House of Commons - Treasury - Written Evidence

Select Committee on Treasury Written Evidence

Memorandum submitted by Which?

INTRODUCTION AND BACKGROUND

1. Which? campaigns for all consumers. With around 700,000 members in the UK, we are the largest consumer organisation in Europe. Entirely independent of government and industry, we are funded through sales of our consumer magazines and books.

2. Thank you for the opportunity to submit evidence to the Treasury Committee inquiry into financial inclusion. For a number of reasons set out below, we think that tackling financial exclusion is one of the key public policy challenges facing the UK. We also argue that, due to major `environmental' trends under way, financial exclusion is likely to be a growing problem for policymakers.

3. Moreover, exclusion affects the way the whole range of consumers' financial needs are met[322] although we appreciate why the committee has focused on banking services, affordable credit, access to advice and provision for the future/ long-term savings as these are probably the most pressing issues.

4. On final point we would make in the introduction is that exclusion has generally been associated with consumers in the lowest income/ socio-economic cohorts. And it is quite true that the most vulnerable consumers in society are most affected by financial exclusion and its associated disadvantages. However, we take the view that exclusion affects a much wider population of consumers especially the mass market of consumers on lower-medium incomes—this can be seen especially in the ability of the retail financial services industry to provide access to decent, value for money pensions and long-term savings products and objective financial advice.

5. Which? campaigns to ensure that the needs of all consumers are met fairly and cost-effectively. The financial products and services sold by the industry are just means to an end, ways of meeting those needs. We are agnostic about whether consumers' needs are met by state, market, or alternative models although clearly we have to be pragmatic about our recommendations[323].

6. Financial inclusion is a complex and sensitive subject. Consumers are not homogenous and can be profiled in many ways according to income, age, region, ethnicity, gender and so on—each associated with specific aspects of exclusion. Therefore, when formulating policies to promote financial inclusion these need to be tailored to meet the needs of different groups.

7. However, in the broadest sense, we have identified three groups of consumers classified according to how well the `market' can meet their needs. This classification is closely correlated with income but perhaps it is more accurate to think in terms of profitability to the retail financial services industry. These groups are:

— Consumers who are permanently excluded and whose core financial needs can only be met by state sponsored or provided solutions

— Comparatively wealthy consumers whose needs and wants can be successfully and profitably met by the retail financial services industry

— The mass market of consumers on lower-medium incomes who make up the largest group in society and whose core needs are best met by a combination of state, market and quasi-market solutions as their circumstances dictate.

8. While the most disadvantaged in society are worst affected by the consequences of financial exclusion, we think the mass market group present the most difficult policy challenge for government. The major trends we have identified lead us to question the degree to which the retail financial services industry can meet the needs of the `average' consumer in many of these core areas. As a result, we argue that radical thinking is needed to meet the core needs of this group.

9. Therefore, when addressing the financial inclusion challenge, we argue that the government should be looking at the issue from the perspective of these two groups—permanently excluded and mass market consumers—not just tackling the more obvious exclusion borne by consumers on lowest incomes.

10. The extent to which the retail market can meet the needs of all consumers very much depends on which core need (and which product associated with meeting those needs) is being evaluated. For example, it could be argued that the retail market has been very successful at meeting the needs of mortgage consumers.

11. However, the same cannot be said for pensions or access to generic financial advice and guidance where the retail market has not been able to provide access to consumers on lower-medium incomes on terms which both make sense for consumers and met shareholders expectations of return on capital. This is why we actively promote alternative models such as collective pension schemes, and a National Financial Advice Network. And we are very pleased that the idea of collective pension schemes in the form of a National Pension Savings Scheme has been recommended by the Pensions Commission in its second report.

12. We think that similar thinking will be needed to develop alternative solutions for meeting a wider range of consumers' core financial needs such as equity release and income protection products. To this end, Which? will be bringing out a report this year called Bridging the Gap which will propose alternative solutions to meet these needs using a combination of state, third sector and market based initiatives.

13. So far, in contrast to other major countries such as the USA, France and Canada, the UK government has relied on a voluntary partnership approach with the financial services industry to tackle financial exclusion supported by a number of specific programmes such as the Financial Inclusion Fund and Financial Inclusion task Force. We do not think that this approach is likely to address effectively the existing or potential problems associated with financial exclusion.

14. The individual Government initiatives and programmes are very welcome of course but we believe a dedicated and coordinated strategy is needed to ensure that the core needs of consumers currently affected by exclusion, and those who face the risk of future exclusion, are met fairly and effectively.

15. In practice, this means that the limits of market based solutions must be recognised and alternative state sponsored/ quasi-market solutions promoted by government—especially when it comes to providing access to objective financial advice and guidance, and core products such as pensions, savings and loans and, in the future, equity release and insurance products.

16. Moreover, despite the public commitments (and the efforts of some individual financial institutions), we do not believe that the retail financial services industry generally is genuinely committed to tackling financial exclusion. Therefore, we argue that it is time for government to formally intervene to ensure that exclusion is challenged. The precise form of intervention needs to be consulted on but we think interventions such as a Universal Service Obligation (USO) for basic banking services or a US style Community Reinvestment Act (CRA) should be considered—although we recognise that these are difficult issues which need to be evaluated carefully.

17. In addition, we recommend that the government introduce CRA style disclosure requirements so that policymakers can gauge the extent of financial exclusion and the behaviour of individual firms.

18. The role of regulators in tackling public policy issues such as financial exclusion should also be considered by government. The FSA does not currently have an explicit public policy objective to tackle financial exclusion nor does it oversee USO's. We are currently assessing whether the FSA is the appropriate institution for overseeing public policy on financial exclusion and will be publishing our recommendations in a policy report on financial regulation due to be published in the Spring of this year.

