do not shop around when they are dissatisfied.
2.13 Behavioural science has some theories to explain the low levels of switching in the current account market13. We welcome the Government’s commitment to make use of behavioural economics and agree it is relevant to financial services. CFEB recently published Transforming financial behaviour, which identifies drivers for changing consumer behaviour and ways these could be harnessed to improve financial capability14. The report seeks the views and experiences of others in using behavioural strategies and we would welcome the contribution of retail firms and others to help inform our work.
2.14 To increase the number of financially capable consumers who are able to exercise choice effectively, a range of remedies will be needed on the demand and supply sides and at their interface. On the demand side, CFEB is striving to enhance the public’s understanding and their ability to manage money. We are exploring interventions such as the Financial Health Check at key financial decisions.
September 2010
11 Pain or gain: Does consumer activity reflect utility maximisation, Centre for Competition Policy, University of East Anglia 2008 [www.uea.ac.uk/polopoly_fs/1.104668!ccp08-15.pdf] 12 Consumer awareness of the FSA and financial regulation, FSA, to be published September 2010, copies available from the FSA on request. 13 The psychology of personal current accounts, OFT 2008 [http://www.oft.gov.uk/shared_oft/reports/financial_products/oft1005e.pdf] 14 Transforming Financial behaviour, CFEB 2010 [www.cfebuk.org.uk/pdfs/20100713_transforming_financial_behaviour.pdf]
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Written evidence submitted by the Payments Council
1. INTRODUCTION
1.1 The Payments Council is pleased to have the opportunity to submit written evidence to the Treasury Committee’s inquiry into Competition and Choice in the Banking Sector. We recognise the importance of payments in access to retail banking and so have focussed our response on this aspect of the banking sector.
1.2 The Payments Council is the organisation that sets strategy for UK payments. It was established in March 2007 to ensure that UK payment systems and services meet the needs of users, payment services providers and the wider economy. Whilst the Council is funded by its membership, which consists of banks and other bodies that provide payment services, the Board does have an Independent Chair and four Independent Directors who represent consumer and business interests. These Independent Directors, whilst in a numerical minority, can collectively veto any decision of the Board. The Council also operates several User Forums to enable better understanding of user requirements of the payment system over a wide range of subjects.
1.3 The Payments Council has three core objectives: • to have a strategic vision for payments and lead the future development of cooperative payment services in the UK; • to ensure that the payment system is open, accountable and transparent; and • to ensure the operational efficiency, effectiveness and integrity of payment services in the UK.
1.4 The Payments Council works closely with its contracted schemes, for the benefit of the UK payments industry. These include: • Bacs Payment Schemes Limited; • CHAPS Clearing Company (covering two schemes: the CHAPS Sterling and Faster Payments); • LINK ATM Scheme; • Cheque & Credit Clearing Company Limited; • Belfast Bankers’ Clearing Company Limited; and • UK Domestic Cheque Guarantee Card Scheme.
The clearing schemes are run by their respective Boards which are responsible for setting the work of the schemes and their entry criteria. This response covers the contracted schemes, with the exception of the UK Domestic Cheque Guarantee Card Scheme as it has been agreed this scheme will close on 30 June 2011.
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2. ACCESS TO PAYMENT SYSTEMS
2.1 We believe that the entry criteria set by the clearing schemes are reasonable and proportionate. It is a vital balance to get right, given their economic importance, between enabling sufficient access to schemes to create competition amongst players and ensuring that the criteria are robust and can withstand changing economic environments. As systemically important infrastructure, it is critical that payment systems are not made unstable by the failure (financial or technical) of a scheme member. Therefore, any criteria that restrict or inhibit access to the clearing schemes are only in place to the extent that is necessary to protect the systems against specific risks, or to protect the financial and operational stability of the system. As a case in point, it is important to note that the payment systems worked very well during the extreme market convulsions in late 2008.
2.2 The Payments Council has seen no evidence to suggest that the entry criteria for the clearing schemes impede competition and it is in fact the policy of both the Council and the schemes themselves to encourage new Members. The schemes aim to be as transparent as possible and ensure that information regarding membership is available in the public domain on their websites and that firms are encouraged to make enquiries about potential membership.
2.3 The schemes do not cover agency bank relationships with clearing Members but we have no reason to consider that these are causing problems. The ratio of agency arrangements to scheme Membership suggests that the agency market is competitive and thriving. If there were issues, we would expect to be made aware of any problems via applications to become direct Members, complaints about the rules of scheme Membership and wider market comment.
2.4 Over the last five years there have been twelve applications for membership across the schemes, all of which have been successful. Two of these new Members are expected on stream during the later part of 2010. Additionally, Faster Payments has received two applications for Direct Agency status, which are currently under consideration. When the technical specifications for the Faster Payments Service were drawn up, a variety of ways of accessing the service were designed so that payment institutions and others which did not want to become full members could still use the service by different routes such as direct agency access. 84
3. RAISING CONSUMER AWARENESS ABOUT CHOICE
3.1 The Payments Council pushes an agenda of transparency so that customers have the necessary information to make an informed choice about their providers. With the roll-out of the Faster Payments Service, we have published information on our website concerning Member status on the scheme – including which banks are operating in the scheme and what their individual limits are for single immediate payments and for standing orders. We believe it is important that consumers have the ability to chose their provider if speed of payments is important to them.
3.2 As part of our transparency agenda, we also operate a sort code checker on the UK Payments website that allows consumers to check whether their account (or an account they are sending money to) can receive various payment types or be eligible for having a Direct Debit instruction set up on it.
3.3 Whilst this work is important for informing consumers, we also see it as having a vital function in pushing our members to offer the best choice and service to their customers.
September 2010
85
Written evidence submitted by the Yorkshire Building Society
Executive Summary
• Building societies make a crucial contribution to the competition, diversity and strength of the UK’s retail financial services sector. Yorkshire Building Society (YBS), as a mutual, is able to offer competitive rates on savings and mortgages because it does not have to maximise returns to shareholders. YBS believes that, provided they are able to compete on fair and level terms, building societies can further enhance the level of competition in the financial services market..
• YBS believes that, in investigating competition and choice in the banking sector, the Treasury Committee may wish to scrutinise (a) the distortions that injecting public funding into plcs has created in the market, and (b) how current and proposed regulation of financial services is a significant and growing barrier to fostering competition, choice and innovation in the sector.
• YBS has welcomed the Government’s stated intention to “foster diversity in financial services, promote mutuals and create a more competitive banking industry1” and is encouraged by the Chancellor’s recent statement that “building societies and mutuals have an important role to play in the future”. YBS looks forward to seeing how this stated intention to promote mutuals is translated into action.
• One of the biggest priorities for YBS is to ensure that current and future regulatory requirements appropriately reflect the mutual model. A number of new and proposed regulatory requirements have been created or implemented. These new and proposed regulations have tended to favour large legacy institutions, with additional prudential regulation typically representing a disproportionate cost to small firms. In addition, we believe that little account has been taken of organisational entity in terms of regulating the financial services industry.
• YBS therefore believes that the Government should commit to alter the terms and approach of regulatory and supervisory authorities, including the FSA and its successor bodies. This would include appropriate and proportionate treatment of mutuals in respect of capital and liquidity requirements, and other key regulatory issues such as the funding model for the Financial Services Compensation Scheme. In particular, the financial mutual sector needs access to a mutual capital instrument.
1 Introduction
1.1 Yorkshire Building Society (YBS) welcomes the opportunity to contribute to the Committee's important and timely inquiry into competition and choice in the banking sector. YBS, which also incorporates the Chelsea and Barnsley building societies, is the second largest building society in the UK, with a strong belief in, and commitment to, the mutual ethos. With total assets of £30 billion, the Society
1 The Coalition: our programme for government, page 9 86
holds £23 billion in residential mortgages and £23 billion in members’ savings from 2.8 million members, and employs approximately 3,000 staff in a network of 178 branches and 77 agencies located across the UK.
1.2 The Yorkshire's geographical reach creates a business that is big enough to compete, yet small enough to care. Its commitment to the communities it serves is reflected in its retention of branches in areas where many other lenders have withdrawn. Over the last few years YBS has experienced a growing high street presence, at a time when many others have been reducing theirs. Our approach to mergers (see also paragraph 2.5 and 3.1) is predicated on the creation of a strong organisational centre balanced by the retention of local names, brands, character and presence in and understanding of the local communities from which we derive our strength and sense of identity and purpose.
1.3 YBS views its approach to financial stability and strength as being a direct consequence of its mutuality and the governance arrangements this entails. Strong capital and liquidity positions ensure the Society and its constituent brands are well funded. Although not untouched by the financial crisis, YBS’s financial resilience enabled it to emerge from this period of instability in much better shape than many quoted banks, without having recourse to taxpayer support. Moreover, the mutual sector as a whole, through consolidation, has largely protected the sector’s own strength and, in turn, enhanced the stability, vigour and diversity of the wider UK retail financial services market and supported its recovery.
1.4 YBS continues to work hard to maximise opportunities for its members to contribute to the effective running of the Society and in order to develop and sustain over time a robust mutual governance model. This accountability structure is a key differentiator between the mutual model and that of the plc. Member forums, a members panel and member 'question time' meetings also play their part, as part of a coherent and self-iterating programme of member engagement, in ensuring that the Society's leadership team remain continuously accountable (with votes on key issues, for example, remuneration), take decisions for the longer-term, and act with the interest of members at heart. The long-term, sustainable approach to lending that YBS has maintained in the past decade and more has allowed the Society to retain a strong financial position during and after the financial crisis.
1.5 This submission seeks to address important issues in relation to competition and choice in the banking sector, including:
• The distortions that injecting public funding into plcs has created in the market for competitors which do not have the benefit of the implicit guarantee that State support entails. • Throughout the period of financial crisis and following it, building societies retained a higher level of consumer confidence than plcs. This is reflected in regularly measured levels of customer satisfaction2.
2 see Building Societies Association report ‘Customer service at mutuals is better than at banks’ (March 2010) 87
• How current and proposed regulation of financial services is a significant and growing barrier to competition to the sector. How regulation disadvantages building societies by failing to take into account comparative organisational structures on issues such as capital and liquidity requirements. • Specific proposals on how to ensure the future stability and growth of the mutual sector in a way which creates a level playing field with the banking sector, something which YBS does not believe currently exists.
2 The impact of the financial crisis on competition and choice
2.1 An immediate consequence of the financial crisis of 2008 was, for mutuals and quoted banks alike, a substantial tightening in credit available to consumers. YBS, in common with other building societies, was less badly affected than the retail banks – most notably the nationalised and part nationalised banks – and has been able to continue to offer a wide and well balanced range of competitively priced products which continue to top "best buy" product league tables3.
2.2 But, whereas the retail banks benefited handsomely from taxpayer support (variously including the Bank Recapitalisation Programme, the Asset Protection Scheme (APS) and the Credit Guarantee Scheme), these initiatives, although ostensibly accessible on fair and level terms by the building society sector, were largely unavailable to most mutuals to draw down upon.
2.3 YBS was in a position to utilise the Credit Guarantee Scheme (CGS), which was for it a potentially suitable vehicle. Although in principle the scheme was the perfect vehicle to strengthen depositors' and broader market confidence in the mutual sector, in practice, it was much less accessible to the mutual sector than to banks, when the need arose, because many building societies were too small to issue debt securities which this initiative sought to underwrite with State support.
2.4 Although YBS did not require the type of support that other, more short-term, shareholder-focused financial entities did, counter-intuitively, those retail deposit taking institutions that took State aid came to be seen by many as enjoying a special status as “too big to fail” which enhanced the perception of their attractiveness in the eyes of actual and prospective depositors. Consumer inertia to switching means this remains a legacy of the period of instability. YBS believes that this situation could be exacerbated as the Special Liquidity Scheme is withdrawn.
2.5 Nonetheless, the building society sector in general, and YBS in particular, has played its part in reinforcing the stability of the mutual sector, and the continuance of a diverse and more robust financial services sector, through a process of defensive consolidations: YBS merged with the business of the Barnsley Building Society in December 2008 and merged with the Chelsea Building Society in April 2010. It is important to note that this strengthening of the building society sector was achieved at nil cost to the taxpayer.
3 In 2009, YBS received 1130 best buy mentions. 2010 (between January and July) YBS has received 1351 best buy mentions (this excludes Chelsea Building Society between January and March 2010) 88
2.6 So far as consumers were concerned, the market in mortgages saw a reduction of products from 27,105 in April 2007 to just 2,516 products in January 2010, according to Money Supermarket. Today, although lending criteria remain strict, that figure has risen to 2,990, and among the best mortgage products are to be sourced from the building society sector.
3 The impact of widespread consolidation among banks and mutuals
3.1 In the course of the past two years, YBS has merged with other building societies (see paragraph 2.5 above). The circumstances and rationale for each transaction were different, but both building societies share YBS’s commitment to mutuality and the values which go with this.
3.2 The financial services market has changed fundamentally in recent years, and scale is increasingly important for the efficient operation of building societies and access to funding markets. However, while remaining big enough to compete, YBS is small enough to care about its customers and the communities it serves. In addition, YBS strongly believes that its retention of the three separate brands of 'Yorkshire', 'Barnsley' and 'Chelsea', with their own high street presence and product sets, competing with each other and other providers in the sector, sustains strong competition, while helping to ensure the longer-term strength of the mutual sector in the utility retail financial services.
3.3 In YBS’s view, the system protects and in fact entrenches incumbency; militates against dynamic competition in the marketplace; and, most crucially, denies consumers real choice; and, structurally and behaviourally, obviates the switching between brands and products that, in a truly competitive banking sector, this would predicate.
3.4 New regulation to support financial stability, as well as enhanced capital and liquidity requirements, have collectively had the perverse effect of further entrenching the position of the large quoted banks, a number of which are supported by substantial taxpayer support. This has further protected their positions and, in inverse proportions, enhanced the disparity between the competitive positioning of banks and mutuals to high street consumers. As the BSA has noted, in 2009, the Lloyds Banking Group had a 24% share of new mortgage lending and 28% of the increase in deposits; Santander took about an 18% share of new lending and 23% of the increase in retails deposits.
3.5 Existing regulators can easily give the impression that they find it easiest to deal with large deposit-taking institutions, based on a plc model. This has the effect of further legitimising the plc model in preference to the mutual one, in spite of the fact that, as we explain elsewhere in this memorandum, and as the coalition Government has made clear, mutuality has a key role to play in delivering choice, competition, value, innovation and, therefore, enhanced financial stability. Mutuals, which stick to utility banking, have played their part in ensuring the continuance of diversity and vigour in the mutual sector. YBS has, through its 89
merger with the Barnsley and Chelsea, strengthened all these businesses, as well as provided reassurance to their depositors, members and staff.
3.6 It is worth remembering none of the building societies which went down the path of demutualisation have succeeded in remaining independent entities.
4 The key barriers to entry inhibiting increased competition — including regulation
4.1 Building societies make a crucial contribution to the competition and diversity of the retail financial services market. YBS is, as a mutual, able to offer competitive rates on savings and mortgages as it does not pay dividends to shareholders. YBS believes that, provided they are given a level playing field, building societies can further enhance the level of competition in the sector, in the interests of consumers.
4.2 YBS believes that regulation is a significant and growing barrier to competition in the sector. A number of new and proposed regulatory requirements (such as capital and liquidity requirements, the Mortgage Market Review, changes to the Financial Services Compensation Scheme) have been created or implemented. While the intention to further stabilise the system is welcome, there needs to be greater recognition and understanding of the cumulative effects of all these regulatory changes on market competition.
4.3 These new and proposed regulations have tended to favour large incumbent organisations, protecting them from competition, with additional prudential regulation typically representing a greater proportionate cost to small firms. In addition, we believe that little account has been taken of organisational structure in term of regulating the financial services industry.
5 Explore the Government and competition authorities’ strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market
5.1 YBS has welcomed the Government’s stated intention in the Coalition Agreement to “bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry”4. YBS has also been encouraged by a recent statement from the Chancellor that “building societies and mutuals have an important role to play in the future” and the Government wants to “strengthen them and support those who want to create mutuals.”5 YBS looks forward to seeing how this stated intention to promote mutuals is translated into action, and believes that the mutual sector could benefit from and support new entry.
