Competition and choice in retail banking - Treasury Contents

1  Introduction

1. The Independent Commission on Banking (the Vickers Commission) was established by the Government in June 2010 to "consider the structure of the UK banking sector, and look at structural and non-structural measures to reform the banking system and promote competition". It will formulate policy recommendations with a view to:

  • "reducing systemic risk in the banking sector, exploring the risk posed by banks of different size, scale and function;
  • mitigating moral hazard in the banking system;
  • reducing both the likelihood and impact of firm failure; as well as
  • promoting competition in both retail and investment banking with a view to ensuring that the needs of banks' customers and clients are efficiently served, and in particular considering the extent to which large banks gain competitive advantage from being perceived as too big to fail."[1]

2. The ICB will publish its interim report in April 2011. At that stage we will call Sir John Vickers, Chair of the ICB, and his fellow Commissioners to give evidence on their developing conclusions. The Government has said that it has yet to set a timetable for responding to the Commission's final report which is expected to be published by the end of September this year.[2]

3. Much of the debate about the financial crisis has been framed in terms of the effect on the economy as a whole, or on the impact on taxpayers. These are extremely important issues, but although bank customers have largely been sheltered from the direct effects of the financial crisis, consumers will ultimately suffer if the banking system operates in a way which inhibits effective competition in retail banking. For this reason, in July 2010 we launched an inquiry into competition and choice in the retail banking sector. The terms of reference were to:

  • Assess the impact of the financial crisis on competition and choice in both retail and wholesale banking;
  • Assess the impact of widespread consolidation among banks and mutuals;
  • Examine the key barriers to entry inhibiting increased competition, including regulation;
  • Examine whether competition is inhibited by difficulties faced by consumers in accessing information about products;
  • Explore the Government and competition authorities' strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market;
  • Consider the relationship between competition and financial stability;
  • Consider the impact of free banking on effective competition; and
  • Look at the role of foreign-based operators and whether they are likely to return to the UK.[3]

4. Our inquiry spanned twelve oral evidence sessions. We heard evidence from a wide range of institutions, including consumer groups, banks and building societies as well as the regulatory and competition authorities.

5. We are grateful to Adam Phillips, Chairman of the Financial Services Consumer Panel, Peter Vicary-Smith, Chief Executive, and Dominic Lindley, Principal Policy Advisor, Which?, Philip Cullum, Deputy Chief Executive and Ms Sarah Brooks, Head of Financial Services, Consumer Focus, Lord Turner and Hector Sants, Chairman and Chief Executive at the Financial Services Authority, Sir Donald Cruickshank, Eric Daniels, then Group Chief Executive, Helen Weir, then Group Executive Director, and Patrick Foley, Chief Economist, Lloyds Banking Group, Stephen Hester, Chief Executive and Brian Hartzer, Chief Executive, UK Retail, Wealth and Ulster, RBS, Benny Higgins, Chief Executive, Tesco Bank, Vernon W Hill II and Anthony Thompson, Vice Chairman and Chairman respectively at Metro Bank, Bob Diamond, Chief Executive, and Antony Jenkins, Chief Executive Global Retail Banking, Barclays Plc, Ms Jayne-Anne Gadhia, Chief Executive, Virgin Money, Ms Ana Botin, Chief Executive, Santander UK, John Fingleton and Clive Maxwell, Chief Executive and Executive Director respectively at the Office of Fair Trading, Douglas Flint, Group Chairman, and Joe Garner, Deputy Chief Executive UK, HSBC plc, Neville Richardson, Chief Executive, and Rod Bulmer, Managing Director, Retail, The Co-operative Financial Services, Graham Beale, Chief Executive, and Chris Rhodes, Executive Director, Group Product and Marketing, Nationwide and Mark Hoban MP, Financial Secretary to the Treasury for sharing their views on this important subject with the Committee. We are also grateful to those who submitted written evidence.

