Creating competition in retail banking

With the recommendation by the UK CMA (Competition and
Markets Authority) to conduct a review of competitiveness in the current account
banking market, what are some of the areas that they may consider to increase
competitiveness?

Breaking up the
banks.
This is the Labour party’s big idea – creating a set of competitor
banks by splitting the big banks. The primary focus for this would be the Royal
Bank of Scotland and Lloyds Banking Group. However this isn’t a new idea and is
already being tested with the creation of TSB from Lloyds Banking Group and
Williams & Glyn’s from RBS. However already there are lessons to be learnt
from this process.

While there was initial interest from a number of players
the list of serious bidders rapidly shortened when the complexity, the capital
required and the price being sought became clear. The initial two successful
bidders the Co-op (Lloyds) and Santander (RBS) after lengthy negotiations and
detailed planning withdrew their bids.

Separating the bank’s technology whether cloning (TSB) or
migrating to a new platform is proving to be enormously complex and very
expensive.

The payback period is very long and without the subsidy and
support of the selling bank would be even longer. TSB for instance does not
expect to break even for many years and that is despite being helped by Lloyds
lending the new bank a book of loans.

While breaking up the banks will mean that there are more
places to have a current account there is no guarantee that this will ensure
better deals for customers, particularly given that the easiest option for the
broken up banks is to be clones of the original banks just simply without the
scale advantages. With little to differentiate them having more players in the
market doesn’t result in real consumer benefit.

Creating a payments utility
separate from the big banks.
One of the often heard complaints from new
entrants is that the big banks have an advantage because they own the payments infrastructure
and the cost for new entrants to use that infrastructure is a barrier to entry.
One option would be to create a separate payments utility not owned by the banks.
However that does not mean that it will necessarily be cheaper for new
entrants. For a start there is the cost of acquiring and separating the
infrastructure from that of the banks that currently own it which would need to
be paid by customers of the utility. There is also the question of how to
charge for the use of this utility. The charge would need to reflect the
significant cost of running, maintaining and investing in modernising the
infrastructure – it is not simply the cost of using the infrastructure because
otherwise what is the incentive for whoever ends up owning the infrastructure
to invest in it to make it not only continually available but also suitable for
new innovations as they come along? Commercial reality dictates that for banks
with high transaction volumes that cost per transaction should be lower.

Portable bank account
numbers.
Many of the challenger banks are supportive of the concept of
portable bank account numbers. They look at the mobile phone industry and see
the way that customers can take their phone numbers with them. However before
recommending this change the CMA needs to research just how big an inhibitor to
switching bank accounts for customers is the change of account number. Given
the Seven Day Switching Service where the banks guarantee no interruption to
direct debits and standing orders and given the limited numbers of times customers
actually have to know their account number in order to transact, would portable
bank account numbers really open the floodgates of customers switching bank
account numbers?

Ending ‘free when in
credit’ banking.
In the UK customers have got used to so-called ‘free
banking’ where as long as a customer remains in credit, whilst they get little
or nothing for the balance that they retain, they don’t pay charges. A number
of the challenger banks have complained that this gives the incumbent banks an
advantage as it is difficult (but not impossible) to compete on price and
because it gives banks offering current accounts a distinct advantage over
those who don’t in terms of the low cost of all those balances when it comes to
lending. It will take a brave politician to move to compel the end of free
banking. Of course to attain transparency then the cost of each transaction
e.g. cost of an ATM withdrawal, the cost of paying in a cheque, the cost of a
direct debit, etc, would need to be made clear to customers and, the
challengers would argue, that that would enable customers to choose between
banks. However looking at a market where this is the way banking is conducted,
Australia, then not only is there a greater concentration of current accounts
held with the Four Pillars (Nab, Westpac, CBA and ANZ) than with the
equivalents in the UK, but Australian banks are amongst the most profitable retail
banks in the world. Despite that there are not lots of new entrants fighting to
get a slice of the pie. For customers Australia is also one of the most
expensive countries to bank. It would appear that ending ‘free banking’ alone would
not solve the perceived competition problem.

Set a maximum market
share for current accounts.
On paper this would appear to be the solution.
The big banks could be given a period of time over which they must reduce their
share of the market to for instance to no more than 15% of the market each
leaving the challenger banks to fight over the remaining 40%. The banks would
need to be told the mix of customers they must dispose of, just as Lloyds was
instructed for the disposal of TSB. However what does this do for consumer
choice? Not all customers were happy to be told that they were moving from
Lloyds to TSB without an option. Given that the CMA investigation is about
creating competition and making it easier for customers to switch banks this
does not appear to be the solution.

Make it even easier
for new challengers to enter the market.
Measures have already been put in
place to reduce the capital required, shorten the process and allow challenger
banks time to grow into being a full scale bank. The benefits of this are
already being seen with the likes of Atom Bank being announced. It is difficult
to see what more could be done in this area.

Make retail banking
more profitable to encourage more new entrants.
There is little chance of
this being one of the recommendations of the CMA. The reality is that with
increased regulation, increased scrutiny and rising costs for compliance retail
banking is becoming less and less attractive a sector for investors. As JC
Flowers have recently remarked with Returns on Equity going from double to single
digits there are more attractive sectors to look at investing in.

Is the CMA looking to
solve a problem that customers don’t see as a priority?
With the advent of
Seven Day Switching the number of customers changing banks has risen – over one
million customers have chosen to do that. The biggest beneficiaries have been
TSB, Santander and Nationwide Building Society. There more than a handful of
challenger banks out there – Tesco, Marks & Spencer, Metro Bank, Co-op
Bank, Handelsbanken, Aldermore and others with current accounts on the way – amongst
them Atom Bank and Virgin Money. Despite that the market share of the large
high street banks hasn’t changed significantly. The question is why aren’t customers
changing banks? Is it simply because they see banking as a utility, that each
of the banks are pretty much the same, that for most customers (unlike bankers,
politicians, financial journalists and consumer champions) banking doesn’t enter
their consciousness unless they have a bad experience. In the grand scheme of
things for most customers they have far more important issues to think about
than whether they should switch their bank accounts.

Perhaps it is time that the CMA focused on something of more
day to day importance to consumers.

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