4 The Coalition: our programme for government, page 9 5 Hansard, 16 June 2010 90
5.2 But YBS believes that more emphasis should be placed on strengthening existing financial mutuals to ensure that they compete vigorously, sustainably and effectively with plcs. That provides the shortest route to enhancing the competitive dynamic in the retail financial services market. That means providing mutuals with a non-publicly funded vehicle that enables them to draw down upon fresh capital, recognising that their organisational structure inhibits their ability to inject capital from the markets in the same way as quoted banks. In YBS’s view, the only credible way to achieve this highly desirable public policy outcome is to provide mutuals with a capital instrument to capacity build within the existing mutual sector and, in this way, drive choice and competition in the interests of consumers, rather than shareholders (see also paragraph 5.5 below).
5.3 One of the biggest priorities for YBS is to ensure that current and future regulatory requirements appropriately reflect the mutual model. We believe, for example, that the Financial Services Authority (FSA) has not, to date, taken organisational structure into account when regulating the financial services industry and has failed to cater adequately for building societies both in its regulation of the UK market and in its European and international negotiations. We believe that the mutual sector should be treated as a sector in its own right and not be treated in the same way as plcs.
5.4 YBS therefore believes that the Government should commit to alter the terms and approach of regulatory and supervisory authorities, including the FSA and its successor bodies. YBS proposes the following:
• An appropriate treatment of mutuals with regards to the Capital Requirements Directive in order to ensure a capital instrument consistent with mutuality. The definition of core capital needs to be consistent with mutual ownership if it is not to disadvantage mutual firms. • A review of the current funding model for the Financial Services Compensation Scheme (FSCS), where allocation does not reflect risk and the burden falls disproportionately on building societies. New arrangements are needed that more accurately reflect the relative risks faced by banks and building societies. In particular, the way in which building society regulation has developed over time has created an anomalous position in which the FSCS – and, therefore, the depositor protection threshold of £50,000 – applies to the consolidated group of businesses within a mutual, whereas for a plc with banking licences per brand, the consumer protection is multiplied by the number of banking licences it possesses. This could sustain an existing behavioural incentive for understandably risk-averse depositors to see banks rather than mutuals as the best home for their savings. • The European Commission has proposed that deposit protection cover should increase to EUR 100,000 per individual from 31 December 2010. At this time coverage will also be limited to each deposit taker and the temporary arrangement for dual cover for merged building societies will end. As building society legislation makes it far more difficult for the operating of subsidiaries, this potentially places building societies at a disadvantage to plcs, which do not operate under such restrictions and can therefore 91
continue to benefit from dual protection. We fully accept that if dual protection received a dual levy that would be appropriate and fair.
5.5 These changes can be implemented without cost to the taxpayer.
6 Conclusion
6.1 YBS has been pleased to offer these thoughts to the Committee which it trusts the Committee will find helpful. YBS would be delighted to have the opportunity to expand on its views and ideas, in oral evidence, if the Committee would find this useful.
September 2010 92
Written evidence submitted by the Paragon Group of Companies
Introduction
1. The Paragon Group of Companies welcomes the opportunity to submit evidence to the Treasury Select Committee’s current inquiry into competition and choice in the banking sector.
2. We are the UK’s leading specialist provider of residential mortgages to professional and investor landlords. We launched our first specifically targeted private rented sector mortgages in 1995 and have increasingly specialised in this market over the last fifteen years.
3. The company has been publicly-listed for the last 25 years and is currently the UK’s third largest lender of privately rented residential property finance. We have approximately 40,000 landlord customers and manage £10 billion of loan assets. Our buy-to-let arrears, at 0.97%, currently stand at less than half of those typically achieved in the owner-occupier market.
4. As a non-deposit taking lender, Paragon has extensive experience in the securitisation markets. We were the first to undertake a securitisation in the UK almost 25 years ago and we have successfully completed more transactions than any other market participant, all of which have been straightforward, transparent and low-risk.
Executive summary
5. The key points of our submission are as follows:
• Non-deposit taking lenders utilising securitisation were the mainstay of many of the more specialised parts of the UK mortgage market prior to the credit crunch, providing vital competition to the major banks and an important source of choice for consumers
• Securitisation played a vital role in the UK mortgage market more generally, accounting for 80% of the net funding needs of the mortgage industry in the twelve months before the credit crunch
• Fundamental problems in the US housing market – not the securitisation model itself – contaminated the global wholesale funding process and caused the liquidity issues that still persist today
• Non-deposit taking institutions, such as Paragon, that draw primarily on securitisations to fund new lending have been impacted negatively by the impairment of credit markets. Despite remaining profitable, our ability to make new advances has been severely constrained
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• Government and Bank of England support packages have to date been skewed in favour of the mainstream banking sector. Non-deposit takers have been excluded, placing them at a significant competitive disadvantage
• Competition in some lending markets has been eradicated by the lack of wholesale funding availability, with many of the major banks not engaging in sectors traditionally served by non-deposit takers
• In the case of the buy-to-let market this has serious social consequences – a shortage of funding for private rented homes is emerging at a time when people are increasingly unwilling or unable to enter the owner-occupier market and the social housing sector is already at full capacity
• Ensuring that credit flows are sustained and that competition in lending markets is increased will be crucial to the recovery of the British economy and, within the housing sector, to a stable and growing private rented sector. Reinvigorating securitisation markets lies at the heart of this
• We welcome the Government’s focus on reviving securitisation and would urge HM Treasury and BIS to look at ways of improving non-banks’ access to warehouse funding – a key element of securitisation that remains highly challenging and is limiting the recovery of wholesale-based lending
The importance of securitisation to competition
6. The main business model utilised by non-deposit taking lenders involves the aggregation of mortgages into a warehouse facility, with funding provided by banks until public securitisation allows debt to be raised through the issuance of bonds. Lenders whose business is based on this model rely on securitisation for long term funding and have been the mainstay of many of the more specialised parts of the UK mortgage market. Securitisation has therefore played a vital role in the UK mortgage market. In the twelve months prior to the credit crunch, 80% of the net funding needs of the UK mortgage industry were provided by the capital markets through securitisation.
7. As a result, the non-deposit taking sector, funded in the main by the securitisation markets, provided a vital source of competition for mainstream banks in the mortgage market in advance of the credit crunch. This helped to drive product innovation and a diversity of finance for consumers in a stable way, and without any of the risk associated with many mainstream banking practices in recent years. It has been more fundamental problems in the US housing market that have contaminated the global wholesale funding process and resulted in the liquidity issues that still persist today.
8. The example of Paragon demonstrates how securitisation has been – and can in the future be – used responsibly. We pioneered the use of Asset-Backed Securities in the UK and have securitised £19.5 billion of first mortgages and consumer loans through 53 public transactions. All continue to perform well and we have no exposure to any toxic assets, having neither originated nor acquired such assets. 94
The continuing impact of the credit crunch
9. The impact of the credit crunch was particularly severe on the availability of funding from the capital markets for non-deposit taking institutions and as a result, such lenders have been unable to compete in the mortgage market since 2007. As a result, we are unable to secure the necessary warehouse funds on economic terms to originate new mortgages to private landlords. The wider non-deposit taking sector is in a similar position.
10. There have been some signs in recent months that the market for Residential Mortgage Backed Securities (RMBS) is improving. Investor appetite has increased across the credit spectrum and recent deals have attracted a large number and greater range of investors. However, the market remains fragile and requires nurturing and support.
The current state of competition
11. Competition in some lending markets has been eradicated by the lack of wholesale funding availability, with many of the major banks not engaging in sectors traditionally served by non-deposit takers. Bank of England figures show that specialist mortgage lenders accounted for just 3.7% of new mortgage lending in 2009 compared to 21% in 2007. Specialist lenders provide an important source of competition for mainstream lenders, ensuring product innovation and consumer choice.
12. The buy-to-let market is an example of a specialist lending sector that has been adversely impacted by the closure of the wholesale funding markets. The availability of buy-to-let mortgage products for landlords has declined by over 90% since 2007 due to the forced withdrawal of non-deposit taking lenders the focus of high street lenders on their mainstream residential mortgage businesses. The buy-to-let market is now dominated by just two lenders, Lloyds and Nationwide, which together account for approximately 80% of the UK’s buy-to-let business and face little competition in this important part of the market.
13. The decimation of product availability in this particular market is not due to a lack of demand from investors or concerns about the credit quality of the product. Buy-to- let lending, when underwritten appropriately, is high-performing and reliable and arrears in the buy-to-let market have outperformed the wider market for 34 of the past 38 quarters. Paragon’s arrears levels remain significantly below those of the wider mortgage industry and industry peers. We are also experiencing robust demand for new loans from our customers, but we are unable to satisfy this demand due to funding constraints.
14. Due to the dysfunction in capital markets, non-deposit taking institutions such as Paragon, which were core providers of finance for investment in the private rented sector before the credit crunch, have been unable to extend loans to new landlord customers. This has potentially very serious social consequences that should not be overlooked, such as increased levels of homelessness.
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15. Demand for private rented sector accommodation has expanded significantly in recent years due to a combination of short-term economic factors and longer-term structural changes, such as a growing population, increasing numbers of single person households, expanding numbers of students and economic migrants and the general housing shortage. Proposed changes to the financial regulator environment are also likely to reduce the availability of residential mortgages as the Financial Services Authority clamps down on interest-only and self-certified loans. There is increasing evidence of a shortage of properties and there will be upwards pressure on rents without new investment by private landlords. The Royal Institution of Chartered Surveyors reported in August that the proportion of surveyors reporting rent increases rather than falls was growing.
16. Market domination by two lenders – as is the case in the buy-to-let market at present – is both non-competitive and of detriment to private landlords and private tenants at a time of rising tenant demand. There continues to be little competition and choice for borrowers in this market.
Barriers to entry persist
17. Ensuring that credit flows reach consumers and businesses continues to be key to the recovery of the British economy. The securitisation market lies at the heart of this and its continued fragility is being felt on the wider market in the form of poor competition and choice for consumers.
18. Both the coalition government and the previous administration have recognised the importance of securitisation markets to the future of mortgage finance. The previous administration’s Guarantee Scheme for Mortgage-Backed Securities provided some lending support, but excluded non-deposit takers, skewing the market in favour of mainstream banks and placing non-deposit taking lenders such as Paragon at a competitive disadvantage. Furthermore, the expiry of this facility has exacerbated the funding gap that currently exists in the market, which will get considerably larger as the Treasury and Bank of England’s liquidity support schemes also expire over the next two years. The Council of Mortgage Lenders estimates that there will be a £300 billion mortgage funding shortfall over the next five years due to lenders having to repay Government support schemes.
19. We are encouraged by the acknowledgement of HM Treasury and the Department of Business, Innovation and Skills that securitisation is important as a funding source for banks and non-bank lenders alike in their recent joint consultation on “Financing a private sector recovery”. Reinvigoration of the securitisation market is essential to future recovery as retail deposits alone were insufficient to support lending before the credit crunch and will not be sufficient to support sustained mortgage availability moving forward.
20. In particular we would urge the Government to explore ways of improving non- banks’ access to warehouse funding – vital to the revival of the securitisation market – on more acceptable terms. We will be submitting our views to Government on this issue as part of its consultation.
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Conclusion
21. It is important that Government supports the financial community to address dysfunction in the wholesale funding markets, especially as both securitisation markets and the wider economy remain fragile. We urge HM Treasury to form a securitisation forum to facilitate a full and frank discussion with RMBS market participants about the measures needed to restore a sensible, prudent and transparent securitisation market, needed to increase competition and ensure a stable flow of mortgage finance.
22. Paragon is separately working on public-private solutions that would help generate meaningful competition and choice across all sections of the mortgage market.
September 2010 97
Written evidence submitted by Toynbee Hall
Toynbee Hall welcomes the opportunity to respond to the Treasury Select Committee’s enquiry into Competition and Choice in the Banking Sector.
Summary
• The financial crisis has hit the most vulnerable the worst. It is these groups who see the strongly the negative impacts of financial instability. • Choice and competition in the banking sector is about promoting a fairer market. A tightening of affordable lending will have an ongoing negative effect on creating a banking system that is fair for all. • Creating the conditions for new entrants into the banking sector will have a positive effect on the market by introducing new suppliers; however the committee needs also to consider demand side policies. • Hidden bank charges are a problem for those who are already at the margins of the banking sector. • Moving away from free banking will hit those already in poverty worst, and will provide a disincentive for people opening bank accounts even when it is in their best interest.
1. Introduction
1.1. Toynbee Hall is a charity based in Tower Hamlets that produces practical innovative programmes to meet the needs of local people, improve conditions and enable communities to fulfill their potential. Toynbee Hall works with over 6,000 members of the community each year to support them to meet the challenges that they face and to encourage them to take control of their lives.
1.2. Toynbee Hall has been a pioneer of financial inclusion work in the UK third sector for some years, and continues to develop services and projects to help improve the lives of people facing financial exclusion. Current projects include:
• SAFE (Services Against Financial Exclusion) provides preventative financial capability training for organisations and their service users and problem-solving financial inclusion support for individuals. • Evaluation and Measurement develops methodologies and tools for measuring and evaluating levels of financial capability and inclusion and the impact of interventions designed to improve them. • The Illegal Money Lending Team provides supports to victims of loan sharks across London, through helping them to identify their financial/well-being priorities and supporting them to achieve them. • The London Strategic Financial Inclusion Champion is based at Toynbee Hall. The Financial Inclusion Champions are a national team of network-builders who support 98
organisations to make links, share best practice and close gaps in provision around Financial Inclusion. • Transact, the national forum for financial inclusion, a network of over 1000 organisations committed to practicing and promoting financial inclusion
1.3. Our comments in response to the consultation are therefore focused on the impact of the proposals on financial inclusion, and have chosen to respond to those questions that we believe have a financial inclusion element.
1.4. The recent financial crisis will have an adverse effect on the everyday lives of the most vulnerable in society1. Those most vulnerable in society often do not have access to mainstream financial services and therefore suffer further from a poverty premium, when poorer households pay more for goods and services. Without a bank account, for example, a household will not be able to take advantage of the lower costs of their utility bills by paying through a direct debit2. If Britain is to be able to exit the recession in an effective way that will not cause further detriment to the vulnerable people in society, then it is important that there is a banking sector which caters for all in society in a fair and equal way. This will have a further positive effect on financial stability, by increasing consumer confidence in the banking sector lowering the chances of another run on a British bank3.
1.5. Toynbee Hall welcomes the committee’s interest in competition and choice in the retail banking sector. Effective competition in the banking sector permits consumers to actively engage in the market by switching to better offers. This drives firms to deliver lower prices and higher quality due to the risk of losing customers. Whilst on one hand effective competition is driven by the business model of banks, we would ask the committee to consider the other side of things: the relative weakness of consumers. This is especially the case when thinking about those who are understood as being “financially excluded”4, that is those who currently do not participate in mainstream financial services. We would ask the committee to consider what effects choice and competition have on these more vulnerable groups to ensure that fair retail banking markets are created for all. This includes a consideration of the effects of changes in free banking for these groups.
1 http://www.esrc.ac.uk/ESRCInfoCentre/about/CI/CP/Our_Society_Today/economists/RecessionBritainPublication. aspx 2 http://www.savethechildren.org.uk/en/docs/poverty_briefing.pdf 3 http://news.bbc.co.uk/1/hi/business/6996136.stm 4 http://www.fsa.gov.uk/pubs/consumer‐research/crpr03.pdf 99
2. The Financial Crisis
2.1. The financial crisis has had a detrimental effect on consumer participation in the retail banking sector. This translates into having a negative effect on choice within the market. As a result of the financial crisis, banks have tightened the purse strings and lending to individuals has decreased5. This increases the chances of an individual of becoming financially excluded, because the high street will no longer lend to them. These individuals are forced to turn to door-stop lenders or loan sharks. Loan sharks target the most vulnerable and have been found to charge up to 825% APR on loans6.
2.2. The threat on financial stability caused by the financial crisis also rests on the ability that markets have for working fairly for all consumers. Toynbee Hall would therefore welcome the committee giving attention to current campaigns that are seeing to address bank lending to individuals7.
