Examination of Witnesses (Questions 140
TUESDAY 14 MAY 2002
140. I do not think the argument surrounds the
word "excessive". The implication of what is being said
is that the four large banks are exploiting a dominant position
to make these very large profits from small and medium-sized enterprises
who find it extremely difficult to move from your grasp.
(Mr Goodwin) No evidence was put forward of exploitation
of a dominant position. It was a desktop exercise done based on
the formula we have been describing to determine excess profits.
No evidence was put forward of dominant behaviour in the marketplace
or behaviour that was inappropriate in the marketplace as to how
we conduct our business.
141. But you are dominant, you have a dominant
share of that small and medium-sized enterprises market.
(Mr Goodwin) Which is exactly what you would expect
to see in a mature, highly competitive marketplace.
(Mr Ellwood) There are 12 providers of SME current
accounts and it really is fairly straightforward to switch, indeed
we all try to take business off one another. There are tens of
thousands of accounts each year which move from one supplier to
another and that is likely to increase.
142. But a succession of reports has found that
it is very difficult for small and medium-sized enterprises to
move. It is only recently that the switching has been made much
(Mr Ellwood) Under the Business Banking Code we have
committed now to give advice about standing orders and direct
debits within five days and to make sure that the accounts are
moved very quickly indeed. There is a total commitment to do that.
143. I agree that there is a commitment now,
but that has not been the case over the last three years, has
(Mr Ellwood) It has been formalised more recently.
It has been possible to switch accounts and accounts do get switched
from one supplier to another.
(Mr Goodwin) A possible misconception around switching
is that we do not benefit; certainly our view is that we benefit
from switching. Last year we grew our customer numbers, so we
do want to attract new customers and to enable that to happen
they cannot all just be business start-ups. We have to get customers
to switch from other banks. The facts of the matter are that customers
have been switching between the banks.
Chairman: We shall take up switching
144. I am just trying to follow your arguments.
You are saying on the one hand that it does not matter if you
make lots of profits because the customers are happy. You are
saying that okay, the profits might be very large but it is only
in the last three years and before that they were more reasonable.
In some cases, Royal Bank of Scotland for instance, you are saying
that you do not actually know what the profit is because you do
not take the trouble to analyse this sector of the market as far
as the costs for your groups go. It does seem to me that your
responses are all over the shop. The suggestion is not that there
is some level of profitability at which it is unreasonable to
operate; that is obviously not reasonable in a free market. The
suggestion is that you have a cosy market in which it is possible
to achieve very high levels of profitability because the customers
do not have a reasonable alternative, so they accept what they
(Mr Goodwin) It is precisely the Commission's assertion
that there is an appropriate amount of profit to make. That is
precisely what the methodology does. It calculates an amount which
the Commission considers to be normal profit and then sets out
to calculate what we have made and compares the two. That is how
it arrives at excess profits. It is actually fundamentally premised
on setting a level of profit which is considered to be appropriate.
Chairman: We shall leave that, but it
does seem to us a little odd that we have the Director General
of Fair Trading commenting on the Competition Commission's proposals.
According to Sir Bryan Carsberg, a former Chairman of the International
Accounting Standards Board accepting that methodology, the perception
in society is that you are making excess profits and you telling
us that everybody is talking a load of baloney and they are wrong
and you are not wrong. Meanwhile this perception is going to be
building up. This morning we had a press release from Which,
which is challenging the big banks to end their £500 million
rip-off. I would suggest to you gentlemen that you do have a problem
of perception in society.
145. As I understand your argument, we have
to take the good with the bad and we have to take it over the
cycle, therefore the last three years have been the good years
and you are going to offset them against the bad years. You said
you are at the peak. Can we therefore anticipate that your profits
will go down in the next couple of years?
(Mr Barrett) I hope not.
146. You are not at the peak then, are you?
You used that word "peak". As far as I am aware, when
you are at the peak there is only one way you can go.
(Mr Barrett) There are taller peaks.
147. You would have some difficulty getting
to them. I am taking the point you made which is a fair point.
There are bad years and good years. It is unfair to alight on
a good year. Fine. Now you have had your good years and you mentioned
a peak, so can we anticipate that overall you will start giving
a bit back to your customers. That is what the customers would
(Mr Barrett) It would depend. One should not be dismissive.
Somebody commented on the fact that customers are satisfied. The
highest customer satisfaction levels we have in a worldwide business
at the moment is our small- and medium-sized enterprise business
in the UK. I do not think that should be dismissed, because to
dismiss it would assume that these are not rational grown-up people.