1. ACCESS TO BANKING SERVICES

— Action taken by the Government and the banking industry towards reducing the 1.9 million households in the UK without a bank account

— Access to banking services, including the operation, usefulness and regulation of basic bank accounts, and access to cash withdrawals.

19. We think there are two key issues relating to basic banking services:

— Access to the important benefits provided by current account type facilities; and

— The impact of changes in the ATM and bank branch market

Access

In today's world, we argue that access to banking should be seen as a utility rather than a discretionary, commodity good. It is becoming as increasingly important as other utility goods such as energy (electricity and gas) and telecommunications. Therefore, when market failure occurs (in the sense that consumers are denied access to basic services) it is valid to consider all type of intervention to ensure that consumers core needs are met fairly and efficiently.

20. We will not go into great detail about the scale of exclusion in the banking sector or the impact that can have on consumers as this has been covered in great detail in reports from HM Treasury and others[324]. However, the headline figures are striking. According to the Family Resources Survey 2003-4, over 13% of individuals in the UK do not have a current account. As nef points out in its discussion paper on basic bank accounts[325], the problem is even greater for those in deprived areas—35% of individuals in deprived areas in the UK lack basic accounts. The UK fares badly against other European countries—the percentage of excluded in most European countries is much lower than UK levels at around 4-5%.

21. This regional dimension is important. Mapping the regional distribution of financially excluded groups suggests that 68% of financially excluded groups live in the 10% of the most financially excluded postcode districts, with a quarter living in the 3% of post codes with the highest concentrations of financial exclusion[326].

22. The knock-on effects for consumers facing financial exclusion are well documented. Not having access to current account facilities and direct debits can lead to consumers: paying higher charges for other financial transactions such as cheque cashing; denied access to, or paying higher charges for, other products and services such as telecommunications, and utilities such as gas or electricity; denied access to loans or being forced to turn to non-mainstream lenders. Financial exclusion has wider consequences for society (as pointed out by HMT[327]) through entrenching social exclusion and contributing to child poverty.

Progress made

23. Therefore, progress made by the banking industry should be judged against the scale of detriment caused by financial exclusion. In that case, we do not think that reasonable progress has been made.

24. The UK government has relied on a voluntary, partnership approach with the major UK retail banks to tackle the problem of access to basic banking facilities. The key initiative in this field has been the basic bank account which offers a simple transaction account and facilitates use of ATMs and direct debits. These accounts are accessible free of charge over the counter at most post offices. UK banks signed up to a commitment to work with the Government to halve the number of unbanked households by 2006.

25. Progress has not been encouraging in our view. While the headline figures quoted by the British Bankers Association seem to indicate that this voluntary strategy has been a success, careful analysis suggests otherwise. For example, there is a significant disparity between the net numbers of basic bank accounts opened and the increase in the number of post office accessible accounts[328].

26. In addition, nef reports that, in contrast to the claims by the BBA that 5.7 million basic bank accounts had been opened by March 2005, only 1.3 million of the new basic accounts had been opened since the launch of universal banking in April 2003[329]. Furthermore, only 2.2 million of these accounts are accessible through the post office.

27. Overall, we suspect that there is a significant difference between the headline figures quoted and the number of accounts that are actually being actively used by consumers who were previously excluded which suggests that progress towards the 2006 target needs to be challenged.

28. As well as doubts about the actual penetration of basic bank accounts among the target market, concerns have been raised about the attitudes of the banks in promoting basic bank accounts.

29. To be fair, recent mystery shopping carried out by the Banking Code Standards Board (BCSB) in 2005 suggests that there have been improvements in the experiences of consumers trying to open basic bank accounts[330]. 67% of people who took part in the exercise would be prepared to recommend the bank they had opened an account (this is up from 41% in 2003, and 57% in 2004).

30. But there is room for improvement and a wide variation in the performance of different banks assessed in the survey. For example:

— the BCSB survey found 30% of its assessors had difficulty in getting literature and in some cases it was not available at all

— 26% (over 1 in 4) staff did not recognise the need for a Basic Bank Account. In one case, the figure was close to half (47.5%).

— only in 38% of cases was literature displayed in branches, in 62% it was either behind the counter or not on display at all

— in 20% of cases on average assessors were actively dissuaded from opening a basic bank account. In the case of one bank, this figure was 40%.

— In about 20% of cases, attempts were made by staff to sell a more complex product than the basic bank account. In the worst case, this happened on 40% of mystery shops.

— Speed of opening an account is crucial where payment of benefits is concerned. The BCSB states in the report that unnecessary delays (in one case up to 7 weeks) are unacceptable and more must be done to help applicants, many of whom are not financially literate or may not have English as a first language.

31. The wide variation in performance of different banks and building societies is confirmed by looking at the data for the number of basic bank accounts opened. BSCB/ BBA analysis suggests that the number of basic bank accounts being currently opened by different institutions as a proportion of ordinary current accounts ranges from 2% to 54%[331].

32. We conclude that the evidence strongly suggests that the level of commitment from the banking sector generally (with a few notable exceptions) under these voluntary arrangements is insufficient to deal with exclusion from basic banking services.

33. Banks in other major developed economies face statutory regulation in relation to financial exclusion. For example, in the USA, the Community Reinvestment Act and Home Mortgage Disclosure Act require banks to disclose details of consumers to whom they are currently providing services. Indeed, it is possible for anyone with access to the internet to see how what proportion of loans individual branches of banks have made to various groups of consumers eg. those on different incomes, or different minority ethnic groups etc. Banks are rated by the banking authorities and these scores are publicly available. This has led to banks investing in local communities to ensure a positive score under the legislation.