3. Demand side policies are needed for effective markets
3.1. New entrants into the retail banking sector will be beneficial to mainstream consumers in that it will have a positive effect on choice and competition8. Toynbee Hall would like to the committee to consider consumers who are for whatever reason excluded from mainstream financial services.
3.2. The availability of choice in the retail banking market can be offset by the strong presence of consumer inertia. Evidence shows that consumers tend not to shop around for competitive deals on their bank accounts. In addition, consumers have concerns that the switch might be problematic. In 2008, the number of consumers found to have switched bank accounts in the previous 12 months was 6%; the lowest in Europe9.
3.3. The other barriers to switching are not simply that the consumer does not want to switch, the problem is more that they are not able to switch. Evidence shows that a majority of low income consumers feel they do not have the knowledge to be able to switch bank accounts10. Or at least switching is sufficiently difficult enough for it to act as a disincentive.
3.4. Toynbee Hall considers inertia and the lack of financial capability to be significant barriers to creating a successful competitive market. Any policies around the development of fairer
5 http://www.guardian.co.uk/money/2010/aug/31/mortgage‐lending‐plunge‐july 6 http://www.guardian.co.uk/money/2010/jan/15/loan‐sharks‐poorest‐households 7 http://betterbanking.org.uk/ and http://www.londoncitizens.org.uk/pages/pdfs/Press%20Release.docx 8http://www.oft.gov.uk/shared_oft/reports/financial_products/OFT1005.pdf, pp24‐54 9 Ibid, p85 10 Ibid, p106 100
markets for banking therefore should consider demand side policies as well as supply side policies.
4. Free Banking
4.1. Toynbee Hall welcomes the need for more transparency from banks when it comes to charges. There is a need to deal more effectively with unfair bank charges. Incurring bank charges acts as a disincentive to opening an account for many people on low incomes11.
4.2. Consumers who are financially excluded are more like to feel the adverse effects of hidden bank charges. Through a combination of lower financial capability as well as not having the savings to recover from being overdrawn, these consumers are more likely to incur them.
4.3. Furthermore, these charges often outweigh the benefits for many people in holding a bank account.
4.4. Toynbee Hall are concerned, however, that if customers are charged for holding a current account, this will provide a disincentive for the financially excluded to enter into mainstream financial services; therefore making those who are not included into mainstream financial services, more vulnerable to the pitfalls of financial exclusion
Recommendations
• A retail banking sector needs to be set up in which they create the condition for a fair service to all consumers. For those who cannot access mainstream affordable credit, there should be viable options for these people to turn to. We would therefore recommend the continuing support of CDFIs in order to ensure the existence of viable alternatives. • We recommend the consideration of how demand side policies can have a positive effect on creating a fairer banking sector. Improved financial education, targeted at those who need it the most, should be provided to increase the knowledge and skills needed for all consumers. • We recommend that further research be conducted to look into the effect of banking charges on low-income groups.
September 2010
11 http://www.jrf.org.uk/sites/files/jrf/2222‐financial‐exclusion‐policy.pdf, p26 101
Written evidence submitted by the Association of British Credit Unions Limited (ABCUL)
1. Executive Summary
1.1 Credit unions are financial co-operatives owned and controlled by their members on a ‘one- member-one-vote’ basis. They offer safe savings products and affordable loans and an increasing range of other services.
1.2 Credit unions are legally constituted under the Credit Unions Act 1979. They are regulated deposit takers with the same protections and safeguards as those afforded to banks and building societies.
1.3 Credit unions provide inclusive services to the whole of their communities rather than simply the better-off.
1.4 Over the past decade savings, loans and assets held by credit unions have grown four-fold and membership has tripled.
1.5 Impending reforms of the Credit Unions Act, which has been described by the World Council of Credit Unions (WOCCU)1 as amongst the most restrictive in the world, will see credit unions able to reach out to new groups and develop new services.
1.6 At present, the Legislative Reform Order (LRO) which will bring in these vital reforms is still making its way through Parliament. We are keen for this process to be completed as quickly as is possible, so that credit unions and consumers can start to benefit from the reforms
1.7 ‘The Coalition: our programme for government’ states a commitment to ‘bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry’. We believe that the continued development of credit unions is vital to this process as the only true, local alternative to the mainstream banking system.
1.8 Internationally, there is a proven model for credit union development which – following professional development, strengthened governance and the flexible and proportionate application of regulatory and legislative frameworks – rests on the development of centralised shared services to enable credit unions to benefit from economies of scale whilst retaining their localised nature and autonomy.
1.9 With a back-office system in place, all credit union services could be made available through the Post Office network. This would greatly increase the accessibility and visibility of credit union services whilst providing a new source of revenue to the Post Office network and boosting its sustainability.
1.10 The development of the back-office system and Post Office partnership would cost somewhere in the region of a one-off £10-£15 million. Given its potential to address several key areas of government policy, this represents significant value for money. The system would increase diversity and competition in banking, improve the sustainability of the Post Office network and address the present lack of universal financial services provision.
1 See www.woccu.org 102
2. Introduction
2.1 We welcome the opportunity to respond to this inquiry. ABCUL is the main trade association for credit unions in England, Scotland and Wales, and our members serve around 85% of Britain’s credit union membership. Credit unions are not-for-profit, financial co-operatives owned and controlled by their members providing safe-savings and affordable loans facilities. Increasingly credit unions offer more sophisticated products such as current accounts, ISAs, Child Trust Funds and mortgages.
2.2 At the end of March 2010, credit unions in Great Britain were providing financial services to 761,708 adult members and held almost £600 million in deposits with around £475 million out on loan to members. An additional 107,077 young people were saving with credit unions. 2
2.3 At 30 September 2009, the 325 credit unions belonging to ABCUL were managing around £568 million of members’ savings on behalf of over 470,000 adult members.
2.4 The Credit Unions Act 1979 sets down in statute the objects of a credit union; these are four- fold:
• The promotion of thrift among members; • The creation of sources of credit for the benefit of members at a fair and reasonable rate of interest; • The use and control of their members’ savings for their mutual benefit; and • The training and education of members’ in the wise use of money and in the management of their financial affairs.
2.5 Credit unions in Britain are small, co-operative financial institutions often extending financial services to those unfairly excluded from the financial services the majority take for granted. They are owned and controlled by a restricted membership and are operated for the sole benefit of this membership. The Credit Union Act 1979 sets down these operating principles in law. The central, local and devolved governments of the UK have consistently supported credit union expansion and development in recognition of the benefit that they provide.
2.6 The Coalition Government, since coming to office, has committed to bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry.3 At a meeting of the All-Party Parliamentary Group on Credit Unions on 30th June 2010, the Financial Secretary to the Treasury, Mark Hoban MP, explicitly identified credit unions as part of this drive to support mutuals in financial services saying:
“We are determined to help credit unions grow and expand into the future. But growth and expansion must be established on the basis of credibility – credibility that can only come as credit unions build sustainability. And it is in the interests of credit unions, the members of credit unions and the movement as a whole that sustainability is built.
“This Government believes that strong credit unions will greatly enrich British society, so it is in our interest to do whatever we can to help the credit union movement to prosper.” 4
2 Figures from unaudited quarterly returns provided to the Financial Services Authority 3 The Coalition: our programme for Government: http://www.cabinetoffice.gov.uk/media/409088/pfg_coalition.pdf 4 See: http://www.hm-treasury.gov.uk/speech_fst_300610.htm for full speech 103
2.7 Internationally, credit unions are a successful alternative to mainstream financial services providers – the chart below compares international market penetration.5
Country Market Penetration Total Assets (USD) Average Assets (USD)
Ireland 75.4% 20,052,172,916 39,865,154
Canada 47% 229,693,740,409 243,062,159
USA 44.3% 896,823,977,926 116,349,763
Australia 24% 42,172,247,180 379,530,154
Great Britain 2% 1,072,321,685 2,220,127
2.8 Credit union in Britain have not yet achieved their full, internationally proven potential – although there are pockets which exemplify what is possible with the right support, such as Glasgow where 1 in 5 people is a credit union member.
2.9 Measures taken to develop the credit union sector have built a strong base from which to expand into the future. With radical legislative reforms in train and a decade’s foundation building behind the sector, the right support over the next few years has the potential to push British credit unions into a comparable position with their international counterparts nationally – injecting a strong element of diversity, choice and extra competition into British financial services and providing a better deal for consumers of all incomes and a more stable financial services system overall.
3. Credit union development so far
3.1 In the decade since the turn of the century, credit unions in Britain have undergone a fundamental shift in their developmental philosophy and have earned significant recognition and support as a result.
3.2 Beginning with a seminal research project published in 1999 by Paul A Jones of Liverpool John Moores University, Towards Sustainable Development,6 British credit unions – led by ABCUL – began to implement a new model of development based around a recognition that credit unions needed to be professionally-run, financial businesses before they could be socially effective ethical financial services. Credit unions would need to have a broad membership, operate from high-street premises and provide a quality of service comparable with that of the mainstream financial services.
3.3 Developments that have contributed to this transformation include:
3.3.1 Increasingly credit unions began to employ trained staff, implement sound governance and provide services to a wider range of people – requiring a greater level of sophistication of product offering including: ISAs, Child Trust Funds, insurance and mortgages.
5 Figures taken from the World Council of Credit Unions’ Statistical Report, 2009. See: http://www.woccu.org/publications/statreport 6 See: http://s.coop/towardssustainabledevelopment 104
3.3.2 In 2002, credit union regulation became the responsibility of the Financial Services Authority which meant, for the first time, credit unions were prudentially regulated and supervised. Furthermore, savings were guaranteed by the Financial Services Compensation Scheme and complainants had recourse to the Financial Ombudsman Service.
3.3.3 ABCUL successfully lobbied for various regulatory and legislative changes which have allowed for, amongst other things, an increase in the upper-rate of loan interest, greater flexibility around common bonds and a package of legislative reforms ongoing which will put British credit union legislation on a par with any other movement in the world. It is imperative that these final legislative changes are passed as soon as possible to promote the unrestricted, natural growth of British credit unions.
3.3.4 A new era of financial support was begun – epitomised by the DWP Growth Fund – which tied funding to contractual growth targets and developmental goals. The Growth Fund to April 2010 has provided 260,000 loans totalling £113 million and saving recipients in the region of £86 million compared with the leading doorstep lender, Provident Financial. Furthermore, according to DWP’s interim evaluations of the scheme’s effectiveness, participant credit unions have grown significantly in organisational strength and asset size compared with their non- Growth Fund counterparts. Average loan-processing costs have been reduced by 60% to £66 per loan.7
3.3.5 A major training and development project – DELTA – was undertaken by ABCUL to support the continued development of credit union staff and volunteers and to ensure the institutional soundness of the credit union movement.
3.3.6 The Credit Union Code of Governance was developed to ensure strong standards of internal governance were standardised across the credit union movement as an essential prerequisite to positive growth.8
3.3.7 ABCUL and some our leading members – with infrastructure support from the Co-operative Bank – developed the Credit Union Current Account (CUCA) which brought a full current account facility with debit card functionality to the British credit union movement for the first time.
3.4 As a result of these and other initiatives the credit union sector has built over the past decade to a position of strong fundamental foundations. The decade to 2007 saw savings, loans and assets all grow by more than four-fold and membership almost treble.9
3.5 Below we set out how a further package of one-off support will enable the British credit union movement to emulate our international counterparts through developing a strong infrastructure which will afford credit unions the same economies of scale enjoyed by much larger institutions whilst retaining the local, ethical ethos which sets credit unions apart from their financial services counterparts.
4. A credit union back-office
4.1 Credit unions in Britain, whilst currently being a small feature of the financial landscape, have taken great developmental strides in the past decade.
7 See: S. Collard & L. Day, Evaluation of the DWP Growth Fund – Interim Report, PFRC / Ecotec, May 2010 8 See: www.credituniongovernance.coop 9 See P. A. Jones, Breaking Through to the Future, Liverpool John Moores University, 2008: http://s.coop/breakingthroughtothefuture 105
4.2 The imminent introduction of the Legislative Reform (Industrial and Provident Societies and Credit Unions) Order (LRO), having undergone an extended period of review and consultation begun in 2006, will cement the significant legislative and regulatory recognition already secured with a modern, proportionate and flexible framework on a par with the best in the world and removing significant barriers to growth.
4.3 It is vital that the LRO is passed as soon as protocol allows; many credit unions and potential partners are keen to use the new legislation to bring benefits to consumers. 4.4 The missing piece in the developmental jigsaw, based on international best-practice, is the development of a centralised, back-office system which would provide the economies of scale necessary to bring great efficiencies and consistency of service to the credit union sector building capacity and resulting in a step-change in credit union development.
4.5 Those services which the back-office might provide include:
4.5.1 A common accounting platform for credit unions enabling central treasury and liquidity management
4.5.2 Central loan processing, credit control and marketing resource
4.5.3 Human resources, legal and compliance services provided centrally
4.5.4 Significant cost reductions in providing more sophisticated products, including CUCA, pre-paid debit cards, insurance, ISAs and mortgages
4.5.5 Potential for centrally managed internet and telephone banking
4.5.6 A conduit through which full collaboration with the Post Office could be achieved in that, through the common platform, all credit union accounts and services can be accessed at all Post Office branches earning a transaction fee for the Post Office and greatly increasing the accessibility and visibility of credit unions
4.6 The implementation of a back-office for credit unions would result in a significant step-change in the sector’s development leading to a fast growth in scale and reach and introducing the sector as a significant new player in the financial services market.
5. The potential effects of a credit union back-office
5.1 Even on conservative estimates, the potential for credit union growth with a back-office system in place is enormous. We anticipate credit union membership to grow from 750,000 to 2 million in five years – potentially by much more.
5.2 This would have the effect of increasing the diversity, choice and competition in financial services as per the Coalition’s commitment in its programme for government.
5.3 It would also have the effect of bolstering the credit union business model and creating a much more sustainable credit union sector. This was outlined as the Government’s vision for the movement in the Financial Secretary to the Treasury Mark Hoban’s recent speech to the All-Party Parliamentary Group on Credit Unions, and this was a vision similarly articulated and supported by the previous Government.
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5.4 A collaboration with the Post Office could also meet the government’s commitment to ensuring that the Post Office network is freed to develop its range of services and increase revenue and sustainability. This would improve the situation further by making inclusive, ethical financial services available through the network which is already the leading provider of financial services to those most in need of access to fair financial support through the Post Office Card Account (POCA). Pensioners, benefits claimants and small businesses are the main users of the Post Office’s services and credit unions have a strong role to play in serving these groups.
5.5 The Government has also committed to altering the prevailing culture of borrowing to one of savings and investment. A greatly strengthened credit union sector would boost this effort. Under the Credit Unions Act, credit unions have as part their statutory objects both the promotion of thrift amongst members and the training and education of members in the wise use of money and the management of their financial affairs. There are several key ways in which credit unions do this most notably through payroll deduction which, drawing on the insights of Behavioural Economics and Richard Thaler’s Nudge theory, deducts savings at source before an individual has had seen the money and greatly increases the likelihood that they will stick to their saving plans.
5.6 The on-going consultation jointly conducted between HM Treasury and the Department for Business, Innovation and Skills, Financing a Private Sector Recovery, is seeking views on ways in which private finance can be utilised to finance a growth in private enterprise and credit unions have a role to play in this. The upcoming LRO will enable credit unions to serve bodies corporate as well as individuals and therefore funding small enterprises will be an area in which credit unions could potentially play an important role following its passage – particularly should their capacity be strengthened by the back-office.
5.7 The Government’s ‘Big Society’ policy has received much attention and is another area where a stronger credit union movement can have an important role to play. The Big Society Bank could be used to support the activities of credit unions, both in themselves as social enterprises, but also, pending legislative reforms, as conduits for finance to small social enterprises in their communities. Similarly, an expanded and strengthened credit union sector will have more capacity to support social enterprise through its own resource.
6. Other areas for support
6.1 Credit unions, under their co-operative structure, are directed by an elected board of volunteer directors. We feel there is a potential role that large banking groups could play – jointly with ABCUL – in creating a volunteer hub which would match skilled banking employees with eligible credit unions to strengthen credit union governance.