6. We heard evidence from such a wide and diverse range of institutions to ensure a full understanding of the state of competition in the UK retail market. All the witnesses we heard from came with their own position and interests to defend. For example, the large banks stressed how competitive retail banking in the UK was and how the system delivered choice and value for consumers. Conversely, consumer groups and new or growing entrants to the market focused on how uncompetitive UK retail banking was and the negative impact this had on consumers.

7. We would also like to thank Dr Pinar Bagci, Senior Consultant with the Brattle Group for her expert advice and assistance in this inquiry and Mark Falcon, Head of Economic Regulation, Hutchison 3G UK ('Three').[4]

Competition: an overview

8. Competition cannot be divorced from wider regulatory issues, including the 'too important to fail' problem. The banking crisis of August 2007 onwards revealed major structural flaws in banking systems around the world. In particular it exposed the reality that Governments felt unable to allow systemically important financial institutions to default on, for example, their bonded debt. This exposed the implicit subsidy to these financial institutions, as their cost of credit was reduced to take account of probable Government bail outs. The 'too important to fail' problem is an important barrier to competition, but it is not the only such barrier.

9. We believe effective competition cannot take place in an environment where firms which are perceived as 'too important to fail' are both protected from the discipline of the market place and derive tangible benefits from this status. This moral hazard distorts competition and places new or growing firms at a serious disadvantage. Banks which are perceived as small enough or not systemically important enough to be allowed to fail not only face normal difficulties in breaking into the market. They face higher funding costs compared to those who benefit from this implicit subsidy. Financial stability is also imperilled, as the absence of the threat of failure can actively encourage greater or excessive risk-taking—the moral hazard problem. However, this Report does not deal with these issues in detail. The Vickers Commission is examining the too important to fail problem. They were also examined by the Treasury Committee in Too important to fail—too important to ignore.[5]

10. This Report focuses on competition. As the ICB has noted, in a well-functioning market existing suppliers not only compete with each other, but have to deal with the threat of potential new entrants. This gives them the incentive to provide a choice of products to well-informed consumers. Those who succeed in attracting and retaining customers—by offering cheaper, higher quality and/or innovative products or services—prosper, whilst poorer quality or over-priced products are forced out of the market, and firms which persist in trying to sell such products ultimately fail.[6]

11. Concerns about the effectiveness of competition in the banking market go back many years. In 1998, the then Chancellor invited Sir Donald Cruickshank to undertake a review of the retail banking sector in the UK. In March 2000, Sir Donald Cruickshank published his report Competition in UK Banking. The report examined whether competition was effective in the markets for money transmission, services to personal customers and services to small and medium sized businesses (SMEs). Its conclusion was that "competition problems were found in all markets investigated."[7]

12. Since then the Office of Fair Trading (OFT) and Competition Commission (CC) have conducted almost twenty inquiries into competition in different parts of the retail banking market. Many of these inquiries and investigations have focused on particular segments of the market, such as the personal current account market (2008), Cash ISAs (OFT, 2010) store card credit services (OFT, 2004, CC, 2006). There have been two studies specifically on SME banking, by the Competition Commission in 2002 and the Office of Fair Trading in 2007. Most recently the OFT conducted a market study Review of barriers to entry, expansion and exit in retail banking.[8] There have also been a number of EU inquiries into the banking sector, including the European Commission's 2007 inquiry into retail banking. The sheer number of inquiries and investigations suggests long-standing and widespread concern about the effectiveness and nature of competition in the banking sector.

13. The market for retail banking is not like that for restaurant meals, groceries, clothes or newspapers, where, as Lord Turner has noted, "the philosophy of free competition and free customer choice easily produces good results". In such markets the customer can assess the quality and price of what is on offer and make an informed choice. In contrast, retail banking sells many products such as long-term investment and insurance products which are:

  • long-term in nature, only revealing their quality many years hence;
  • purchased only once or twice, thereby ruling out learning from repeat purchases;
  • complex, which makes it difficult for consumers to assess.

Added to this—as in many other product markets—there is asymmetry of information and knowledge between consumers and producers.