They are sophisticated and they are running businesses. When they
list the number of challenges that they confront in their business
life, banking and access to finance ranks down sixth or seventh
and way ahead of it are things like red tape and tax and payroll
taxes, etcetera. One should not assume that these are captive
people who are ignorant of what their choices or their options
are. Let me go back to your point on the profitability peak. It
depends going forward on the economy. For example, we saw a lot
of stress last year in sectors because of foot-and-mouth disease
and related industries; we saw a lot of stress in that sector.
It depends on the economy, it depends on interest rates in the
economy it depends on demand for their products and services.
What happens is when strain is felt on the economy, then loan
losses escalate very dramatically in that particular business
because a lot of people are working very close to the edge. When
demand drops credit losses go up. It is difficult. Over a normal
cycle the cycle has cyclical downturns in it and over a normal
cycle you would expect loan losses to climb quite dramatically.
As a businessman, what one tries to do is offset that. You offset
that by trying to increase productivity, change the business model,
improve risk management approaches, etcetera. I would hopeI
guess to be blunt that is what we are employed to doto
try to find ways of smoothing our businesses through different
periods of difficulty, but the history of small- and medium-sized
business all around the world is that it is a very dangerous sector
and subject to major cyclical corrections from time to time.
148. Would you like to comment then? I would
expect you to have satisfied customers at the moment because in
a growth market they may not like your charges, but there is an
ability to pass it on to customers, because it is a buoyant economy.
It is when the economy gets bad that the experience of small and
medium-sized businesses is that you stop being that friendly bank
manager and they are the first port of call for retrenchment.
Then you have dissatisfied customers. When the bad times are bad
small businesses are the first to feel it. When the good times
are good, there is no recognition from you that these are very
good times and you can treat your customers a bit better. It is
one way. When it is good, it is very good for you. When it is
bad, it is very bad for them not you.
(Mr Goodwin) I do not think there is a model which
says it is very good for us at a time when it is bad for the customers.
If we start incurring credit losses it is very bad for the customer
because it is their business that is going under and it is not
a good time for us. We share the pain through the cycle with our
customers. It is fair to say that some element of customer satisfaction
reflects on how well their business is doing. A survey which the
Commission commissioned on customer satisfaction said that 84
per cent of our business customers were satisfied with their bank.
149. The Federation of Small Businesses in evidence
to us on this particular point, your argument about the cycle,
pointed out that in the early 1990s small businesses were very
poorly capitalised. At the last point they measured it in 2001,
they actually banked more with you than you lent to them. That
is the point in the cycle presumably where they tend to focus
on the interest being paid to them on their accounts and that
is where the overcharging arises.
(Mr Ellwood) I do not accept that at all. If you look
at the bad debt charges in the early 1990s, they were about six
times greater than they were last year and the year before. We
are affected by that economic cycle and clearly when we see huge
write-offs like that, it has a massively poor effect on the profit,
so we suffer in exactly the same way as the customers.
150. You are now making them suffer presumably
because they are banking with you.
(Mr Ellwood) It is interesting. If you ask them what
they are worried about, first of all they are not worried about
access to finance, that is the eighth thing they are worried about.
They are worried about low turnout, they are worried about Government
red tape. Bank charges as a material issue did not feature on
some SME research done by the Competition Commission itself. They
are not concerned.
(Mr Goodwin) It is also worth recognising that those
SMEs which have funds tend not to keep then in a current account,
they move them into many of the products which we all have available
where they earn interest on the balance. It is not that they are
denied interest on the money that is simply in current accounts
where in return for the availability of relationship managers
there is no interest on that account.
151. I want to ask whether and to what extent
provisioning policy should be taking account of the cyclical variation
in your profits.
(Mr Goodwin) Provisioning policy in our case is very
simple. You provide as and when you believe there is going to
be a loss. It is not appropriate or indeed possible for us to
provide in any other way than that. In some respects it would
make profits very smooth if you could somehow charge an amount
each year through the cycle, but that would require you to be
able to predict precisely the impact of the cycle, precisely the
duration of the cycle, precisely where you are in the cycle and
would require you to suspend all known auditing and accounting
standards. It just would not fly.
152. Do you have specific as well as general
provisioning in your accounts?
(Mr Goodwin) Yes, we do.
153. I would obviously be referring to the general
provisioning here. Does anybody else want to comment on this?
(Mr Ellwood) The general provision we have is a fallback.
The principal provision is the specific provision. We think the
only accurate way is to do that on an "as it arises"
basis rather than to try to smooth it over the cycle to the extent
that you do not really know what is going to happen over the course
of the next two or three years. We have seen some huge swings
in the economic cycle but to try to predict them could lead to
some inaccuracy in the level of provisions going forward.