6.2 Currently, credit unions are restricted from accessing capital markets. A liquid secondary capital market for credit unions would assist greatly in increasing their scale. Potential avenues for this are greater emphasis on Subordinated Debt, the imminent introduction of Deferred Shares – as per the Building Society sector – and Social Investment Bonds.
6.3 Another feature of the credit union sector internationally is the appearance of Stabilisation Funds which work to intervene where credit unions are in difficulty through various means. ABCUL have recently commissioned a research project into the viability of such an initiative in Britain and we feel there is great potential for supporting credit union strengthening in such a scheme.
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7. Conclusion
7.1 Credit unions in Britain operate on an internationally proven model which has great potential to increase diversity and competition in financial markets.
7.2 In the past decade, credit unions have undergone a reassessment of their development model leading to a great strengthening of the sector due to various initiatives involving reform of the regulatory and legislative framework, strengthening governance and management, increasing the sector’s capacity and securing appropriate investment.
7.3 A credit union back-office – as well as several other strengthening initiatives – and a full partnership with the Post Office network has the potential to transform the credit union movement and build upon the strong foundations laid over the past decade. This would assist in various areas of government policy and as such, any investment represents excellent value for money.
September 2010 108
Written evidence submitted by 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 Future of Banking Commission 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.
4 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.
Structure of this response
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 109
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.1 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.
9 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.
1 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 Market Definition, OFT403. 110
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’.2 > 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’.3 > 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.4
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.
Evidence from members of the public and bank customers
13 Since October 2009 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.5 This culminated in the Which? Big Banking Debate on 4 February 2010 attended by over 300 people.6
14 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.
2 Page 2 Personal current accounts in the UK, July 2008, OFT. 3 Paragraphs 56 – 60 Personal current account banking services in Northern Ireland, Market Investigation 15 May 2007, Competition Commission. 4 Market Investigation into Payment Protection Insurance 5 June 2008, Competition Commission. 5 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/). 6 A summary of the Which? Big Banking Debate is available here: http://www.which.co.uk/banking/ourevents. 111
15 Nearly three-quarters of participants of the Which? Big Banking Debate considered banks should be broken up to create more competition, while nearly fifty per cent consider separating investment banking from day to day banking is essential.7 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 rate8), 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 39 to 41).9
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?” Participant, Which? Big Banking Debate
“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 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.
19 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:
7 Polls were taken during the Big Bank Debate via electronic key pads of key questions. 8 See chart 3.2 Trends in Lending, July 2010, Bank of England. 9 See for example the results of Lloyds Banking Group which holds a market leading position in current accounts, deposit saving accounts and mortgages. 112
“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”. Consumer, which.co.uk/banking
“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.
Customer satisfaction surveys and complaints
23 Which? has conducted satisfaction surveys of its members for savings, current accounts and mortgage providers in 2008, 2009 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.
24 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:
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Table 1 –Satisfaction results for personal current account brands10 Bank 2008 2009 2010 Lloyds Banking Group (a) 59% 55% 49%
(HBoS) 56% RBS (b) 61% 57% 55% HSBC 57% 60% 58% Barclays 53% 55% 53% Santander (c) 44% 58% 52% Average ‘Big 5’ 57% 53% (excluding Santander for 2008) (57%) Banks achieving 70% or greater satisfaction results First Direct* 85% 90% 88% Virgin One - - 88% Co-operative bank 82% 84% 86% Smile 88% 91% 85% Nationwide 79% 79% 72% First Trust - - 72% Cahoot* 82% 84% 71% Intelligent Finance* 72% 74% - Notes – (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. Source: Which? annual satisfaction surveys 2008, 2009 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
10 The 2010 Which? current account survey was conducted in October – November 2009 and April 2010 and consisted of over 14,500 Which? members through an online survey. 114
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.11 The average satisfaction score amongst the Big 5 for savings accounts was only 47 per cent, First Direct and Co- operative Bank were the only brands to score 70 per cent or higher. The worst performing bank brands were Santander at 39 per cent 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 per cent satisfaction compared to the best result of 87 per cent (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 2009). 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.
29 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.12 For example, over 5 years FOS has dealt with over a 5 fold increase in personal current account and deposit saving complaints, while mortgage complaints have risen by 140 per cent.13 The FSA has reported similar findings in the number of complaints brought to its attention.14
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.
11 Which? savings account research was conducted in October – November 2009 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 4500 Which? members through an online survey. 12 See Which? press release ‘Too many complaints wrongly dismissed’ at http://www.which.co.uk/about- which/press/campaign-press-releases/personal-finance/2009/05/too-many-complaints-wrongly-dismissed-says-which.jsp 13 See the Annual Review 2008 / 09, FOS (http://www.financial-ombudsman.org.uk/publications/ar09/about.html). 14 See Which? press release ‘Complaints reflect financial firms’ standing amongst consumers, says Which?’, 3 September 2009 (http://www.which.co.uk/about-which/press/campaign-press-releases/personal-finance/2009/09/complaints-reflect- financial-firms-standing-among-consumers-says-which.jsp). 115
Product performance
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 per cent in March 2009. 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 per cent 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 per cent, while others have fallen to zero.
Table 2 Illustrative changes for current account in-credit interest payments Credit interest rates on a £1 to £1000 balance Bank brand or building society Account name Jun-08 Mar-09 May-10 High interest accounts 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% Halifax15 Ultimate Reward Current A/c 5.12% 2.50% 0.00% Lloyds TSB Classic Plus 4.00% 2.50% 2.50% Barclays Bank Current Account Plus 2.99% 0.00% 0.00% HSBC Bank Account Plus 2.50% 3.00% 0.00% Low interest accounts Alliance & Leicester Premier Current A/c 0.99% 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% Source: Moneyfacts and Defaqto
15 £5 a month reward paid if account is credited with more than £1,000 each month 116
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 per cent of the revenue from so called ‘free’ bank accounts.16 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 £97 billion daily directly from consumers rather than going to wholesale money markets, bond or shareholders.17 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.
34 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 per cent, higher than any rate for the last 15 years.18 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 2009, 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.19 Ostensibly this is a simpler, more transparent overdraft policy. However, a consumer would need to have an overdraft of nearly £2000 in order to pay less than the average authorised overdraft rate.20 The OFT’s 2008 market study estimated that, of those accounts in overdraft, no more than 10 per cent of accounts were over £1000 and no more than 5 per cent over £2000 in debit.21 This leaves 90 – 95 per cent 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 per cent.
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 per cent LTV, mortgages with 95 per cent 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
16 Figure C.4, annexe C, Personal current accounts in the UK, a market study, July 2008, OFT. 17 This is the estimated daily credit balance in current accounts for 16 banks, it excludes savings deposits. See paragraph 2.23 of Personal current accounts in the UK, a market study, July 2008, OFT. 18 Source: Bank of England. 19 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 20 A daily rate of interest, based on the effective annual rate of 18.86 per cent, requires a credit balance of £1935.50. 21 Chart 4.5, Personal current accounts in the UK, a market study, July 2008, OFT. The OFT estimated that 40 per cent accounts in overdraft were upto £100 in value, and about 32 per cent between £100 - £500. 117
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% LTV) 2000 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
Source: 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 (i.e over 60 per cent) 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 > 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 per cent (their lowest in the history of the Bank of England) 118
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 4.5 per cent above base rate. Which? is also concerned with the behaviour of Skipton Building Society which raised its SVR by 1.45 per cent in March 2010, breaking a promise to customers that its SVR would never be more than 3 per cent above base rate;22 > 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 £40 from £35.
Bank performance
39 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 4 banks have performed especially well:
> The retail-arms of the Big 4 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 Group23 – Profitability of the retail business in the first half of 2010 was £2,495 million, compared to £360 million for the same period in 2009. The increase in margins was attributed to "the continued re-pricing of risk and a decrease in the LIBOR spread to Base Rate. Low interest rates also meant that more mortgage customers moved onto, and are staying on, standard variable rates. Retail has also reduced the proportion of more expensive term deposits, while maintaining strong deposit growth."
UK tax payers own 41 per cent of LBG shares, managed by UKFI.
· RBS24 - Profitability of the retail business in the first half of 2010 was £416 million, compared to £37 million for the same period in 2009. RBS noted “Widening asset margins across all products and an increasing number of mortgage customers choosing to remain on standard variable rate were the key drivers. Liability margins, however, fell as a result of lower interest rates, a competitive market place and our focus on saving balance growth.”
UK tax payers own 84 per cent of RBS, managed by UKFI, with £282 billion of assets publicly insured under the Asset Protection Scheme.
40 Some improvement in the availability of mortgage lending has been reported.25 However, the cost of funding mortgage lending has fallen but lenders are only passing on
22 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. 23 2010 Interim Results, Lloyds Banking Group, http://www.lloydsbankinggroup.com/investors/financial_performance/company_results.asp. 24 Royal Bank of Scotland Group, Interim Results 2010, http://www.investors.rbs.com/our_performance/resultsandpresentations.cfm. 25 ‘Mortgage margins at all time high’, 19 August 2010, press release, Moneyfacts. 119
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.26 As noted by Sir Martin Taylor, former CEO of Barclays, to the Future of Banking Commission: ‘the investment banking activities of a universal bank were at all times parasitic on the retail bank balance sheet.’
41 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.
42 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.
43 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.27 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.
26 ‘Banks customers still paying for mistakes by investment bankers’, 19 August 2010, www.guardian.co.uk 27 ‘New Barclaycard is touch-and-pay’ http://news.bbc.co.uk/1/hi/business/6945991.stm. 120
Market concentration
44 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.
45 The main driver of recent changes has been a significant increase in mergers. Since April 2008, there have been 14 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.
Table 3: Mergers and Acquisitions in UK Banking (since April 2008) Year Financial Institution Merged with/ Acquired 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 2009 Co-operative Financial Services Britannia Building Society 2009 Yorkshire Building Society Chelsea Building Society 2009 Nationwide Building Society Dunfermline Building Society 2009 Skipton Building Society Scarborough Building Society 2010 Barclays Standard Life Bank 2010 Coventry Building Society Stroud and Swindon Building Society Source: Bank of England (2008). ‘Financial Stability Report’, Issue 24, pgs 24-25, 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/
Market shares
46 The market share for three key retail banking services - personal current accounts, savings and mortgages - are summarised below. 28 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 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).
28 Data was drawn from the following Mintel reports: Current, Packaged and Premium Accounts, Finance Intelligence, June 2009; Deposit and Savings Accounts, Finance Intelligence, May 2009; Mortgages, Finance Intelligence, March 2010. 121
Table 4: Estimated market share for key retail finance markets Banks / building Personal current Deposit savings Mortgages 2009 societies accounts 2009 (%) accounts 2008 (%) (%)
Lloyds Banking Group 28 25 25 (a)
RBS (b) 17 11 13
HSBC (c) 14 9 11
Santander (d) 12 13 18
Barclays 12 9 10
Nationwide 8 10 8
Other (e) 9 23 15
Notes: (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.
47 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.29
Table 5: Historical market share of the ‘Big four’ banks Year Personal Current Deposit savings Mortgages (%) Accounts (%) accounts (%) 2009 (a) 71 59 67 2006 66 44 47 1998 (Cruickshank report) (b) 59 19 17 (a) This excludes Santander, which has grown significantly through its acquisition of failed banks over the last 3 years and recent purchase of branches and accounts from RBS. (b) De-mutualised building societies held 42 per cent share of the deposit savings account market and 48 per cent share of mortgages, these have subsequently all failed or been acquired by the big banks.
29 The ‘big four’, prior to recent mergers and other market changes, include Lloyds TSB, RBS / NatWest, Barclays and HSBC 122
Market entry and exit
48 Which? has identified a number of potential barriers to entry, drawn from written responses submitted to the Future of Banking Commission 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.
> 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).
49 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 123
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).30 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.31 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).32 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.
Consumer engagement and switching behaviour
54 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
30 The 2010 Which? current account survey. 31 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. 32 Paragraphs 4.91 – 4110, Assessing the effectiveness of potential remedies in consumers markets, April 2008, OFT. 124
about a customer’s bank account and increase confidence in the switching process.33 This includes work with Bacs, the payment system provider, to address problems with transferring accounts and improve information to consumers.34
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 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 per cent of Which? members have ever switched personal current account. Switching rates amongst Which? members average 6 per cent per year (measured over a 5 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 per cent 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 per cent 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 40 per cent 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.
59 Nearly 30 per cent 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.
Free banking and its impact on switching
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
33 Personal current accounts in the UK – a follow up report, October 2009, OFT. 34 see http://www.bacs.co.uk/Bacs/Corporate/BacsServices/Pages/Acccountswitchingservice.aspx. 125
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 per cent of this arising from net interest payments (the difference between interest paid and the income banks earn from interest).35
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.36
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 and continuation of hidden or opaque charging models that may be difficult to challenge for fairness, leading to a serious risk of untended consequences.
Conclusions on switching
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.
64 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
35 Figure C.4, annexe C, Personal current accounts in the UK, a market study, July 2008, OFT. 36 79 per cent 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 1022 representative members of the public, surveyed September 2007. 126
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 1999 (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.
Regulation – implicit subsidy
69 Which? established a Commission into the Future of Banking early in 2010, and received evidence from key players amongst banks, regulators and government.37 Evidence to the
37 The full report of the Future of Banking Commission can be accessed at http://commission.bnbb.org/banking/sites/all/themes/whichfobtheme/pdf/commission_report.pdf 127
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 banking industry, because it’s been underwritten implicitly against failure, without paying a premium, has enjoyed a huge subsidy”.38 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 Future of Banking Commission: “Ultimately the heart of the problem does come down in my view to the inherent riskiness of the structure of banking that we’ve got, and the difficulty of making credible the threat not to bail out the system, which is what is underpinning the implicit subsidy and creating cheap funding for large banks taking risky decisions.”39
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 5 banks in the UK amounted to £50 billion for the period 2007-09, representing about 90 per cent of the total implicit subsidy available to the banking industry.40 In its submission to the Future of Banking Commission Virgin Money estimated private equity investors demanded a 10 – 13 per cent 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.
State aid – the role of UKFI and sale of branches by RBS
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.41 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
38 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-209873.pdf. 39 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-209925.pdf. 40 Page 4 - 6, The $100 Billion Question, March 2010, Andrew Haldane, Bank of England: http://www.bankofengland.co.uk/publications/speeches/2010/speech433.pdf 41 For details see Chapter 3 of the Budget 2009, April 2009, HM Treasury. 128
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.
74 UKFI is the company established in November 2008 by the Government to manage UK shareholders interests in failed banking institutions.42 It has three objectives:43
> 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. 44 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.’45 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.46 Which? does not consider this a promising
42 Page 30, ‘Reforming Financial Markets’, July 2009, HM Treasury. It was announced on 28 July 2009 that UKFI has now taken formal responsibility for those investments in Bradford and Bingley that were not passed to Santander. 43 Letter to Treasury Committee from the Chancellor, 3 November 2008. 44 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 2009 (‘the guidance’). 45 Paragraph 20 of the guidance. 46 Press release Royal Bank of Scotland Group PLC – RBS Agrees Sale of Branches to Santander, 4 August 2010. 129
outcome for consumers and view this as a huge missed opportunity.47 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.
79 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.
The role of competition in the regulatory regime for banks
47 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/ 130
84 Financial services are not subject to the same rules governing competition as most other industries in the UK.48 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 1998. 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.’49
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.’50 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.51
89 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.
Competition and stability
90 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’.
48 Special arrangements exist for media and public interest issues which includes national defence and recently financial stability. 49 Section 164, FSMA 2000. 50 Section 2(3)(g), FSMA 2000. 51 An initial complaint about the treatment of investment advice and advisors by the FSA was made under the Financial Services Act 1986, and subsequently followed up by the OFT after FSMA 2000 came into force. 131
91 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.
92 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.
Regulation and market confidence
93 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.
94 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.52 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 per cent of those holding general insurance products bought their policy without comparing it to any other product.53
95 Consumers of financial services may possess ‘bounded rationality’ and/or ‘non-standard preferences’.54 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.55
96 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.
