Interest rate rise will be the litmus test for challenger banks
Banks don’t like periods of stable interest rates and the
rates in the UK have been stable for a long time now. The reason that banks
like to have the interest rates changing frequently is because each change is
an opportunity to improve the net interest margin, to squeeze a bit more profit
out of the customer.
With the Governor of the Bank of England, Mark Carney,
indicating and then soft shoe shuffling away from the position that interest
rates could go up as early as the end of 2014 savers shouldn’t get too excited
as firstly the rise won’t be large and secondly banks usually don’t pass on the
full amount to customers but keep a bit back for themselves. Bank business
plans are built on the assumption that they won’t pass on the full benefits to
the customer. With bank profitability squeezed by regulation and low interest
rates this is why the banks are looking forward so much to greater interest
So the question is whether the challenger banks will back
their branding of doing banking differently by not following the herd and instead
passing on the full amount of the rate rise? After all it isn’t as if they are
incurring additional costs (other than typing into the computer the new
interest rate which is not exactly difficult) when the rate rises so there is
no justification for taking a slice of the interest rate rise.
Most of the challenger banks find themselves in the position
where they have more deposits, whether from savings accounts or from balances
on current accounts, than they need. A sure fire way to lose money as a bank is
to be paying out more to customers in interest than you are receiving back in
interest and fees. This is why you won’t find the likes of TSB, Metro Bank,
Aldermore or Handelsbanken appearing in the best buy tables for savings
accounts. They want you to like them but they’d rather not attract too much of
your money, particularly at a high cost.
TSB, the spin off from Lloyds Banking Group, is in the worst
position. So bad is the situation for TSB that Lloyds has had to pad out TSB by
lending it a book of loans to soak up some of the excess savings for the next
few years. Not only that it also has an infrastructure (branches, back office
and IT systems) which is larger than it needs for its existing customer base. It
is like a new boy at school where its mother has bought it a uniform that is a
few sizes too big to allow for growth. This means that for TSB passing on the
full interest rate increase will only extend the loss making period of the
bank, which it is unlikely shareholders will support.
Equally you won’t find the challenger banks topping the
lending price tables. They want to lend you money but, given their cost of
acquiring deposits they can’t in the long term price aggressively. This is
where the incumbent banks have a significant advantage. Their cost of funding
is far lower. Having large numbers of current accounts with large balances for
which the majority of customers are paid no interest they can afford to lend at
far lower rates than the challenger banks if they chose to. Instead of passing
this advantage onto customers they choose to make a larger profit whilst still charging
competitive prices to win new business.
When it comes to existing customers the challenger banks
don’t appear to be backing their customer focused words with actions. A primary
source of profits for banks are made from customers whose fixed rate or
discount deals and have ended and have been moved onto the bank’s Standard
Variable Rate. This is always higher than what a new customer could get. If the
challenger banks really are focussed on long terms relationships with their
customers and with providing good value for money then when the end of a fixed
rate or discount period is coming up rather than just telling the customer that
they are going to move onto the SVR (which the banks wouldn’t tell them if they
weren’t obligated to) they would be offering them a new fixed rate or a new
discounted rate. However most banks don’t do this because they want the
additional profit they make from having customers on the higher interest rate.
Instead they mark the customers as DND (Do Not Disturb), waiting until a customer
threatens to move their mortgage before considering making them a better offer.
Only at that point and only for certain customers do they then offer them a
better deal to keep them. The message this sends to customers is that there is
no reward for loyalty. Instead their loyalty is a means of subsidising the price
of loans to new customers.
For challenger banks that have started from scratch, rather
than from acquiring another business or a book of loans the jury is still out
as to their attitude towards existing versus new customers. They have not yet
been tested by a large volume of maturing customers and have not had the chance
to demonstrate whether they really want to do banking differently from the
However the challenger banks that have been spun off from
another bank or have grown by acquiring mature mortgage or credit card books and
have seen customers offers mature have had the chance to demonstrate that they
are doing something different but have not taken it.
When the first base rate rise is announced customers will
have the chance to judge the challenger banks by whether they pass on the full
rise to savers. This will tell customers whether these challenger banks are
really serious about taking on the legacy banks, genuinely have a different
attitude towards treating their customers fairly, and are putting their money
where their mouths are or whether it is all just marketing hype.