34. In France, consumers have a legal right to a bank account under the 1984 Banking Act—if banks refuse to open an account for consumers s/he can apply to the Bank of France which nominates a financial institution to provide the bank account. And in Canada, legislation entitled `Access to Basic Banking Services Regulations' was introduced in 2003 to ensure that all Canadians could obtain bank accounts without difficulty.

35. Therefore, we argue that it is time for government to formally consult on the use of interventions such as a Universal Service Obligation (USO) for basic banking services or a Community Reinvestment Act (CRA)—although we recognise that these are difficult issues which need to be evaluated carefully.

36. In addition, we recommend that the government introduce disclosure requirements along the lines of the CRA so that policymakers can gauge the extent of financial exclusion and the behaviour of individual firms. It is difficult to see how the required disclosure requirements could be operated effectively under a voluntary Banking Code.

ATMS and bank branches

37. However, it is not just in relation to basic bank accounts that we doubt the commitment of the major retail banks to financial inclusion. We have submitted evidence previously to the TSC on the impact of the growing number of surcharging ATMs and the closure of bank branches in deprived urban and rural areas[332]. With respect to financial exclusion the most worrying aspect is the potential impact of the growth in surcharging machines.

38. As evidence from the Campaign for Community Banking Services (CCBS)[333] submitted to the TSC shows, 40% of the branch network (over 5000 branches) have been closed since 1989. Branch closures have direct and indirect impacts on local communities—branch closures can lead to reduced access to free ATMs .

39. Although the branch closure programme was halted by fierce public and political opposition we are concerned that this pause is about to end, as indicated by the closures in 2005 by HSBC—the first of the major banks to recommence branch closure programmes. Analysis by CCBS estimates that approximately a thousand more communities are at risk of losing their last branch.

40. As we said in our submission to the Select Committee's Inquiry on Cash Machine charges, the banking industry had turned to the Post Office as a solution for consumers to access and manage their accounts. However, we noted that Post Offices too have been subject to branch closures and that many of the ATMs installed in and around Post Offices already charged or were about to charge. We were pleased to see that the intervention of the Select Committee triggered a positive response on the part of the Post Office which announced its decision to increase the number of free ATM machines. However, despite this positive step, we remain concerned. It is not clear how much progress the Post Office has made yet towards its targets for introducing free machines, or what impact the decision to end the contract for the Post Office Card Account will have on the business case for introducing free machines. But more importantly in our view any increase in free Post Office based machines has to be set against the continued growth in charging machines. Nationwide state that the number of charging machines increased by 16% between September 2004 and September 2005 while the number of free machines fell by 0.3% in the same period. It estimates that if current trends continue charging ATMs will make up 50% of the total by end-2007[334].

41. The impact of branch closures on ATM availability is difficult to ascertain without detailed mapping of the present and future situation regarding free non-branch ATMs. We would like to see the financial institutions and IADs providing detailed information on the localities where new surcharging ATMs will be cited. To provide some impetus for this, we have undertaken the precursor to such a project.

42. For a sample of 58 of the 800 communities that the CCBS have identified as branchless, we conducted some rudimentary non-scientific research to assess access in those communities of free and charging ATMs. For each community name supplied to us by the CCBS, we used the `ATM Locator' tool on the LINK website to map the closest five free and surcharging machines to the given epicentre. Of the 58 communities assessed:

— 4 communities (6.9%) had no ATM less than 2km from the epicentre;

— 21 (36.2%) had a free ATM within 2km of the epicentre;

— 13 (22.4%) had a free ATM between 2 and 4km of the epicentre; and

— For 24 communities (41.1%), the closest free ATM was 4km from the epicentre or further.

43. Our findings would suggest that branch closures are indeed having an impact on consumer's free access to their own money. In view of the economics of cash machines, we think these `free ATM black out areas' are likely to increase significantly over the next few years.

44. As ATMs convert from free to surcharging machines, groups of people living in affected areas will be ostensibly forced to use surcharging ATMs for their primary cash access. While we agree that surcharging ATMs are reasonable as convenience machines where consumers can exercise clear choice, we are seriously concerned that matters of financial exclusion and location will make `convenience' machines used for more than they were designed.

45. This is particularly disturbing in an era where consumers have salaries, benefits or pensions deposited directly into their current account (the latter two as a result of a clear government policy).

46. What is most disappointing is the attitude of the major banks to the alternative shared branch solution proposed by CCBS. We do not expect the retail major banks to maintain branch networks which lead to unacceptable losses for shareholders. Therefore we have been campaigning for the industry to adopt a cost-neutral branch sharing model for vulnerable communities.

47. CCBS has undertaken feasibility studies into this model and it has been shown to work in the USA. Which? as part of the CCBS attempted to persuade the BBA to undertake a proper pilot study of the shared branch model. The BBA did undertake their own version of a pilot study. However, Which? wrote to the BBA setting out our concerns about the flaws in the way the pilot study was being established and concluded that the pilot was designed to fail. Therefore, we were not surprised when the BBA concluded that as a result of the lessons from its pilot study, the shared branch model was not viable.

48. We would urge the TSC to revisit the issue of shared banking[335]. We would be happy to provide the TSC with copies of the communications setting out Which?s serious reservations regarding the BBA's pilot study.

49. Therefore we believe that as well as measures to ensure that banks meet their obligations on basic bank accounts we recommend that:

— banks and building societies should be required to carry out a proper feasibility study into shared branch services.