97 Which? has responded to the Government’s consultation on reform of the Consumer Rights Directive, proposing a principles-based approach to restore consumer protection
52 Financial Capability in the UK: Establishing a Baseline, FSA. 53 Page 5, Financial Capability in the UK: Establishing a Baseline, FSA. 54 For a summary of these concepts see Assessing the effectiveness of potential remedies in consumer markets, April 2008, OFT. 55 This was considered as part of the OFT’s personal current accounts study. 132
from unfair prices.56 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.
98 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.
99 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 check, currently to be supported via the Consumer Financial Education Body.57 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.
56 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 57 http://www.hm-treasury.gov.uk/d/consult_financial_regulation_condoc.pdf 133
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.
104 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.
September 2010 134
Written evidence submitted by the Co-operative Financial Services
Executive Summary The Co-operative Financial Services’ (CFS) merger with Britannia, in August 2009, 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. 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 £14 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 2009, created a strong business with £70 billion of assets, 13000 colleagues and nearly nine million customers. 135
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. 4. 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 9. 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. 11. Thanks to this focus we’re leading the way in customer service and advocacy and this has been recognised by the industry: In 2009, 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. 136
The FSA recently announced that The Co-operative Bank has the lowest ratio of complaints with just 2.1 for every 1000 accounts and that over 95 per cent 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. 14. 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 £1billion of lending since 1992, 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 44 countries. 19. 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 2009 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 4%. 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 137
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 40% over the last 3 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 90% loan-to-value option across our mortgage range, which has proved popular with first time buyers. 24. 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. 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. 29. 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. 138
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 Skills4Schools 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 Skills4Schools. 33. In 2009, CFS’ Skills4Schools programme enabled over 8000 young people to improve skills such as numeracy, money management, employability and even safe driving. 34. 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 Sale of parts of government-owned banks 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. 39. 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. Regulatory Environment 40. 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. 139
41. 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. Infrastructure 42. 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 £250m 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. Financial Services Compensation Scheme 43. 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. 44. 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 45. 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. 46. 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. 47. 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.
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Identification and Verification 48. 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 49. 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. 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. 54. 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. September 2010
141
Written evidence submitted by Tesco 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 £4.8bn and total savings deposits of £4.5bn.
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.
4. 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. Barriers to switching. 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. Access to information. 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 142
and expenditure, as well as wider product holdings, through a closed user group. This puts smaller players at a disadvantage.
III. Regulation. 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. Practical – barriers to switching
9. 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.
10. Around 95% 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 account1. 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 (e.g. 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
1 Source: GfK NOP 143
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.
14. 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. Access to information – a level playing field
15. There is, rightly, an increasing focus on responsible lending – most notably in the OFT guidance published recently2 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
2 Irresponsible lending – OFT guidance for creditors, March 2010 - http://www.oft.gov.uk/shared_oft/business_leaflets/general/oft1107.pdf 144
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.
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. Regulatory
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.
19. We have a number of concerns about the current regulatory system:
• There is a lack of certainty about the process and outcomes. 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.
• There is a lack of stability and consistency. 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 2007/8, via the Payment Services Regulations in 2009, by the introduction of the Lending Code in 2009/10, the OFT’s Irresponsible 145
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 14 July 2010.
• It is resource intensive, particularly for smaller banks. 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.
September 2010
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Written evidence submitted by RBS 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.
• 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 13th July in turn.
Assess the impact of the financial crisis on competition and choice in both retail and wholesale markets
4. 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. 147
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 1970s and 1980s, 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.
9. 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. 148
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 29 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 (e.g. 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.
14. 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 149
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 (e.g. in payments processing) are accessible at relatively small sizes through arrangements with specialised processing companies.
19. 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.
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
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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, e.g. 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.
24. 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. 151
Consider the relationship between competition and financial stability;
29. 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.
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 1984 that led all other banks to swiftly follow suit (Midland gained approximately 450,000 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.
34. 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.
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35. In August, the Bank of England Quarterly 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 2009 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.
September 2010 153
Written evidence submitted by Lloyds Banking 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, e.g.: • 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.
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CONSUMER OUTCOMES IN THE UK MARKET
4. International benchmarking evidence suggests that the UK banking market is producing outcomes consistent with a competitive market.
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 9 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 64,000), advances in card technology and in the types of savings, mortgage and insurance products available to consumers.
9. 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 155
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: Improving transparency • 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.
Improving the switching process for consumers • Introducing “one-stop-shop” switching for current accounts and introducing the ISA promise and automated ISA transfer service.
Increasing ease of use • Offering products with very clear, simple charging structures in personal current accounts and credit cards (e.g., 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 156
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.
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.
14. Since its entry to the UK market in 2004, 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 (e.g., 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.
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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 4.6% share of the personal current accounts market in the UK and up to approximately 19% of the Group’s mortgage assets. The business would consist of: o The TSB brand o The branches and branch based customers of Lloyds TSB Scotland and a related banking licence o The branches, savings accounts and branch based mortgages of Cheltenham & Gloucester o Additional Lloyds TSB branches in England and Wales, with branch based customers o The Intelligent Finance brand and all its customers and accounts
19. 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 14% 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 “this plan effectively addresses the Commission’s competition concerns and at the same time ensures the return of Lloyds Banking Group to long term viability… this is to the clear benefit of customers and tax payers.”
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 158
years. Data from Moneyfacts from February 2010 shows that consumers can choose from a wide range of providers. There are: • Nearly 40 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.
24. 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, 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 (e.g., First Direct) provide current account services using principally non-branch channels of communication (i.e., 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 159
significantly less concentrated than for utilities, grocery retail, mobile telecommunications, and the fiercely price-competitive home broadband and pay TV markets.
29. 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.
FIGURE 1
1 Source: Bankscope, Datamonitor, etc
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
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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
34. 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.
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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.
September 2010 162
Written evidence submitted by David T Llewellyn, Professor of Money & Banking, Centre for Financial Markets and Institutions, Loughborough University
COMPETITION, CONTESTABILITY and EFFECTIVE COMPETITION IN BRITISH BANKING
EXECUTIVE SUMMARY When considering the nature and structure of competition in banking and retail financial services, three alternative concepts are to be identified: competition, contestability and effective competition. A market may appear to be highly competitive but competition may nevertheless not be effective in the market place. Even though there may be many competitors in a market, competition is only effective in practice if consumers are able: to make rational and informed choices between competitors, and to exercise choice at low transactions costs. Both may act to limit effective competition. Even if consumers are able to make rational choices, the transactions costs of exercising this choice may be high. Information is the major constraint to making rational choices, and transactions costs to executing them. Combined, they can have the effect of limiting the effectiveness of competition even in a market place which is contestable or which has many competitors.
Banking is not a homogeneous business but a conglomeration of different businesses. For this reason, the focus needs to be on sub-markets. Banks are involved with different customers, markets, and products in each market. Competition takes place in sub-markets rather than generically between firms. It is necessary, therefore, to focus on the collection of narrowly-defined markets if the true nature of competitive conditions in the banking industry are to be understood.
Competition can be especially powerful when it develops from outside the traditional industry rather than developing endogenously within the industry. For this reason, competition would develop to consumer advantage if entry barriers were to be lowered, and if diversity in the banking system were to be fostered. In particular, enhancing the role of the mutual sector in retail financial services as is allegedly the government’s aim) would be beneficial.
The degree of contestability in some banking and financial markets has increased. Many of the traditional entry barriers have been lowered partly because of the impact of technology. It is evidently the case that the degree of contestability varies considerably between sub markets. The impact of new entrants is not measured by the market share they secure which may be quite limited. The biggest potential impact is in terms of how they force incumbents to behave differently. Although entry barriers have declined in some banking markets, and as a result contestability has increased, this is evidently not the case in all banking markets. Entry barriers may be powerful in some banking markets which means that excess returns can be sustained for incumbents, and anti-competitive practices can be sustained.
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NATURE OF COMPETITION 1. When considering the nature and structure of competition in banking and retail financial services, three alternative concepts are to be identified: competition, contestability and effective competition. The first-mentioned focuses on the traditional way of considering competition in an industry and considers factors such as the number of suppliers, the market share of the dominant players (as, for instance, measured by Herfindahl indices) etc. This dimension also considers the type of competition in an industry: perfectly competitive, monopoly, complex monopoly, monopolistic, oligopolistic, etc.
2. In some industries (and in some banking markets) the traditional way of measuring competitive conditions has become less appropriate because of increased contestability. A market is said to be contestable if entry and exit barriers are low: i.e. it is easy for new firms to enter the industry at low cost, but equally easy (and at low cost) to exit (Baumol, 1982). In this case, incumbent firms are restrained in exercising monopoly power (such as through high costs, prices, and profits) because, if they were to do so, new firms would enter the market. In the extreme case of perfect contestability, even a monopolist would be forced to behave as if it faced many competitors because of the threat of entry by others. It is the credible threat of entry that deters anti-competitive behaviour by incumbents, irrespective of the number of firms actually in the market at a given point in time. In a contestable market the number of actual competitors is largely irrelevant in determining competitive conditions in the market. A later section argues that contestability has increased in some, but certainly not all, banking markets in the UK.
3. The main purpose of this memorandum is to consider effective competition. A market may appear to be highly competitive (as measured in standard ways) but competition may nevertheless not be effective in the market place. Even though there may be many competitors in a market, competition is only effective in practice if consumers are able: (1) to make rational and informed choices between competitors, and (2) to exercise choice at low transactions costs. Both may act to limit effective competition.
4. There are many reasons why in some markets consumers are unable to make rational choices. If consumers do not have sufficient information to make comparisons and rational choices, competition between suppliers may not be effective in practice. For instance, some years ago independent research commissioned by Abbey National revealed that more than half of bank account holders were unaware that they could obtain higher interest rates if they switched banks. We also find a wide range of prices and interest rates for almost identical products offered by different banks. There are also cases where the true price and costs of a financial product are difficult to discern (and hence for comparisons to be made) because of its complexity and the occasional practice of obfuscatory pricing. To alleviate some of these problems the Financial Services Authority introduced a “Treating Customers Fairly” requirement on financial firms.
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5. Even if consumers are able to make rational choices, the transactions costs of exercising this choice may be high. Clearly, consumers will incur the costs of “shopping around” only to the extent that the expected benefits exceed the costs and there are sometimes impediments in making this calculation in financial services (Llewellyn, 2005). In an empirical study of the current account market in the UK, Gondat-Lerralde and Nier (2004) find that switching costs are a key determinant of competition in the market. The bundling of products and services may mean that the purchase of one service may be dependent on the purchase of other services from the bank. For instance, loans to SMEs are often dependent on the individual firm having many other services (payments, etc) supplied by the same bank. The Competition Commission (CC) focused heavily on the issue of bundling (which it defined as “the supply of a product is made conditional on the take-up of another product or obtaining services at a reduced price when taking out another service") in its 2002 enquiry. There may be considerable inconvenience attached to buying a particular product from the “best” bank if, because of bundling, many other services need to be switched. Switching costs may be high. The CC found that “there is only a very limited degree of switching of main bank accounts by SMEs. This is one of the most important characteristics of banking services to SMEs”. Furthermore, consumer inertia may inhibit switching and the search for the "best" deal, and in some cases redemption penalties may be high especially when long-term contracts are involved. There may also be costs in disturbing an existing relationship with a bank because of the information advantages gained though a long-term association. This relationship can work to the advantage of both the bank and the customer.
6. Research by the Consumer Panel of the Financial Services Authority found that, contrary to the evidence, 39 percent of consumers believe there are no differences in costs and charges between banks because there is competition between them (Consumer Panel, 2001). Clearly, if this expectation exists the cost-benefit calculations of shopping around are adverse. In fact, the evidence is that there are significant differences between almost identical products offered by different banks and even by the same bank. Research undertaken by the FSA suggests that this is most especially the case with short-term products (Cook, et. al., 2002). In an attempt to enhance consumer awareness in financial markets, the FSA now publishes tables of comparative information.
7. Information is the major constraint to making rational choices, and transactions costs to executing them. Combined, they can have the effect of limiting the effectiveness of competition even in a market place which is contestable or which has many competitors.
METHODOLOGY: MARKETS V. INSTITUTIONS 8. A central methodological issue when considering the degree of competition in the banking industry is whether the focus should be on the total market or on individual banking sub-markets. In the latter case the issue arises as to how to define (and with what degree of fineness) the relevant markets. The general conclusion here is that banking is not a homogeneous business but a conglomeration of different businesses. For this reason, the focus needs to be on sub-markets. Banks are involved with different customers, markets, and 165
products in each market. The emphasis on sub-markets is considered in Bikker and Groeneveld (2000) and in Bikker and Haaf (2002b) where they define a market as “all suppliers of a good who are actual or potential competitors”.
9. A central, though difficult, research area in banking is how to measure and define competitive conditions in banking markets and how to make comparisons between countries. Several alternative methodologies (e.g. Structure Conduct Performance, Panzar and Rosse Model, et. al.) have been applied in an extensive literature. A theme here is that these conventional approaches have become less appropriate because they are too aggregative. Evidence from the UK, and the work of the Competition Commission, suggests that the focus needs to be on micro banking markets and that these markets might need to be defined very narrowly. Competition takes place in sub-markets rather than generically between firms. Unfortunately for research purposes, there is often a paucity of data regarding sub-markets and the profitability of banking business in these disaggregated markets. However, some research has been conducted applying this approach. For instance, Courvoisier and Gropp (2002) in a ten-country study found significant correlations between margins and product-specific measures of industry concentration. Similarly, Bikker and Haaf (2002) found that when focussing on a national scale, the degree of market concentration of the largest banks is often modest and they have only limited market power. On the other hand, when the analysis is conducted on a disaggregated basis large banks often do have market power.
10. There are several reasons why different sub-markets need to be distinguished: competitive conditions vary between sub-markets, consumer behaviour is different in each market (e.g. with respect to the extent that a product is regarded as commoditised, i.e. purchased mainly on the basis of price), the profitability of different sub-markets varies, there are cross-subsidies between different markets (where prices in some markets are set high relative to cost and risk while in others they are set low), and the way banks compete differs between sub-markets. In an empirical study, Corvoissier and Gropp (2002) find that different banking products are affected differently by competition and concentration: increased concentration leads to less competitive pricing in loan and deposit markets but not in savings and time deposit markets.
11. Analysis of competition in the banking industry therefore needs to focus on sub- markets rather than regard banking as a homogeneous business. As banks operate in sub-markets, profits are generated in such markets and the overall ROE is based on the sum or profits in sub-markets. This was the focus of two Competition Commission enquiries where the conclusion was that competitive pressures vary greatly between different sub-markets, e.g. between, for instance, loans to SMEs and savings deposits for personal customers. This analysis was applied in the adjudication of the proposed merger between two banks. The CC rejected the bid by LloydsTSB for Abbey National not on the grounds that it would have serious negative impacts on competition overall, but because it would have significantly diminished competition in two sub-markets: SME banking and personal current accounts. And yet, in the wake of the banking crisis, the government allowed a merger between LloydsTSB and HBOS which 166
would create equal, if not more, competition concerns in the same areas as identified by the CC in the earlier case.
12. It is necessary, therefore, to focus on the collection of narrowly-defined markets if the true nature of competitive conditions in the banking industry are to be understood. This also means that profitability may vary between banks within the same country (and also on average between countries) because of the particular business mix of individual banks, and also because there may be substantial differences in competitive conditions between sub-markets with such differences themselves varying between countries. It also means that aggregate concentration figures (e.g. Herfindahl indices) may give a distorted and misleading indication of market power. Thus, for instance, aggregate concentration in the UK banking sector is comparatively low but is high in some sub-markets such as SME banking products and services.
ENTRY BARRIERS AND CONTESTABILITY 13. The nature of contestability was briefly outlined above. While competition (as, for instance, measured by the number of competitors) may be low overall, competitive conditions may be strong in particular markets if they are contestable. The key (though not the only) characteristic of contestability is that entry and exit barriers are low. In practice, there are many entry barriers into some banking markets (Llewellyn, 1999).