154. Everybody will acceptall of you
will acceptthat there is a level of monopoly control in
the market which will lead to excess profits. The question is
whether you are in that oligopolistic or monopolistic situation.
There is a need for some meaning to the term. Would it not be
helpful if you, as a group of banks, maybe together with other
banks who are not represented here today, produced your own estimates
of at what trigger point you think a signal would be being given
by a level of profitability that there was an oligopoly in the
market, which took account of the fact, for example, that some
banks go bust or have very difficult times, Baring's, BCCI got
themselves into corruption, so that people have some other measure
by which to assess whether the Cruickshank report got it right?
(Mr Goodwin) There is an important issue of behaviour
in the market rather than being tied to any specific amount of
profit. It is what happens in the marketplace. You could have
inappropriate behaviour and inappropriate competitive behaviour
with very low levels of profitability. Profitability is one part
of it, but an examination of what actually happens in the conduct
of business is equally important and that was part of the inquiry
which did not ever get off the ground.
155. Why do you not publish your own version
of what you think would be a useful trigger?
(Mr Barrett) The problem is that it is a very arcane
and esoteric subject. It seems to me that the critical issue is
that profits are egregious or excessive, if there is abusive behaviour
in the marketplace. Abusive behaviour can come from monopoly or
collusive oligopolistic behaviour. It seems to me the critical
issue therefore is not what the profit is, but whether the market
is contestable, what the barriers are to entry for other people.
If you are making excess profits, clearly other people like to
make those kinds of profits and they enter a market. The issue
then is what is restraining additional competitors entering that
market to make what seems to everybody outside the business easy
money. There was nothing in the report; nothing, which pointed
to any abusive behaviour; none. There is intense competition in
this market, multiple providers, each of us are employing thousands
of people in this market whose contracts require them to raid
business from the other guy. So I do not accept that there are
any of the abusive behaviours which are classically in competition
theory, which are classically associated with either collusive
oligopoly or monopoly situations. Given that the market is contestable
and there are some remedies to make it more contestable, that
was an appropriate area of investigation by the Commission. To
come down with its price controls, in the absence of explicit
evidence of abusive behaviour, I find extraordinary.
Mr Tyrie: I agree with you that the methodology
is flawed. All I am doing is asking you to produce your own evidence.
156. We will move on now. It is a very good
point. The perception is that you are making these excess profits.
What we are saying as a Committee is that if you, in communicating
with the Competition Commission and others try to find some middle
ground then people could perhaps understand where you are coming
from. That is a really important issue.
(Mr Dalton) May I comment on that and the point about
what level? It seems to me that people could argue the point but
the issues here are around what level is excessive and the criterion
which has been used is anything in excess of the cost of capital.
Then there comes the question of how it is calculated. There are
at least a couple of things in the calculation which deserve debate
and that is happening. Then if you say that return on equity (ROE)
is the measure which is being used, it seems to me that it is
reasonably fair to look at other ROEs, to see whether they are
at the same level and if so, whether these are excessive. It is
true, it is a fact, if we look at the ROEs in the United Kingdom,
that the bank ROEs rank eleventh out of 32 industries in the FTSE100
in terms of the level of them. There are at least ten which are
above that and that is other industries. If you decide to look
across the world and look at other banking systems, if you look
at the UK banking system, the ROE over the last five years has
been about 30 per cent and so has the US. If you look at Europe
in 2002, the ROEs in the banking system were 28.6 per cent and
the UK was 30 per cent. We have the same ROEs in the UK as exist
in many other banking systems.
157. That is very good, but as Mr Barrett said,
it is an arcane and esoteric subject. Could you try to make it
simple for us little subjects?
(Mr Barrett) It is a good point because what happens
is that one-liners like £500 billion rip-off take two seconds
to deliver; it takes two hours to dismantle them.
158. Recently there have been two inquiries
into banking for small and medium-sized enterprises: one was Cruickshank
and one was the Competition Commission. They both effectively
came to the same conclusion, that small and medium-sized enterprises
are not getting a fair deal. All we have heard this morning is
the four of you absolutely solid in refuting that but without
any real particulars to detail why these are being rejected.
(Mr Goodwin) What we have been doing for the last
ten minutes is wheeling out particulars of what was wrong. Cruickshank
and the Competition Commission used precisely the same methodology;
precisely the same. No-one should be surprised that they came
up with the same answer.
159. But that methodology is not disputed.
(Mr Goodwin) You are right that there are perception
issues here which are important and which we need to work on.