— in the certain communities where even shared branches are clearly not justifiable, the banks and building societies must commit to ensuring that these communities are served by free non-branch ATMs;

— there should be exemptions for those individuals who rely on state support to meet basic living costs. The technology should be developed so that ATM cards belonging to current accounts receiving (for example) income support, disability allowance, or pensions are earmarked to be exempt from ATM surcharges.

2. ACCESS TO AFFORDABLE CREDIT

— Measures to enable households excluded from mainstream credit to have access to affordable credit;

— The role of credit unions and community development finance institutions;

— The provision of interest-free loans from the Social Fund.

50. It is important to stress that credit is not a bad thing per se—managed well, access to fair and affordable credit provides useful benefits to consumers. However, there are major issues to be addressed in the market. We think the three key issues relating to provision of credit which policymakers need to address are as follows:

— Access to fair and affordable credit

— Unfair and irresponsible practices in the lending sector

— Access to objective advice to cope with debt related problems as a result of the fall-out from the explosion in personal debt

51. According to the NCC, in 2002 7.8 million consumers were denied access to mainstream credit[336] and had to turn to the sub-prime providers such as home credit lenders who in some cases charge in excess of 300% APR.

52. In addition, organisations such as CABx and the Consumer Credit Counselling Service report an increase in the number of clients reporting with debt problems.

53. We believe that tackling debt-related exclusion issues will become an increasingly important challenge for government because of the growth of risk based pricing by the financial services industry and the level of consumer debt in the UK.

54. Therefore, coordinated action is needed to meet three objectives of providing access to alternative sources of credit; ensuring the lending industry behaves fairly and responsibly; and providing access to financial advice.

Alternative sources of credit

55. We are encouraged by the initiatives undertaken so far by the government to promote and develop alternative sources of credit for those consumers the mainstream industry cannot serve fairly and cost-effectively. We are very supportive of the role of credit unions in meeting the savings and credit needs of communities. We think the role of credit unions could be expanded to meet other needs eg providing access to general financial advice. We see credit unions as providing one of the access points in a National Financial Advice Network.

56. However, despite the obvious potential credit unions have for promoting financial inclusion, the sector faces a major hurdle in that individual credit unions need to build up substantial savings before they can lend out to borrowers. Furthermore, credit unions as mutual organisations cannot be expected to take undue risks with members' savings.

57. The decision to relax the interest rate cap on credit union loans should help credit unions offer more competitive savings and therefore increase the available loan capital and allow better management of risks. But this is not enough in our view. As part of our Bridging the Gap work, we are evaluating whether better use could be made of `quasi-market' sources to provide credit unions with access to low risk sources of loan funds. In addition, we are investigating what role the government could play in underwriting loans for consumers who do not have savings built up within a credit union—allowing credit unions to administer the actual loans. We see merit in the idea of allowing independent organisations such as CABx or CCCS recommending clients who have a need for emergency funds to credit unions for this type of loan. However, this clearly needs to be evaluated further and we will be producing more detailed models as part of our Bridging the Gap report.

Ensuring the lending industry behaves fairly and responsibly

58. We are of the view that the behaviour and practices of parts of the lending industry (mainstream and sub-prime sectors) have contributed to the unprecedented levels of personal borrowing in the UK. The FSA's recent Financial Risk Outlook reports that 1 in 8 families are having difficulty meeting their obligations[337].

59. We have been critical of a number of practices followed by the sector[338] in particular:

— Unsolicited credit limit increases and unsolicited credit card cheques

— Aggressive direct mail marketing campaigns which promote inappropriate or expensive products when better options are available

— Mis-selling of add-on products such as payment protection insurance

— Lenders not doing enough to ensure that consumers can afford the credit offered—data sharing is a particular issue.

60. As part of our Time For A Change strategy we are developing a series of principles and practices including specific measures for the lending sector. These will cover: product design marketing practices, pre-contractual information, credit-checking, final contract and account management, and data sharing. We are hoping to persuade the sector to work with us in developing a set of voluntary standards to promote fair and responsible lending along the lines of our successful Fair Mortgage Campaign.

61. So far, we have ruled out supporting the idea of a cap on interest rates to tackle extortionate lending. Our fear is that given the existing capacity constraints there is a risk of more consumers being displaced into the fringes of the lending industry. We believe it is preferable if the government focuses on building capacity in the third sector.

Providing access to financial advice

62. As mentioned below in our response to question 3, we think the case for a coordinated, centrally managed National Financial Advice Network is compelling. We appreciate that debt advice is a priority for government. However, we believe that it is preferable to look at providing advice on consumers' general financial needs rather than focus on one specific aspect. Moreover, we think this would be more cost effective rather than have individual advice solutions for debt, pensions and other general financial advice needs.

3. FINANCIAL EDUCATION AND ACCESS TO FINANCIAL ADVICE

— The role of the Financial Services Authority, the Department for Education and Skills and others in promoting and supporting improved financial education in the schools, other education institutions and the workplace and the progress of the national strategy for financial capability;

— The provision and regulation of generic financial advice about savings and debt

63. We strongly support the work of Government and others such as the Personal Finance Education Group (PFEG) to promote and support financial education. Financial education and information campaigns as a prerequisite for an informed and active consumer population. However, it is our view that given the legacy problems facing the UK it may take a generation for initiatives to pay dividends. More importantly financial education should not be seen as a substitute for effective regulation of markets.

64. We believe there is evidence of growing demand and need for unbiased advice and guidance on general financial matters. We do not think it is possible to look at debt and savings in isolation. General financial healthchecks and help on individual matters are becoming increasingly important.

65. These demand factors include:

— 1.5 million overindebted households

— in the field of pensions, the risk and responsibility of providing for the future is increasingly being transferred from the state and employers to individuals, coupled with major changes to employers final salary schemes

— the need for `emergency' advice in the face of mis-selling scandals eg. pensions mis-selling, mortgage endowment mis-selling and contracting out mis-selling. Consumers can be reluctant to return for advice to the same industry which caused problems in the first place.