14. The degree of contestability in some banking and financial markets has increased. Many of the traditional entry barriers have been lowered partly because of the impact of technology (Llewellyn, 2002). The process of deconstruction (whereby component parts of banking products are supplied on an outsourcing basis) also has the effect of lowering scale barriers, delivery barriers, set-up costs, skill requirements, and the barrier of integrated processes. In particular, the process of deconstruction and outsourcing means that a new entrant is no longer required to supply all the components within the value chain of a product and, therefore, is able to concentrate on that part of the value chain in which it has a potential competitive advantage. To the extent that consumers have become more prepared and able to unbundle, this potential entry barrier has also weakened. Equally, the development and increasing sophistication of credit-scoring models has made it easier for new entrants to enter some lending markets. The development of technology has also lowered some traditional information barriers to entry to the extent that it has increased the supply, and lowered the cost, of some information needed to provide some financial products and services.
15. More generally, the development of the Internet, and its application to banking, has had the effect of lowering entry barriers into some sub-markets in the banking industry. In particular, it has lowered the marginal cost of transactions, has made distance and location increasingly less significant, has lowered consumer search costs, has increased the availability of information, and has lowered the cost of price discovery. It has also raised transparency which has lowered search costs for consumers and raised the potential for consumers to make rational choices between alternative offerings by different banks.
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16. It is evidently the case that the degree of contestability varies between sub- markets. While in new entrants have entered some banking sub-markets, other markets have been untouched. The CC noted that there are few suppliers, and high entry barriers, in the markets of general-purpose business loans for SMEs. It also observed only limited entry by suppliers into the provision of liquidity management services, and in particular current accounts with overdrafts and bank loans. In fact, some past new entrants have withdrawn from these markets. On the other hand, there is a large number of suppliers of some other banking services to SMEs. There have been several new suppliers of Time Deposit accounts and asset-related loans that have entered these markets. As noted by the CC: “this shows the relative ease of entry into these activities on a niche basis”. There has also been some entry into the supply of current accounts without overdrafts. Equally, in some personal banking markets (notably savings accounts) there have been several new entrants including Supermarket Banks.
17. The degree of contestability therefore varies considerably between sub-markets in banking. This can be represented in a Contestability Matrix (Figure 1) where sub-markets are defined in terms of customer groups and products. There is no scientific basis to the precise numbers indicated in each cell (i.e. each sub- market) which are impressionistic and given for illustrative purposes only. Nevertheless, they may be a reasonable reflection of the relative contestability of each market.
NEW ENTRANTS INTO BANKING MARKETS 18. Competition can be especially powerful when it develops from outside the traditional industry rather than developing endogenously within the industry. There are several reasons for this: new entrants have different cost structures than incumbents, they are more prepared to challenge traditional ways of conducting business, the basic economics of the firm are different, alternative business models are applied, they apply a different business strategy and business mix of products and services, and the incumbents often do not understand the business models of the new entrants and hence may find it difficult to develop competitive strategies against them.
19. In various countries new entrants into some banking sub-markets have included supermarkets, motor car manufacturers, DIY furniture stores, the Post Office, utility companies, insurance companies, and even well-known football clubs! They tend to have certain common characteristics: entry barriers are low in the relevant sub-markets, new forms of delivery are utilised, and only a limited range of products is offered rather than the full range of products and services offered by conventional banks. In addition, they are focussed within the value chain by outsourcing a large proportion of processing, and have low fixed costs (partly because they do not need to cover the substantial costs of establishing a processing infrastructure), low costs overall, and no legacy costs through dated IT systems and infrastructure. Furthermore, they often enter the market in partnership with an incumbent bank.
20. The impact of new entrants is not measured by the market share they secure which may be quite limited. The biggest potential impact is in terms of how 168
they force incumbents to behave differently. For instance, faced with competition from some new entrants, at one time Lloyds TSB offered a Current Account paying interest of 3.5 percent against its norm of around 0.5 percent.
21. Although entry barriers have declined in some banking markets, and as a result contestability has increased, this is evidently not the case in all banking markets. Entry barriers may be powerful in some banking markets which means that excess returns can be sustained for incumbents, and anti-competitive practices can be sustained. There are entry problems in four main areas: (1) deterrence to entry, (2) cost and pricing asymmetries facing new entrants, (3) the advantages possessed by incumbents, and (4) the difficulty for new entrants to induce customers away from long-standing incumbents with whom they may have had a long relationship.
22. The context of the CC study on SME banking was that around 85 percent of SME traditional banking business was at the time in the hands of only six banks and the bulk was in the hands of only four. The CC considered in detail how entry barriers might operate in the SME banking market. In the process, they identified several barriers of varying degrees of intensity: information problems for new entrants about the credit-standing of SMEs; free banking provided by incumbents to start-up firms creating pressure on new entrants to offer it to the majority of their customers whereas incumbents offered it to less than 20 percent of their customers, and the scope by incumbents to negotiate with customers who are considering switching. In addition, potential new entrants often lack access to relevant skills such as credit assessment and relationship management. An incumbent may also have economies of scope in the provision of a range of services: in particular, the “first-port-of-call” advantage.
ASSESSMENT 23. Our central theme has been that different concepts of competition need to be applied to banking with special attention given to “effective competition”. It has also been argued that competition can be particularly powerful when it develops from outside the traditional industry. For this reason, competition would develop to consumer advantage if entry barriers can be lowered, and if diversity in the banking system is fostered. In particular, enhancing the role of the mutual sector in retail financial services (as is allegedly the government’s aim) would be beneficial This is argued further in Richie (2010). 169 F I G U R E 1
CONTESTABILITY MATRIX
C U S T O M E R G R O U P S Individuals Large firms Small firms
PRODUCTS/SERVICES PRODUCTS/SERVICES Payments 2 5 2
Loans 8 10 2
Deposits 10 10 8
Advice 7 10 3
etc.
etc.
SCORE: 10 IS HIGH CONTESTABILITY 1 IS LOW CONTESTABILITY
The scores are arbitrary and illustrative only, and no scientific basis has been applied. 170
REFERENCES Baumol, W J (1982), “Contestable Markets: An Uprising in the Theory of Industrial Structure”, American Economic Review, Vol. 67, pp 809-822.
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Bikker, J A and Haaf, K (2002b), “Measures of Competition and Concentration in the Banking Industry: A Review of the Literature”, Economic and Financial Modelling, Summer.
Consumer Panel (2001), Consumers in the Financial Market, Annual Survey, Financial Services Consumer Panel, London.
Cook, M, Easley, F, Ketteringham, J and Smith, S (2002), “Losing Interest: How Much can Consumers Save by Shopping Around for Financial Products?”, Financial Services Authority, London, Occasional Paper 19, October.
Courvioisier, S and Gropp, R (2002), “Bank concentration and retail interest rates”, Journal of Banking and Finance, 26, pp2155-2189.
Gondat-Larralde, C and Nier, E (2004), “Economics of Retail Banking: An Empirical Analysis of the UK Market for Personal Current Accounts”, Bank of England Quarterly Bulletin, Summer.
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Llewellyn, D T (2002), Technology and the New Economics of Retail Financial Services, Building Societies Association Annual Lecture, BSA, London.
Llewellyn, D T (2005), “Trust and Confidence in Retail Financial Services: A Strategic Challenge”, paper presented at the Building Societies Annual Conference, Building Societies Association, London, May.
Michie, J (2010), Promoting Corporate Diversity in the Financial Services Sector, Oxford Centre for Mutual and Employee-Owned Business, Kellogg College, University of Oxford.
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Written evidence submitted by the Financial 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 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.1
4. 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 (e.g. poor explanation of the key features of a product), negative externalities (e.g. when the failure of a bank causes depositors of other banks to withdraw deposits, resulting in a run on those banks) and moral hazards (e.g. 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.
1 We have not been required by the Treasury to take a specific action to date. 172
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.
9. 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.
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Our role in the consolidation of banks
10. Before the 2007 to 2009 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 (e.g. 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.
Our role in the consolidation of building societies
11. In relation to building society mergers we have a prudential supervisory role (under FSMA) and a regulatory role (under the Building Societies Act 1986 – ‘the Act’). The Act sets out the regulatory procedures 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 2009 (in relation to the Derbyshire, Cheshire, Barnsley and Scarborough Building Societies).
Our role in support of credit unions
14. 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 174
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.
New authorisations
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:
Retail Wholesale 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 Ltd2 China Construction Bank (London) Ltd Northern Rock plc3 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.
2 Formed as a resolution vehicle for Dunfermline Building Society. 3 Northern Rock plc is a new banking entity that arose from the split of the good/bad assets of the previous bank. 175
The authorisation process
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.
19. 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.
Foreign entrants
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.
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FSA consumer protection activities and competition
Our overall consumer protection strategy
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.
The role of consumer information in consumer protection
24. 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.
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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 Body to take forward the financial capability work we previously undertook and to help consumers understand financial matters and manage their finances better.
Banking Conduct Regime
27. We took over regulation of banks’ and building societies’ conduct of retail banking services (excluding non-mortgage lending) on 1 November 2009. 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 90% 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.
Retail Distribution Review (RDR)
29. 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 178
adviser charges to ensure equivalent standards apply across the whole industry.
31. In preparing the RDR, we commissioned an analysis by economic consultants4 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.
Effective competition
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.
34. 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.
4 www.fsa.gov.uk/pubs/policy/oxera_rdr10.pdf 179
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 right level of concentration?
39. 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.
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40. 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.
41. 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.
42. 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.
43. 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.
Consequences of ‘free banking’ and other forms of bundling and cross- subsidisation on competition
44. 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.
45. 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 14 million customers 181
hold such accounts. These accounts now provide a significant source of fee income for banks.
46. 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.
47. 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.
48. 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.
Competition mandate for the Consumer Protection and Markets Authority
49. 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 182
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.
Potential structural options on a competition mandate for the CPMA
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); 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.
• A mandate to deliver better markets for the benefit of consumers through specific market interventions − 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: o giving the CPMA the power to make rules on competition and consumer protection grounds; o 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 o conducting periodic market studies, with the necessary resources and powers to obtain information and to follow up as appropriate.
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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.
• A mandate to deliver structural change − 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.
• A mandate to deliver economic regulation on the model of utilities regulators − 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.
Relationship between competition and financial stability
54. 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 184
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 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.
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Written evidence from nef (the new economics foundation)
Promoting a Diverse and Resilient Banking System
1 Executive Summary
1.1 Banking is unlike any other industry sector. It has unique properties that require an approach that goes beyond competition and choice to examine its broader social, economic and environmental impacts. We argue that effective reform needs to take as its starting point a re-statement of the function of banking, and while acknowledging that there is a strong case for reforms of the investment banking industry, we focus here on retail banking. 1.2 The most important privilege of the banking sector is the ability to create credit. This effectively hands complete control over the allocation of credit and significant control over the money supply, the means of exchange that underpins the economy, to private banks. Closely connected to this is the problem of moral hazard arising from the implicit and explicit government guarantees of banks’ solvency. 1.3 These features of banking make it more analogous to public utilities, natural monopolies or merit goods1 such as health and education, than to ordinary free market industry sectors. The incoherence caused by the privatisation and deregulation of a public good creates inherent instability in the banking system. 1.4 Apart from these unusual features, the banking market does not approach anywhere near conditions of perfect competition. Therefore a laissez-faire deregulatory approach paradoxically leads to less competition and choice. Other observed market failures include:- • the demise of relationship banking; • distorted incentives and short-termism; • patchy access to finance and poor customer service; • withdrawal of support from local economies, and; • increasing risks from increasing scale. 1.5 We argue that among the plethora of useful reform initiatives, the watchword for transforming banking for the better is ‘diversity’ - of function, scale and location, and ownership. 1.6 We further argue that to truly get at the roots of systemic instability, the committee should consider convening a separate inquiry into the case for and against monetary reform.
2 The Function of Banking
The banking system is, by its very nature, not subject to the normal laws of market competition. Although competition and choice merit careful examination, the 186
Committee is well advised to take a broad approach to reform. We believe it is necessary and desirable to start any review of banking with the question “What is the function of banking?” and we offer the following definition2: ‘To facilitate the allocation and deployment of economic resources, both spatially and temporally, to ecological sustainable activities that maximise long-term financial and social returns under conditions of uncertainty’
We argue that a fundamental redesign of existing market structures is required for banking to fulfil this function.