14. These characteristics mean regulation will always have an important role to play in the retail banking market. However, policymakers should put competition at the forefront of regulation of the retail banking sector. A properly competitive market can drive firms to provide choice and deliver better outcomes for consumers in a way which reduces the need for costly and heavy-handed regulation. The Government has said it believes enhanced competition can deliver better outcomes for consumers. Indeed, Mark Hoban, Financial Secretary to the Treasury, has gone further and stated that "competition is probably the best way of getting the right outcomes for consumers."[9]

15. Competition depends on a number of factors. David T Llewellyn, Professor of Money and Banking at Loughborough University noted that "when considering the nature and structure of competition in banking and retail financial services, three alternative concepts need to be identified: competition, contestability and effective competition". He detailed these as:

  • Competition—"consider factors such as the number of suppliers, the market share of the dominant players"
  • Contestability—"a market is said to be contestable if entry and exit barriers are low"
  • Effective competition—"competition is only effective in practice if consumers are able:

1) to make rational and informed choices between competitors, and

2) to exercise choice at low transaction costs."[10]

16. The Cruickshank report on competition in UK retail banking expressed concern about the high levels of concentration in UK retail banking, particularly in the personal current account and SME markets. The financial crisis—which has resulted in consolidation across the sector through mergers and exit from the market—has led to a significant increase in concentration in many parts of the retail market. Concentration levels in the personal current account market are now higher than at the time of the Cruickshank report.

17. We also received a large body of evidence suggesting that competition was proving ineffectual in certain parts of the retail market. Whilst the CEOs of the large incumbent banks told us UK retail banking was "enormously competitive", a far larger range of witnesses and organisations variously described retail banking as a "limited oligopoly" or as a "sort of oligopoly."[11] Equally, we received much evidence about low levels of consumer satisfaction, poor treatment of consumers and what Lord Turner has described as "a series of waves of major customer detriment".[12]

18. For competition to be effective, customers need to know what they are buying and how much it costs. They also need to be able to transfer their custom from one provider to another. Our inquiry has led us to conclude that these pre-conditions for effective competition in the retail banking market are not present.

19. First, we are concerned at the continuing lack of price transparency and comparability in the personal current account market. Without such clear information it is impossible for consumers to distinguish between the offers made by rival providers and indeed lack of transparency reduces the incentives for those providers to make distinctive offerings. Second, we are concerned that the switching process—despite improvements—remains cumbersome and does not always work smoothly. We believe that effective competition will remain a chimera unless urgent steps are taken to improve price transparency and comparability and the switching process. In this report we set out the evidence which has led us to this conclusion.

1 Back

2   Q 1073; HM Treasury Press Notice, Sir John Vickers to chair the Independent Commission on Banking, 16 June 2010 Back

3   Treasury Committee Press Notice, New Inquiry announced into competition and choice in the banking sector, 13 July 2010 Back

4   Relevant Interests of the specialist advisers are as follows:

Dr Pinar Bagci: Economic consultant advising companies on competition and regulatory matters. Clients have included regulators, competition authorities, companies, securities exchanges and investment and retail banks. I am currently not advising any banks on any matter but am working with Visa on the matter of interchange fees

Mark Falcon: Head of Economic Regulation, Hutchison 3G UK Ltd ('Three'), a mobile telecoms operator Back

5   Ninth Report of Session 2009-10, HC 261-I Back

6   ICB, Issues Paper: Call for Evidence, para, 3.8, p 21 Back

7   Competition in UK Banking: A Report to the Chancellor of the Exchequer, by Don Cruickshank, p viii, para 10, March 2000 Back

8   Ev 241-243 Back

9   Q 1069 Back

10   Ev w37 [note: references to 'Ev wXX' are references to written evidence published in the volume of additional written evidence published on the Committee's website] Back

11   Q 631 Back

12   Lord Turner speech to British Bankers Association Conference, Protecting Consumers and Winning Trust, 13 July 2010 Back

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Prepared 2 April 2011