— Consumers may need advice and guidance when obtaining due redress whether at the individual level or as a result of major scandals. An indication of that demand and need can be seen from the 1 million unique visits Which? had to its mortgage endowment website.

— The UK's state benefit system is seen as being very complex and there is a need for advice on claiming benefits and resolving benefit problems.

— The UK financial system and products is hugely complex so we believe there is a real need for help with general financial planning. However, the retail industry is unable to serve consumers on lower-medium incomes because of the economics of access.

66. It is too early to judge the effectiveness of the national strategy for financial capability. However, we are very concerned that the FSA appears to be placing too much emphasis on the private sector to meet this need for generic advice.

67. The need and demand for advice and guidance among all parts of society can be best met by a `mixed economy' of providers including the state, third sector and private sector.

68. There are already a large number of third sector organisations of various types who are involved in delivering advice and education doing a commendable job. However, we are of the view that these efforts are being dissipated by the absence of a coordinated programme to provide access to advice to those who need it most.

69. We conclude that the combination of factors facing the UK mean that the need for a National Financial Advice Network is more compelling than ever. This network should be the key agency for delivering advice and coordinating the delivery of the national strategy for financial capability.

70. We are campaigning for the creation of a National Financial Advice Network using the existing infrastructure of citizens advice bureaux, local government advice centres, the workplace, specialist charities, trades unions etc and supported by a dedicated helpline) to provide access to financial healthchecks/guidance but which could also coordinate and deliver financial education on the ground. This is built around the existing model of the Community Legal Service which provides access to legal advice for consumers on lower incomes.

71. Which?s preliminary estimates are that it would cost about £200 million a year to run. This need not necessarily be new money—it could be funded by redirected resources from the existing fragmented financial education programmes and by fines on industry. If consumers are to be truly educated, informed and protected there will need to be a move away from the current fragmented and uncoordinated approach towards a more coherent and coordinated strategy which addresses the different stages of consumer need.

72. A degree of additional central funding may well be needed but not providing this much needed resource would be a false economy. Providing access to financial advice for consumers on lower-medium income consumers costs money regardless of whether this is provided through a NFAN type institution or through existing private sector channels. The question is which is the most cost-effective and fairest mechanism for meeting the existing need for unbiased advice?

73. We are of the view that it is likely to cost more to meet this need through private sector channels not least because of the additional regulatory requirements. One of the main reasons for regulation is where conflicts of interest exist in the distribution chain—a primary cause of these conflicts of interest are the commercial imperatives which operate when the private sector financial services firms are involved. This is not a criticism per se, but there are clear conflicts between consumer and shareholder/producer interests which need to be addressed by regulation/intervention with consequent cost-implications. These particular conflicts would not exist with a NFAN type organisation.

74. Moreover, we believe that a NFAN would result in cost-savings for the industry as many consumers who are not profitable for industry to serve would be filtered out. This would produce a double benefit for industry as conversion rates[339] would be improved which in turn would free more time for `prospecting' for new sales leads. As the Pensions Commission report shows, these prospecting costs are a significant proportion of business costs and when coupled with low conversion rates results in major inefficiencies in the advice system (see answer to Question 5 below for details).

75. However, it is difficult to put a precise figure on the cost of operating a NFAN because of the different assumptions and because we do not have access to the commercial data needed. Therefore, this is why as a first step we are calling for the Government to fund a proper feasibility and pilot study to evaluate the costs. We suggest this could be a job for the Financial Inclusion Task Force.

76. We do not see the FSA as being the appropriate organisation for operating this network. Its priority should be focusing on making markets work in the consumer interest. We have previously raised concerns about the structure of the FSA primarily concerning the dual roles of wholesale and retail regulation. Requiring the FSA to coordinate the delivery of advice and education would further undermine its effectiveness.

77. We favour two possible models for coordinating delivery of advice and education. Either a standalone agency similar to the Financial Ombudsman Service could be established which would be linked to the FSA but operationally independent. Alternatively, a standalone agency could be created under the auspices of a major government department similar to the Legal Services Commission which coordinates the Community Legal Service. Whichever model for coordinating delivery of advice and education is chosen, the critical factor is that this should be properly resourced[340].

4. INCENTIVES AND BARRIERS TO SAVING FOR PEOPLE ON BELOW AVERAGE INCOMES

— The operation of the Government's Savings Gateway accounts programme;

— The impact of the Basic Advice Regime in encouraging saving;

— The extent to which decisions on saving are influenced by factors affected by financial services regulation, such as the cost of regulated advice, as opposed to other factors, such as State benefits system

78. This issue is the main focus of our submission to the TSC and is hugely relevant given the recommendations of the Pensions Commission to establish a National Pensions Savings Scheme. Our analysis suggests that the retail industry cannot provide pensions to the lower-medium income segment of the market as the economics of access prohibit this. We are pleased to see that the collective approach to providing access to savings that Which? has been advocating for some time now[341] has been recommended by the Pensions Commission in the form of the National Pensions Savings Scheme. We see no other way of providing the decent, fair, sustainable and affordable pension schemes consumers want.

79. However, we are very concerned that the retail insurance industry recognises that the NPSS exposes the poor value of its pension products and will seek to undermine the NPSS before it is established. Moreover, we are concerned that actions taken by the FSA will undermine the NPSS, further exacerbate affordability problems in the pensions market, and inadvertently create the conditions for mis-selling (see RU64 below).