3 Banking is Special
3.1 Banking is unlike any other industry; this has been made abundantly clear in the current crisis. Banks enjoy certain privileges that normal commercial businesses do not have. The most important of these is the privilege of ‘credit creation’, and closely connected is the problem of moral hazard arising from the implicit and explicit government guarantees of their solvency. Credit Creation 3.2 In modern economies, through fractional reserve banking, banks play a key macro- economic role in the creation and allocation of virtually the entire money supply as credit. This is accepted by the Federal Reserve and the European Central Bank and by most monetary economists, although it does not feature in most general equilibrium models of the economy used by orthodox economists3. Private-sector commercial banks can thus be seen to provide a key public utility function as the originators and allocators of the money supply. Moral Hazard 3.3 This leads inevitably to the second privilege, that risks are effectively underwritten by the taxpayer. This happens in two ways: in order to prevent the sudden loss of confidence that can lead to a run on the banks they are provided with a highly valuable deposit guarantee scheme funded at taxpayers’ expense. This is compounded by the problem of institutions that are too systemically important to fail. One estimate of the value of this implicit guarantee in the UK, in terms of allowing banks access to cheaper capital, is over £50 billion a year4. This figure has swollen following the banking bailout, as these banks would have faced significantly higher funding costs without the government interventions, but the pre-crisis figure for 2007 was still £11bn. Significantly, this value accrues almost entirely to the largest five banks. An Incoherent System: Public Money, Private Banks 3.4 The government, via the Bank of England, has a monopoly on the creation of legal tender. The means of exchange that forms an essential building block of any modern 187
economic system is therefore limited to a single currency that allows no legally enforceable competitors. There are alternatives to a monopoly fiat currency, but discussion of these is outside the scope of this paper. What is relevant to the reform of the banking system is that the provision of a reliable and stable currency to fulfil the function of a means of exchange is a public good. But the advent of electronic banking and the demise of notes and coins (which now make up less than 3% of the money supply) have resulted in money now mostly existing in electronic form as credit created by private banks. This could never have been envisaged by the architects of the 1844 Bank of England Act that banned the private creation of money by conferring a monopoly of issuance of notes and coins on the central bank. 3.5 The means of money creation and its allocation have significant economic, social and environmental impacts. The Bank of England’s attempts to control retail price inflation does influence credit creation indirectly through interest rates and, more recently, quantitative easing, but essentially the quantity and allocation of money in the economy is determined by private banks. 3.6 Thus an inherent contradiction exists: a stable monetary system is a public good, money is backed by a state guarantee in the public interest and in this respect nationalised, but its creation and allocation is controlled by private banks motivated only by profit. It should hardly come as a surprise when private banks are bailed out by the taxpayer when the system crashes. 3.7 These features of banking make it more analogous to public utilities, natural monopolies or merit goods such as health and education, than to ordinary free market industry sectors. Retail banking underpins economic activity and has a related impact on social inclusion. Access to basic transactional banking services is increasingly important for full participation in the economy and for social justice. The cost of not having a current account and access to mainstream credit, borne by the most financially disadvantaged, can reach £1,000 per year5. Forcing people into the arms of loan sharks and confining them to the cash economy provides fertile ground for criminal operations and tax evasion. 3.8 Although ‘public good’ industries often incorporate market mechanisms and competition to great benefit, they are ultimately managed and regulated in the public interest and subject to democratic control. Broader economic, social and environmental goals take precedence over profit. We would argue for this reason alone that the structure of the banking market, the level of financial returns, the number of market participants and their scale and scope, are all appropriate and indeed essential subjects for regulation. There are further arguments for state intervention based on observed market failures which we examine next. 188
4 Laissez-faire leads to Market Failure
4.1 The banking sector displays fundamental flaws in approximating to anything close to conditions of perfect competition. Indeed, the nature of banking as outlined above is such that a laissez-faire approach will lead to less competition, not more, and even improving competition cannot of itself address all forms of market failure. Deregulation destroys competition 4.2 Policy on banking regulation has been largely based upon assumptions, derived from neo-classical economics, of perfect competition and information that have no basis in reality. A rigorous and objective review of competition in the banking sector must start without making such deductive assumptions about how economies and markets work based upon hypothetical models of general equilibrium. It should take a more inductive approach based upon empirical evidence of what is actually happening in the sector. 4.3 Over the last three decades, regulators became exceedingly relaxed about competition in the banking sector, relying on the UK sector’s international standing as proof of its competitiveness. Policy permitted an ever more homogeneous and top-heavy sector to develop. Consolidation, takeovers and aggressive acquisitions left the UK economy with fewer banking institutions and the competitiveness of UK banks in terms of their product offering to UK citizens and businesses was neglected. They have been, to a greater or lesser extent, doing the same things and offering customers the same products. 4.4 The sheer profitability of the financial sector makes it clear that the system is not competitive in the usual meaning of the term. Competition is meant to ensure that the lure of high profits will attract new entrants who will offer products at a cheaper price. The fact that this has not occurred suggests that there are major barriers to entry and that incumbent institutions are operating in an oligopolistic6 rather than in a competitive market. Over 85% of current accounts are now concentrated in the hands of the big five banks7. This destruction of diversity has had profound effects: The demise of relationship banking 4.5 These few big banks operate at an ever-more profitable distance from their customers, thanks to new, automated techniques such as credit scoring. ‘Relationship-banking’ has gone in to decline, as employees with direct knowledge of borrowers have been shed in favour of centralised IT systems able to deliver more ‘efficient’ computer ratings. However, homogeneity in approach to credit scoring leaves some sections of society underserved while decreasing system resilience as a small number of institutions chase the same group of customers and assess them in the same way. Distorted incentives and short-termism 189
4.6 The recent problems in the system have been compounded by the way in which traders are remunerated on a very short-term basis, creating incentives to maximise short-term returns. Similarly, the financial ‘engineers’ creating new products for the derivatives market are often paid immediately for the returns forecast over the whole term of the product. This creates potentially destructive incentives to develop products with a long ‘tail’ of risk. 4.7 Institutions have converged on those activities that offer the highest returns, particularly over the short time horizons against which performance is generally judged in listed companies8. There is little to be gained from accepting lower returns now to move into sustainable long-term sectors that may ultimately produce higher returns, if all your shareholders have left in the meantime for rivals posting better quarterly results. Choice for whom? The lack of access to finance 4.8 As institutions stopped specialising, either geographically or by market sectors, less profitable activities – such as maintaining a branch network and providing financial services for low-income people9 – became ever more marginalised. The spatial and social dynamics of branch closure are important. Academic research shows that branch reductions have generally been greatest in more deprived and ethnically diverse areas, and lowest in more affluent ones10. This means that where finance is available, it is often on exorbitant terms – a typical APR from the legal end of the home credit market, is 272 percent11. 4.9 According to the Campaign for Community Banking, the number of bank branches in the UK is now just 9094 – 43 per cent fewer than just 20 years ago12. The UK has 197 bank branches per million inhabitants (including building societies). This compares with over 500 and 1010 branches per million inhabitants respectively in Germany and Spain13. Not only does Spain have more banks per head of population, they are also far better disbursed than they are in the UK. The UK has 162 banks14 compared with France’s 450 banks15 and Germany’s 2,000 banks16. Both countries have a variety of banking forms, such as savings banks, co-operative banks, private banks, municipal banks and post banks that are firmly anchored in local communities. This helps explain the superior performance of these economies is providing access to finance17. 4.10 And, when we find a branch that is still open, there are fewer people to deal with any queries we have. Figures from the British Bankers Association (BBA) show that in the five years from 2003, Abbey reduced its staff numbers by 12,897, Lloyds TSB cut 15,058 staff, and the Royal Bank of Scotland, 11,200. Since the BBA data was compiled, Lloyds TSB announced plans to make 11,000 more staff redundant and RBS announced plans for a similar number of cuts.18 Withdrawal of support from local economies 4.11 Nor is it just a question of access for individuals. Access to banking is vital to the survival of retail and other services in many medium-sized rural communities and in 190
less well-off suburbs, estates, and inner cities. If active people and small businesses go to bank elsewhere, they are likely to spend elsewhere, too. Those that suffer most from the loss of local amenities are the most vulnerable: older and disabled people, those with mobility difficulties, and carers. Economies vs diseconomies of scale: Increasing returns means increasing risks 4.12 While economies of scale are important, they also bring dangers. The concept of ‘too big to fail’ is well-documented and tends to allow returns to be increased by increasing the risk to the taxpayer. Crucially, the theory of diversification of risk through universal banking has shown to not hold true when a small number of very large banks all converge on similar portfolios. Shareholders should have control over their own risk diversification and have a broad range of divergent institutions in which to invest. 4.13 As financial institutions grow they move further and further from their customers, and the knowledge of the products they are buying, selling or trading inevitably suffers. The fact that the crisis was sparked by an international market in subprime mortgages in the United States, about which very few had any real knowledge or great understanding, underlines this point.
5 Strength in Diversity
5.1 With others, nef has been advocating a series of reform proposals which are documented in previous publications19, and for brevity we do not reproduce them here. Instead we focus below on one key theme: diversity.
Diversity of function
5.2 We need financial institutions to focus on specific functions and to do a good job, not to chase the latest bandwagon. Retail banking is a very different business from investment banking, but universal institutions that devote large resources to speculative activity put at risk their ability to provide core functions for their customers – payments, settlements, savings and loans. Government must see through its commitment to the creation of a Post Bank, Green Investment Bank, and Big Society Bank, which we suggest should be based closely on the recommendations of the Social Investment Task Force for a Social Investment Bank20. However, we would also benefit from banks that focus on particular industries, customers and products. Diversity of scale and location 5.3 Large banks, or rather banks that can service large customers, have their place in the ecology of finance, but we need many more smaller and medium sized banks that 191
are not too big to fail. We need regional and local banks with the particular knowledge, experience and culture of the areas they serve. This notion is not fanciful as comparisons with competitor economies demonstrate. A vibrant Community Development Finance Institution sector should be encouraged by introducing a UK version of the US Community Reinvestment Act which would provide greater transparency over where banks deploy their capital – or more to the point where they choose not to. Diversity of ownership
5.4 Britain has a long and proud heritage of mutually owned financial institutions. The sector was demolished in the 1990’s to little good effect according to an All-Party Parliamentary Group inquiry21. The government should seriously consider re- mutualisation as part of any forced demergers or sales by large banking groups. They should also remove the harsh and artificial constraints on the credit union sector, which is puny compared with competitor nations. While only about 0.5% of the adult population in the UK is member of a credit union, the equivalent figures for Ireland, the US, Australia and Canada are 45%, 30%, 20% and 16%, respectively22. Key benefits of diversity
5.5 Greater diversity in the banking sector would:- • help ensure that less profitable activities are not left behind; • provide greater clarity to savers about the use of their deposits and the potential risks and returns associated with a bank; • allow greater management focus at Board level on areas of banking that are considered overtly or covertly to be poor relations within large universal banks, and help reconnect senior management with high-street customers; • allow more focussed micro-prudential oversight, and; • assist macro-prudential oversight and promote greater system resilience by creating ‘fire-walls’ between different parts of the system.
We need a financial system that channels finance to ecologically sustainable activities that maximise long-term financial and social returns. We need to explicitly promote diversity and resilience as much as competition and choice, not least because the latter will be harder to achieve without the former.
6 Examining the Roots of Instability – an Inquiry into Monetary Reform
For the reasons outlined above, we believe that a system that allows private control over a public good creates incoherence and instability in the banking system. We recommend that the Select Committee convenes a separate inquiry on the case for and against monetary reform, including the nature and operation of credit creation under our existing current system of fractional reserve banking, and allowing a 192
thorough review of all alternative variations on creation and control of the nation’s money supply. September 2010
1 Merit goods confer positive externalities on the economy and society as a whole that are not enjoyed directly by the customer. This leads to too few of such goods and services being supplied in a free market, hence they tend to be subsidised or provided directly by the state 2 Nissan S and Spratt S (2009) The Ecology of Finance (London: nef) 3 “…the fractional reserve system… permits the banking system to create money.” (Federal Reserve Bank of Kansas City, 2001, p. 57.); “The actual process of money creation takes place primarily in banks.” (Federal Reserve Bank of Chicago, 1961, p. 3); “At the beginning of the 20th century almost the totality of retail payments were made in central bank money. Over time, this monopoly came to be shared with commercial banks, when deposits and their transfer via checks and giros became widely accepted.” (ECB, 2000); Quoted in Werner, R, A, 2009, “Can Credit Unions Create Credit? An Analytical Evaluation of a Potential Obstacle to the Growth of Credit Unions”, Centre for Banking, Finance and Sustainable Development, Discussion Paper Series, No. 2/09, University of Southampton, School of Management. 4 Haldane A (2010) The $100 billion dollar question (London: Bank of England) 5 Thiel V (2009) Doorstep Robbery (London: nef) 6 An oligopolistic market is one where a handful of firms have control or extensive influence, enabling them to impose worse services or higher prices on buyers. A well‐known example of this is the OPEC cartel of petroleum exporters. 7 Vickers et al (2010) Issues Paper: Call for Evidence (London: Independent Commission on Banking 8 Public limited companies whose shares are listed and traded on stock exchanges 9 Dymski G A (2009), The global financial customer and the spatiality of exclusion after the ‘end of geography, Cambridge Journal of Regions, Economy and Society 2009, 2, 267–285; French S, Leyshon A and Signoretta P (2008) All gone now: the material, discursive and political erasure of bank and building society branches in Britain. Antipode, 40: 79–101. 10 Leyshon, A., French, S. and Signoretta, P. (2008) Financial exclusion and the geography of bank and building society branch closure in Britain. Transactions of the Institute of British Geographers, 33: 447–465. doi: 10.1111/j.1475‐ 5661.2008.00323.x 11 Provident Financial Group – see up‐to‐date information on lending rates at www.providentpersonalcredit.com 12 French D (2009) Branch Network Reduction Report (London: Campaign for Community Banking). 13 Ibid 14 List of banks compiled by the FSA on 30 June 2010. Accessed at http://fsa.gov.uk/pubs/list_banks/june10.pdf 15 Accessed at http://www.fbf.fr/Web/internet/content_fbf.nsf/(WebPageList)/les+chiffres+du+secteur+bancaire /$File/Chiffres_cles_des_banques_francaises_2007.pdf, p. 10 16 Accessed at http://www.german‐banks.com/html/12_banks_in_facts_figures/sub_01_markt/ban_0501.asp 17 Thiel V (2009) op cit. 18 Coney J (2010) Fury over Britain’s vanishing banks, Money Mail, 3 February 2010. Accessed on 5 September 2010 at: http://www.thisismoney.co.uk/savings‐and‐banking/article.html?in_article_id=498645&in_page_id=7 19 Simms A et al. (2010) Better Banking (London: nef). Simms A & Greenham T (2010) Where did our money go? (London: nef) 20 Cohen R et al. (2000) Enterprising Communities: Wealth Beyond Welfare, report to HM Treasury, October 2000 (London: Social Investment Task Force) and Cohen R et al. (2010) Social Investment: Ten Years On, report to HM Treasury, April 2010 (London: Social Investment Task Force) 21 Welch I (2006) Windfalls or shortfalls: The true cost of Demutualisation (London: ACCA) 22 Werner R (2009) Can Credit Unions Create Credit? An Analytical Evaluation of a Potential Obstacle to the Growth of Credit Unions, Discussion Paper Series, No 2/09, Centre for Banking, Finance and Sustainable Development, Southampton University 193
Written evidence submitted by the Financial 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 real 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.
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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 research1 on 9 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, 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
1 "Stick or twist: an analysis of consumer behaviour in the personal account market" at consumerfocus.org.uk 195
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.
Adam Phillips, Chair Financial Services Consumer Panel
5 November 2010 196
Further written evidence submitted by 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:
> Preserve the vital consumer protection functions currently undertaken by the OFT. 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.
> Ensure competition issues are addressed comprehensively. 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.1 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 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
4 The OFT has a number of duties that are not currently part of the CC’s role:
1 The NAO have published two key reports: Review of the UK’s Competition Landscape (http://www.nao.org.uk/publications/0910/competition_landscape.aspx), and Progress report on maintaining competition in markets (http://www.nao.org.uk/publications/0809/progress_market_competition.aspx). 197
> 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 (1999) 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
9 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. 198
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.2 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.3
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:
> 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 (e.g. structural reform of firms) and demand side (e.g. 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.
2 See paragraphs 84 – 89 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 3 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/m34.htm 199
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. 200
Annex 1 - Existing competition duties and functions of the OFT and CC Activity / power OFT’s role CC’s role Competition Act OFT is the only enforcement body for competition law None. investigations and (abuses of dominance and anti-competitive agreements), enforcement, including except where certain sectoral regulators (Ofgem, Ofcom Appeals are referred to the Competition Appeal Tribunal exercise of European etc) may also investigate. (not the CC). competition rules. The OFT is granted powers of investigation, to make visits (dawn raids), require information etc.
It may impose remedies (directions) and financial penalties to end an infringement. It may also pursue criminal cases where a cartel has been uncovered.
Exemptions from competition law may apply, which the OFT can in some cases remove (withdrawing the benefit of a block exemption from a specific agreement) Mergers The OFT is responsible for ‘phase I’ scrutiny, deciding The CC is the referral body for ‘phase II’ detailed merger which mergers should be referred for a detailed analysis. analysis.
The OFT may accept ‘undertakings in lieu’ of a reference All mergers operate to a strict timetable that is rigidly to the CC. adhered to.
The OFT and CC have recently published joint guidance on assessing mergers. Market Investigation The OFT is the relevant body (alongside sectoral If referred, the CC has a statutory deadline of 24 months References regulators) to make MIR references to the CC to complete an investigation (imposing remedies may take longer). It also has a wide range of powers to Certain tests must be met before a reference can be gather information and impose remedies to address the
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made. However, OFT also emphasises that it has restrictions to competition it identifies. discretion in deciding whether to make a reference. CC reports tend to be authoritative. They benefit from the use of independent ‘commissioners’, which act as critical friends for the officials undertaking the investigation (a feature missing from normal Competition Act investigations). Market Studies No formal power or requirements rest on the OFT to None. undertake market studies.
Instead, they are conducted under the OFT’s general powers and duties of ‘obtaining, compiling and keeping under review information about matters relating to the carrying out of its functions.’ Super-complaints The OFT is the relevant body to which super-complaints None, unless an MIR is made. are made.
It has discretion over what actions (if any) may follow a super-complaint. Accepting or reviewing The OFT is tasked with reviewing existing Orders made by The CC reviews any Order that the OFT refers to it, and ‘undertakings in lieu’ or the CC, or undertakings in lieu, to ensure they are decides on any changes. ‘Orders’ made by the CC complied with.
It also advising on whether they should remain, be varied or revoked and may refer the issue back to the Competition Commission for review. Note: in a number of cases, powers of the OFT to refer issues also exist for the secretary of state. 202
Written evidence submitted by the Competition Commission
This note provides an overview of the role of the Competition Commission (“CC”) and a summary of the CC’s inquiries relating to aspects of the banking and financial services sectors during the last ten years.
Role of the CC
The CC is an independent public body which conducts in-depth inquiries into mergers, markets and the regulation of the major regulated industries. All of the CC’s inquiries are undertaken following a reference made to it by another authority, most often the Office of Fair Trading (OFT) (which refers merger and market inquiries), or one of the sector regulators (which can refer markets within their sectoral jurisdictions or make regulatory references in relation to price controls or other licence modifications) or as a result of an appeal from a decision of one of those sector regulators.1
Under the Enterprise Act 2002 (the Act), the OFT can review mergers to investigate whether there is a realistic prospect that they will lead to a substantial lessening of competition (SLC). The OFT may seek undertakings from the merging parties to address any competition concerns. If that is not possible it may refer the merger to the CC for an in-depth investigation. The CC has wide ranging powers to remedy any competition concerns, including preventing a merger from going ahead or requiring a company to sell off part of its business. In exceptional circumstances where public interest issues are raised, the Secretary of State may intervene as provided for in the Act, and may prevent a merger from being referred to the CC or may make a merger reference himself.
The Act also enables the OFT (and the sector regulators) to investigate markets and, if they are concerned that there may be competition problems, to refer those markets to the CC for in-depth investigation. In market investigations the CC has to decide whether any feature or combination of features in the market prevents, restricts or distorts competition, thus constituting an adverse effect on competition (AEC). If the CC concludes that this is the case, then it must seek to remedy the problems that it identifies either by introducing remedies itself or by recommending action by others.
Undertakings or orders are the primary means by which remedies are given effect under the Act (and the Fair Trading Act 1973). The OFT has a statutory duty to keep these undertakings under review, and if it considers that due to a change of circumstances a set of undertakings or an order should be varied or terminated, then the OFT refers it for consideration by the CC. Responsibility for deciding on variation or termination of undertakings lies with the CC.
In relation to regulatory references, the CC’s role is dictated by the relevant sector- specific legislation.
1 The sectors include airports, air traffic services, electricity, gas, financial services, postal services, railways, telecommunications and water. 203
Size, structure and operation of the CC
The CC operates under a Chairman (Peter Freeman) and Chief Executive (David Saunders). CC governance is provided by the CC’s Council comprising in addition the three Deputy Chairmen and three non-executive members.
The CC employs about 140 staff, the great majority of whom are professionals (primarily lawyers, economists, business advisors and inquiry staff).
The CC also employs about 35 part-time Members, who are experienced industry figures, professors of economics, competition lawyers, etc. Members are paid only for the inquiries on which they serve and, whilst appointed by the Secretary of State2, are completely independent of political control.
Inquiries are conducted by a small Group of CC Members (selected and appointed to the inquiry by the Chairman), normally led by the Chairman or one of the Deputy Chairmen. Decisions in individual cases are taken by consensus3 by the Group (who are by statute sovereign) working closely with the expert staff team.
The CC is widely recognised for being highly transparent: inquiry Groups hold hearings with parties and publish evidence, working papers and provisional decisions to ensure that parties are appraised of the issues under consideration. The CC publishes an administrative timetable for each inquiry and is bound by a statutory time limit for determining competition cases.4
Whilst the CC’s focus is primarily on competition, it necessarily takes other public policy issues into account, particularly when considering remedies.
The CC’s work on mergers and markets is subject to judicial review by the Competition Appeal Tribunal (CAT), and on regulatory matters also by the general courts.
The CC’s inquiries relating to the banking and financial services sectors
The CC has completed six reports on topics within the banking and financial services sectors over the past ten years. Four of them were under the 2002 Act:
• Payment Protection Insurance, Jan 2009 (followed by remittal Nov 2009- Oct 2010); • Northern Irish Personal Banking, May 2007; • Home Credit; Nov 2006; • Store cards; March 2006;
Two earlier reports were made to the Secretary of State under the Monopoly and Merger provisions of the Fair Trading Act 1973:
2 For an eight year term following open competition 3 The CC would not normally expect to reach a decision from which more than one member dissented. 4 Two years for a market investigation; 24 weeks plus 8 weeks extension for a merger review 204
• SME Banking – a monopoly inquiry - March 2002 (reviewed August 2007); • Lloyds TSB/ Abbey National - a merger inquiry - July 2001.
Details of these inquiries are set out in Annex A.
Annex A: Summary of the CC’s inquiries in the banking and financial services sectors
Payment Protection Insurance (Feb 2007 – Jan 2009 followed by remittal Nov 2009 - October 2010)
Terms of reference and status of the remittal • The reference followed a super-complaint from Citizens Advice and covered the supply of all PPI services (except store card PPI services) to non-business customers in the UK. The CC reported on 29 January 2009, requiring a prohibition on selling PPI at the same time as credit – the point-of-sale prohibition (POSP), a ban on selling single-premium PPI policies (where a multi-year policy is paid for in one up- front fee, added to the cost of the loan; the FSA took action on this in parallel and there are now no single-premium personal loan PPI policies sold) and various remedies to increase and improve information flow and transparency. • On 30 March 2009 Barclays challenged aspects of the CC’s final report including inclusion of the POSP in the package of remedies. Lloyds and Shop Direct Group Financial Services Ltd (which sells retail PPI through brands such as Littlewoods) intervened in support of Barclays; the FSA intervened in support of the CC. In October 2009, the Tribunal upheld the CC’s conclusions as to the competition problems in the market but ruled that the CC must consider further the inclusion of the POSP, taking account of the possible loss of convenience for consumers in no longer being able to buy PPI at the same time as credit. • Following a remittal from the CAT in November 2009, the CC carried out a detailed analysis of the impact of the POSP on customers’ convenience, including conducting a customer survey. In October 2010 the CC confirmed the POSP for all forms of PPI except retail PPI (a small part of the overall PPI market).
Product market • PPI services are insurance services supplied to protect a borrower’s ability to maintain credit repayments in the event that the borrower suffers an accident and/or sickness and/or unemployment and, under some policies, death. Short-term income protection (short term IP) sold alongside credit was found also to be PPI – whilst the sales focus is on a customer’s income rather than outgoings, the policy typically insures the same events in the same way, with the same benefits. PPI is predominantly sold through three distribution channels: face to face contact in branches (over half), over the telephone, and over the internet. • Most PPI policies are sold by credit arrangers (banks, building societies, mortgage intermediaries) at the point of sale of the credit being issued but there are a few providers of PPI policies that do not also supply the credit to be insured (i.e. stand- alone PPI). 205
• The CC found that PPI sold by an individual credit arranger is not in competition with other credit arrangers’ products (though is in competition with the very small stand-alone PPI/ short-term IP market), hence each credit arranger selling PPI is a virtual monopolist. • Given the market definition, markets are essentially monopolies. In terms of share of supply, the newly-merged Lloyds Banking Group has 40-50% of gross written premiums.
Key issues • The CC found there to be little competition among distributors and intermediaries in relation to the supply of any type of PPI policy sold at the point of sale. The CC found the following features of the market causing an AEC: the extent of competition between providers was limited (on both price and non price factors); there were barriers in terms of customer search for PPI policies (time consuming, limited information available, complexity of policies, misunderstandings in relation to PPI improving the credit application process, low level if stand-alone provision); barriers to switching (e.g. access to consumers’ credit information); barriers to entry and expansion; and the point of sale advantage in selling PPI combined with a credit product (i.e. stand alone providers were at a competitive disadvantage); barriers to new entry (e.g. building scale and access to customers at point of sale). • The consumer detriment included higher prices, less choice and less innovation. Total consumer detriment would be significantly more than £200 million per year (some elements of consumer detriment could not be quantified including the scale of the adverse selection problem5). • The CC found that if a POSP were introduced there would be an overall benefit to consumers of all types of PPI (save retail PPI). Some customers would value an opportunity to reflect on their options away from the credit point-of-sale. In addition the package of remedies – including the point-of-sale prohibition – would introduce competition which is likely to bring substantial benefits to consumers in terms of lower prices, better products and more choice.
Remedies • Remedies included prohibiting selling PPI at the credit point of sale and transparency measures for consumers (e.g. price comparison tables, the provision of annual statements), all PPI providers must provide comparative data to the FSA, a prohibition on the sale of single-premium PPI policies, a requirement to unbundle retail PPI from merchandise cover. The remedies will be implemented by means of an order.
Store cards (March 2004 – March 2006)
Terms of reference
5 High PPI prices are likely to have resulted in adverse selection in the markets for PPI, resulting in increased claims costs on PPI policies and increased impairment costs on credit sold to PPI customers, compared with the levels that would arise given the lower PPI price levels that we would expect in a well-functioning market. A further detriment to consumers as a result of high PPI prices is therefore the increased costs of supplying PPI at high PPI prices due to adverse selection: paragraph 77 of the CC’s report, January 2009.
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• The OFT’s reference specified the relevant market as the supply of (a) store card credit services and (b) consumer credit services through store cards. The CC requested a change to the terms of reference to include also insurance services (i.e. insurance purchased in association with provision and use of store cards). The geographic market was the UK.
Product market • By taking out a store card, a cardholder enters into a direct contractual relationship with the provider, not the retailer. Providers often offer store card insurance (PPI) covering card repayments. • The main sources of income for store card providers are interest income on balances not settled within the interest-free period; card related insurance income; income from fees levied for late payment of accounts; and other income including merchant fees from certain retailers. • The store card market remains an important source of credit and associated insurance. There were more than 11 million store cardholders with outstanding balances of well over £2 billion. • The distribution chain comprised department stores and clothing retailers, and store credit providers typically financed and administered the store cards on their behalf. At the time, six large lenders (five of which were quoted companies) accounted for around 90 per cent of the market. A few retailers, notably Argos, financed and operated their store card programmes in house; however, most contracted their store card operation to a provider who managed it on their behalf. The two largest providers were General Electric Consumer Finance UK (GECF – largest provider having a share between 50-70 per cent) and HSBC Group (HSBC – the second largest providing John Lewis and Marks and Spencer).
• There were found to be two relevant economic markets: an ‘upstream’ market, where providers compete for retailers’ store card contracts; and a ‘downstream’ market for the supply of credit and insurance through store cards to retailers’ customers.
Key issues • There were no adverse findings in the upstream market and in particular no barriers to entry by financial institutions. • In the downstream market, the CC found that there was little or no competitive pressure on setting APRs; there was little or no competitive pressure on the levels of late payment fees or on the pricing of insurance sold with store cards; and providers did not include sufficient information on their statements. Many store card programmes had APRs clustered around 30 per cent and there was little competitive pressure to reduce them. • Various features of the market had the effect of insulating from competitive pressures consumer credit and insurance services provided through or in association with store cards. • Detrimental effects on consumers included higher prices, less choice, and lack of transparency. Over the period since 1999, consumer detriment was found to have amounted to at least £55 million a year and possibly significantly more.
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Remedies • Remedies related primarily to increasing consumer transparency and included full information on statements (key items of information to be prominently displayed on the front page of the store card statements e.g. the current APR and an estimate of interest payable next month); an APR warning on store card statements; and the provision and prominent display of a facility to pay by direct debit. Where store card providers offer a package of payment and price protection or payment and purchase6 protection, they must offer payment protection alone as a separate item. All remedies were implemented by an order. The remedies are now under review following the implementation of the EU consumer credit directive.
Home Credit (December 2004 – November 2006)
Terms of reference • The reference from the OFT followed a super-complaint from the National Consumer Council. The product market was defined as the provision of credit, typically in small sum cash loans, the repayments for which are collected in instalments (often weekly or fortnightly) by collectors who call for that purpose at the customer’s home. The geographic market was the UK.
Product market • The mean value of a home credit loan was around £300. APRs generally exceeded 100 per cent and for loans of around 6 months often exceeded 300 per cent; • All parties investigated were legitimate licensed businesses (to be distinguished from illegal lenders i.e. loan sharks).
Key issues • At a national level, this was a highly concentrated market and one in which the leading lender (Provident) had a very substantial market share. The CC found that Provident accounted for around 60 per cent of the supply of home credit in the UK on most measures, and that the six largest lenders together accounted for over 90 per cent of UK supply • Two features contributed to the weakness of competition creating an AEC: insensitivity of customers to prices and the failure of lenders to compete in any significant way on price. There were also incumbency advantages for established lenders (i.e. knowledge of customers’ credit worthiness). Price insensitivity and incumbency advantages were preserved by the lack of data sharing, customers’ requirement for an agent they can trust and the regulatory prohibition on door-to- door canvassing of loans. • The CC found that customers generally paid higher prices than could be expected in a competitive market and on average £20 higher.
Remedies • Four remedies were selected with the objective of increasing price transparency and decreasing information asymmetries between incumbent lenders and other lenders. These remedies were: increased data sharing on payment records through credit reference agencies; requirement for lenders to publish their prices for home credit
6 ie. protection covering damaged, lost or stolen purchases 208
loans; better information provision to customers on loan accounts; and early settlement rebates.
Northern Irish Personal Banking (May 2005 – May 2007)
Terms of reference • The reference from the OFT followed a super-complaint from Which? and the General Consumer Council for Northern Ireland (GCCNI). The terms of reference for the inquiry covered the supply of Personal Current Account (PCA) banking services in Northern Ireland.
Product market • The product market covered all personal current accounts (PCAs) but not other types of personal financial products such as credit union accounts and offset/current account mortgages. • The inquiry categorised the banks into ‘clearers’ (e.g. Governor and Company of the Bank of Ireland, AIB Group – trading as First Trust Bank, Northern Bank and Ulster Bank) and ‘non clearers’ including building societies (Abbey National, Alliance & Leicester, Halifax, Nationwide, Woolwich), banks based in Great Britain and banks providing a remote service.
Key issues • The inquiry analysed branch networks including entry and expansion; bank conduct including charging structures and complexity for the consumer; customer conduct including levels of switching; unilateral and co-ordinated effects and financial performance. • The features that restricted or distorted competition in the PCA market in Northern Ireland were (a) unduly complex charging structures and practices; (b) lack of transparency in banks’ explanation of charging structures to consumers; (c) lack of consumer switching between PCAs and banks.
Remedies • The CC’s remedies aimed at increasing transparency of charges for consumers and covered clear language, explanations of the level of charges and interest rates, advance notice of charges and debit interest incurred and changes to the switching process. Remedies were implemented by means of an order.
SME Banking (2000-2002 monopoly investigation, Fair Trading Act 1973)
Terms of reference • On 20 March 2000, the CC was asked by Ministers to investigate the supply of banking services by clearing banks to small and medium-sized enterprises. The CC was required to determine whether a monopoly situation existed, whether firms exploited their monopoly position and what could remedy any exploitation.
Product market • The CC defined SMEs as businesses with a turnover of up to £25million. • The CC found the market for SME banking to be highly concentrated especially with regard to the four largest clearing groups (Barclays, HSBC, Lloyds TSB and 209
Royal Bank of Scotland Group) that accounted for over 90 per cent of liquidity management services in each geographic region.
Key issues • For a number of reasons customers showed an unwillingness to switch. • There was a similarity of pricing between the major banks; the use of selective negotiation to reduce prices for those considering switching; and high barriers to entry (including branch infrastructure and high sunk costs). • The CC found that as a result of the consumer and competition issues identified, the four largest clearing banks were charging excessive prices and therefore earning excessive profits.
Remedies • The Secretary of State asked the OFT to negotiate remedies to give effect to the CC’s recommendations. As a result, a number of behavioural and transitional undertakings were given by the four largest banks. Behavioural undertakings were designed to: make switching easier and faster; limit bundling of services, and improve price information and transparency to SMEs. Transitional undertakings were also sought to strengthen competition in the short term. These required the banks to offer either current accounts paying interest (at BoE base rate minus 2.5 per cent) or accounts free of core money transmission charges.
OFT and CC review of undertakings given by banks (August 2007) • OFT found that the transitional undertakings had been successful in achieving increased levels of competition and that the four banks had complied with their requirements. The market had however become more competitive due to the impact of the behavioural undertakings and general market trends. The OFT therefore recommended the four banks be released from their transitional undertakings but that the behavioural undertakings remain in place to address their concerns over customer switching levels and customer awareness of costs. • The CC largely agreed with the OFT’s advice, and decided in December 2007 to lift the temporary price controls that had been imposed in 2003.
Lloyds TSB/ Abbey National (Feb – July 2001 merger inquiry, Fair Trading Act 1973)
Terms of reference • Proposed merger between Lloyds TSB and Abbey National
Product market • Lloyds TSB was one of the four leading clearing banks (others were Barclays, HSBC and RBS/National Westminster Bank). Lloyds and Abbey National were found to overlap in the following product markets: financial products sold to personal customers (current accounts, mortgages and savings accounts); markets for financial products sold to small and medium enterprises (SMEs); markets for financial products sold to larger firms and wholesale banking.
Key issues • The proposed merger would reduce competition in the supply of banking services to SMEs as it would eliminate one of the very few players outside the big four. The 210
merger would result in higher prices for personal current account (PCA) and SME banking services, and decrease innovation and consumer choice. Efficiency gains would result from the merger but the CC did not consider these would be passed on to consumers in the form of reduced prices.
Remedies • The CC concluded that there were no possible remedies in relation to the PCA and SME markets short of prohibiting the merger that could adequately address the adverse effects. The Secretary of State accepted this recommendation and prohibited the merger.
4 November 2010