Reasons why UK consumers are not saving enough for the future

80. Before commenting on the three specific issues outlined above it may be helpful to set out the reasons we believe consumers in the UK are underproviding for the future.

81. Which?s qualitative and quantitative research points to the following reasons as being the prime factors: unaffordability (compounded by record levels of personal debt); industry inefficiencies caused by weak competition and the absence of economies of scale; lack of incentives due to lower long-term investment returns; lack of confidence and trust in pensions and pension providers; fears about stockmarkets and a marked preference for less risky assets such as cash deposits and other `assets' such as property.

The impact of the FSA's proposals to remove the RU64 rule

82. The RU64 rule was the mechanism which gave effect to the substantial improvements stakeholder pensions (SHPs) brought to one of the most dysfunctional sectors consumers encounter. The FSA's proposals are hugely detrimental to the consumer interest and the wider public interest. The removal of RU64 will:

(i). undo much of the progress made by the government and consumer advocates in introducing market disciplines and meaningful competition to the retail pensions sector and will simply prolong market inefficiencies. Prices are bound to rise significantly breaching the SHP price cap—making pensions even less affordable and wasting substantial amounts of taxpayers money in the process;

(ii). undermine the valuable consumer protection provided by RU64, by creating the conditions for sales of unsuitable, expensive products; and

(iii). undermine public policy initiatives initiated by the government. Removing RU64 will fatally damage stakeholder pensions thereby setting the FSA in direct conflict with the government's desire to introduce market disciplines and make retail pensions competitively priced and affordable. The abolition will also allow the retail pensions industry to seriously undermine the National Pension Savings Scheme before it gets off the ground. Abolishing RU64 will allow the retail industry to build up a `war-chest' to fund marketing initiatives to persuade consumers to opt out of the NPSS.

83. The FSA has fallen for the classic industry lobbying technique which argues that regulatory intervention is preventing the market from working. Therefore, it is trying to create the conditions for the market to deliver.

84. We are at a loss to explain why the FSA seems to have bought so unquestioningly the disingenuous arguments put forward by the insurance industry that the SHP price cap has exacerbated pension underprovision by lower-medium income consumers in the UK and that, if only prices were allowed to rise, the industry would play its role in closing the pensions gap.

85. For this contention to be valid, a number of conditions would need to be met—namely, (a) that the industry has an interest in selling products to this market and (b) the price cap has prevented consumers from accessing pension providers.

86. The FSA has not made a reasonable case to support either argument. There is no evidence that the industry has ever been interested in this particular market except on hugely expensive terms. Nor is there any evidence to suggest that the industry would be interested in this segment of the market given the margins available elsewhere (unless of course they were able to sell to this market in the belief that the likelihood of regulatory intervention would be reduced because of the removal of RU64).

87. Crucially, the FSA has not explored in any detail the more likely reasons why lower-medium consumers are not contributing enough to pensions. The FSA is wrong to blame restricted access to pensions on the price cap effect and therefore is wrong to justify allowing prices to rise on these grounds. To allow substantial price rises to occur at a time when affordability and lack of trust and confidence are the key barriers to consumers contributing to pensions is misguided in our view.

88. The impact on public policy initiatives seems not to have been understood by the FSA. The insurance industry is well aware that the report of the Pensions Commission and other research highlights the basic unsuitability of the `retail' pensions model for meeting the pension needs of lower-medium income consumers. There is a growing belief that alternative models are needed to meet the needs of this consumer segment to circumvent the inefficiencies of the retail model. This, of course, threatens the basic business model of the industry.

89. So, we suspect the real reason for this lobbying to raise prices is that, as well as allowing firms to maximise revenues from higher income groups, a rise in personal pension charges will allow the insurance industry to entrench its position in advance of the implementation of the Pensions Commission's recommendations.

90. We hope at this stage that the TSC would be able to bring some pressure to bear on the FSA to reconsider its approach to RU64 as its proposals in our view are a grave mistake and would constitute a major strategic policy error on the part of the FSA.

91. Even if the industry was interested in the lower-medium income market, making pensions more unaffordable is counterintuitive and the very consumers the FSA claims it wants to help will have less incentive to save for the future, and industry sales people will have less scope for recommending personal pensions—assuming of course personal pensions are sold in a properly regulated environment.

92. The industry may well have sold products to lower-income groups in the past. But it should be remembered on what terms this was—the charging structures were such that it was taking between 7-10 years for consumers making monthly contributions to break even and this was at a time when markets were delivering double digit growth. Overall, it must be reasonable to assume that the combination of industry inefficiency, and shareholder demands will force firms to maximise the opportunity provided by FSA to extract greater revenue from higher income groups—industry is unlikely to want to sell to lower income groups unless it can missell without fear of regulatory intervention.

93. But it needs to be said that the FSA will be creating the conditions for the mis-selling of unsuitable products if it goes ahead with these proposals. One of the other major benefits of SHPs was that it made mis-selling almost impossible in a properly regulated environment as SHPs were so demonstrably better value and more suitable for consumers. RU64 was the mechanism which made this benefit clear. Removing RU64 will make the sale of more expensive and therefore unsuitable products easier for industry who it should be remembered have a primary duty to shareholders. It is expected that bancassurers and multi-ties will grab an increasing share of market among lower-medium income groups and as the FSA's realises these distribution channels only have to recommend most suitable products within their `range'—and it is unlikely that they will include the remaining SHPs within their range.

94. It is misguided of a regulator to condone and promote significant price rises when affordability is a major issue. As mentioned, we find little to suggest in the FSA's arguments that information solutions or `competition' will keep a lid on price rises—even the FSA seems to accept that to be fair. Indeed, it is likely that further upward pressure will be put on charges as a result of depolarisation. As the ABI report on `Paying for Financial Advice' suggests, commission levels already appear to be bid up. This must feed through to higher charges unless the industry is willing to absorb these increased costs—which is highly unlikely.

95. The answer to the underfunding of pensions is not to allow pension charges to rise but to implement the National Pension Savings Scheme as recommended by the Pensions Commission.

Savings Gateway

96. The idea behind government initiatives such as the Savings Gateway and the Child Trust Fund is attractive. Getting consumers used to the savings habit can have significant additional benefits in terms of financial inclusion—not least in providing consumers with greater confidence to deal with financial issues. The savings gateway concept seems a relatively simple concept with the benefits readily understandable.

97. However, it is too early to say whether the Savings Gateway will make a significant difference to financial inclusion. We suspect that much more will need to be done in terms of raising awareness to overcome the barriers to saving outlined above.

Impact of the Basic Advice regime in encouraging savings

The extent to which decisions on saving are influenced by factors affected by financial services regulation, such as the cost of regulated advice, as opposed to other factors, such as State benefits system

98. The issues relating to the Basic Advice Regime and impact of financial services regulation are linked so we have commented on these two issues together.

99. We do not think that the introduction of the Basic Advice Regime will have any significant impact in encouraging savings. This goes back to the fundamental point that the retail industry cannot serve this target market on terms which both (i) provide an incentive for consumers to forgo current consumption and save for the future and (ii) meet shareholders expectations of returns on capital. Nor has this been the case in the past despite the claims of the industry. Therefore, not surprisingly we see no sign that the Basic Advice regime is encouraging retail insurance firms to actively target consumers on lower-medium incomes.

100. Regulation can have potentially positive and negative effects on the levels of savings:

— Effective regulation can provide consumers with confidence to provide for the future, while at the same time avoiding unnecessary costs

— Ineffective regulation can undermine consumer confidence and/or add to distribution costs which can have the effect of denying access to consumers

— misguided regulatory actions can cause inefficiencies and distortions in a market.

Regulation and consumer confidence

101. We have not explicitly researched whether regulation per se is having an impact on consumer confidence but our research suggests that one of the key barriers to providing for the future is consumer confidence and trust in the financial system and products[342]. We believe that this confidence has been badly shaken by a series of financial scandals such as Equitable Life, various mis-selling scandals such as pensions and mortgage endowment scandals and scares relating to occupational schemes.

102. One of the FSA's statutory objectives is to maintain confidence in the financial system and while this objective may well be met in relation to `systemic' issues in the wholesale financial markets it is difficult to maintain that this objective is being met sufficiently well in relation to individual consumer confidence. Therefore, we would argue that improving confidence in the regulatory system is one of the critical factors in improving and maintaining confidence in the financial system and products.

103. Which? is producing a policy report in the Spring of 2006 which will detail our proposals for improving the effectiveness of the regulatory system from a consumer perspective.

104. Regulatory costs and savings behaviour

105. It is important to challenge some of the claims made by the retail financial services industry about the impact of the costs of financial regulation on savings behaviour. To summarise, the industry claims that the existing regulations are too costly and this prohibits firms from selling to lower-medium income consumers under the stakeholder pensions price cap—1.5% for the first ten years and 1% thereafter[343].

106. We actually agree with the retail industry that it cannot sell to the target market at the price cap levels (certainly in its current form). The point we have always made to HMT and FSA is that the industry would need to sell at a charge level around twice the current price cap level. This would clearly be unacceptable as it would provide no incentive for consumers to save using long-term products and selling products at those charge levels would in our view constitute mis-selling given consumers appetite for risk.

107. We argue that during the consultation on the level of the stakeholder pension price cap the industry was being disingenuous in arguing for an increase in the price cap from the then 1% per annum. It did not seek a price cap rise in order to sell to the Government's target market but rather to maximise revenue from more profitable groups of consumers on medium to higher incomes. In the end we were pleased that the Government did not give in to the industry's more unacceptable demands and limited the increase to 1.5% for the first 10 years and 1% thereafter. Our evidence suggests that this is more than enough to allow the industry to make a reasonable return on capital from consumers making contributions of around £100 a month.

108. However, while we were encouraged by the Governments firm but fair stance towards the industry during the price cap consultation, it is dismaying to see that the industry seems to have achieved its objective of breaking the new price cap through alternative means (see The impact of the FSA's proposals to remove the RU64 rule, above).

109. Without access to confidential figures it is difficult to say precisely what proportion of distribution costs arises from explicit regulatory costs. No one supports unnecessary regulation and we have argued for a long time that an overreliance on rules based regulation encourages a culture of compliance and adds to costs without addressing the root causes of market failure and consumer detriment[344].

110. However, we have long suspected that the industry has tried to overplay the cost of regulation by conflating general business costs and regulatory costs. Even if the FSA didn't exist (with the associated compliance costs), firms would still have to gather information in order to establish which products are suitable for potential clients—this should be a requirement as part of due diligence, and it should be hoped that firms and advisers would see this as being good business practice anyway regardless of whether statutory regulation existed or not.

111. In a sense, the conduct of business and disclosure rules, and compliance requirements deployed under statutory regulation simply `codify' what should be part of the normal business and risk management process. To be sure, there is a debate about the amount of information that must be disclosed and collected and we see merit in having a debate around streamlining this volume of information.

112. A common criticism we hear from industry is that FSA requirements have greatly increased the costs associated with the sales process (ie. the fact finding referred to above) and compliance costs. The FSA does indeed mandate certain information requirements. However, it should also be noted that the FSA also works by setting down high level principles and allows firms significant discretion as to how these high level principles are met. The FSA does not mandate specific approaches for example in ensuring sales are compliant with high level principles. It is very much up to directors in firms to weigh up the risks to the firm of various approaches. They are free to choose how many sales are double checked by compliance staff. We have been made aware of one example inside a major UK financial institution where compliance departments double check 100% of sales by front line staff.

113. The industry claims that the length of time to complete the sales process has increased signficantly under regulation and this has therefore increased distribution costs. It is not clear how much of this increase is attributable to regulation per se. We suspect that much of the claimed increase is `self-imposed' in that firms are `gold-plating' the regulatory requirements to ensure that mis-selling is not occurring. As mentioned, the FSA allows firms significant discretion as to how the high level principles are met.

114. Therefore, it has been our view that the main costs of distribution relate to general business costs and specifically marketing and selling costs, and set-up costs not regulatory costs. So, cutting regulatory costs would result in a very small reduction in overall distribution costs.

115. There is strong evidence to support this view. To begin with, charges on personal pensions and other long-term savings products such as endowments were unacceptably high even before the FSA came into existence—or the disclosure requirements which were introduced in 1995.

116. Compelling evidence comes from the Pension Commission's Second Report which looked at the distribution costs associated with the existing personal pensions market. The Commission modelled the set-up and ongoing costs of providing a group personal pension to a small employer[345] of 23 employees. The total costs assumed by the Pensions Commission were £805 in set-up costs plus a further £31 a year[346] in ongoing costs.

117. The key components in the set-up costs were:

Costs embedded in IFA commission

Prospecting/ marketing £233

Establishing the scheme £217

Advising individual whether it is worth saving £80

Persuading individual to save in particular scheme £80

Initial set-up costs for provider

Sales consultant and staff incentives £160

118. It is worth noting that compared to these major set up costs the Pensions Commission modelled the cost of complying with regulations to be £5. In terms of ongoing costs, of the £31 annual cost, compliance costs amount to £4.50.

Impact of benefits on savings behaviour

119. Some commentators have argued that a combination of a higher universal state pension (which would remove the need for means testing) plus incentives would provide the necessary encouragement to stimulate savings.

120. It would seem `obvious' that means testing is a barrier to getting consumers to save. But the issue is more complex that it may first seem. We begun our qualitative research programme on pensions expecting to find that that means testing would be a clear disincentive to save. However, on reflection it became clear that if means testing was a disincentive then a number of conditions would need to be met.

121. Firstly, consumers would need to be consciously thinking about contributing to pensions and be consciously weighing up options for providing a retirement income some years down the line. Secondly, consumers would need to be aware of means testing and the impact of means testing on pensions.

122. However, the qualitative research Which? undertook suggest that neither conditions are necessarily met—certainly within the reluctant groups of savers.

123. There did not seem to be a great deal of awareness of how means testing works among the groups we surveyed (see Summary of research contained in Which?'s submission to the Pensions Commission). To be sure, once this was explained there was a great deal of `anger' among group members. However, in practice means testing did not make a difference as the groups had no intention to save anyway. The majority were simply not making conscious decisions or choices about whether to rely on means tested benefits. The sense we got from our research was that respondents were expecting `something to turn up'. But there was no sense that means testing was that `something'.

124. Therefore, although it may seem counterintuitive, it looks as if means testing is not having a significant direct impact on savings behaviour of groups who are not making the necessary level of contributions. It is unclear whether means testing is having an impact on the savings behaviour of those groups who are currently making some savings—ie. if means testing is causing those savers to contribute less than they might do.

125. The key point is that, whatever the perceived impact, changing means testing on its own will not provide effective incentives to save.

126. However, regardless of the direct impact of means testing we do take the view that simplifying the pensions structure is important and should be done as one of a number of measures. Simplicity is crucial to encouraging consumer engagement with the pensions system. Means testing per se may not be a barrier to savings, but it does add to the complexity of the pensions system and this complexity does act as a very real barrier. Moreover, means testing makes the advice process more complex, more uncertain and therefore more expensive.

5. THE ROLE OF THE GOVERNMENT, THE FINANCIAL SERVICES AUTHORITY AND OTHER BODIES AND ORGANISATIONS IN PROMOTING FINANCIAL INCLUSION

— The work of the Financial Inclusion Taskforce, and the use of resources from the Financial Inclusion Fund;

— Lessons from successful local or regional initiatives designed to address geographical concentrations of financially excluded households.

127. Which? supports the various government initiatives and the work undertaken by others to promote financial inclusion. However, we take the view that this work needs to be better coordinated particularly in relation to developing alternative financial products, providing access to unbiased advice, delivering financial education programmes, and implementing policies to tackle financial exclusion (including industry monitoring).

128. As stated in our answer to question 3, we favour two possible models for coordinating action. We do not think the FSA is the appropriate body for coordinating this work. We would suggest that either a standalone agency similar to the Financial Ombudsman Service or Legal Services Commission be created.

129. While the coordination of financial inclusion policy should be undertaken centrally, specific problems with exclusion need targeted solutions especially when it comes to access to banking services, and provision of advice. As outlined above, the regional dimension is important with 68% of financially excluded groups living in the 10% of the most financially excluded postcode districts, with a quarter living in the 3% of post codes with the highest concentrations of financial exclusion[347].

130. The Financial Exclusion Taskforce provides an ideal opportunity to coordinate pilot studies for shared branch banking, and the National Financial Advice Network.

6. THE BENEFITS OF FINANCIAL INCLUSION AND THE EXTENT TO WHICH FINANCIAL INCLUSION MEASURES CAN CONTRIBUTE TO COMBATING POVERTY AND REDUCING BARRIERS TO EMPLOYMENT